4 Reasons Why Your Cost is More Than Just Price
June 18, 2018
When it comes to managing supply chains, the focus is often on price. However, price is not the same as cost. In fact, the hidden costs of a product are where much of the non-value add in your metal fabrication purchases often hides. With that in mind, here are four reasons why your cost is more than just price.
Food for Thought
Imagine your company has a net profit of 5%. If you can reduce supply chain-related costs from 7% to 4.5%, then you have helped increase profits by 50%. This gives you the ability to increase profits without an increase in revenue or associated costs – i.e. sales and marketing.
However, cutting supply chain costs cannot be done in shotgun style. Instead, one must be surgical in their approach, ascertaining the drivers behind certain expenses and then prioritizing the impact. Only in this way can reductions in supply chain costs have the greatest value.
Reason 1: System Cost
The goal of performing a supply chain spend analysis is to identify the total cost of service. This includes looking at the costs behind activities, such as opening a purchase order and paying suppliers, shipping, warehousing, and even supply chain management. That’s right, those two-week junkets to Asia to visit your fabrication partners can add up and should be included in your cost accounting system.
Another hidden cost is inventory. It doesn’t matter if your supplier is next door or halfway around the world. If their production times or payment terms require your company to take possession of goods before they are needed, then you are basically tying up cash that could be better used elsewhere.
This is not to say that you can achieve daily inventory turns – we live in the real world, not business school. But inventory is often used to hide waste, and this can lead to other problems.
Reason 2: Transaction Costs
Not to get too technical, but just about every transaction involves a certain amount of friction and overcoming this friction can be expensive. The sources of friction can include activities such as placing an order, managing invoices, organizing delivery schedules, unpacking and storing, and even managing returns.
While many leaders will file these activities under the often used “cost of doing business,” the reality is that you are not helpless in bringing these costs down. It starts with tracing the processes behind these costs. This includes workarounds due to inefficiencies in your ERP system, or issues in how purchase orders are transmitted and confirmed by suppliers.
Either way, transaction costs can add up to nearly 30% of the total cost of supply chain management – just think about the costs associated with receiving orders and processing payment. As such, a reduction in this area can have almost the same impact as getting a price reduction from a supplier.
Reason 3: Storage Costs
It’s not like real estate is cheap, but for some reason few companies account for the cost of storage. Now, if your company is in a project-based industry like oil and gas, then you probably don’t need to worry about keeping entire rigs in storage. Instead, these installations are built by your fabrication partners and then assembled on site – though you’ll still need to keep a small amount of spare parts.
However, a farm equipment OEM doesn’t have the same luxury. They will need storage space to keep finished products and spare parts at all times. This not only means a centralized distribution center but maybe regional supply depots or parts on consignment throughout a sales network.
As mentioned, you probably won’t get to zero inventory, but taking a closer look at what you are paying for warehousing might spur some questions about how to optimize space.
Reason 4: Service Levels
The reality is that everyone’s boss is the customer. They are the ones who create demand for what we do, and by extension, help to pay our salaries. However, there is a trade-off when it comes to keeping customers happy.
In the case of managing a supply chain, this means not only having enough of the right inventory on hand, it also means ensuring replenishment times – including shipping – are within limits, while maintaining product quality.
While this comes at a cost, small changes can have a big impact. For example, working with fabrication partners to establish a supplier-managed inventory program can not only reduce the price of a product, it can also shorten the time from order to delivery.
Another option to reduce production time is to look at how a product is designed. In fact, most strategic partners offer this as a service to their customers with the benefit of shorter production times and better quality.
Lastly, managing service levels also depends on qualifying the expectations of your customers. If your industry measures replenishment cycles in minutes rather than days, then you might want to consider ways to bring production closer to your customers. This could either be through costly investments in in-house production facilities or by finding a partner closer to your customer’s location.
“The supply chain stuff is really tricky.” – Elon Musk, CEO of Tesla and SpaceX
As you can see, product price isn’t the only factor when it comes to measuring the effectiveness of an organization’s supply chain management. Instead, the focus should be on cost, and this means taking a closer at the underlying drivers.
This brings up a question – what can you do?
For starters, you will want to map your supply chain from beginning to end, making sure to identify those processes which drive cost. While this doesn’t mean performing value stream maps of your supplier’s processes, you will want to dissect your processes. Doing so is the first step to correctly calculate System Cost.
From there, you will want to look at each transaction and figure out if there is a better way. This will help you to greatly reduce Transaction Costs, which can add up to a significant portion of the overall cost of the products your company sells.
While you are at it, take a closer look at Storage Costs, as it is highly likely that you’re spending too much on warehousing. Lastly, look for ways to improve customer satisfaction while keeping Service Costs in check. Following this approach will turn your supply chain from a cost center to a profit center, making you a hero within your organization.