I was speaking with my Purchasing Manager last week; Patrick is a very capable and effective purchasing professional who has become addicted to Lytica’s fast track cost reduction methods. We discussed surprising things that we have seen in procurement which we label as “crimes” because they rob shareholders of value. In no particular order, I’d like to share some of the classic ones with you:
Crime #1 – Purchasing parts at the same price point as the last PO: It might seem like a buyer has done well by maintaining historical prices but what if the market is significantly lower? You must ask two questions:
- Does the buyer know the current market for the parts in question?
- Are there other manufacturers who make the same part at a better price?
We have seen situations where pricing was set during a time of allocation and these high prices survived multiple repurchases even when the shortage had passed. Millions of dollars were lost when the company thought it had good performance. This would never happen at your company, right? Maybe it could.
Crime #2a – Negotiating without knowledge of full volume potential: We have seen companies and small electronics manufacturing services (EMS) providers placing orders for components with pricing based solely on the volume of a single purchase order. If there are monthly POs, the price could be based on only one-twelfth of the volume and, worse, the manufacturer wouldn’t know the total annual amount of business on components. The supplier’s opportunity is hundreds of times larger but their pricing doesn’t reflect it which is unfair to both the supplier and the company.
Crime #2b – Buying into the “volume dictates” price theory: Related to Crime #2a is the belief that individual component volumes dictate price – they don’t, except at low new product introduction (NPI) volume levels. All quotations will show a volume vs. price relationship and if you accept quotations without negotiation you allow this relationship to exist when it shouldn’t. Your total potential level of business with a supplier should determine your pricing, not individual lines on a page.
Crime #3: Not keeping up with technology and tools
Equation #1 = SUMPRODUCT(($BJ$18:$BJ$276)*($AO$18:$AO$276)*($H$18:$H$276=$AK4)*($AJ$18:$AJ$276=$BH$2)*($AO$18:$AO$276>0.0001))
Equation #2 =GETPIVOTDATA("MfgPartGroupKey",$I$3,"NumOfMPNInGroup",I4)/GETPIVOTDATA("MfgPartGroupKey",$I$3)
Equation #3 =D11/VLOOKUP(E11,N:P,3,FALSE)
If any of these Excel equations are a complete mystery to you, you need an Excel course.
Your data is in bad shape if you cannot, within a few hours, compile a list of what you are buying, the quantity and price, the description and commodity designation along with who the manufacturers are and list of qualified alternatives. Bad data or the inability to analyse it puts you at a performance disadvantage and costs your employer vast sums of money. You are being paid more than you deserve as it takes you longer than it should to do your job. You need to make sure that you are able to perform at competitive global levels. This requires that you can access data and analyse it. You must keep up to date.
Crime #4 – Not keeping up with knowledge: There is a progression from data to information to knowledge. For example, a data point might be “I am paying $0.50 for this part”, and information from an online source might be that the average distribution price for my part is $0.55, with a range from $0.52 to $0.60. Other information may be that there is a red bird sitting at my window.
Both of these pieces of information are useless unless you happen to be paying more than the web published distribution prices. Information combines data in ways that are relevant – and sometimes not. Knowledge is information that lets you take action and is extremely powerful when combined with experience. An example of knowledge is that you should be paying $0.45 for this component.
I call the mathematical product of knowledge and experience wisdom. Giving knowledge to the inexperienced gets you nowhere, as does holding back knowledge from the experienced. Knowledge in the hands of the experienced is highly effective in getting favorable results; it is a crime not to access available knowledge.
The illustration to the right below is an effectiveness plot of knowledge and experience. Using vector algebra, one can see that a lot of knowledge in the hands of the inexperienced (a) is as ineffective as a lack of knowledge in the hands of the experienced (b). The ideal situation (c) is high knowledge and high experience resulting in highly effective performance.
In manufacturing, especially with lean initiatives, benchmarking and data driven decision-making have made companies highly effective. Procurement needs to do the same. Knowledge lets you focus your efforts on opportunities as opposed to being diluted by trying to do everything.
Crime #5 – Price Management with franchised distribution only: The amount of faith put in franchised distributors is sometimes unsettling! Here, the Russian proverb ‘trust, but verify’ (made famous by President Regan) must be taken seriously. We have seen clients paying distribution prices which are higher than published website pricing and, in some cases, many times the direct price available to the client. Benchmark your pricing to know what fair market is for you.
Distribution is a difficult and complex business. These global companies have seen their margins erode year after year and are trying to redefine their business model to aid their profitability. They are trying to find higher margin products and services to maximize gross profit as their commodity component business continues under extreme pressure. Since we are talking here about components, you need to make sure that you remain competitive as distributors adjust to new competitors and increasing manufacturers’ control.
Are you using distribution but your company is large enough to buy direct? If you are a large user/buyer of electronic components, you should be able to elevate your requirements to the manufacturer directly. In addition, small to mid-sized companies that use an EMS provider should be able to capitalize on their buying power. In any case, know what a direct price would be and manage to give the distributor a fair margin and you a good price.
Crime #6 – Purchasing from independent distributors or brokers: Sometimes independent distributors and brokers provide good value but supply chains using these sources carry a higher level of risk than franchised or traceable ones. Risk eventually translates into cost as failures occur. If you do use these sources, make sure you can answer these questions through due diligence actions:
- Do the parts come with an original certificate of compliance or test data to support the manufacturer’s specification?
- Has this ‘provider’ been in business for a long time and will they provide references?
- Are they a member of a respected association (e.g. ERAI or ECIA)?
- Is there a Statement of Work outlining all expectations and an agreed problem recourse defined prior to any POs?
Crime #7 – Being reactive instead of proactive: In operations, there is always pressure to get things done yesterday. Achieving competitive pricing requires preparation and forethought and, if you are not prepared, time pressure will have you working reactively. In this mode you do not have the option to take advantage of opportunities which would be available had you been proactive. Things you should consider doing:
- Change the way you source your components. Collapse your approved vendors’ list (AVL) to a few excellent suppliers working in your best interest. Create and maintain an AVL database.
- Maintain performance metrics on these suppliers for delivery, quality and price. Bias your business towards high performers.
- Adopt lean principals and make data driven decisions. Keep your knowledge current.
- Manage your component risk. Obtain lifecycle data and keep this risk visible to management. This should help you take action so that you are not surprised during production.
- Use ABC item classification to help you allocate effort.
None of the above crimes will put you in jail; although many should. The penalty will come from reduced company competitiveness and productivity. This, of course, only puts jobs in jeopardy and threatens our quality of life.
Ken Bradley is the CEO and founder of Lytica Inc., a Canada-based provider of supply chain and pricing intelligence to the electronics manufacturing industry.