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Whether you source your materials locally, domestically, near shore, off shore or a combination of these, you want to obtain the lowest “Total Cost” on every purchase. Here are six key factors, beyond price, that you should consider when developing your sourcing strategy and evaluating your costs. By developing a “Total Cost” strategy, you can ensure that you are fully measuring and evaluating all costs and give yourself the best overall outcomes with no hidden costs.
1. Transportation & Logistics
Transportation & Logistics takes into consideration all of the costs associated with getting a product from your supplier to your plant. For domestic suppliers, this may include trucking, UPS, or FedEx. For off shore sourcing, the costs go up substantially and may include items such as inland transportation, taxes & duties, ocean freight, port fees, broker’s fees, and transportation to your plant. From my experience, freight & logistics costs can average 10-12% of the price of products shipped from Asia to the US Midwest. Costs will vary widely depending on the country, distance, size, weight, and value of the product so it is best to capture your actual costs and add them to your “Total Cost” calculation.
Ideally you should try to build the cost of transportation into your price. This reduces cost volatility and minimizes the overhead of managing the process. Negotiate contracts with your suppliers where they are responsible to stock and deliver material locally in return for locking in your business.
2. Lead Time
What do long leadtimes cost your company in lost sales and excess inventory? According to the Department of Commerce AceTool, transportation from most emerging market regions to your plant can take anywhere from 30 days to over 70 days. In order not to lose sales due to inadequate availability, a company would need to hold an additional 60 to 90 days of stock to cover this gap. If you have $10M in inventory, that could be between $1.6M and $2.5M in additional inventory.
A “Total Cost” sourcing strategy should strive to minimize the leadtime needed for your supplier to deliver material. Look for suppliers who have production systems in place to manufacture product quickly or who offer programs such as Vendor Managed Inventory & Industrial Vending. Alternatively, negotiate contracts with your suppliers where they are responsible to stock and deliver material locally in return for locking in your business.
What is the cost to your company of poor quality? Poor quality can lead to unhappy customers and increased costs including additional inspection, line rejects, and customer repairs & returns. There are also hidden costs such as the time engineers spend reviewing discrepant material and creating work arounds.
Your “Total Cost” strategy should include evaluating a supplier’s quality history, their processes and systems to make sure that they have the capabilities to produce high quality product and be trouble free. Putting in place Certified Supplier Programs will ensure that this happens and in the long run will reduce your costs.
4. New Product Development
There is a saying that 90% of the cost of a product is designed in. Can you afford not to have good supplier input during the product design cycle? Tailoring your designs to use the most cost effective parts, suppliers, and manufacturing processes will significantly reduce your “Total Cost” over the long haul.
If you’re not already doing it, your strategy should include making your supply chain team, manufacturing, and outside suppliers an integral part of any new product development project. And nothing can replace face to face discussions between your design engineers, your suppliers and your manufacturing team.
In addition to the cost of creating and maintaining purchase orders, there are numerous other overhead costs that should be considered where evaluating the “Total Cost” of an item. While some think that the supply chain team is the only overhead associated with sourcing material, in reality virtually everyone in your company plays a role including accounting, quality, manufacturing, and engineering. By mapping your business processes, you can see how each function interacts with the supply chain and provide opportunities for lowering your costs.
Finally any “Total Cost” sourcing strategy should consider the risks associated with each supplier. I can tell you from personal experience that the disruption caused by a supplier bankruptcy is enormous. Other risks to consider are IP protection, transportation delays such as port congestion or strikes, and delays due to weather or natural disaster as evidenced by recent problems in Japan with the Tsunami and the flooding in Thailand. While it is difficult to put a dollar figure on these risks until they become a problem, any strategy needs to make sure that these risks are looked at and factored into your sourcing decisions.
As you can see price alone does not tell the complete story of what a product is costing you. A good “Total Cost” sourcing strategy will build in all of these factors and in the long run lower your costs & increase customer satisfaction. Your “Total Cost” sourcing strategy should look for suppliers who are low cost in every way. You should ask: Will they provide fast leadtimes, reliable, local delivery, and excellent quality? Will they participate in design efforts? Are they easy for accounting to do business with? Will they commit to long term, flexible contracts with stable pricing? Your strategy will help you decide.