Title

Six ways manufacturers can save on direct spend

Section
Insight
Summary

Mid-sized manufacturers need to overcome behavioural challenges, inefficiency and financial waste if they are to better manage their direct spend and improve their bottom line. But where should you begin?


If yours is a reasonably sized business, chances are it’s already managing indirect spend. But when it comes to directs, few dare to try.

Companies often take the view it’s too difficult, disruptive and potentially damaging to consider changing either the source of supply or the composition of the final product. In the case of manufacturing, it can in fact make them very nervous — sometimes with due justification.

Factory managers, for example, suspect the scale of predicted paper-based savings isn’t credible when the costly and complicated steps required to realise them are factored in.

It’s true that there are numerous challenges to overcome to ensure these savings really hit the bottom line; but the flipside is unlocking plenty of previously untapped savings. 

It’s true that there are numerous challenges to overcome to ensure these savings really hit the bottom line; but the flipside is unlocking plenty of previously untapped savings.

Identifying direct spend challenges

Take a mid-sized manufacturing company that produces heavily engineered or assembled-to-order products and parts. Over the years it has grown by acquisition, leading to process inefficiencies and financial waste.

Private equity shareholders demand every savings opportunity be explored, and with direct materials comprising up to 60% of procurement spend, it’s worth the effort.

We look at the six main sticking points that procurement has to overcome, if it is to create value from direct spend.

1. Supply chain behaviour

The chief challenge is trying to change behaviour and thinking. No mean feat. To have even a shot at this, you first need to demonstrate to stakeholders that you understand and appreciate the complexity of sourcing direct materials in manufacturing environments.

Spend on directs in these businesses tends to be driven by a strong engineering or design function, so any interference will likely get push-back from day one.

Plant managers generally have the power to run their own P&Ls, which means direct materials are often purchased at plant level and frequently on an ad hoc basis. Usually, engineers decide what they think customers need; they approach sales; sales sell it; a bill of materials is put together; and buyers/planners are asked to get them.

There’s little thought into the purchasing and almost always no negotiation on quotes.

Plant managers are motivated by on-time delivery, margins and keeping the operation running, rather than seeking the best deal or considering total cost of ownership.

For high margin, after-market products, they see little benefit in a 10% cost reduction — particularly when making just one small change could alter the tolerance of a part that could affect how a customer sees its function.

On top of that, getting a new part qualified could mean months of delays and complications with suppliers, particularly if business will be shifted away from an incumbent vendor. 

2. Inefficient procurement systems and processes

Growth by acquisition often leads to numerous sites doing their own buying instead of leveraging purchasing power. And lazy buying – often under the guise of being ‘lean’ – leads to localized supply bases and tactical, uncoordinated purchasing.

Procurement is an after-thought, instead of a source of ideas, support and innovation. Changing this view is about educating stakeholders and improving the capability of buyers.

At a minimum, tactical people require upskilling. Try to centralize some major categories across the business, for example, the top five complicated categories, and use a lead buyer concept for other strategic items.

Companies should also consider having more than one source of supply for vital items to reduce risk.

Another complication is that lengthy, pre-existing supplier relationships mean plant managers may be getting much more value from the vendor than is revealed by out-of-date drawings or specifications. The customer may own the IP but if a supplier has been making that part for two decades, there are doubtless undocumented tweaks and improvements that have been made.

But how much of a premium are you paying for this tribal knowledge? It’s another issue that can lead to the credibility of anticipated savings being challenged. The starting point to counter this is an apples and apples comparison.

3. Lack of spend analytics

Information is key to bringing about any sort of change but very little spend analytics seems to occur.

Sometimes 300 purchase orders (POs) could be issued for the same part in one year, but instead of spotting the trend and bulk ordering for a better price, businesses are suffering from repeat orders of tiny volumes. This behaviour is usually driven by production planning being organized around customer projects.

Examine ordering patterns, POs and category spend data to identify improvements to be made.

4. Lack of long-term planning 

Lateral thinking is also required. Instead of high-cost sourcing from the UK or US, try to overcome the perception of poor quality, low-cost sources such as China.

People raise objections over lead times, but planning ahead will ensure there is no issue with the additional time to deliver products from further afield. What’s more, if you’re making a 60-70% saving you can afford to buy twice as much and have it shipped and stored.

In addition to the prevalent mistake of unnecessary ‘gold-plating’, setting up machinery for a short run can be a massive waste of time and money. Making larger orders for repeatable items and storing the remainder often makes more financial sense. 

The problem is, most factories are run by projects that lack the oversight to detect the production of common components. If they could be decoupled, the identical elements could all be done at the same time.

Another typical problem is that the multiple SKU numbers generated by a slight change to a common part skews valuable purchasing data, making it harder to identify opportunities for economies of scale.

For example, if you knew you ordered thousands of base plates and then made alterations-to-order afterwards, you could buy in bigger quantities and make a saving. 

A shift in thinking is required to examine activities across a whole year.

If you’re making a 60-70% saving you can afford to buy twice as much and have it shipped and stored.

5. Recognizing the value of procurement

Sponsorship is essential, otherwise it’s near impossible to get plant managers to heed and help with what you’re trying to achieve. You need a COO who controls operations and empowers purchasing people to work on joint projects with colleagues from engineering and quality assurance.

Objectives need to be clear from the outset, and procurement must make it apparent that it’s not just about saving money but making people’s lives easier — boosting choice and removing workload. In reality, you’ll be limited on the number of parts you can switch because of time and risk restraints.

Based on our experience, roughly 70% of the category savings are typically driven by the small proportion of parts (less than 20% of SKUs in a large program tender), which you move away from existing incumbents.

These parts are mostly reallocated in the supply base to better align with suppliers’ capability sweet spots, though some may move overseas where the coefficient of variance is low and there’s sufficient volume.

The other 30% comes from leveraging your existing incumbents.

Once your stakeholders see the value you have delivered, not only in reducing costs but augmenting your supply base capability, they will likely stop pushing back on change and become your sponsors.

6. Setting achievable goals

Despite a multitude of opportunities for improvement, keep in mind that you don’t actually want to change too much. If you alter everything, the company will fail — you’ll have issues in transition and there’s a risk that amends won’t go on to pass even the first article test.

In addition, many suppliers are set up to support customers. So if volumes drop, you won’t warrant the same level of service and attention.

Exploring any change requires a well-thought-through business case. Information is power, and procurement should be in an excellent position to identify duplication of effort and wasted expense. Use that to persuade, cajole, inform and inspire the business to make much-needed change.
 

If you'd like help in overcoming the challenges of direct spend management, please contact Waldo Saville using the links below. 


[Arthur Mattousch, principal at Efficio, also contributed to the development of this article]