Cost Reduction Technique with ERRANT concept

Cost Saving or cost reduction management is part of the regular cycle in managing supply chain activities.  When I was the managing manager in dealing with cost reduction activities, there are few challenges faced by us.

Example as following:-

1.       Unable to proceed due to lack of technical knowledge
2.       Do not understand the processes
3.       Held up by rigid technical specification
4.       Fear of making error of judgment when switching to cheaper option
5.       Comfort zone of team members or stakeholders in the company, resulting in objection to       reduce cost unnecessarily

The key to cost reduction is always be open to ideas, review option, or solution to the problem, be objective instead of subjective to the issue on hand and most importantly, get away from the comfort zone.

People are reluctant to move away from the comfort zone due to the fear of any changes made will reflect badly on them or the refusal to be challenging that certain option to reduce cost is possible.

For example, when I was a Production Manager in a chemical plant operation, one of the biggest issues is the cost of operation.

•      High number of head count
•         Low output compare to other factories in the region
•        High wastage's

I was a newly appointed to the post of production manager and the first action we did was to review and what can be done.

We could not eliminate any of the processes or reduce the head count. Therefore, obviously, we cannot replace anyone.

However, I realize that we can reduce the cycle time to produce the product drastically with close monitoring and target setting. In addition, we proceed to introduce key performance indexes to be measure against achievement and we work slowly to reduce the cycle time of production with training, equipment upgrade, and aligning the product produced to the equipment we need to upgrade.

True enough, our productivity went up and cost reduces.  But we also reward extrinsically and intrinsically the employees who made these happen. 

The above example happened more than 25 years ago and I attempt to repeat it again with another company where, this time, I was the Procurement Manager of the company.

I use the same structure of cost reduction for material purchases and other related area and this time, over a period of 5 years of activities, we saved almost Ringgit Malaysia 6.0 million.

It goes back to the same structure of elimination process, reduction, replacement, aligning the process, work slowly for those issues, which need time to progress and target setting.

It works well!

In this article, I reproduce the cycle, which I used in the process of cost reduction as following:-

•       Eliminate – review which processes or material, which can be targeted for eliminate from the operation.  Most of us will find this is not possible, but we are looking at some task or process, which can be made redundant or combined with other process.  Example, during the process of purchasing material, we realize that we need to purchase two separate components from a particular supplier, in which we will assemble it on our production floor. What can be consider is that, what is the possibility of the supplier produce and assemble it before delivery? What will be the cost of the supplier compare to your own cost?
•       Replace – if we cannot eliminate a expensive material required for the product, can we replace it with a substitute? For example, can a material with a certain plastics be replace with a cheaper plastics but still able to maintain the same quality standard for the product to function? I manage to repeat this replace methodology numerous occasions without any reduction in quality.
•       Reduce – if the elimination and replace is not possible, then let look at the process parameter.  Where is the possibility of reducing the usages or wastages?  Alternatively, if this is a formula issue, can the material use be reduce and replace with another material also used in the formulation?
•       Align – what is the possibility to align the cost of the material or processes? It will be surprising to notice that, there are incident where the cost of an identical or almost identical part has cost variances. It can also not be the same part, but sometimes suppliers tend to play around with pricing. There could be two different parts or component with difference design but similar processes or cost, but due to pricing techniques, offer a vastly different cost to you.  As a procurement person or involve in technical evaluation of material or processes, the need to understand every single operation involve is important. Cost analysis data need to be utilized and costing technique such as Should Costing can be implemented.
•       Nibble – can you reduce the cost gradually if the above steps becoming impossible? There are suppliers who held firm to their pricing or processes, which are difficult to control. Kaizen concept (meaning continuous improvement) technique will be an asset to achieve continuous cost improvement.
•        Target – set a realistic target for the cost reduction or elimination project and each cost reduction initiative should have a measurement system in place to check the progress.

And we need to always remember this sad news, cost reduction management is never finish. It just like removing garbage from the stream, it never ending. People throw money away without realizing the impact until much later if there is no real cost management in a business organization.

Sacrificing H & S over increase output to deliver on time

In a very competitive business environment, many companies are hard pressed to ensure all customers order are delivered on time.

Price is not the only consideration when customers places new orders.  In many cases, well organized customers will award the order to the suppliers based on the price, available capacity and quality of the produce.

Audit will be made to cover production processes, capacity issue and manpower concern.

Nevertheless, businesses do grow from time to time and if a business entity were able to expand their share in the market by having new customers, those audit report will be rendered invalid.

How does companies deal with the increase of orders, thus, stretching the production capacity to above 100% of the rated capacity of the plant?

There are few option available:-

a) increase manpower to run the production process
b) overtime works are made frequently, including on holiday and weekend
c) expansion of production assets (machines and materials)
d) delaying deliveries to customers (last resort)
e) outsourcing works


Some companies will not be able to add new assets due to lack of space and capital constraints. On top of that, profit objectives override many of the considerations. Delaying deliveries will normally a last resort, to avoid negative records with customers.

Many will go for the easiest option, i.e. workers are asked to work longer hours.


When business profit override all other considerations, when workers are ask to increase output via overtime works, who is monitoring the welfare of the employees?

During the course of my audit and inspection of suppliers site, I have came across workers who hardly have a day rest in one month! Some of these workers are working almost 18 hours per day, 7 days per week.

I cannot stop to wonder, how these workers manage to stay alert on a daily basis.

On the workers part, monetary benefit of higher take home wages override their own well being, If you are a worker from a 3rd world country and your salary is less then USD250.00 per month, working long hours to gain more money to take home is the primary consideration.

 During one of my visits to a China factory a few years ago (understood that, workers safety has improved over there since then), workers are paid on piece rates and there is no control on how many hours a workers can work per day! The bottom consideration was actually, how much these workers want to take back per month in wages!! The factory bosses of course is happy to oblige these workers needs cause there is a hunger for cheap product out from the factory.

The question we have to ask ourselves is at what risk we are taking? What were the probability of  one worker got into an accident due to exhaustion, putting his or her life in jeopardy? Worst, the tired worker may also put their colleagues life into danger.

A tired forklift driver may drive the truck over the shipping dock with a load of material, for example. The end result, he may be killed or seriously injured.

There was an actual incident in a chemical company belonging to a large conglomerate, where a tired workers failed to observe a key process during overtime work and the mixture in the tank flare up and cause an exothermic reaction. The fire department has to be summoned to the plant to prevent a serious incident, including fire.

Normally, companies which chases monetary gains over safety and health issue resort to such practices of uncontrolled overtime works. This is not the only reason,

Other reasons could be as following:-

a) Swallow management skill in solving problem related to capacity matter
b) Lack of health and safety awareness
c) Unable to communicate effectively with customers to plan ahead orders
d) Inferior thought of losing a contract, thus pushing facility to work over the capacity
e) Lack of long term planning to forecast future business expansion
f) Placing corporate and social responsibility at the bottom of the list of priority

To solve this matter and avoid disruption to supply chain, many large organizations are now putting more effort to carry out annual surveillance audits on corporate and social responsibility of suppliers. These audit may not be fool proof as many of the audit are carry out within a day and records could be tampered with, but this is a real start.

These audit will cover, for examples, rest days to employees, controlled overtime work and other workers benefit as required under the legislation.

The key objective of carrying out such a audit is not only to enforce compliance, but also raise awareness to the suppliers and also to the employees.

There are key responsibility from both buyer and seller (customers and suppliers) to ensure profit are made with sacrifices to health and safety issue.

Dealing with Difficult Suppliers

If you are a procurement professional or indirectly dealing with third party entity, it is always your own expectation that your request for certain condition to be met is a forgone conclusion. Suppliers are expected to fulfill all your requirement, provided you are demanding these within the scope of the supplies requirement.

You may request the suppliers to change their packaging method to meet your own internal needs. Other examples from a procurement person is for changing of delivery schedule, requesting answers for non conform material supplies or even to a very simple demand for the suppliers to place additional label to the package so that your warehouse team can identify the package easily during receiving.

However, once in a while, some suppliers will play "hardball" with you and refuse to compliance to your needs.

How can you handle such issues in a manner which will not harm future relation or ensure they bend down to your wishes?

The key to tackling difficult suppliers is to have a effective strategy right from the sourcing stage. This mean, even before the supplier has been conceived into your organization, the cast has been set. This is where, the rules of the games are made known to all potential suppliers, so that they are aware of the need to toes the specific condition if they desire to be in business.

Suppliers can sometimes be difficult to handle if;

a)  A company are putting too much egg into one basket (almost sole supplier)
b) You have only one supplier that you work closely with
c)  You hardly made any demand for improvement from them
d)  Price increase are easily accepted without much negotiation
e) Your buying power is weak and you over reliance on suppliers to act as a "bank" to your operation
f)  Information on parts supplies are not clear and later, you demanded on supplier to improve

To avoid the above, the sourcing and procurement strategy must be aligned in order that no a single supplier in your book are becoming too powerful to the extent that, you needed them more then they needed you when comparing on the surface.

When creating a professional supplier - customer relationship, the biggest mistake an organization can made is by relying solely on the supply chain or procurement team leader or manager to hold the stick. This can be initially effective but in the long run, familiarity breed contempt as the relationship becoming too comfortable for the suppliers.

It is always a good strategy to ensure, even though the procurement team hold the key to most decision, communication and demands are made through other channel.

Example, the quality department may issue a demand for improvement directly to the supplier and procurement team members stay out from such demand, at least in the eye of the supplier.

The end game, however how big or small a supplier is, the needs to be in business to be relevant is more important and the pressure from multiple front will work wonder for any organization.

Having conclude it, however, like any strategy, alignment and synchronization of the strategy is very important too, as without any planning and synchronization, a difficult supplier can bounced back and you may have to face the full impact of it as well.

MANAGING CHANGE - why it is so difficult sometimes when it can be easy

Just last week, we organized a short 90 minutes briefing seminar for all our suppliers.

The reason for this session is to do a thoroughly briefing to them about the implementation of  bar code system in our supply chain operation. It is a straight forward request to all supplier to print a bar code label on all packaging ordered by our procurement department.

Before going to the result of the meeting proper, let me go back to the beginning of this project

Background

18 months earlier, our CEO commented that the supply chain process need to be streamline to reflect overall group practices. Our Europe facility and North Africa facility already started with the program, whereby, all movement of material internally and externally are monitored through barcoding system.

All receiving , delivery and internal movement are scanned to be updated into the ERP system immediately.

This simple project should not have any resistance in the first place either internally or with suppliers as bar coding system has been in existent since Bernard Silver created the first bar code program in 1949 and patented in 1952.

Internal Resistant

However, the first sign of objection came as the IT and Procurement team felt that, even though this system is good for implementation, there were various issue on hand.

The reason given were as following:-

a) No supporting structure in place in term of software support and logistical issue
b) Lack of trained personnel on the operation level to handle the system
c) Information were scattered and many missing link on how to go about it
d) Suppliers readiness to implement has not been investigated
e) Current ERP system is not geared to support a efficient bar coding system
f) Warehousing team gave negative comment on the project as they preferred the current manual system of receiving material and later updated into the system once total receiving completed

 Managing the Change

 The end result was, I was left with little option but to brain storming it, initially with myself and later with my IT Manager who is personally convinced this is a way to go forward, i.e. both of us felt this change is necessary.

We conclude the following issue which made the change process difficult;

a) Request for information from the senior management not deliver promptly and accurately.


To effect change, the support must come right from the top to ensure all information required are provided. When this does not happen or if there is a delay in conveying, this will disrupt the process of change.


b) Failure to communicate accurately

The next issue we realize was that, when information finally flow down to the team who need to powered the change effect, the information was scattered and inaccurately given. This lead the local manager involve been given wrong instruction or data to proceed and when this result in failure, the change cycle was braked to a halt.

c) Failure to Convince it will work &  not getting really involve

Apparently, when the European sector and North Africa sector implemented the system, they were facing a number of technical issue. To solve this issue, upgrade work was needed or a new ERP system were needed to ensure these will work in the long run.

By not been convincing by itself on the system, change will not work. When a leader ask for change, the leader himself must experienced the change effect. They have to believe into the change itself and get involve.

d) Did not research into Impact of Change

For change to be effective, the ability to evaluate current status quo of operation and personnel behavior and the change in operation and personnel behavior needed to ensure the change will be met with no or little resistant.

e) Lack of  Correct Information and Training

When we have all the negative response from (a) to (d) , then this directly translated to a mismanagement situation.

When the action from (a) to (e) was reversed, with change in behavior from the top the internal resistant to manage the project disappear gradually. The IT department with the correct information managed to nailed down the right process.


With the new development giving the positive feeling to the team, the procurement department begin to inform all the supplier and in clear step by step information how to implement the bar coding system.

The result from this 1st phase of informing, resulted in suppliers with a good integrated management system, almost immediately managed to fulfill our request. These suppliers are earlier, do not understand how we want to proceed with the system and their inquiries to us was not able to be addressed correctly or effectively.

Those which does not have a system in place to print bar code label internally, are requested to source for a suitable system to allow such application in place.

However, to made the change effect more pronouncing, we decided that we should call all suppliers for a briefing session. Made no mistake about why we decided on this major briefing. There is no reason to fear, suppliers will not co operate with us on this matter. The key reason why we have a briefing were;

 a) For change to be effective internally or externally, communication is the key to deliver the objective of those change.
b) Even though most supplier will understand why this is required, a message still needed to be sent out to these stakeholder.
c) Need to outline clearly the procedure, even though communication has been made via emails, the session allow suppliers to interact with us and get good rapport to ensure the change is manage smoothly.

This session resulted in better understanding and overall, all of them understood why this is required.

Understand Why Supplier Increase Cost

Imagine, one day, you receive an email from a major supplier, with the most important sentence in the email which wrote...... "We have no choice but to increase the selling unit price to you at the end of the year."

When there is a price rise request, procurement responsibility is to investigate those increase and if it is within the margin acceptable compare to the actual cost of material rise. By the standard rule, the portion of the increase should the actual / formulated raw material required per part of produce produce. Nothing else should be inside those price rise, unless there is a  demand for overhead cost absorption as well.

But if there is a unilateral price increase request from supplier, the role of procurement is to investigate this and look for alternative way of resolving this conflict.

Questions which need to be asked as a procurement person;

a) Is there anything we can do to halt this demand for price rise?
b) If yes, what the action plan required?
c) If no, what is the reason for these request?
d) Is there a concern that supplier is putting pressure onto the company due to position of strength?
e) What is wrong with the procurement strategy when this happen?

Understand Reason for Price Increase

In a business environment, the pattern of supply and demand play an important role toward determining the cost of acquisition. The greater the demand compare to supply, material available will be scare and need to be share among all users. This will definitely drive up prices, as in any free flowing economy system.

There is also time, when a supplier can decide to choose which customer they preferred to deal with. This could be due to payment term, quantity and quality of supply, or a private offer from a major customer to secure greater capacity of the supplier output.

And there is times as well, due to a particular customer issues which can drive up the cost of production and shipment.

Very often, the cost of commodity or material involve in the product increase drastically which causes price to be adjusted by suppliers to their customers.

Limiting the Impact

Remember, when the position of the supplier is stronger then the customer based on SWOT analysis, it is always good to ensure as a buyer relying on those supplies, to strengthen the position when compare to the supplier position.

Porter 5 forces principal is always an important guiding light for all businesses to understand the true strength of the competition.

a) What is the buying power of customer?
b) Is there any substitutes material able to be utilize to offset the price increase?
c) Is the entry barrier to the industry easy or difficult?
d)  What is the bargaining power of the suppliers?


The ability of the procurement department to halt or reduced the impact of price increase always fall back to past action and commitment to correct any weaknesses with current action (suppliers has to be convinced). Future action will be a forward looking plan to ensure the position of the buying company is strengthened.


Putting the egg into one basket, of course, as matter of fact, a very risky move and weakened a buyer position. The alternative option is the best, i.e. ensuring all supplies are not controlled by one entity.

Beautiful statement has been said before. Partnering your best supplier to ensure success of any businesses is one of them. But all partnership or co operation, an expiry date will arrive, more often due to competition issue and directly pushed from external forces.

Company lost it competitiveness very often due to loyalty to one supplier or business partnership and the leader lost forecast on the reality of the competition until it is too late to focus.

At times, price rise can be completely halted by looking at issues beyond the selling price of the part. Focusing on what can be done to eliminate the needs to have a price rise. Can the any improvement be made from the supplier or even from a customer point of view.

Improving forecast and reduce the inventory level at supplier warehouse may bring cost down. Very often, supplier has no choice but has to react to last minute demand from a customer and this increase cost of shipment and production. On the other hand, a inaccurate forecast resulted in supplier stock becoming redundant and they maybe unsaid frustration which lead to future price increase to recover losses.

Long term strategy

A forward looking strategy which  constantly review supply base is one of the way to handle and limit price increase. Review not only weaknesses at supplier factories , but it is equally important to review internal weaknesses.

Anticipate the next move in the market place, even though this are only forecasts to reduce surprises. 

Collaboration - to supply chain efficiency

Often, as a supplier to major customers, the structure of business is such that, these established customer or sourcing division dictate the condition of supply. Example will be large conglomerate like WALMART or KINGFISHER will have a ready tailored requirement of mode of supply.

The policy will indicate;

• packing method
• carton sizes to use
• label requirement
• expected cost of purchase
• quality control
• term of freight





Demand Planning Cycle





Demand Planning Cycle

• lead time requirement

Many times, the sales or marketing division of the supplier side will be overwhelmed by the requirement, as if this is a cast in stone.

Is that so?

Ironically, the expert of the product are with the manufacturer or supplier and not the buyer and as the originator of these product, these supplier should know best how to handle and ship the order.

Cost of moving product from seller to buyer can be collaborated and review jointly before any decision should be made, irrespective of any constraint set out by the buyer guidelines.

Typical example of cost of supply chain which can be optimize are as following:-

1. Packing quantity per box, there are cases where the box are not fully optimize  either by increase the quantity or changing the box size. Large retailers for example always wish to set a standard guide line for display box size on its shelf. However, very often, both parties are blinded by increase in cost due to unable to optimize the packing method. Setting box sizes without looking at other aspect can increase cost of shipping and handling tremendously.
2. Limit on weight, due to the need to optimize cost of delivery and ease of calculating value of purchase per shipping container, supplier are given a set of lower and upper limit to meet, on the weight, otherwise, the goods will not pass quality control. Due to this, supplier sometimes failed to question the reason behind this control, beside for those product which are sold by weight. Supplier role in this area is to educate buyers on this aspect. Lighter products which still able to meet the stringent standard required will meant lower shipping and handling cost, beside able to lower the cost of the product.
3. Innovative proposal, smart seller will always look for opportunity to to offer product or make offering "outside the box". It could be a one-off offering for certain product in which both side will be able to take advantage to increase turnover and profit. Inability to look into this aspect continuously and forming assumption that "it waste of time" or "we have tried before and failed" will result in stagnant relationship. Innovative proposal could also meant the offer to shortened lead time by building stock and communicate effectively to the buyer. Fear of unwanted product due to low sales can be avoided by regular information flow from both side.

The inability of seller to make the correct move and build up effective strategy to build a solid supply chain relationship with their customers, are sometimes always due to been overwhelmed by the buyer requirement. Lesser noted experience on this aspect is also part of the reason as well.

       

Demand Planning - Why we should not ignore this process

Demand Planning is a process of budgeting future business potential and many businesses are implementing this process to forecast what will be future expectation. It will never be 100% accurate, but it at least give an indication how to plan the sales and production operation for the next quarter or 6 month cycle.

Mistakes were made when companies produced a plan that project a forecast of one year but never review it regularly. In a fast moving business environment and very often volatile, a demand planning cycle should not last more then 3 to 6 months.

Product that are highly competitive and fast evolving, should have a shorter cycle, compare to a stable slow evolving product.

The benefit of having a demand planning process is many and below here are the common benefits of the process;

Demand Planning Cycle

1. Eliminate high storage of inventory - by having a forecast, procurement specialist will review total purchased volume and reduce storage for material forecasted to have lower production
2. Production capacity are aligned to the forecast projection
3. Aligning cost of doing business 
4. Improve collaboration with suppliers by communicating future expectation of material supply
5. Improve collaboration with customers by communicating and sharing the plan with them 
6. Improve supply chain value creation - maximize output and performance of each level of process
7. Focus on profitability and cost - having a demand plan enable empowerment of the team in the business to target the desire performance require to improve cost and profitability

 However, the biggest sin in most businesses, is the total disregard  of this process and many are reluctant to implement.

Most excuses given were;

• customer not giving us the forecast - this is a complete mistake and misconception as demand planning is a effort from the S&OP (sales and operation planning) and with gainful input from the market, i.e. customers

•  it will never be accurate - again, this process is never about been 100% accurate and to be close to perfection, this process need to be a short term goal (ideally for 3 months, maximum 6 months) and need regular review

• we are not in control what the customer will order - it show lack of collaboration on regular basis to improve the forecast

• the market is too volatile to have a accurate demand planning - actually in such a scenario, demand planning is more important then ever and need very short term goal and measured in weeks instead of in months.

End result of not doing this is the opposite of the benefit of having a demand planning. Cost will be high and inventory will be high. Production `cost may goes up due to unable to cope with additional order, or workers will be idle, which also translate into higher cost due to lack of productivity.

Negotiation - The Pitfall to Avoid

Many year ago, I was asked by my superior to attend a business meeting in Shanghai together with him, and my scope is to represent our Malaysian operation to deal with a sales contract to be awarded upon successful business negotiation.

The company in Shanghai is our established long term customer of more then 10 years and we have a cordial working relationship all the while.

The first question I asked to my superior, "What is the real issue with this negotiation and what can we do?" The reply was, "We do not really know what they wanted, except we were ask to attend the meeting in relation to the price quotation submitted earlier".

Upon arrival into the meeting room in Shanghai, we were surrounded by a negotiating team of 6 person.

Beside the chairman of the team, he has personnel from sales, quality and finance sitting inside the meeting room, and here, we were, 2 person team, i.e. myself and my superior.

The endgame of this meeting was without doubt, a trashing.

The demand was:-

a) Lower our prices to those they targeted, otherwise the business will go elsewhere
b) You have to make the decision within few hours as they need to wrap up the process within the week itself

What is right and wrong here?

The negative are as following:-

a) We did not take seriously of this meeting, thinking that our opponent for this process is our long term customer and they will have some emotional connection with our company
b) We did not prepare anything at all, thinking that they are formalizing the  latest deal and need our attendance to check on certain issue which may be overcome easily by us
c) We did not ask them seriously for the real agenda of the meeting and trust the content of the invitation which read something like, " to negotiate and finalize the term of supply for the new contract."
d) We did not have any Plan B in our briefcase to overcome any issue
e) We always thought that the pie is fixed for us and nothing will change
f) We betting on our track record of good quality, delivery and historical pricing which should be good for the customer


What we should have:-

a) Asking for the full agenda for the meeting and what is the real concern which we need to prepare for
b) Prepare for Plan B even if this will not be use based on few possibilities outcome from the meeting
c) Must not have assume that the customer will stay with us for the long term without any serious demand
d) Review closely the proposal submitted to ensure no surprises

On our customer side, what they have done with this negotiation was perfect and based on our amateurish preparation, we are "dead meat".

What have they done correctly?

a) Plan well by including all the key members of the company to be in the team, i.e. proper evaluation of the business proposal and feedback from every member of the team must have been considered before calling for the meeting
b) Reveal little about the meeting agenda and since we did not ask for more detail, work to their advantage
c) Negotiation are on their home ground and, thus advantage of familiar surrounding
d) They have arrange Plan B if our side is unable to provide what they needed
e) They have formed their zone of possible agreement  (ZOPA) and we have not done that

In the end of the day, we lost the negotiation process but kept the business by;

a) Providing to them most of their demand
b) Reduce our margin for the business considerably
c) Lick our bitten ego

The are blinded by the "enemy" and got a trashing and we allow this to happen due to our own ignorance and overconfidence.