Guide to Supply Chain Management Page 9

  Integration, most often accomplished through technology, plays a critical role in reducing the per-unit transaction costs of low-value items and services that are bought in large quantities. E-procurement is the use of information systems to identify and manage suppliers in a way that eliminates paperwork, delays and cost. Electronic data interchange (EDI), now common, saves data input time and eliminates errors. Electronic billing saves costs and makes it easier for buyers to audit historical payments made to suppliers. Billing by assumed usage based on an easier-to-collect variable, such as billing for machine hours based on electricity consumption, since electricity consumption can be more easily tracked than machine hours (this practice is called back-flushing) saves labour and, if done correctly, sacrifices very little accuracy. In addition, technology is used to automate and improve many of the traditional manual processes, such as requests for quotations (RFQS), reverse auctions, spend visibility and contract compliance. Electronic RFQS are embedded in enterprise resource planning (ERP) systems, saving both buyers and suppliers overhead cost.

  For strategic categories the most effective solution is usually tighter integration with suppliers to reduce their operating costs. This includes partnering to increase the role of the suppliers, as well as approaches that minimise the cost of transactions between the buyer and the supplier, such as long-term agreements and supply chain integration. Long-term contracting reduces transactions costs by allowing suppliers to reduce their sales costs, and consequently their prices, with fewer customers.

  For non-critical items, the best solutions are ones that use economies of scale to reduce unit costs and simultaneously reduce complexities in purchasing, thereby mitigating the bullwhip effect. These solutions include consolidating suppliers, centralising the procurement function and long-term contracting.

  Reducing the number of suppliers helps the chosen few realise economies of scale and thereby reduce their costs and their prices. Many companies have consolidated the number of suppliers, making reductions of 50–80%. Here are some examples of the more aggressive consolidations seen in participants in the study carried out by Boston Strategies International:

  A Dutch retail chain consolidated its supply base for interior decoration products by 62%, for a 28% savings.

  Two US medical device manufacturers reduced the number of their suppliers by half in two years.

  A regional utility in the United States typically awards its largest supplier 40% of the business, compared with 5% in 2000, in order to get better reliability and responsiveness.

  A US switch and connector manufacturer is single sourcing to reduce administrative costs, provide an easy and simple product pricing structure and achieve economies of scale. The company is collaborating increasingly with its suppliers in demand forecasting, shipment visibility and sharing proprietary information.

  A manufacturer of coated paper halved the number of equipment suppliers that it had between eight and ten years ago, and cut the number of indirect suppliers by 50% between 1993 and 1995.

  Group purchasing can also achieve the economies of scale that are needed to negotiate better prices with suppliers. For instance, many companies belong to shippers’ associations in order to get better transportation rates. Even large companies benefit from group purchasing: FedEx and General Mills have participated in a group purchasing initiative for indirect products and services. Independent of that group, General Mills organised 11 companies to make a transportation consortium using a solutions provider called Nistevo. The companies included Fort Howard Packaging, Land O’Lakes, Morrell, Nestlé and Pillsbury.9 Service industries also use group purchasing organisations (GPOS): Dana-Farber Cancer Institute participates in a consortium buying group called Novation as a mechanism through which it sources surgical supplies and pharmaceuticals.

  Outsourcing

  Outsourcing and offshoring are often confused. Outsourcing, the contracting of a third party to manufacture or deliver a service, can be offshored but does not have to be. Offshoring, sourcing from overseas, is often outsourced, but does not have to be.

  Cost reduction is often the driving force behind a management’s decision to outsource, so it is an important element of rationalisation strategy. There is an important financial advantage in the transfer of assets to third-party logistics (3PL). Offloading tangible assets such as warehouse facilities and vehicles and intangible assets such as information systems increases ROA, making companies more attractive to lenders and shareholders. If the value of an outsourcing deal is significant, it can result in a rise in the share price.

  Just as important, however, outsourcing can help improve supply chain effectiveness by better serving customers. Outsourced providers often provide serious advantages over doing the job in-house, such as the following:

  If it is a more global network than the company purchasing the services, it will allow that company enhanced access to foreign markets.

  Heavy investment in IT platforms provides measurably higher service levels and service reliability compared with in-house systems. For example, best-of-breed transportation management systems (TMS) and warehouse management systems (WMS) offered by 3PL providers frequently can handle complex pick/pack operations more readily than in-house solutions.

  Value-added services which would be challenging for a company that is not a logistics specialist to provide. For example, while most production operations can handle basic boxing, 3PL providers often excel at custom packaging operations involving plastic (“bubble” or “clamshell”) packaging, security (hermetically sealed) packaging, kitting, customised packaging by customer, or personalised packaging by consumer (for example, through individualised insertions).

  Outsourcing has gone from being almost non-existent in 1985 to being prevalent, even predominant, today. Activities targeted for outsourcing include contract manufacturing10 and various logistics including, in order of frequency of outsourcing: transport (67%), customs brokerage (58%), freight payment services (54%), freight forwarding (46%), warehouse management (46%) and shipment consolidation (42%). The value of offshore arrangements has increased steadily. The cumulative value of deals in place has increased. Between 1950 and 2005, US manufacturers moved huge amounts of work abroad, as manufacturing’s percentage of US GDP was more than cut in half. Most of that was as a result of offshore contracts.

  Three aspects of an outsourcing decision should be considered as part of a complete analysis:

  Which activities to outsource and which to keep in-house – core competencies should never be outsourced.

  When to vertically integrate – for example, whether to purchase a dedicated supplier.

  How many services to buy as part of complex product purchases – for example, when buying complex equipment, sellers often offer to provide maintenance and repair services for the life of the product.

  Sydney airport11

  Airports have become more profit-driven in recent years, as governments worldwde have moved to privatise transport infrastructure and operations. European and Middle Eastern governments have regulated airport ground handling services to ensure adequate competition and hence lower costs.

  Australia’s Sydney International Airport outsourced a particularly wide range of services in the early 2000s in conjunction with its privatisation. It handles 27m passengers per year and employs 62,000 people.

  The airport used a set of criteria to decide which activities to outsource. Not surprisingly, cost advantage was the first criterion. However, this was balanced with other considerations, such as the operational and contractual risk involved in the activities, confidence in the outside providers’ level of skill and expertise, and security.

  After screening and consideration, its outsourcing initiative has been extensive, covering many activities such as:

  civil infrastructure and ground maintenance;

  fixed plant and equipment maintenance;

  baggage handling systems at the domestic terminal;

  support servic
es, including fleet management and call centre;

  service contracts, including cleaning, trolley retrieval and waste disposal.

  Based on the responses to its initial requests for proposals, the airport targeted a 10% savings in Phase 1 and a 15% savings in Phase 2. The quotation process allowed the airport to identify potential savings of 40% on street sweeping and 10% on paving. Encouraged by the results, it divided the outsourcing initiative into two phases: phase 1, which involved a consolidation of maintenance areas into one group for baggage, airfield, terminal, services, utilities and asset planning; and outsourced ground maintenance (airfield line marking, mowing and sweeping); and phase 2, which involved a comprehensive facilities maintenance contract. Phase 1 achieved the targeted 10% cost reduction and phase 2 saved the additional targeted 5%.

  The outsourced providers’ contracts were structured in a gain-sharing fashion. The contractors received a fixed management fee and reimbursement for direct expenses, the total of which needed to be below the previous year’s budget. The contract also called for continuous cost reduction over time, and measurement according to a balanced scorecard with predefined key results areas (KRAs), which were measured quarterly. The KRAs had a minimum score of 50, an expected score of 75 and a maximum score of 100. If the supplier fell below the minimum score, the airport notified it that it was in default and put it on notice of potential dismissal. Above-expected performance on KRAs led to a bonus payment.

  Sydney’s actual experience with the outsourced maintenance provider got off to a shaky start. The provider had a slow start-up, delaying the transition, and had trouble taking over responsibilities from previous contractors on schedule. There were also communication gaps between the airport staff and the contractor team, and some turnover problems, perhaps related to the supplier’s inexperience in airport operations. In addition, it was discovered that the supplier did not fully understand the KRA compensation scheme. However, the minimum savings of 5% sought by the airport were achieved. The contractor also scored satisfactorily on quality and safety. Over time the contractor’s performance has significantly improved and is still working at the airport.

  Despite the challenges of implementing the outsourced contracts, the airport’s financial results have been impressive. The savings achieved by the outsourcing initiative helped the airport realise earnings before interest and tax (EBIT) of 57% and earnings before interest, tax, depreciation and amortisation (EBITDA) of 80% in 2004–05.

  Lean manufacturing’s focus on waste reduction

  Lean manufacturing concepts have broad applicability to the supply chain. Lean is often described as a philosophy or even a religion. One lean consultant described it as a set of principles that includes putting the customer first, having an end-to-end total value stream perspective, focusing on consistent flow and eliminating waste.12 There are innumerable ways to characterise and define lean, and experts work with many process tools that may be classified as part of lean thought. The breadth of scope of lean makes it both important (the reason why it has had such a profound impact on business) and challenging (it seems to defy definition and boundaries).

  Lean applies to SCM in two ways. First, its focus on eliminating waste fits squarely with the rationalisation supply chain strategy. Second, its toolkit for inventory reduction directly supports the synchronisation strategy (see Chapter 7).

  The purpose of this section is not to provide a comprehensive list, or even to claim a direct linkage between these tools and lean, but rather to outline methods that relate to lean and are especially effective at reducing cost and executing a rationalisation supply chain strategy. The following tools have yielded exceptional results in waste elimination programmes:

  the seven types of waste;

  the 5S approach to workplace organisation;

  total quality management (TQM);

  total productive maintenance (TPM);

  cellular manufacturing;

  diagnostic tools such as the 5 Whys, the plan-do-check-act (PDCA) cycle, value stream mapping, work sampling, root cause analysis and throughput analysis.

  Seven types of waste

  Lean theory has identified seven types of wasteful activity. While the concepts were originally formulated to apply to manufacturing environments, a broader interpretation is entirely applicable to service industries. Below are the seven types of waste and an interpretation of each type of waste’s applicability to SCM across a variety of industries.

  Overproduction and overprocessing. Overproduction means anything more than is required by customer orders. Overprocessing and the related concept of overengineering refer to any extra work steps than are required to satisfy customer demand.

  Unnecessary inventory (see Chapter 7). In pure lean theory, all inventory is ultimately bad since the ideal state is a one-piece flow through the entire production system. In reality, small amounts of buffer inventory are required because of the differences in capacity from operation to operation.

  Transport and motion. Transportation is wasteful since it adds cost that could be avoided if the product was made or service provided at the point of consumption.

  Wasted steps or efforts in the production process. Anything or any service that takes two steps but could be made with one step is wasteful. This type of waste can often be readily identified in day-to-day office or plant activities.

  Defects and rejects. Defects represent wasted effort that must either be discounted or thrown away. Rejects are worse since they also incur customers’ wrath and discontent and are a possible adverse influence on buying behaviour.

  Waiting. Time, as a resource like labour or materials, can be wasted by waiting. Queue time often comprises up to 90% of the production cycle time, so waiting can be a prime target for waste reduction efforts.

  Unnecessary motion. Excess motion, such as back-and-forth movement that could be accomplished in a single well-designed motion, or excess keystrokes that could be accomplished with a shortcut key, is similarly wasteful since it consumes energy and cost. Motion at the activity level is analogous to transportation at the supply chain level.

  Other wastes have been added to this list since the original seven were developed by Taiichi Ohno, vice-president of manufacturing, and Shigeo Shingo, head of industrial engineering and factory improvement training at Toyota in the 1950s. For instance, reprioritisation or replanning, especially if it involves changes to the plan, wastes management time and production effort. The ideal state is a stable plan that has a minimum of change and reprioritisation. And wasting human talent can exacerbate all the other wastes since it is required to avoid and eliminate waste in the first place.

  5S

  Another lean tool for waste reduction is “5S”, which stands for sort, sequence, shine, standardise and sustain. Simple in concept, but challenging to execute, 5S can have a dramatic impact on organisations if applied in depth to all aspects of the work process.

  Sorting at a simple level just means organising things, but at a detailed level it means thinking about and understanding the best way to organise every aspect of every step of the work, which is an engineering process and arguably a science in its own right. To illustrate the range of complexity, consider these two examples. First, simple: a secretary organises incoming mail by addressee; and second, more complex: FedEx organised its jet engine maintenance to handle routine maintenance as a separate work stream from repairs, thereby more efficiently organising work to lower cost and improve reliability.

  Sequencing at a simple level means putting work activities in the optimal order. But in the context of a supply chain, sequencing is fundamental. A US company imports minerals from China, then screens, crushes and dries them. It also takes precipitated calcium carbonate (PCC) from its paper operations and de-waters it to produce bagged ground calcium carbonate, then trucks it to market so it can go into diverse products such as floor tiles and chewing gum. If it screened, crushed and dried the stone before importing, its operations and its cost would
be very different. Also, if it trucked the bulk PCC to market and bagged it in the local market, its cost and network would be very different. The sequence of operations is a key determinant of its supply chain cost.

  Shining means keeping things clean, but if it is applied methodically, can have dramatic impact on companies’ long-term costs. Again, this can be practised at many levels. For example, a plant manager insists on keeping the floor clean for safety; and UPS is able to maintain a high degree of uptime in its fleet of 100,000 ground vehicles because of its careful attention to maintenance and individual drivers’ pride in their vehicles.

  Standardising is easy to conceptualise but hard to implement. Take, for example, Southwest Airlines’ standardisation of its aircraft fleet (see page 81). A large decision like that one is difficult, especially if the current fleet is highly non-standardised and the cost of standardising is high. Yet the benefits have proved to be high as well.

  Sustaining is a way of saying that, to be effective, the improvements from 5S initiatives changes need to stick.

  Total quality management

  Quality management, a theory of work evolved by W. Edwards Deming, an American author, professor and consultant who is best known for his early contributions to Japanese quality systems (see also page 88), and Walter Shewhart, a physicist, engineer and statistician famous for his pioneering work in statistical process control, laid the groundwork for the elimination of gaps between the product or service and the customer’s perceived needs. TQM is the engagement of the workforce in ensuring processes that continuously eradicate quality problems. Although not classically considered to be part of lean, TQM and other quality management programmes can play a major role in reducing costs. When implemented in a culture of kaizen (the Japanese term for continuous improvement), tools such as the cost of quality, poka-yoke and Six Sigma can reduce total cost significantly: