Optimization Should Drive Complex Direct Materials Decisions
Paul Martyn penned a good post over on Combine Notes last month that got me thinking about how best to explain the power that optimization can bring to the decision support process for direct materials sourcing practitioners. Many practitioners I speak with in manufacturing -- in fact the great majority, I would argue -- have a very limited understanding about the true applicability of optimization for complex buying decisions.
But optimization approaches, when used strategically, go far beyond the classic "split of business" scenarios that many of us are used to. In fact, optimization is most powerful when used to truly look at total landed cost that incorporate such factors as make versus buy, logistics / transportation, tax / tariff duties, and risk. As Paul discusses, "several of our clients are looking at how their decisions are dependent, including decisions on supply, manufacturing (where to source manufacturing), distribution (direct or through distribution center), transportation carrier and transportation mode (full truck, rail, flatbed, less than truckload, air, etc). This type of total landed cost analysis is uncovering orders of magnitude more savings than more arcane sourcing processes that focus exclusively on squeezing supplier margins (a component easily handled with optimization based sourcing practices)."
I also like what Paul has to say regarding the fact that procurement and sourcing negotiations are not just between buying organizations and their supply community. Rather, "Good spend management teams understand that their negotiations are with their suppliers AND their operations [organizations]." Paul's logic, which I would not dispute, is that decision modeling and optimization tools can help procurement organizations to make the best possible margin and value decisions staring with design engineering processes and going all the way through to logistics, transportation, and inventory management.
For example (mine, not Paul's), consider whether a series of metal stamped parts that go into a sub-assembly should be made in house, outsourced to a single supplier (or multiple suppliers), or dual-sourced on the piece part level. And how would you best look at this decision in the context of global sourcing and transportation costs, supply risk, and other variables. Is a supplier that is willing to offer a JIT program for all the stampings and ship parts at a Six Sigma level who is 3% higher on a unit cost basis than a combination of suppliers that can provide a better piece part price, but do not offer the same quality and delivery levels the better partner? Or not? Advanced optimization approaches that can help an organization model this decision to arrive at the best possible answer for their specific needs and risk tolerance levels.
In summary, Paul's main argument, I believe, is that you can't separate out these decision factors from each other and achieve an optimal sourcing result. It is precisely the combination and intersection of the various factors which enable the creation of an approach which yields the best total cost approach in a complex, global manufacturing environment. Now, I doubt that optimization makes sense for all types of sourcing approaches as a stand-alone tool, but when you combine it with competitive negotiation approaches as part of the process, it's hard to go wrong with including such capabilities as a core part of your decision support arsenal. Thanks, Paul, for such an insightful post! And here's an end of year virtual toast to CombineNet's growth and evangelism of optimization.
- Jason Busch
But optimization approaches, when used strategically, go far beyond the classic "split of business" scenarios that many of us are used to. In fact, optimization is most powerful when used to truly look at total landed cost that incorporate such factors as make versus buy, logistics / transportation, tax / tariff duties, and risk. As Paul discusses, "several of our clients are looking at how their decisions are dependent, including decisions on supply, manufacturing (where to source manufacturing), distribution (direct or through distribution center), transportation carrier and transportation mode (full truck, rail, flatbed, less than truckload, air, etc). This type of total landed cost analysis is uncovering orders of magnitude more savings than more arcane sourcing processes that focus exclusively on squeezing supplier margins (a component easily handled with optimization based sourcing practices)."
I also like what Paul has to say regarding the fact that procurement and sourcing negotiations are not just between buying organizations and their supply community. Rather, "Good spend management teams understand that their negotiations are with their suppliers AND their operations [organizations]." Paul's logic, which I would not dispute, is that decision modeling and optimization tools can help procurement organizations to make the best possible margin and value decisions staring with design engineering processes and going all the way through to logistics, transportation, and inventory management.
For example (mine, not Paul's), consider whether a series of metal stamped parts that go into a sub-assembly should be made in house, outsourced to a single supplier (or multiple suppliers), or dual-sourced on the piece part level. And how would you best look at this decision in the context of global sourcing and transportation costs, supply risk, and other variables. Is a supplier that is willing to offer a JIT program for all the stampings and ship parts at a Six Sigma level who is 3% higher on a unit cost basis than a combination of suppliers that can provide a better piece part price, but do not offer the same quality and delivery levels the better partner? Or not? Advanced optimization approaches that can help an organization model this decision to arrive at the best possible answer for their specific needs and risk tolerance levels.
In summary, Paul's main argument, I believe, is that you can't separate out these decision factors from each other and achieve an optimal sourcing result. It is precisely the combination and intersection of the various factors which enable the creation of an approach which yields the best total cost approach in a complex, global manufacturing environment. Now, I doubt that optimization makes sense for all types of sourcing approaches as a stand-alone tool, but when you combine it with competitive negotiation approaches as part of the process, it's hard to go wrong with including such capabilities as a core part of your decision support arsenal. Thanks, Paul, for such an insightful post! And here's an end of year virtual toast to CombineNet's growth and evangelism of optimization.
- Jason Busch
And, then, to Paul’s point, it’s not necessarily the sourcing teams’ purview to make the final decisions but they can now take multiple options to their customers—their operations organization—and clearly articulate the trade-offs.
OK, I know we’ve all heard enough about Chris Anderson’s long tail pitch, but if we take a long tail view of our commodities, for a moment, there are a lot of opportunities—some mundane, some complex—that never benefit from optimization. So, I agree, let’s get more optimization-based decisions in complex, direct materials, but let’s also consider the huge opportunity of putting the power of optimization into every buyer’s hands so its benefits are not just limited to a few categories but applied across a long tail of commodities.
Eric makes an excellent point about the use of optimization on, as he put it, 'more mundane purchasing decisions'.
In fact, when you think of purchasing items, regardless of the category nuances (complex/simple), there are several financial factors that optimization can help shed light on. For example, payment terms is a straightforward example of a financial supply chain factor that benefits from Expressive Commerce (suppliers proposing options/buyers considering options via optimization). Payment term analysis is a 'standard' component of our buyers' sourcing analysis. Our buyers request discounts from their suppliers based on the buyers ability to expedite the payment terms (i.e. from 60 to 45 days). Buyers can also look at the associated cost of extending the payment terms (60 to 90 days).
This example of Expressive Commerce has, in a recent Aberdeen study, been used by 'Best in Class' buyers to unleash 'savings for both buyers and suppliers, including extending payment terms and lowering the cost of procured goods for buyers, enabling access to cheaper trade financing, improving cash flow visibility and predictability for suppliers, and creating an overall less costly supply chain for both partners. For many companies this is a multi-million dollar opportunity.'
Expressive Commerce (delivered as a self-service application by CombineNet) incorporates payment terms and additional 'finance supply chain optimization' best practices to generate savings above and beyond the savings acheived by reducing supplier rates.
This practice, while not limited to, is increasingly important when organizations consider low cost country sourcing. As Aberdeen points out, "Successful enterprises have been able to save from 10% to 35% of total costs on goods purchased from emerging markets. However, most companies are still leaving significant money on the table because they fail to take into account the supply chain finance opportunity when sourcing from low-cost countries."