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The perfect supply storm

May 1, 2006

5 Min Read
The perfect supply storm

It''s never been a more challenging time for middle-market industrial companies throughout the plastics and related oil-and-gas-derivative supply chains.

In the past year, middle-market suppliers have seen an unprecedented rise in the costs of critical materials like resin, and have even had to deal with commodity shortages and restricted allocations in the tightest periods. Indeed, the combination of inflationary commodity pricing, geopolitical instability in all corners of the world (Venezuela, Iraq, Iran, and North Korea), and China''s insatiable appetite for raw materials has caused a perfect supply storm, which has been amplified by upstream brand owners and OEMs-especially in automotive-that have been extremely reluctant to allow suppliers to add surcharges or pass through material cost increases. It doesn''t look like we''re about to turn the supply corner, either. With pricing volatility and fluctuating levels of global supply and demand, each month seems to present its own new set of challenges. And it''s likely that a new hurricane season in America will not do anything to help.

A lean sourcing solution

Perhaps the only good news on the horizon is that progressive companies are beginning to employ lean sourcing techniques to reduce costs while proactively addressing supply risk. Lean sourcing, an organizational approach to direct material cost reduction, is based on the concepts of strategic sourcing and lean manufacturing. It requires organizations to understand and award supplier contracts by taking into account all factors that influence total enterprise cost. In addition, it emphasizes waste elimination-both the process waste (the purchasing process itself) and inventory waste (often what a company ends up with when they maximize piece-part savings) common to typical purchasing approaches. Lean sourcing helps companies not only reduce unit prices for key materials on a one-time basis, but it creates sustainable cost-reduction approaches that pay dividends for years.

Lean sourcing focuses on two key areas: sourcing and how supply management integrates with lean manufacturing and logistics (global and otherwise). On the sourcing front, lean sourcing helps companies reduce costs by focusing on supplier identification, qualification, negotiation, collaboration, and performance management (quality, terms, and lead times). In inflationary commodity markets, lean sourcing yields cost-avoidance for categories with spiraling material costs such as foam and resin.

One Chicago-based manufacturer was able to use a lean sourcing approach to make its foam suppliers separate out value-added costs from material costs, forcing vendors to compete and lock-in on the former while floating the latter (providing complete transparency into price increases). This kept price increases to a minimum relative to competitors'' in a market where suppliers were attempting to pass on 50%-70%-plus price increases almost overnight, without justifying the new premiums.

Think globally

Global sourcing, and in particular low-cost-country sourcing, also offer substantial savings opportunities for U.S. companies. Be it polybags, commodity injection molded parts, or more complex subassemblies that combine plastics with other products, global supply options also help generate real savings in rising commodity markets. Several rules of thumb are useful here. First, look at specific categories that contain at least 25%-30% labor content. Second, identify higher-volume items with lower part complexity. Mold tooling is a good category to source globally. If you are in the automotive industry, consider internal body parts like roof supports or tailgate brackets. Compression molded parts may also be a good fit for global sourcing. And remember, think "shoebox." If it fits in one, and meets some of these other criteria, it might be a good candidate.

Look to futures

From a financial angle, sophisticated organizations that depend significantly on commodities with a direct or indirect link to petroleum markets can use hedging techniques to partially or fully lock-in costs on a forward basis by trading futures contracts based on the underlying commodity of what they''re buying. In the plastics market, companies considering these types of hedging strategies, such as cost averaging-where a proportion of forward requirements are purchased forward on the futures market-can reduce the peaks and troughs inherent in a highly volatile spot market. Spot prices are driven dramatically by demands of the here and now; if buyer or seller can average between the spot and forward prices over time it will flatten the curves. Beyond upstream resin derivatives, processors can hedge polymers themselves through the London Metal Exchange, which currently offers polypropylene and linear low-density polyethylene contracts.

For buying organizations of all sizes, competition and financial hedging in the sourcing process almost always has a positive impact on pricing in the long term (though the right strategy for a particular situation is often varied). We have observed that companies with as little as $5 million in annual revenue can achieve significant savings by identifying the right set of suppliers, and then conducting competitive negotiations via online bidding (either sealed bid or reverse auctions). But often, implementing and monitoring savings is just as important to identifying lower prices. Only by closely monitoring annual savings by category, actual costs of purchase vs. budgeted costs, compliance with contracted / negotiation prices, defect rates, purchase order reliability, on-time delivery performance, and supplier responsiveness, can companies implement lean sourcing savings that hit the bottom line, year after year.

Lean sourcing cost reduction is not just about identifying, implementing, and monitoring unit cost savings. We''ve seen companies achieve significant results from partnering closely with suppliers to achieve collaborative cost take-out goals. By pursuing initiatives that focus on part standardization (to reduce the overall number of SKUs that an organization purchases) through to reducing inventory levels (and working capital requirements), progressive industrial companies are identifying new ways to reduce purchasing costs even after they lower unit costs by identifying the right set of global suppliers and forcing them to compete for their business.

Lisa Reisman is managing director at Aptium Global, a firm that works with small and medium-sized manufacturing companies to save money on direct material purchases through a lean sourcing approach that attempts to minimize impact on cash flow while maximizing impact on the bottom line. She can be contacted at [email protected].

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