Lean Manufacturing Topic of the Day:  The Hidden Costs of Procurement

Lean Manufacturing Topic of the Day:  The Hidden Costs of Procurement

Another look at the Make / Buy decision process?

Lean Manufacturing defines “Value Adding” activities as those that do, in fact, add value to the final product.  They typically change the form, fit, or function of the product.  They are the activities that the customer must have, and is willing to pay for.

While there will likely still be activities that are currently necessary, by our strict lean definition, they are not “value adding.”

This is particularly true of the standard procurement process.

I’ve listed some of the steps, below, that the typical manufacturing company follows in order to acquire purchased material.  Look this list over and ask, for each, does it add value?

Planning / Forecasting
Capacity Planning / Master Scheduling
Requirements Planning (MRP: explode the bill of material, gross to net requirements, lot sizing, etc.)
Request for Quote / Competitive bidding (price and delivery)
Re-negotiation (as required)
Generation of Purchase Orders (PO’s)
Review confirmations from suppliers (agreeing to our terms and delivery requirements)
Expediting (as needed)
Packaging (paid for by the supplier, but included in his/her price)
Transportation / Freight from supplier site to our plant
Receiving inspection
Un-packaging from shipping container (de-trashing)
Stocking (locating each part in its appropriate place within the stockroom)
Cycle Counting (to maintain inventory accuracy)
Picking / Kitting (getting the parts back out of the stockroom)
Material Handling (move the kit to the shop floor)
De-Kitting at the production area

Some of the above steps are less pertinent for a repetitive manufacturer (except during new product introduction, or engineering change activity).
Just about all of the above steps are applicable in a job shop, “one of a kind,” environment.

The one thing that ALL of the above steps have in common is that they are all NON-VALUE-ADDING!

To test this hypothesis, one merely need ask:  “If we were to find a way to eliminate this step, would the customer care?”  If the answer is no, it is likely not a value adding activity.

The article “Lean Supplier Development: A Synopsis” addresses many of the internal causes, and suggests solutions.

Lean Supplier Evaluation Checklist ” provides an exhaustive list of parameters that are worthy of consideration in choosing your “A” suppliers.

The “Lean Manufacturing Tool Kit” provides an explanation of many lean techniques that attack the above forms of waste, such as “Vendor Managed Inventory,” “Reserving Capacity,” “Certifying Suppliers,” “Dock to Stock” / “Dock to Shop Floor” techniques to by-pass the stockroom, etc.

One additional item worthy of discussion is the magnitude and extent of the true hidden costs of procurement.  These costs are seldom adequately considered when doing a make-buy analysis.

In addition to these hidden costs of procurement, and perhaps of even greater impact, is the loss of control and lack of responsiveness.

If we have an un-predicted hiccup in-house, we can make the decision to work overtime, split the lot, etc. so as to recover.  Such flexibility is greatly reduced when dealing with remote suppliers.
This problem is further compounded when dealing with foreign suppliers.

We would encourage you to ask the questions:
What is it that the supplier will do, that we could not do equally well in house?
How can the supplier perform all of the production and procurement functions, add a profit, plus the cost of packaging, and transportation, and still produce it cheaper than we can?
What is the cost of any underutilized capacity (overhead)?
What is the value of the increased flexibility and responsiveness of “make” vs. “buy”?

Why can't we produce the item in-house cheaper than purchasing it?

A common logic trap that many companies fall into is in the allocation of overhead.  It goes something like this:
“We can’t afford to make product A in house” so the item is changed from “make” to “buy”.
This leaves a smaller manufacturing base in house to absorb the same fixed overhead, and thereby raises the internal cost of the remaining production items.

Now the internal “make” cost of product B is too high.  So we sent it to the outside.  In the mean time, we’re adding purchasing people, stockroom folks, receiving people, … (all overhead costs!) to handle the increased procurement load.
A partial solution is to utilize activity based costing (ABC) for the allocation of your overhead.  When correctly applied ABC will generally alleviate much of this issue.

Another technique that may be applicable (a compromise of sorts) is to lease space, on site, to key suppliers.  This action can at least reduce the packaging, and transportation costs.  And, the supplier will typically have a greater sense of urgency when physically on-site!
This can be a practical action when the supplier possesses some unique capabilities, intellectual property rights, and/or expertise not readily available in house.

As product life cycles shrink, and the consuming public demands ever faster responsiveness, the above considerations will continue to grow in importance.

Sometimes the high cost of making products locally, isn’t so high after all.  Just ask the companies that repeatedly write off millions in excess/obsolete inventory due to the length of their supply chain.  Don’t get caught in this same trap!

It often takes an outsider to change some of these long held views.  We’ve got the experience and successes to gain credibility with your management team.  Schedule a call.  There’s no charge, and I guarantee that you’ll attain value well worth your time invested.

Good luck on your continuing lean journey.

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