Rising costs, delays in manufacturing and supply chain issues are far too common in this post-pandemic world. Is it possible to save money as inflation rises in the economy of 2022 and beyond? The Principal Managing Director of Thurman Co, Angela Thurman was asked multiple questions about reducing costs and fighting off inflation in a recent podcast appearance. In this blog, we have taken Angela’s answers and shared them along with industry definitions. Our goal is simple, to help more people understand how reducing costs is possible, with strategy adjustments that Angela shares in the answers she gave on the show.
Want to watch the podcast? Click this link: Adventures in Supply Chain – Marcia Williams’ Interview with Angela Thurman
Is it possible to achieve cost savings in the current situation where we have material shortages and inflation?
Angela’s short answer, Yes, “I believe it is.”
Angela’s full answer: I believe it is. You must consider what you plan to measure against – is this RFP going to measure against the ROI of an existing solution, a comparison between multiple potential suppliers, a “make versus buy” scenario, or some other situation? Your financial analysis then needs to consider inflation, and the suppliers’ responses should all address the possibility of any potential material shortages.
ROI: Return on Investment
RFP: Request for Proposal
Inflation: “Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country.” According to the IMG
Where do we start? In which areas should we be focusing on? Direct/ indirect?
Angela’s Full Answer: My experience has been primarily with the Direct side, and I believe that if we start there, we will see the greatest potential savings first. Then we can consider Indirect opportunities.
Direct: Purchases focused on the supporting the company’s core business.
Indirect: Purchases that maintain the business but do not contribute to the overall profitability of the company.
Have you seen any changes if you compare RFPs before and after Covid? Any changes in requirements or clauses?
Angela’s short answer: “supplier organizations can no longer claim a force majeure for COVID-19.”
Angela’s full answer: In my opinion, supplier organizations can no longer claim a force majeure for COVID-19. We’ve been in this situation for much too long now, and they should have implemented their recovery plans so that an RFP issued today would address any resource restrictions caused by COVID-19. That being said, suppliers can certainly expect some grace if their delivery times have increased.
I also expect suppliers to request, and expect, longer forecast lead times, and to freeze those forecasts for a longer period. That means that a buyer cannot drop in new requirements or push out deliveries that were forecasted.
On the buyer’s side, they can also expect that given these longer forecast lead times, if the supplier doesn’t meet the deliveries promised they may be able to obtain a rebate of some kind for poor On Time Delivery performance. This is often included in a MSA or SLA, but not often invoked.
Force de Majeure: “Force majeure is a clause that is included in contracts to remove liability for unforeseeable and unavoidable catastrophes that interrupt the expected course of events and prevent participants from fulfilling obligations. These clauses generally cover natural disasters, such as hurricanes, tornadoes, and earthquakes, as well as human actions, such as armed conflict and man-made diseases.” Information per Investopedia.
MSA: Master Service Agreement
SLA: Service Level Agreement
How do we calculate savings? Which price should we consider: standard cost, average cost, last purchase price?
Angela’s short answer: “I tend to rely on the standard cost”
Angela’s full answer: I tend to rely on the standard cost, which is typically the price provided in the MSA or SLA. If the price is adjusted from the standard due to something like expedite fees or a volume discount, this will affect the average cost. Over time, the buyer and supplier may want to evaluate the average price (particularly if there have been frequent discounts) and consider adjusting the standard to a new price that better matches the true price of the item or service. Last purchase price is not a good metric, in my opinion, because you may not be in the same position you were last time.
Average Costing: “inventory is valued at a moving average. What this means is that the value of inventory is an average of the different items that comprise the inventory, without taking into account their individual values. Unlike standard costing, average costing doesn’t require any predefined standards for the tracking of inventory and determination of manufacturing costs.” According to SKB Accounting
Standard Costing: “all of its inventory accounts are valued at a standard cost. This standard cost accounts for direct material, direct labor and fixed and variable factory overheads. The actual cost will, obviously, see variances in both price and quantity.” According to SKB Accounting
How do we implement savings that look good on paper? Any actionable steps that you could provide, it would be great.
Angela’s full answer: When a buyer issues a RFP, try to take advantage of as many savings opportunities as possible:
- Volume discounts
- Long lead forecasting
- Purchase Orders matched to the supplier’s production cadence
- Standard lot sizes
- Reduced paperwork
- Favorable payment terms
Compare the RFP(s) received against the current solution if one exists. What if you do nothing? Is that a potential solution? What would that cost the company? If the RFP has been sent to multiple potential suppliers be certain that you’ve fully evaluated each potential solution for risk as well as ROI.
Lead Time: Supplier lead time is defined as the period of time between a supplier receiving an order and the time that the order is shipped. This KPI measures the lead time (typically in days) and also compares the quoted time with actual delivery time, the frequency of late deliveries, and how significantly this impacts your business or production. According to Una.
What metrics should we include on the contract to ensure we are getting and maintaining the savings accomplished?
Angela’s full answer:
- On Time Delivery is #1
- Order Acknowledgement – if the PO is not acknowledged (and you have evidence of that) how can you hold the supplier accountable to deliver?
- Unit Price
- Shipping Terms – if the contract indicates that the supplier is to ship in a specific way, make certain that they are compliant to avoid unnecessary cost and wasted time
- Quality – depending on the product, what happens if there is a defect? How does this affect the unit, lot, or entire order?
- Forecast confirmation
Find many Key Performance Indicators and how to handle them on this SourceDay article.
How do we track price increases when we have hundreds of items?
Angela’s full answer: This is dependent on the type of product and whether this is a MSA or SLA in place. It is the duty of the supplier to notify the purchaser of any price increase and the reason for that increase. If there is a MSA or SLA in place, this increase must be agreed.
Assuming that there are hundreds of items to track, there are software systems in place that can help with that. It doesn’t have to be a manual update in the ERP system. At a minimum, a system-wide update can be made on a regular basis (such as every other day, for example.)
ERP – Enterprise Resource Planning: Enterprise Resource Planning (ERP) is a process used by companies to manage and integrate the important parts of their businesses. Many ERP software applications are important to companies because they help them implement resource planning by integrating all of the processes needed to run their companies with a single system. An ERP software system can also integrate planning, purchasing, inventory, sales, marketing, finance, human resources and more. According to Investopedia.
How do we know if it is a “fair” price increase?
Angela’s full answer: If there is a MSA or SLA in place, the supplier must provide a reason for requesting a price increase, and that increase must be agreed upon before it can be implemented. If, however, the product is only purchased on an ad hoc basis, each quote is an individual case. There are many ways to determine if the price increase is fair, here are a few:
- Comparable purchases – Compare the price in this offer to recent purchases of equal quantities of similar items
- Expert opinion – Ask an expert in the field for their opinion as to whether the price is fair
- Replacement cost – Try to determine the cost to replace the item with a similar item
- Parametric calculation – Try to calculate the price using an independent variable from a similar, recent purchase. For example, have you purchased the same item but in a different quantity?
There are many ways to help fight inflation and reduce costs as Angela discussed in her answers above and we hope you apply many of these lessons to your purchasing process moving forward. For anyone who is still feeling overwhelmed processing their RFPs, perhaps the solution to reducing anxiety is to consider talking to Thurman Co directly. A consultation might help add confidence and increase efficiency in one fell swoop. After all, there is wisdom in seeking counsel when needed.