Supply Chain Management and the Total Cost Concept

In the era of control regime, the task of purchasing and selling was relatively easy - competition was less and the market was assured. But suddenly all that changed - the markets opened and competition increased; selling is now possible only if prices are reduced and quality improved - in other words, the customer wants more and more per unit cost.

To minimise the total production costs, it is recognised that one way is to tighten operations; another time tested method is to reduce cost of inputs. While it would be desirable that our suppliers reduce the cost of their supplies to us, the importance of building a relationship with the supplier has been recognised.

Establishing a long term relationship is possible only when the supplier and purchaser jointly decide to reduce the life cycle cost of an item by proper procurement, in such a way that it would lead to a win-win situation to both the parties - in other words, suppliers become “Partners in Progress”.

Purchaser cannot squeeze the supplier endlessly; sourcing the right item from the right vendors, getting it to the purchaser’s premises in the right way at the right price and at the right time can alone optimise costs for the purchaser. This is possible only if there is mutual trust, which builds up in long term relationships.

The purchase bill can be lowered if the total life cycle cost is optimum. In other words, the Total Cost ofAcquistion and Ownership of the item must be optimum. The major costs involved as we trace the path of a product from it’s raw material stage till it is consumed in our process would look like this -

SUPPLIERS COST STRUCTURE LEVER COST Wastage, spillage, pilferage 1 Inventory carrying cost 3 Handling and storage cost 1 Inspection & testing cost 2 Transportation & freight costs 3 Packing & forwarding costs 3 Duties & taxes 4 Margins of supplier 15 Labour & other overheads 16 Manufacturing cost 12 Raw Materials cost 40

SUPPLIERS COST STRUCTURE
LEVER	COST
Wastage, spillage, pilferage	1
Inventory carrying cost	3
Handling and storage cost	1
Inspection & testing cost	2
Transportation & freight costs	3
Packing & forwarding costs	3
Duties & taxes	4
Margins of supplier	15
Labour & other overheads	16
Manufacturing cost	12
Raw Materials cost	40

Total Cost of Acquisition = Rs. 100/-
Landed Cost = Rs. 95/-
Ex-Works Price = Rs. 83/-

The example given above is only an illustration. It shows that 83% of the total cost of an item is controlled by the supplier; 12% is logistics and 5% is internally controlled costs.

Each of these costs represent an opportunity for reduction.
The basic price of the supplier cannot be reduced. The margins can be played upon. The opportunity for reduction therefore lies in the supply chain - packing, forwarding, transportation, wastages, handling, storing, etc. Efficient supply chain management helps in reducing the Total Cost of Acquisition (TCA) of an item.

It is important to know the right supply chain for an item - this is possible only through the study of the Toal Cost of Acquisition. The TCA concept, which has begun to be followed by some progressive organisations around the world, looks at the following four major levers -

Specifications
• Are we using the correct specs?
• Can we rationalise the variants/sub variants?

Price
• Are we buying the product the most optimal way?
• Number of suppliers
• Import/domestic or a combination of both
• Commercial terms

Logistics
• Are we getting the product to our premises the right way?
• Mode of packing and transportation
• Handling losses
• Stages of inspection
• Inventory Management

Usage
• Are we using the product the right way?
• Operating parameters
• Work practices
• Wastage/recycling

In specifications, requirements should be minutely looked into - whether tailor made or general, number of variants and whether they can be clubbed, lot formation, etc. The organisation needs to relook into it’s own requirement in the changing times to be able to identify alternatives. One example would be the use of zinc for galvanising of steel. Traditionally, high grade zinc with purity of 99.5% has been used by the steel plants. Lately, it has been established that prime western zinc with purity of 98.5% is technically a better substitute, for galvanising of steel and also costs lesser by at least Rs.5OOO/Ton. To identify alternate specifications, periodic diagnostic studies need to be conducted to arrive at the best specifications for any item.

We need to identify and consolidate supplier base and decide on the best and most effective commercial terms with them. One should try to understand the supplier cost structure - his limitations, economics, overheads and margins, his competitors and industry benchmarks, to be able to identify the cost reduction opportunities. A supplier workshop could elicit a wealth of information. An effective negotiation strategy based on this information would help to reach the best price.

Logistics call for an understanding of the total supply chain, the elements of which include inventories, packing, forwarding, freight, storage and handling. The study of logistics is especially important for bulk raw materials, where substantial outflow of freight is involved. Management of logistics is an art which is extremely difficult to perfect - in India, JIT ends up being SHIT -Somehow in Time.

The study of logistics is important to establish a lean supply chain which would give the advantage of quick product changeover capability, excellent short and long term forecast visibility and JIT capability.
While studying the usage, one should look into their own operations and practices - the way the item is charged or fed, losses during charging, is recycling possible, ideas to reduce wastages, pilferage, etc. For example in a steel plant, reversing a conveyor belt whose bottom rubber layer has worn out, and using it postpones it’s replacement for some time. A belt which has worn out on the sides can be trimmed and used on a different location where lower widths are required.

Numerous instances are available on how little ideas can lead to good savings. In India most of the ISO certified companies have been exempted from pre-despatch inspection. Creating a list of approved vendors, entering into profit sharing arrangements with selected vendors, assisting them in their expansion and diversification are only some ways in which companies ensure supplier loyalty. Supply chain management has become important like never before, with the revolution in Information Technology and breakdown of geographical barrires. A combination of meticulous analysis, sensible strategy and effective implementation can enable a company to manage its profitability.