A new purchasing philosophy

Lean enterprise systems require supplier partnerships

By Chris Harris and Chuck Streeter

As companies continue to implement lean enterprise systems, the purchasing of components has become an area where there is opportunity for improvement. Purchased components and other material normally make up a large percentage of the cost of goods sold and therefore make the arena of purchasing one that deserves a great deal of attention in the implementation of lean enterprise systems.

Preparing a purchasing organization for the implementation of a lean enterprise system takes a philosophical change in thought process to support the lean enterprise initiative effectively. The philosophy needs to change from a traditional supplier-customer relationship to a mutually beneficial partnership mentality while understanding true cost and information flow between the new partner and customer. By focusing on this philosophical change to the purchasing organization, understanding who the customer is, understanding the total cost to purchase a component and being committed to the change, a company implementing a lean enterprise system likely will have a higher success rate of implementation and better customer satisfaction.

The question to ask

Scouring the globe looking for the lowest piece price cost for a component is a type of traditional purchasing that can be harmful to a lean supply chain. By sourcing components with many different suppliers in many different countries around the globe, a supply chain can become disjointed and inflexible. For example, take the economic downturn that began toward the end of 2008. Many organizations had purchased raw materials via MRP from a forecast bought in large lots to get a low piece price cost. The raw materials coming from other countries could not be stopped from arriving because they already had been shipped and were on the ocean somewhere. This left companies strapped with large inventories that they had to pay for but could not use because they had no consumers to sell the product to.

Practices such as global purchasing may look good on paper, but when that philosophy is implemented, the stress and extra work that it places on the actual production system can cost the organization a lot of money. A question that purchasing departments and organizations need to ask is “Who is our customer?”

A different thought process

Understanding the customer is vital to being able to provide value to that customer. So when purchasing looks at whom their customer is, the answer will drive the behavior that a purchasing organization exhibits. For example, if the customer of a buyer is his supervisor, meaning that the buyer’s performance is measured upon acquiring the lowest piece price cost, then the buyer, assuming he wants to do well in his job, obviously will spend the majority of his time chasing the lowest piece price, even if he has to scour all over the world.

A different thought process would be to ask:

Who uses the component that purchasing buys?
Does the buyer go to the production floor and see how the component is used?
Is the quantity of components in a box determined by the ease of use in the production system or by the supplier because it can provide the product cheaper in this quantity?
Is the weight of the box with components considered when purchasing components?
Is the frequency with which the box has to be lifted, turned and moved by the production associate considered when a component is purchased?

Unfortunately, too many times these questions are not considered, and the piece price cost becomes the single driving factor of how a component is purchased.

The value produced by a company is determined by the customer that it sells the service or product to. Value is what the customer is willing to pay the supplier for the product. In most cases, the customer is not willing to pay for a purchased component. The customer is only willing to pay for that component once it is added to the final product that the customer wants to buy. Therefore, it is a safe assumption that the value is added on the production floor when a worker assembles the purchased component onto what will become the final product.

When it is agreed upon, as it should be, that value is added on the production floor and that the purchased components support that value-added process, the purchasing organization’s customers become clear. The customers are the production system and the production associates on the production floor because those entities add value to the product.

However, the fact that the purchasing organization’s customers are the production system and associates does not make cost unimportant. Cost always has to be considered when sourcing components – not in the traditional sense, but in a new thought process that considers the total cost of sourcing a component.

True cost

There are many different costs that go into sourcing a component, many of which are not calculated in the cost of a component. Take the questions asked in the previous section. If a production associate has to open a cardboard box, that is a cost. If the production associate has to move the box multiple times due to the large quantity of parts in a box, that is a cost. These are both legitimate costs, but ones that often can be dealt with through a well-designed and efficient internal timed material movement system.

The thought process of looking at true costs that are not normally calculated in the “piece price cost” is valid on a larger scale for buyers in a global economy. Three types of costs need to be considered when determining the true cost of a component: ongoing cost, change cost and risk cost.

Ongoing cost is the cost of the component that an organization incurs as it continually buys the component. For example, piece price, transportation, inventory carrying cost, customs and duties are all costs that occur on an ongoing basis. In the past, many purchasing organizations have looked at the piece price cost and the transportation costs, but rarely considered the carrying cost for the amount of inventory created by their purchasing decision.

The second type of cost is risk cost. Most organizations cannot name one supplier that they never had a quality problem with. Suppliers will have quality problems, and when they do it costs their customers money. This cost can take the form of downtime, poor quality to the end customer, poor end customer satisfaction, expedited air shipments, reworking parts and other costs.

Though most people would agree that quality spills happen and can be expected, seldom do organizations calculate the cost of a quality spill into the component being purchased. Many organizations put this in the column of the “cost of doing business,” but if an organization reasonably can expect a quality problem from a supplier, then it should be calculated in the total cost of the component.

The third cost that needs to be considered when determining where to source a component and how much that component will cost is the change cost. Changing suppliers can cost a lot of money, but many times a purchasing organization cannot calculate the true cost of this change, and the true change cost is neglected.

There are many reasons to change suppliers, and items like volume, quality, price and others need to be considered and included when calculating change cost. For example, a person will have to be sent to the potential new supplier to validate it and its processes. This can cost the company a possible plane ticket, expenses and time lost that the individual would have been doing her normal functions. Tooling may need to be purchased. Testing the new components will have to be done. The prints of the components may have to be changed as well. All of these costs are legitimate and are able to be calculated, therefore they should not be lumped into a category called the “cost of doing business.” It may seem like a daunting task to develop a true cost model for your organization, but if the true cost of a component is to be determined, it is necessary. However, this leads to another important aspect of lean purchasing – the development of suppliers.

Lean supplier development

What if an organization was able to decrease its supply base by 50 percent? What would that do to the “noise” that surrounds a purchasing organization with many suppliers? What would that do to the transportation costs of a facility? What would that do to the chaos and inefficiencies that happen on the receiving dock? What would that do to the quality of the facility, assuming that the 50 percent of the suppliers that the organization chose to work with had good quality?

There can be many benefits to reducing the supply base. So why do many organizations not pursue this initiative? Many organizations want to be diversified and have the capability to buy their components from many different suppliers. This is understandable from a theoretical point of view because the organization wants to have many options, but from a practical point of view the philosophy is flawed.

Take an organization that chooses to buy 30 plastic components from 30 different plastic suppliers. This organization is diversified, but so are its suppliers. So the 30 suppliers don’t have much incentive to take care of that one customer. If one of the 30 plastic component suppliers does not ship product, it shuts down the purchasing organization. So the price of diversification to the organization is that any one of its 30 plastic component suppliers can shut it down. Conversely, the organization cannot shut down any of its suppliers because the suppliers have many more customers, and the organization is just a small part of their business.

Take another organization with a different purchasing philosophy. Instead of diversifying its plastic components among 30 different suppliers, it chose the best plastic supplier and gave it all 30 components. This turned out to be beneficial because the two were connected by the common goal of a successful business. The supplier now was very concerned with the customer because that organization represented a great deal of its business, so if there were problems, the supplier was quick to react. This does not normally happen when the supplier only supplies an organization with one low-volume part. Next, quality got a lot better because the organization chose a supplier with good quality. Transportation costs also went down because shipments of plastic components came from only one supplier.

There can be many benefits to decreasing the supply base and working with suppliers to develop them into long-term partners. The goal of these relationships is to work together to create a mutually beneficial supply chain that provides efficient and consistent value to the end customer, which allows for the companies in the supply chain to prosper. However, even if an organization can change its purchasing philosophy and determine true costs, it must be committed to developing a solid supply base.

Making a commitment

In the future, it likely won’t be facility versus facility or even company versus company. It is going to be supply chain versus supply chain. The organization with the best supply chain is going to win. Therefore, it is imperative that organizations looking to compete successfully in the global economy focus on developing a lean, agile and efficient supply chain.

To accomplish the development of a competitive supply chain, the suppliers have to be a focus. An effective supply chain that competes successfully in a global economy has suppliers that are healthy, efficient and in it for the long run. To achieve suppliers with these traits, it takes a commitment from the customer and resources to help develop good suppliers into long-term partnerships.

The problem with this type of change in thinking is that the benefits likely will not be seen tomorrow. It takes time to have the impact that is expected. But if the end goal is to compete successfully in the global economy, then successfully developing suppliers into key partnerships throughout the supply chain is necessary.

The future

It does not seem that the global economy is going anywhere. It is evident to many organizations that past purchasing practices have not supported new leaner, more agile production systems as effectively as needed. There must be a change in thought process to transform the important aspect of purchasing components into an area that effectively and efficiently supports the creation of value for the end customer.

To achieve the needed change, the company’s purchasing organization needs to change its philosophy from the traditional supplier-customer mentality to a long-term partnership mentality. As this happens, the true customer of the purchased components, the value-added production associate and the overall production system, needs to be considered when sourcing a product. Furthermore, a move from piece price cost to the true cost to the value stream needs to be understood for the purchasing organization to support production in the most efficient and economical way.

There is no doubt that this is a drastic change from the way that many organizations purchase their components, but it is necessary to compete effectively around the globe.

Chris Harris is vice president of operations at Harris Lean Systems, where he has worked since September 2001. He focuses on helping organizations implement and improve their lean enterprise systems. Harris has written many articles and was awarded the Shingo Prize for co-authoring the book Making Materials Flow. He also co-authored two other books on lean enterprise principles and has a new book due out this year on lean supplier development. Harris holds a doctoral degree in business administration.

Chuck Streeter owns Streeter Lean Principles LLC in Indianapolis. He has years of experience in the automotive and electrical industries. He has been responsible for designing and implementing manufacturing processes and material delivery systems to transform mass to lean production processes in North America, Europe and Asia. Streeter earned a bachelor’s degree in management from the U.S. Air Force Academy and a master’s degree in systems management from the Air Force Institute of Technology. He is a retired commissioned officer in the U.S. Air Force Reserve.