Last week we introduced the concept of the supply chain orchestrator in part one of this series. Here we drill down on one type of orchestration, buying materials or components on behalf of suppliers in your supply chain.
Buying on Behalf of Multiple Tiers of the Supply Chain
Buying materials and components on behalf of your suppliers (and their suppliers) is being done by some companies, particularly in the auto and aerospace industries, and to a lesser extent in high tech. There are several reasons that a company may choose to buy materials on behalf of their suppliers:
- Consolidate Spend — In many cases, the majority of materials or components that go into a company’s product are procured by individual suppliers throughout the supply chain, and are not purchased directly by the final product company itself. As a result, this spend is fragmented across numerous firms (especially for commodities such as metals or energy). Savings can be realized by consolidating this spend. These benefits are dependent on consolidation of the spend into significantly higher volumes (at least 2X and preferably 10X the spend amounts of the individual companies involved). For this reason, it is usually makes sense for the player with the most power in the supply chain (often the OEM) to be the Orchestrator who is consolidating the spend. They have the clout and ability to influence the companies in the chain to change how they buy and thereby pull together spend across the entire chain.
- Remove PPV (Purchase Price Variance) — In some industries, a major cause of friction between OEMs and their contract manufacturers has been PPV, where the purchase price of materials reported by the contract manufacturer is different than the actual price paid. See sidebar ‘PPV Example’ from high tech.
- Manage Supply/Allocation Risks — During times of impending tight supply, an OEM/buyer may decide to forward buy critical components on behalf of their supply chain, in order to ensure a continued flow. There is some risk to the OEM/buyer, as this generally needs to be done before the components are actually on allocation. If the projected surge in demand does not materialize, the buyer could be stuck with excess or even obsolete materials. A less risky alternative to outright buying materials is buying capacity options (see hedging strategies), which reduces or eliminates the risk of being stuck with excess materials, but at a price (the price of the option).
- Remove Input Materials Price from the Equation — Negotiations with suppliers can become quite complicated, involving surcharges and other formulas, when the discussions need to take into account fluctuating prices for the commodities that the supplier buys as input materials to their manufacturing processes. By buying those materials themselves, the OEM/buyer removes that from the equation, and is paying purely for the value-add of the supplier’s manufacturing processes. However, this puts all of the commodity price risk onto the OEM/buyer, who may then need to implement an alternate hedging strategy.
- Rationalize Materials — for engineered materials, such as steel. The outsourcing of manufacturing to many suppliers across the tiers has led to extreme proliferation of different chemistries and thicknesses of materials. A supply chain Orchestrator can rationalize these decisions to consolidate the purchasing into far fewer variations, resulting in lower inventory levels and more flexibility across the chain. We will have a case study on this later in the series.
The next articles in this series will describe a case study illustrating how one automotive company consolidates the purchasing of steel across their entire supply chain.
To view other articles from this issue of the brief, click here.