Earlier in this series, we explored some specific examples of supply chain orchestration in practice. In Part One we introduced the concept of the supply chain orchestrator. In Part Two we discussed one type of orchestration, buying materials or components on behalf of suppliers in your supply chain. Here, we explore how a major Automotive OEM is able to leverage information from their networked, multi-tier platform to rationalize the specs for the steel they buy.
Major OEM Buys Steel on Behalf of Its Parts Suppliers
Throughout much of its history, this major automotive OEM was a vertically integrated company, owning its own supply chain assets all the way back to raw materials facilities such as steel mills and rubber plantations. Although they have transitioned to a highly-tiered virtual enterprise model, the OEM still buys steel on behalf of their suppliers. Parts suppliers order their steel via a platform run by the OEM. The OEM buys steel for a supplier by creating two simultaneous transactions: the ‘buy’ transaction to the steel source, and the ‘sell’ transaction to the parts supplier who needs the steel. Title passes from the steel producer to the OEM and then to the parts supplier almost instantaneously. The OEM never takes physical possession of the steel. The physical flow of material is unchanged; there is no cash-flow impact for the OEM, and they do not need to own, store, or manage that inventory. These transactions became a sort of adjunct business and a profit center for the OEM procurement department as they determined the needs, aggregated buys, and resold the steel at an agreed-to price.
The outsourcing of manufacturing to many suppliers across multiple tiers in the OEM’s supply chain led to fragmentation in selection and specification of chemistries, thicknesses, and widths of steel. Now that they buy steel on behalf of their suppliers, the OEM has complete visibility into what steel is being bought across the chain. This has enabled the OEM to rationalize1 and consolidate chemical and dimensional specifications to allow more pooling of supply.
While steel is most often referenced as a ‘commodity,’ it is in fact an engineered material (in contrast to aluminum, for example). The combination of the specification and the source is critical, and can have a significant impact on upstream stamper cost, quality, and productivity. Mills must go through a certification process to be approved by an OEM’s engineering department. The OEM vehicle frames were typically designed in a very localized manner. The chief engineer would separately optimize each frame for weight and cost and optimal thickness, without considering what might be optimal across their supply chain and product lines. As a result, engineers could specify dozens of similar but slightly different thicknesses, each of which requires its own unique Master Coil. Mills charge a premium for sub-coil quantities of special sizes, as they must sell off the excess to someone else.
Multi-Tier Material Specification Approval Process
Several years ago, the OEM moved to a multi-tier material specification approval process that allows them to discover who is buying what and steer suppliers to a rationalized and optimized set of material specifications. By reducing the number of variations, the OEM can buy from fewer Masters, providing a lot more flexibility, such as the ability to combine blanks in the middle tier to reduce waste from the Master Coil. For example, about 30% of the parts in their automobiles are made from steel less than 24” wide. Since Master Coil widths typically range from 24” to 72” wide, someone in the supply chain is slitting the steel to less than 24 wide.” The OEM can coordinate this to optimize the use of those coils.
Multiple Disciplines Assess Tradeoffs
Rationalization and optimization of materials specifications requires examining many tradeoffs and impacts. The OEM engineering, purchasing, and supply chain personnel work together to figure out where cost enters in their supply chain, for example tying it back to Economic Order Quantities.
Automotive OEM Benefits from ‘Knowing the Specs’ Used in Their Supply Chain
Active involvement in the specification process across the supply chain also can help deal with some supplier challenges. Smaller ‘Mom and Pop’ shops may be subject to bankruptcies during tough market conditions. In the past that would have been a bigger problem, because the OEM may not have known the exact specifications of the steel that went into parts manufactured by that supplier. Now that the OEM already knows the materials part of the equation, they can focus on finding the right processing capabilities when looking for a new supplier, making it quicker and easier to bring another supplier on board. The same is true anytime there is a need to change suppliers, such as when transitioning to minority-owned suppliers.
Critical Success Factors for a Multi-Tier Buying Program
The OEM and others that have built multi-tier procurement programs have learned some valuable lessons about what it takes to get a program like this up and running:
- Aligning Internal Financial, Sourcing, Engineering, and IT Organizations — Getting internal agreement within the Orchestrator (sponsor) company is key and is often the main challenge, at first. Often, CPOs or other senior procurement executives will be the initial champion (since they are the ones being challenged with rising commodity prices and they have to come up with a plan if they want to keep their jobs). Although the purchasing executive may recognize and drive the need to rationalize materials, engineering has to be an active supporter and agree to participate and lead the spec rationalization process. Engineers may need to be persuaded that the supply chain benefits of rationalized spec commonality are much greater than the engineering benefits of having project-unique requirements. Multi-tier buying requires not only a financial investment (potentially, new IT systems), but also a change in the financial relationship with suppliers (who are now buying from you). Hence, the CFO also needs to understand and support the concepts, benefits, and financial implications, and fully support the initiatives. IT will need to be involved in any technology platform decisions. Alignment is not always straightforward, since the concepts are often new and internal politics frequently arise. Substantial financial gains, as well as other benefits, must be clearly articulated and the CEO may need to get involved.
- Getting Agreement with Suppliers — There can be resistance from suppliers who feel threatened and see these kinds of initiatives reducing their own spend and their negotiating leverage with mills and/or stockers. Additionally, for suppliers who are better than their peers at procurement negotiations, this removes one of their competitive advantages — they are forced to compete exclusively on their value-add processing capabilities, and this may be viewed as a negative change to them. So, it can make sense to start with the suppliers who are good at value-added processes and don’t feel threatened if they don’t buy the steel. There are some value propositions that can be made to convince suppliers what’s in it for them:
- Stabilized supply — they no longer have to worry about whether they will get raw materials. That becomes the OEM/Orchestrator’s responsibility. Suppliers can concentrate on value-add processing.
- Inventory reduction — with materials rationalization, there can be reductions in the total inventory carried across the network and by each supplier. However, calculating this reduction and how to share the savings is still not an exact science.
As part of their negotiation strategy, some suppliers may underestimate the gains to them. An OEM might be wise to launch with top, relatively trusted suppliers, where there can be a more open discussion.
- Getting Agreement with Materials/Commodity Suppliers — Steel mills have to agree to allocate the necessary capacity and be convinced of the value of reduced credit risks and aggregated orders. This will be part of the overall negotiations, based on the larger, consolidated volumes.
Multi-tier Buying . . . Not for Everyone, But Invaluable for Some
Today, this OEM directs more than $4 billion of steel spend annually across a network of 1,000+ users from 400+ entities, operating out of 500+ locations. They collaborate with their suppliers to manage over 100,000 parts, materials, and part-to-material relationships. The investment, process changes, and effort required to run this vast multi-tier procurement network has been substantial, but well worth the payback. Most companies do not play the dominant ‘anchor tenant’ role in their supply chain. But for large OEMs or key players in a supply chain, especially in industries with large volumes of commodities spend spread out across multiple tiers, a networked multi-tier procurement approach can have enormous benefits.
For more on the role of the Supply Chain Orchestrator see the Orchestrators Collection.
1 In automotive and some other industries, this process is sometimes referred to as materials commonization — Return to article text above
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