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Purchasing: Best Materials Management Strategies

Before a new product is released or a major factory production begins, the materials group should have published a materials strategy procedure for the anticipated build plan. Here are a few strategies to choose from and the benefits and conditions for each strategy:

  1. Create long-term contracts incorporating high-volume commitments with rollback pricing at pre-determined lower-volume cost levels:
  2. By folding in anticipated long-term volume build schedules and quantities, individual part counts go much higher, and consequential increased volume purchase levels drive cost benefits. The contract agreements are written so that the supplier would realize a reduction in risk through rollback pricing if anticipated levels are not achieved.

    For instance, if the 50,000 piece price is set at $10.00, and the 25,000 level is set at $12.50, then, if a buyer enters into a purchasing contract for 50,000 pieces at $10.00, but only achieves the 25,000 level after a pre-determined period of time, the price rolls back to $12.50. The company would make up the difference for all previously purchased parts by paying an additional $2.50 per part penalty. However, the buyer would have the option to negotiate an extension period to use the balance of the 50,000 at the pre-determined pricing. Also, if there had been a significant industrywide cost reduction of the part over the period of the contract, you could renegotiate the penalty or the ongoing commitment based upon fair market pricing.

    This arrangement is in the best interests of both participants in the contract. The supplier benefits because it can forecast component demand with greater certainty while capturing the dollar commitment of the customer and establishing a long-term business relationship. The buyer benefits by having a long-term supply guaranteed at the lowest possible startup cost with a consistently performing, highly committed business partner.

  3. Work with major suppliers to obtain cost incentives for early payments against receivables:
  4. This is something suppliers may or may not take advantage of, depending on the prevailing business conditions. In general, everybody likes being paid on time, and earlier is even better. Consequently, this is an option for discussion with any and all suppliers. Most companies tend to hold onto their payables commitments as long as possible, and the supplier continues to carry the cost of the inventory until it is paid for. By offering the early payment and a better terms proposal, the buyer will resolve the additional cost-to-supplier issue handily. I have made this arrangement in the past, and it has been a win-win for both the supplier and the manufacturer. This requires special attention for the accounts payable people to avoid missing the discount deadline date but results in lower material costs to the buyer.

  5. Establish yearly rebates for meeting pre-determined dollar amounts with suppliers:
  6. This could be a cash windfall at the end of every year. If you achieve a pre-determined dollar amount in actual purchases and receipts, the supplier would write a check for some percentage of that dollar amount. One or two percent for every million dollars is an incentive that is easily affordable to the supplier that typically marks up at levels of 20 percent or more. Combine this with item 2 above, and your company could realize significant income.

  7. Set up in-plant stores where you don't own the parts until they are “checked-out” to the work-in-process operation:
  8. This operation takes place on the manufacturing floor. It comprises a caged area, set up and maintained by the supplier. The supplier is responsible for buying all parts to the master schedule as well as the integrity of the inventory count and the kitting operations required against each work order. The supplier owns the material until it is checked out to the manufacturing floor. In some cases, the supplier staffs the “cage” at its expense. In other cases, the company subsidizes the supplier's staff. The cost benefit resides in the fact that the cost of inventory is not accrued until the material is actually needed. This requires excellent build-schedule management.

  9. Create a system of just-in-time (JIT) deliveries to the contract house:
  10. This is the optimal inventory management scheme from an inventory turns perspective. The material is delivered to the factory floor only when it is needed. This requires maximum shop floor control and sophisticated receiving and accounting operations. The JIT deliveries can be scheduled bi-weekly, weekly, daily, or hourly.

    The manufacturing process must be absolutely consistent and the product well into maturity. JIT is a nightmare for early-stage products that are subject to ongoing engineering changes. The documentation for the processes must be impeccable. Shop floor control must be highly attentive to each work center's momentary requirements, and the line supervision personnel must have absolute authority to halt production in the event of a problem. The communication at all levels of responsibility must be perfect.

  11. Establish agreements with contract manufacturer to purchase all materials as required:
  12. This allows for combined customer volume buying and results in overall individual part cost reductions. By definition, the contract manufacturer (CM) has several customers that may use common parts among them. By centralizing the purchasing operation, lower cost can be passed on to the customer. The contract manufacturer must adhere to the approved vendor list (AVL) and the approved parts list (APL) provided by each customer.

    This fact may limit some of the advantages of centralized purchasing. The contract manufacturer must be accountable to very specific customer process requirements. This can be a difficult issue as the CM is usually located a fair distance from the customer. Engineering change orders, revision control, document control, and quality assurance issues are key concerns for ensuring manufacturing integrity. Unless the customer maintains regularly scheduled visits or has onsite personnel, then both distance and time will take a heavy toll on the product and the customer. While you may gain from a materials handling perspective, you will have to provide for the extra personnel to maintain the control required to run a remote operation.

  13. Synthesize and hybridize (creative combinations of any of the above):
  14. By combining two or more of the strategies above, you have the opportunity to realize an effective overall materials strategy. The strategy, once determined, would mandate the generation of additional procedures that would take your company towards a cost efficient and manageable manufacturing solution. The incorporation of additional strategies may be required over time, but it is in your best interest to decide upon a materials strategy procedure as soon as possible.

    This strategy will determine your overall materials plan and the nature of your manufacturing facility. You will need to meet with prospective suppliers and contract manufacturers to agree upon, and take advantage of, reduced materials cost, potentially adding up to big savings for your company.

2 comments on “Purchasing: Best Materials Management Strategies

  1. Barbara Jorgensen
    May 3, 2012

    Hi Douglas: It occurs to me that No. 6 is a potential game changer. EMS companies tried to stop owning materials after the glut of 2001. I know this was a contentious time for suppliers, distributors and customers. Have EMS companies started to come around again, or is it only with their supplier-direct relationships that they own the material?

  2. dalexander
    May 3, 2012

    Barbara,

    Each contract is unique and the terms are defined by both the competencies and the willingness of the CM to “customize” standard procedures to accommodate a customer's requirement. In some cases, some CMs will not go with purchasing the materials unless it is a full turnkey operation. But, there are always “in-between” measures that can be adopted in order to secure the business. The CM has to have the personnel to do the extra work and there is an add-on fee but in all cases, there are tradeoffs. The OEM has to determine if the cost tradeoffs are workable. ECO/ECN management to multiple suppliers require that the CM have well documented processes and specifically trained people to make sure all suppliers are kept informed on the changes that apply to them.

    It is also important to know what the OEM is going to require of the CM so the proper initial business survey/audit can be all-inclusive. Everyone has to make money so the economic times and seasons come into play as you suggest, but by making various terms tweeks here and there, there are usually ways to work out almost every requirement to everyone's satisfaction.

    The article did not include the additional detailed instructions for part suppliers in forwarding uniquely numbered packing slips and labels to the CM that they could use to follow the inventory in house and keep it separate from other customer's using the same manufacturer's parts. The whole operation went smoothly, but we did have to meet with every supplier to make sure that they knew how to interface with our CM. It follows the old axiom,”The more work up front, then less work on the back end.

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