Transference of Inefficiencies 

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Not something most people give a lot of thought to, assumption is, costs are on the rise and there’s a need to adjust our own costs as well and then pass it on to customers or the next one in the value chain in order to keep our company safe and profitable for a while, or so we think.

 

Is there a way to deal with those cost increases in a different way? What if you become proactive at helping your own vendors identify their inefficiencies so they don’t pass them on to you?

This is a different scenario than charging procurement with capturing cost reductions by negotiating or mandating discounts from suppliers; Which in essence consists in asking your vendors (and for the most part business partners) to sacrifice their margin like the source of cost reductions. 

 

Inefficiencies include things like excessive overhead, a poorly designed plant layout, lack of standards, noncompliance to procedures, rules and regulations, skills deficiencies, absence of a managerial system and indicators, reprocessing, inventories out of balance, poorly maintained equipment, fines and penalties, re-handling of materials, over complicated processes, interruptions in the work flow, tardiness, and a long list of other items.

 

Let’s discuss some real life examples on this and see how this happens more often than what you might anticipate.

 

An important retailer in South America was facing a spike in their logistics and transportation costs, as a standard practice in the industry all these costs are integrated on the final price that customers pay. Arguments presented to the CEO included gas prices, toll fees, inflation reflected on costs of maintenance, fleet age and manpower costs. All those arguments made sense on the books, but what was really happening at the point of execution? When a thorough and detailed assessment of how the logistics and transportation area was actually working, a number of inefficiencies were clearly identified. Half loaded trucks were being shipped for thousands of miles, penalties were being paid for late arrivals plus the additional cost of an overnight stay, lack of compliance on loading sequencing which generated unnecessary re-handling of products upon delivery, subcontracted services that were not complying with capacity requirements and a long list of other issues. When corrections were made and inefficiencies dealt with, the cost of transportation dropped to levels not seen before and inefficiencies were no longer being transferred and paid by the final customer.

 

In a different environment a major natural resources company went into survival mode and was forced to look for ways to reduce their production unit cost due to declining prices in metals, they had enjoyed a long ride of solid high prices and had gone under the assumption that they should not fight any price increases from their suppliers as the focus was on increasing throughput at any cost, unfortunately, a high cost was being paid. Considering that the business model was that over 80% of the work was being done by contractors, a renegotiation strategy was put in place with the purpose of identifying and eliminating inefficiencies and equally sharing the benefit, quite an innovative win-win approach.

Everything, from maintenance to logistic services was assessed and looked at through the perspective of an unbiased third party, important opportunities were identified over three basic categories, Effectiveness, Availability & Utilization and Compliance.

 

Effectiveness measured what the contractor had on site and how effectively these resources were being utilized, by looking at this category it was identified that the skills expected to be brought were not necessarily there. Making tasks take longer than standard and plan, two unnecessary layers of oversight were too much and was creating an increased traffic of people and equipment, detailed observations confirmed productivity levels in the 50%’s; in some cases vendors were not aware of their inefficiencies and had built it up in their cost structure passing it on to the company.

 

Availability and Utilization specifications made by the company were being met but had considered an unbalanced requirement of equipment just to make sure they were covered ‘in case’ it was needed, this was being paid in terms of the equipment being rightfully available with zero hours utilized 70% of the time, in this case an early dismissal was a win-win situation for all parties as equipment could be utilized elsewhere bringing more billing hours to the contractor that otherwise they could not have achieved and were happy to share part of the benefit in the form of a reduced hourly rate for the part of the fleet the company was actually utilizing.

 

Compliance brought up a very interesting set of opportunities, the highlight was a double sometimes triple or more subcontracting scheme of resources that were supposed to be directly available by the first service provider, real issue being that all the mark ups for each one of the sub subcontractors was being paid by the company, eliminating these multiple costs was a hard lesson for many, as the operational group had grown accustomed at being paper pushers of invoices, progress sheets, plans and schedules but nowhere in their line of sight or accountability was to look and identify inefficient costs that the contractors were passing on to the company, to make it even worse many of the so called “contract administrators” had no idea of what were the terms and conditions of the contracts they were managing.

 

Particularly in mid to large size corporations there is a divorce between the procurement functions and the everyday control of the execution of these contracts, the lack of understanding, vision and a methodology to continually capture these opportunities can cost you millions of dollars every year.

 

These opportunities can better be identified by a third party that is neither hiring the services nor providing them as it is the only way in which you can really have an unbiased perspective and also make sure that you get creativity in the way in which issues can be addressed and resolved, as some of the best ideas can very often come from outside your line of business. 

 

Make sure you are not the one paying for all the inefficiencies that are being transferred by your vendors and suppliers.

 

By: Cristopher Del Angel, CEO at To The Top Management Consulting