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01 November 2019

TCO – Making the case for Integrated Supply

A core element of the business case for Integrated Supply is reducing the Total Cost of Ownership – the cash and resources committed to acquiring and holding the ‘long tail’ of production (BOM) and maintenance (MRO) parts.

Total Cost of Ownership (TCO) is a familiar phrase, but it can be a challenge to identify all the costs and cost-saving opportunities involved. At customers I often notice the Procurement budget typically sees the ‘hard’ savings: item price reductions, and perhaps some ancillary costs such as transport and delivery. Across many hundreds of orders such savings certainly accumulate, but on any individual order they can appear trivial.

In my experience these hard savings on sourcing are not the only or most important way in which Integrated Supply can realise financial advantages. There is a wide range of other benefits available, mostly deriving from improvements in Logistics and Processes. These are not intangible, or purely nice-to-have benefits since they may not be apparent on invoices, nonetheless they can have real impact on the Profit & Loss account. Some are readily quantifiable but show up somewhere else than on the Procurement budget. Others are contingent: Integrated Supply creates opportunities that can be converted either into cash savings or into more profitable activity elsewhere. Only if the company acts to realise the benefits.

Savings on other budgets
Examples of real cash savings that I see on other budgets include: reduced financing or working capital costs (because the company doesn’t have capital tied up in safety stocks); lower inventory levels, which can realise savings in facilities (especially if space is being leased) and insurance cover; and major reductions in write-off costs, again because only the required quantities are being bought.

More significant though are the ways in which Integrated Supply can reduce logistics and process workloads, resulting in freeing up labour and other resources. For example, through automated systems and information flows, improved data and fewer errors, economical and ergonomical approaches to storing and issuing parts, aggregation of demand and consolidation of orders and billing, and even process simplification. All these savings can really contribute to slash the resources needed to manage your spend.

Labour and resource requirements are reduced right through the Procure to Pay cycle and beyond (I’ve seen by up to 90% with the best automated ordering and invoicing processes). End users spend less time researching their requirements and raising requisitions. Procurement staff are less engaged in identifying and negotiating with suppliers, obtaining quotations and issuing purchase orders. The workload at goods receiving and issuing is reduced, through consolidated deliveries, delivery direct to lineside and clever storage and replenishment systems. Storemen and production or maintenance engineers spend less time and effort walking to stores locations and hauling parts back. In Finance & Accounts, a single invoice replaces hundreds while smart systems remove the causes of error and dispute. Throughout, assured and accurate supply eliminates the need for unplanned activity and rush orders with their associated costs in overtime, courier delivery and so forth.

Practical choices
These economies in labour and other resources are very real. Yet how they show up on the P&L account depends on what the company does with them in practice. In some cases they may be ‘cashed in’ through, for example, headcount reduction. In many cases, though, firms will choose to use the Integrated Supply dividend to divert effort and resource to more profitable, value-adding activity. Procurement staff, for example, can spend more time on the large, complex contracts where this time investment will show a big payoff. Production staff can increase output if their time is spent building rather than searching for parts. Maintenance staff can similarly return equipment to use more quickly, again increasing productive capacity.

For every factor in the Total Cost of Ownership, Integrated Supply offers economies which can all be evidenced either as cost savings (less cash leaving the company) or as cost optimisation (the same money but used more profitably). These all flow directly and demonstrably to the bottom line. And for the most part these are not one-off savings – they represent a permanent reduction in the cost base, bankable year after year.

There is a further source of savings which I hope will never show up in the accounts. Whenever material supply fails, even for low value ‘tail spend’ items, risk is incurred. A missing maintenance part may lead to lost production, which may not be recoverable. A missing production item might cause late delivery and a compensation claim from the customer. Systemically unreliable production may lead to lost and cancelled sales. Integrated Supply helps ensure that these costs never appear on the P&L.

Making your case
Thus, a business case for Integrated Supply should consider all three elements: Cost Savings visible on the Procurement account; Cost Avoidance implicit both in reduction of the required resource base and the elimination of risk; and the Added Value that arises from the ability to redeploy skills and resources to focus on more profitable channels.

And to round it off, I’d like you to consider these additional benefits: reducing boring, error-prone manual processes, tiring walks to and from stores, tedious arguments with suppliers over small discrepancies, and endless firefighting, which makes the company a much nicer place to work!

In the next blog you can read all about the first element: Cost Savings visible on the Procurement account.

Dirk van den Hengel is CCO at MAG45

Dirk van den Hengel

Dirk van den Hengel is Chief Commercial Officer at MAG45. Dirk is a Supply Chain Management professional with a strong track record in business consultancy and project management. He co-developed MAG45’s international project management department and helped create the company’s value proposition. He holds a Master’s degree in Industrial Engineering & Management Science from Eindhoven University of Technology.