Year in and year out, supply chain managers seem to be given the same charge: Cut costs (and improve performance while you're at it). It's a difficult assignment, particularly when you think that you already have squeezed every penny out of operations possible.

But there is a way to approach this task that can enhance your chances for success. Think holistically about the major ways in which cost reductions can be achieved. In particular, we believe there are three avenues to supply chain cost reduction that companies should aggressively pursue: materials costs, processes, and overhead. This article explores these avenues and shows how the techniques associated with each can reduce supply chain costs while keeping performance high.

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Depending on the industry much of the supply chain costs can be contained in material purchases. Hence most companies focus their cost reduction efforts on the materials they purchase. In pursuing a cost reduction program companies must first formulate a commodity strategy. A commodity strategy is a plan on how the company will reduce costs, improve quality/service and eliminate problems happening within that commodity. You cannot develop the same plan for each commodity due to the nature of the product or service. An example of this would be if we know that plastic prices are rising dramatically we may secure futures or bring in inventory to hedge against increases to our price.

Below are several techniques companies are using to reduce their material costs. Each technique should be evaluated and utilized whenever possible to maximize the cost reduction opportunities available. Think of these techniques as tools in your cost savings “tool-box”.

The easiest way to reduce material costs is to negotiate a lower price on the items you purchase. Ideally the greater your position of power the better deal you can negotiate for your company. This cost reduction approach can support your commodity strategy. The Dells and Wal-Marts of the world have a large advantage over other companies based on the volume of material they purchase. Coming from a position of strength they can and do control pricing agreements. Unfortunately many companies do not have that clout but can still negotiate a great deal for their company if they look at all of the opportunities they have to offer a supplier: Companies have several options to improve their negotiation strength:

• “Pool” purchases within a company to maximize leverage. Many companies will require that divisions within a corporation buy from the same supplier in order to lower costs. For example, the Raymond Corporation, a forklift manufacturer, commonly used this technique to reduce costs. The company had three separate divisions within the corporation at that time, each buying similar components and parts. The company leveraged its spending in all three divisions and saved millions by combining spend.
• Allow suppliers to use your advantageous corporate contracts (MRO, Commodity Items, etc.) in order to reduce their pricing to you. Allied Signal, prior to becoming part of Honeywell, used this approach with their suppliers. “They demanded material cost reductions but helped suppliers by letting them tie into their corporate contracts on office supplies, tooling and corporate travel.”
• Consolidate purchases from several suppliers to one or two suppliers in order to generate leverage. Many times companies will have several suppliers of a basic commodity. If the switching costs are low and the item is simple to produce, you should be able to get a bigger discount by buying that product from one supplier versus several.
• Train purchasing people on how to negotiate better deals. This is a simple statement but I am always surprised by the lack of negotiation training purchasing people receive.

Value Engineering and Value Analysis (VE/VA) are two tools that have been around since Lawrence Miles developed them in the 1940's for General Electric. Value Engineering is “concerned with the improvement of design and specifications at the research, development, design and production stages of product development.”³ This is a great cost reduction tool that has untapped potential in many organizations. Companies are using Value Engineering right at the beginning stages of product development and have active early supplier development teams.

Value Analysis looks at improving product value after a product has been placed in production by either reducing costs or improving performance. In 2002, I started a Value Analysis program at Philips Broadband Network, a subsidiary of Philips Electronics. Our facility produced broadband equipment for the cable television industry. In order to get our Value Analysis program started we solicited ideas from our supply base on how they could reduce our product costs or improve performance on the product they sold us. We received many suggestions and prioritized the ideas. We worked on the ideas that could give our organization a significant benefit. We decided to hold workshops at our supplier's place of business and try to make as many changes as possible during the event that would implement their suggestions. Prior to the workshop we gathered data on the products to be studied (direct and indirect costs of the material, blueprints, specifications and anything else that might add value).

Once we received all this information we scheduled the workshop, which usually lasted two to three days with each company creating a team to support it, made up of buyers, engineers and support staff. The teams would focus on five to six products during a workshop (usually products that were high volume, quality problems, or performance issues). Each item would be placed in the team room along with the corresponding prints, specifications and cost structure. The team would review the data in addition to analyzing the production process of the parts in question. Afterward the team would brainstorm ways to improve the process. We would then prioritize what ideas to work on first and try to change as many things as possible during the event.

During these workshops we would see anywhere from a 10 to 15 percent cost reduction opportunity. In one workshop we were able to cut the cost in half on an electronic assembly resulting in a $250,000 saving.

Reverse auctions have become popular in many companies. “A reverse auction is an on-line, real time, declining-price auction between one buying organization and a group of pre-qualified suppliers. The business process is dynamic where the suppliers compete for business by bidding against each other online using specialized software”. In the study “Facing the Forces of Change: The Road to Opportunity” author Adam Fein reports that on-line auctions are here to stay and growing. In 2000, 25 percent of buyers in companies that purchase more than $100 million were using online auctions. In 2003, that number grew to 42 percent. One local manufacturer in Syracuse, N. Y., reported to me that 90 percent of his sales go through on-line auctions. He stated that he's making less money on his sales but sales volumes have grown to compensate for the smaller margins.

Why do companies like reverse auctions so much? The big reason is the cost savings. Many companies have reported substantial savings the first time they use this tool (20-30 percent). There are several issues with using on-line auctions. The first is poor performance from the selected supplier. In a reverse auction companies will award the business to the low bidder. If the low bidder does not perform up to the agreed requirements, companies usually end up paying more for the cost of the material purchased (working to correct quality problems, resourcing etc.). Online auctions are better suited for commodity items. Why? Some companies are trying to reverse auction “customized” parts or parts with tight tolerances and specifications. The danger again is that a low bidder may not perform up to your expectations and cost you more in the long run. There are many reverse auction companies the largest being Ariba.

Standardization is another proven materials cost-reduction technique. If companies can reuse the same parts across different product lines they are able to reduce costs and develop products faster. Case in point is Toyota, which uses the same car platform across several car lines and divisions (Toyota and Lexus). This allows Toyota to get new cars to market faster in addition to reducing costs by using the same parts across different models. Toyota is working on a bottom-of-the-line car with an expected sticker price of under $7,000 that could hit emerging markets such as India and Brazil by 2009. Toyota's management is banking on breakthroughs in new materials, manufacturing, and low-cost factories. If the Japanese company's engineers do their job, the cost-saving strategies will be deployed in everything from Corollas to Lexus SUVs. “When I asked for the low-cost development project two years ago, I wanted to see technology that would be applied to other vehicles as well,” says Toyota President Katsuaki Watanabe.”

Organizations are now realizing that inefficient processes can be costing them money. The issue for most companies has always been about getting product or services to the customer without realizing the true cost of the processes. When we look at a process there are four areas for review that impact costs: sustainability, core competencies, waste, and variation. If a company focuses on these four areas they can substantially alter their cost structure and improve profitability.

Sustainability entails looking at your operation and trying to eliminate environmentally bad by-products and to recycle as much as possible in order to reduce costs.

3M, for example, has a program called Pollution Prevention Pays (3P). Any idea that could reduce pollution should also save money. In Green to Gold, authors Daniel Esty and Andrew Winston write: “Anything not in a product is considered a cost. As 3M execs see it, everything coming out of a plant is either product, byproduct (which can be reused or sold), or waste. Why they ask, should there be any waste? 3M management has been convinced that anything that increases its footprint emissions, solid waste, energy or water use—is a sign of inefficiency. 3M calculates that the company has achieved $1 billion in first year project savings.”

Many companies are now looking at the life cycle of a product before making a purchasing decision. The life cycle would be purchasing a product, using it and then disposing of it. In Europe electronic device and electrical manufacturers operate under the Waste Electrical and Electronic Directive requiring companies to have an “End of Life” plan for all products and finance the treatment and recovery of electrical or electronic goods. We are now starting to see this type of legislation in the United States. The Supreme Court recently ruled that that the Environmental Protection Agency now has the authority to regulate tailpipe emissions from cars and trucks, which account for about one-fourth of the country's total greenhouse gas emissions. This ruling will have a profound effect on the automobile industry. In the next ten years you will see more environmental regulations applied to companies and how they do business. The smart companies will design processes that are environmentally friendly to avoid paying for these regulations in the future.

Do what you do really well and outsource the rest. That's been the mantra for many companies. Outsourcing got its start in the 1980's as organizations began to realize that they couldn't do everything well internally. Niche companies started to form that were able to handle processes such as warehousing, transportation, and manufacturing. These outsourcing companies have grown in size and now offer lower costs then what companies can do internally. Today you can outsource virtually anything, and according to one account, Dell computer is one company that has figured this out. “By using Contract Manufacturers, Dell Computer supported $3 billion in annual revenues with only $60 million on fixed assets.” The benefit to Dell is not tying up capital on fixed assets. Companies need to evaluate on a yearly basis if it makes sense to continue doing a process in-house versus outsourcing.

The reality in today's world is that every single day somebody is devising or improving a process. To see what is occurring we have to constantly compare our processes to the industry leaders in order to stay ahead of the competition. One area that many companies are outsourcing is their logistics operation. According to one report, “Many manufacturers, retailers, distributors, and wholesalers choose to remain laser-focused on their core competencies by outsourcing more of their supply chain, logistics, and transportation operations to third party logistics providers (3PLs). 3PL's generated over 68 billion dollars in revenue in 2005 (a $20 billion increase from 2001).”

The cost-reduction potential of reducing waste in processes can be seen clearly in the “lean” philosophy of Toyota. In the first quarter of 2007 Toyota sold more cars then GM for the first time ever. In 2006 it was the most profitable automobile manufacturer in the world. Many people are not surprised by this outcome. Toyota has continuously improved through the years and is not satisfied with the status quo. One of the reasons for their great success is their belief in the Toyota Production System also known as Lean Manufacturing. Lean has everything to do with eliminating waste within the process and focuses a company on getting better each and every day. Most companies have started some type of Lean initiative but it's really about a culture change or “Lean Thinking.” James P. Womack and Daniel T. Jones, authors of Lean Thinking, describe this was of thinking as follows: “A way to specify value, line up value creating actions in the best sequence, conduct these activities without interruption whenever someone request them, and perform them more effectively. In short lean thinking is lean because it provides a way to do more and more with less and less- less human effort, less equipment, less time, and less space- while coming closer and closer to providing customers with exactly what they want.” In today's business world every company should be “leaning” their processes.

It's important to note that lean can be applied to any industry. Medical companies in particular have been aggressive in their pursuit of lean. A prime example is Medtronic Xoned, where according to one industry review article, “the benefits have been impressive. Some of the results of the company's lean efforts between 2000 and 2003 have included:

• A reduction in total production lead time in the Jacksonville facility of from 253 days to 129 days.
• An improvement in on-time delivery of from 85 to 96 percent.
• A 38 percent reduction in cost of shipped product.
• A 40 percent increase in productivity per employee based on annual sales.
• A 40 percent reduction in defective parts per million received by customers.
• A 50 percent reduction in plant floor space.
• A 57 percent reduction in rework.
• A 85 percent reduction in scrap.
• A 97 percent reduction in manufacturing cycle time. Despite these results, the company has no plans to rest on its laurels. Lean is an on-going journey of continuous improvement.

Six Sigma is a way to reduce variation within your process, which can then translate to lower operating costs. It's a quantifiable approach to understanding your process. Motorola incorporated Six Sigma into their culture in the 1980's in order to compete against foreign competition within their cell phone division. Statistically speaking, Six Sigma is 3.4 Defects Per Million Opportunities (DPMO) or 99.9997 percent accuracy within your process. The methodology commonly used is called the DMAIC (Define, Measure, Analyze, Improve and Control) process. Most Six Sigma initiatives use this methodology. GE is the company that really propelled Six Sigma to where it is today, spending hundreds of millions of dollars on Six Sigma training for its employees over the past 11 years, but making hundreds of millions of dollars back in savings, gains and profits.

According to one account of GE's efforts, “By 1998, the company had generated $750 million in Six Sigma savings over and above their investment, and would receive $1.5 billion in savings the next year.” Six Sigma is also being used in the service world. The banking industry is also utilizing Six Sigma extensively. Citi Financial, Huntington, Commonwealth, UBS, Chase, US Bank and Bank of America are all employing Six Sigma. “In all, Six Sigma and other quality tools have become part of the Bank of America's culture and have created benefits of more than $2 billion.” In the 2004 Bank of America annual report, Six Sigma is mentioned by executives as being part of their company's culture and making a positive impact on their company's results. Ron Sicker, Managing Partner of the TCM group, which does many Six Sigma implementations, states that “Six Sigma is being used in many organizations as a way to improve and manage your business. Six Sigma allows companies to quantitatively look at problems versus being subjective and guessing what might be wrong.”

Overhead costs can make up a significant portion of a company's supply chain cost structure. Many supply chain Managers are becoming responsible for reducing the overhead costs of their organizations. Companies are finding creative ways to reduce this overhead burden. Below are several areas companies can focus on to reduce their supply chain-related overhead costs.

Part Time/Temporary Workers

One way to drive down overhead costs is to eliminate or reduce employee workforce and related benefits. Many companies are supplementing their work force with part time or temporary workers in warehouses, distribution centers, and other supply chain operations. Benefits can make up 20 to 30 percent of a person's overall salary so it may be beneficial to use part time or temporary workers for certain jobs.

Tax-Aligned Supply Chain

An opportunity for multi-national companies to reduce their tax costs is the tax-aligned supply chain. If you were deciding to build a new facility or implement a new software system you may want to review with your accounting department where the most tax savings can be had from a country standpoint. Locating a supply chain project in the “right” country could save your companies millions from a tax standpoint. According to the Finance-Director.com website multinational companies have “the Potential to reduce corporate tax rates by 40 percent, inventory savings of over 30 percent, Pre-tax profit improvements of 5 percent, driven by better decision-making and improved service” by choosing the right country.

On-Site Partners

Some companies are asking their suppliers to be on site and to actually order and manage their inventory. Jacquelyn Stevenson, engineering planner of Lockheed Martin stated “that several Lockheed Martin commodity suppliers are used as 'on site partners.' The on site partners work at the Lockheed Martin facilities and serve as procurement representatives while helping to manage their inventory. By having the supplier's employees on site it saves Lockheed Martin personnel costs and also allows Lockheed Martin buyers to focus on more complicated mechanical assemblies and subcontract efforts.”

In the United States we are seeing an unprecedented amount of work being done by various states to retain and attract jobs. Many states are offering lucrative programs to entice companies to relocate or create jobs within their area. Organizations are now negotiating with states to build new plants and facilities within their domain. It has become a lucrative bargaining chip for many companies by opening up competition for these new facilities. The main incentives offered to companies by states are tax incentives.

North Carolina, for example, has been very aggressive in attracting companies to locate facilities there. The state recently won a contest with South Carolina to have Google locate a data center in its state. Google will create 210 jobs and invest over $600 million in the new facility. “The cost of wooing Google to the state's foothills could far exceed initial estimates, with tax breaks and other public incentives potentially reaching $260 million”. North Carolina also convinced Dell and Merck to locate operations within their state in 2004. Dell received over $280 million dollars worth of incentives over 15 years with Dell promising to create 1,500 jobs, while Merck received 34.4 million dollars in incentives while promising to create 235 positions.

In 2003 the state of New Mexico negotiated a tax deal with Intel, whereby the company agreed to contribute $30 million for a new high school. For its part, Intel gained access to $8 billion in subsidized industrial revenue bonds that would be used to build more plants. In addition, Intel would receive close to $645 million in tax breaks.

The State of Iowa recently “approved tax breaks in an effort to lure a large Internet company to Iowa. Essentially, the incentives would offer sales-tax and use-tax breaks on equipment, machinery and electricity on an investment of at least $200 million”.

Training Grants

Companies in the United States need to investigate supply chain training grant opportunities. This is a great way for companies to improve their supply chain skill sets and processes at little or no cost. Many companies are utilizing these training grants in order to train their employees on Lean and Six Sigma. Many lean trainers charge $2,500 to $3,000 per day while a Six Sigma implementation can cost between $5,000 to $6,000 per day. This is a great opportunity for companies to bring their companies to a higher level of performance. Many states offer training grants to companies that are hiring employees or upgrading employee skills sets. Typically, they are funded with a certain amount of money and then either refunded or replaced with a new training grant initiative. The State of New Jersey offers training assistance through The New Jersey Department of Labor & Workforce Development. New York State offers various training grants through an effort called Work Force New York. Some of these grants are non-matching and are free to qualified companies.

Utilities

One of the deciding factors for companies selecting a site for a new or relocating facilities are utility costs. In certain areas of the country power costs are substantially less than in other areas. Chattanooga, Tennessee claims to have the lowest utility costs in the country. Many states are trying to eliminate this factor by providing a subsidy for utilities. New York, for example, offers a Power for Jobs program in which the state will subsidize your company's power costs if you commit to create or retain jobs within New York State. California has a renewable energy program that offers many rebate and incentive plans on the use of alternative energy.

When we look at the supply chain we need to look at it from a material, process and overhead perspective. This is an effective way to segment our cost structure. Every day things are changing within these segments. In order to succeed, an organization needs to make sure they are using the right tools available in their cost reduction arsenal. In each area of the supply chain the goal should be to improve and lower costs. The danger for every organization is to be complacent with what they are doing. It can be an easy excuse to say “We already have the lowest cost possible in this area, or “There's no more cost savings to be found in this segment”. These types of thoughts can be precursors to increased costs. Go back and look at your supply chain cost structure and review the cost reduction tools we talked about in this article. Challenge your supply chain managers to explore all three avenues discussed in this article in order to reduce your supply chain costs.