Multi-Tier Sourcing

How are Supply Chain Managers coping with the pressures of global supply - especially in a world where competition for resources is growing fast? Managing these new risks is stretching capabilities - and may represent an excellent opportunity for creative suppliers.

Multi-Tier Sourcing Practices for Commodities Supplier Relationship Management by Manish Govil

As global price volatility and supply risks increase for many commodities, especially for scarce ones, effective strategies to compete for these resources become more important than ever. Emerging countries such as Brazil, Russia, India and China are absorbing much of the world's output of raw materials, and many companies are now finding competition for these resources, where previously supply was taken for granted. This is especially true with commodities used in manufacturing, such as base metals for aerospace, automotive, heavy equipment, and white goods (appliances), and precious metals used in the high-tech and medical fields.

One of the biggest challenges, then, is guaranteeing supply and containing costs through smart sourcing. For global enterprises with geographically distributed operations, this is a four-step process:

1. Identifying and aggregating the material requirements on a global basis. The single most important advantage companies have to secure supply and pricing is demand volume. Often, different regions or even divisions within a company use different names to describe the same commodity. Thus, the first step in volume aggregation is capturing detailed technical attributes of materials and then establishing cross-references among different names.

2. Aggregating the requirements for multiple tiers of the supply chain. This extends the concept in the previous step in two directions. First, cross-referencing includes the organization and the multiple tiers of the supply chain as well as the manufacturers and the suppliers of the material. Second, the original equipment manufacturer (OEM) should aggregate the total demand obtained from this cross-referencing from different suppliers in one contract.

For example, an automotive OEM may buy tailpipes and front-grill assemblies from two different vendors that both independently purchase chrome as a key ingredient. Similarly, an electronics company may get laptops and flat-panel TVs from different contract manufacturers, although both utilize the same liquid crystal displays (LCDs) as a key ingredient.

3. Securing supply for the entire supply chain using contracts that delineate innovative pricing. OEMs can aggregate volume purchases for a material as known to purchasing departments, but here the variables are established at the time of the contract, rather than being subject to change.

d. Total landed price: In traditional pricing, the transaction is based on a single price. It is accepted that this price actually incorporates a number of factors, such as base material cost, transportation cost, material handling cost, inventory handling cost, etc. In a strategic supplier relationship, the trading partners collaborate to bring the true cost down. Hence, they are willing to break down and share the different components of cost. The partner with the lowest cost for an operation may "own" that cost. For instance, if it is cheaper for the supplier to transport material to the buyer's warehouse, it will undertake this activity.

Thus, based on the manufacturing location of the material and the buyer's location, the price for the same commodity may be different for different buyer locations, instead of being an "average price" for all locations. This results in a truer cost, as the supplier estimates and averages the volume it will be supplying to different locations to arrive at a single price.

4. Smart execution against contracts: Increasingly, we are seeing OEMs acting as buyers for their entire supply chain needs. This entails the OEM acting as a broker, reselling materials or allowing suppliers to purchase through the OEM contracts.

OEMs are also collaborating closely with their suppliers for these strategic contracts, on both the demand and the supply side. The buyer may have manufacturing locations distributed globally, similar to the supplier, who in turn may have production facilities distributed globally. Instead of providing for the total demand, if the buyer provides for demand by location and time, the supplier can match supply to production, thereby reducing warehousing and transportation costs for both partners. In the case of supply-constrained environments, the OEM may be best positioned to make trade-offs to maximize the profitability of the entire supply chain.

A good example is that of an automotive OEM needing different specifications of steel of a particular type, where the basic production process of the different specifications is similar. Thus, the capacity for producing them is quite interchangeable. In the case of a supply constraint, the buyer may ask the supplier to provide the type of steel that is used for the more profitable product (the supplier may be agnostic to the supply of the different grades, since they may be very similar in price).

As these examples show, sourcing is no longer the domain of the supplier alone. Advanced software solutions are helping manufacturers understand and manage the complexities of supply-constrained and price-volatile commodities and to integrate complex pricing and contract structures.