I enjoyed Tara Parker-Pope’s recent Well column in the New York Times: Getting Doctors to Think About Costs by Pauline Chen, M.D. Dr. Chen opined about how doctors have been typically unaware of how much various procedures, such as CT scans and MRIs, cost when they order them and even whether they are always necessary. She wrote about a non-profit organization, Costs of Care, that is trying to address this issue and help make medical trainees more aware of costs. The article has a link to an educational video, Hotel Hôpital, which illustrates the opacity of costs to the patient with a hotel stay that is billed in the same way as a hospital stay.

I experience my own version of Hotel Hôpital at a dentist visit a few years ago. Maybe I should call the experience “Hotel Dentaire”. I was visitng the dentist for a 6-month checkup. He had found a cracked filling, which he repaired during the visit.  On my way out, I got my pricey surprise. And, I was asked to pay on the spot. I didn’t happen to have my credit card with me and asked the dentist’s staff whether they could bill me. The reason I was unprepared was because up until that visit, they had always billed me. The staff said no, that I had to pay right then. I had been seeing this dentist for many years, had referred many friends, and was surprised at this sudden, rigidly deployed policy. I asked whether, as I long-time patient, they could give me a little consideration as they had in the past and bill me. I would pay them promptly. They grudgingly agreed, since I had no payment means with me at the time. Then, not only did I get a bill, but I received an unpleasant letter from the dentist as well. He said that when he goes to the store, he has to pay for items right away and who did I think I was not to pay on the spot after the service. Maybe he hadn’t noticed that, unlike dentists,  retailers by law have to affix prices to items in stores and not surprise customers at the checkout.  I’m not sure why my dentist got so angry with me, but I decided that I had to find a new dentist. In retrospect, I realized that the dentist had recently taken his son into his practice. Many dental schools are now teaching practice management. Cash on the barrelhead is part of that. I can fully understand the need to monitor cash flow and administrative costs. But hopefully dentists can also pleasantly communicate with patients and afford them a little notice and slack during transitions to new monetary policies. I had thought I was a valued customer/patient. But I guess my infraction left me in the trash heap of deadbeat patients.

When I saw the Hotel Hopital video, exaggerated as it seemed for a hotel, I could totally relate to the unpleasantly-surprised hotel guest in the video. Typically, insured patients have no idea how much any medical procedures cost since they never see the bill (unless they are uninsured). This has led to people feeling that they don’t have to worry about how much procedures costs, since they are never asked to pay out of pocket.

The medical system in the U.S. is suffering from a huge lack of transparency. However, I’m not sure whether instilling cost consciousness in physicians about the whole medical system is going to reduce the ordering of unnecessary tests and procedures as long as they have to be in CYA mode to avoid lawsuits.

-Sherry R. Gordon

In my last post, 9 Ways to Fight a Supplier Price Increase, I listed approaches to handling a supplier price increase. These involved pushing back.  These days, commodity prices may be at the heart of increases. They can be volatile and unpredictable and offer little room for black and white approaches. Besides using hedging, a technique that only someone who really knows what they’re doing should attempt, other ways to tackle increases can be considered. Sometimes it takes a collaborative effort between customer and supplier to figure out how to avoid the price increase and even to reduce the price by reducing underlying costs. It isn’t done by threatening or bludgeoning the supplier into submission.  Here are 5 approaches for a buyer who is faced with a price increase. Not all are appropriate to every situation, but can be considered, depending upon the circumstances.

• Use competition. This is useful only under some circumstances. If you’ve got a supplier with a highly value-added product or service or one who is sole source, this may not be feasible. If the product or service falls more into the leverage category (rather than strategic or bottleneck), you may be able to hold a sourcing event using software or else use an alternative source whom you’ve wanted to try. Competition can be a useful tool if used cautiously and wisely with suppliers who provide products and services that are more readily available in the marketplace.
• Alternative materials/services. Perhaps the supplier can use a different, less costly material to make the product. Or for a service supplier, a less costly service will meet your requirements than the current one that you are buying. Being creative about alternatives may save you money.
• Value analysis/value engineering. Have you and the supplier done a value analysis of the product? If not, the supplier in particular, may be able to come up with creative ways to make the product more cheaply and potentially improve it at the same time. This can result in mutual benefit to both customer and supplier. Many suppliers, who know their product better than their customers do, are willing and even eager to do a value analysis but are rarely asked.
• Longer-term agreement/contract.  Some suppliers are willing to give their customers a better price in return for a longer-term contract. Extending the contract period can give a supplier the predictability and stability to offer a product or service at a more favorable price.
• Packaging and transportation. Can anything be done to reduce the amount of packaging or make it less costly? Can transportation costs be reduced? Are customers paying inbound transportation markups?  For example, many suppliers make a profit on outbound transportation to the customer by not passing along their savings to their customers.

In Part 2, we’ll look at 5 additional ways to handle supplier prices increases.

Sherry R. Gordon

I was reading the recent blog post at the Spendmatters:   Beyond Shedding the Deadweight in Procurement and Operations. Instead of just cutting headcount, particularly in procurement, Jason Busch suggests other ways to approach cost reduction. Among the suggestions are: driving better efficiency by fully using software solutions in the Procure-to-Pay cycle; using third parties to help you outsource and cut spend; and last, cutting inventory as much as possible and working with critical suppliers to help them reduce their cost structures.  I’d like to add lean to list, both as a continuous improvement toolset and as a way of thinking. Companies should be deploying lean thinking and lean enterprise practices to help remove waste in the entire company. Waste is defined as creating no value and as something that a customer would not want to pay for.

OK, so you’ve heard a lot about lean and maybe your company has a lean initiative going on. Many people still think lean something you do only on the factory floor and it doesn’t pertain to them if they work in an office. No, it’s not just for manufacturing wonks. Or else I hear, “Yeah, we’re lean. We’ve cut everything to the bone.”  That’s lean and mean or lean anorexic, not the real meaning of Lean Enterprise.  Lean and mean is a cost-cutting exercise and is not real Lean, which is a systematic elimination of non-value added activities (i.e., that do not add value to the customer or that the customer would not want to pay for). Cutting 10% across the company is a desperation mentality, value-add and customers be damned, like amputating your own limb. Desperate measure for desperate times.

So what about lean in relation to all things procurement and suppliers? Lean thinking, tools and culture afford the opportunity to reduce and eliminate the sources and causes of waste and cost that come from doing things the way they’ve always been done. It means not just helping suppliers improve their operations and cost structures, but also addressing one’s own internal process inefficiencies that often adversely impact suppliers’ ability to meet customer requirements.

Traditional procurement maintains a big supply base, a short-term focus and is internally driven. Lean procurement is system-oriented with a focus on total cost and internal and external customers. The traditional mentality is to get a better price (’cause that’s what we’re measured on), but potentially pay later in quality, delivery and service issues. Now is the time to look at the supply base and decide based on best value, including performance, which suppliers to focus precious resources on and whom to disengage. Procurement can adopt lean practices such as value stream mapping to identify non-value added activities. It can look at internal workflows and at those involving suppliers. Visual systems (5S) in the office can be used to improve the procurement and supply management work environment so that people don’t waste time looking for things or even waste space. Procurement can identify not only the problems, the root causes of the problems. It can uncover:  Where are the bottlenecks? How much do people have to wait for the next step in the process or for resources due to work imbalances and bottlenecks? And who manages the waiting, which is in itself only additional waste? Procurement should work in concert with other functions to expose and eliminate hidden cost drivers such as: customer complaints, long lead times, systems issues, quotation errors, incoming inspection, expediting, excessive paperwork, poor controls, poor communications, poor supplier quality, etc. Or, eliminate the extra steps and waste in what can be called the inter- and intra-company circle of waste – that is, the waste that occurs in the business processes pertaining to and between customers and suppliers or in the white spaces.

But most importantly, in addition to working on important supplier performance improvement and development projects, procurement can adopt a continuous improvement/lean mentality and culture within its own function both as a model to its suppliers and as an important step to do its part to help restore the entire company to financial health.

McKinsey recently published the results of its global survey on managing global supply chains.  To boil down a seven-page article: they aren’t managing the risk.  Or to quote the article: “relatively few respondents…say that their companies are translating the importance they place on these [risk] factors into corporate action.” Are we surprised at this conclusion? Of course not. Managers who are not addressing risk seem to be a favorite whipping post lately for supply chain pundits.  

So if risks are so important, why are they not being addressed? And, can risks really be avoided or overcome? There are several possible reasons why executives are not addressing risk. Perhaps they are unclear how to do it. Risk is not something that you can eliminate, as many articles on supply management seem to imply. The probability of some supply risks can be reduced, but many catastrophes or supply chain failures cannot be prevented, only mitigated once badness occurs. There is no magic solution. Or perhaps companies have focused global supply chain management on chasing the lowest price for goods and services and have not paid attention to the resulting supply chain complexity and increased risks. In the process of seeking to lower cost with lower price suppliers, companies may be giving up reliability and sustainability.  Another contributing factor to global supply risk is that businesses processes, including supply chain processes, simply evolve over time and are not consciously designed, planned or improved. The resulting processes can become out of control or just inefficient, ineffective and prone to failure.

While it’s discouraging, McKinsey’s study comes to the same conclusion as other similar studies (e.g., Aberdeen Group’s report, “Supply Risk Increases as the Market Stands Still” – subscription required) – supply risk management is still in its infancy and not yet widely adopted. It’s still in the lots of talk but little action stage.

What can companies do about supply risk? I discuss this in Chapter 9 of my book, Supplier Evaluation and Performance Excellence and will post some more thoughts on the subject in future blogs.

In a rush of enthusiasm about a lean supply chain, some firms expect that their suppliers will embrace lean with equal passion. Passion for lean can be contagious, but getting suppliers to adopt lean requires much more work than lean inoculation or indoctrination. Before rushing off and sending out an announcement that suppliers should adopt lean, a lot more must be in place. Some enthusiastic suppliers may be eager to learn more about how to become lean, and you need to be prepared internally to work with them and have a path already thought through. The firm should first identify which suppliers would make the most business impact and from whom both they are you would derive the most benefit by their adopting lean; which are likely to be willing candidates for lean; and who is already on or at least contemplating a lean path. This can be done through a supplier segmentation exercise focused on lean.No, supplier segmentation isn’t just for sourcing. It can be used for lean supply chain and for supplier performance management. Segmentation is a way to determine appropriate resources for managing, developing relationships and working with suppliers, depending on their relative importance to the business. Segmentation is not a science. And it should not become a long, academic exercise, either. It is best when used as a team exercise to help come to a common understanding about and categorization of the current state and for identification of future opportunities for, in this case, lean in the supply chain.

For some strategic suppliers who are vital to and have a high impact on the business, lean supplier development may be the best path. That is, a customer firm may wish to get a supplier to adopt lean principles and practices throughout its business. We are talking real lean adoption, not lip-service lean adoption (which, unfortunately, is an all too common occurrence). However, for other types of suppliers, targeted lean projects geared toward a specific result may provide the best use of resources and a quick win that can help gain support and pave the way for more lean in the future.

Thus, supplier segmentation for lean is a good first step. Actually, there is a step that must be taken before the segmentation – defining first what a lean supply chain really means to your company.

 When my company was a small supplier to Boeing, I was of course happy to have landed them as a customer. Our relationship was excellent and added value to both parties. Boeing took a chance with my company, an emerging technology business. And the initial bureaucracy that we had to go through to become a supplier to such a large company was challenging beyond even their expectations. But on the other hand, there was a lot in it for them. The value that we added was clear. They got the following benefits from using a smaller technology supplier: thought leadership, alignment with and accommodation of their needs, excellent service, and a supplier who would always “go the extra mile” for them.  And for us, they used our product and got benefit from it which helped affirm our value as an emerging company. Together we created synergies that we would not have done alone, in spite of our disparate sizes. Clear value is a key ingredient for success in creating mutually beneficial relationships between customers and suppliers of disparate sizes.

This takes me to the point that I was making in my last post about when your supplier is bigger than you are. A smaller company, whether in a supplier or customer role, can develop a mutually beneficial and cooperative relationship with a bigger organization. Another key is developing and fostering good working relationships among the people at both companies.  The old adage, it’s all about the relationship, applies just as well to customer-supplier relationships.  While companies do business with each other, it’s really the people who do business with other people. Of course, you need to choose wisely when developing relationships, as doing so requires resources. Not every customer or supplier merits the resources required to develop deeper and trusting relationships.

Relationships can and should be built at different levels of the organization. When the time comes for getting a larger company to cooperate with a smaller one, several things may happen. Your contacts are more likely to go to bat for you when needed or break through the bureaucracy. Especially when senior management develops relationships with counterparts at the larger company, then making the business case for change, such as better business processes and practices, becomes much easier to accomplish. However, if the relationship is purely transactional and arms-length, then introducing new processes, business ideas, opportunities, etc. will taken longer (best case) or won’t happen at all (likely case). Transactional relationships are less personal and do not require high levels of interaction and trust, important ingredients for getting a bigger company to work cooperatively with your smaller one. Interestingly, the nature of the relationships between companies may not necessarily indicate the importance of the companies to each other, depending upon whether a company has segmented its suppliers and customers and is pursuing appropriate relationships based upon segmentation.

Many companies are concerned about suppliers who are larger than they are. How do you get a 500-pound gorilla to cooperate with you? Can you actually use the term “manage” in relation to a big supplier company? Actually, can you ever really manage even small suppliers? Not really. You can try to manage and influence the relationship, but you can’t actually manage a supplier. Customers and suppliers are part of the same value chain, but they remain independent entities, no matter how big or small you think your leverage is. Once you stop thinking about managing suppliers, then new possibilities arise.   Many companies assume that because they have no leverage over their large suppliers in terms of their size, they do not even attempt to get suppliers to make changes and improvements in the way that they do things that impact them, the customer.  They focus on the smaller guys over whom they feel that they have financial clout. Or, in a supplier strategy session that I was involved in recently, the team drew teardrops next to the names of some of their big gorilla strategic suppliers because they hadn’t yet figured a way to get these companies to cooperate, were suffering from low levels of cooperation, yet saw the potential benefits of alignment. 

In the next few posts, I’d like to propose some ways to get larger suppliers to work with you and ways to make changes to the dynamics of the relationship. The first step in the process is segmenting your supply base and identifying who your key or strategic suppliers are. If you determine that your relationship with the big supplier companies is purely transactional but should be strategic and you’ve given up in advance on ever getting the situation to change, then it’s time to rethink your approach. You are creating potential risk and cost and forgoing the benefits.

In an effort to flow lean to suppliers, firms are often internally focused. They are concerned with how suppliers can support their needs and tend not to view the situation from a systems perspective. Often it is about what suppliers need to do to satisfy their customers — which is certainly an essential ingredient.  However, firms tend to focus on the invidual parts (sometimes quite literally) rather than on the whole. For example, in an effort to improve material flow in the supply chain, inventory becomes the customer’s sole focus. Meanwhile, customers may forget about the interactions among firms and the relationships that can either support or hinder progress in becoming lean throughout the extended enterprise.

Often it is the “white spaces” (I adapt this term from the classic book, Improving Performance: How to Manage the White Space in the Organization Chart) or intereactions and relationships between firms that are the least visible and least addressed, yet have great potential for harboring hidden cost drivers and for holding the keys to becoming lean. Without a functioning relationship, how can a customer begin to ask a supplier to embark on changes that may be disruptive to the supplier in the short term? On what basis would a supplier want to adopt lean practices without the promise of WIIFM (what’s in it for me)? Making substantive changes just to retain a customer’s business is not always sufficient motivation for a supplier. Without a reasonable relationship in place and a two-way flow of information between customer and supplier, the supplier’s response may be lip service without any real change. The relationship is the “soft stuff” and the inventory is the “hard stuff.” And as they say in change management and organizational development circles, the hard stuff is easy and the soft stuff is the hard stuff.

Some of the hidden cost drivers in the supply chain are relatively easy to uncover, measure and address by adopting classic lean approaches. However, many supply chain problems begin and end with the customer-supplier relationship. The extent to which critical issues, wastes and cost drivers can be identified and mutually addressed depends heavily on the strength of the customer-supplier relationship.

Developing good business relationships with key and critical suppliers can help in areas that are often weak, for example by:

• Developing common and simple communications
• Developing a common understanding of one another’s needs
• Sharing business strategies in order to develop in the same direction
• Understand and overcome differences in quality systems and IT systems
• Mutual involvement in innovation and product design
• Uncovering areas of risk through better knowledge of suppliers’ businesses

To identify hidden cost drivers and waste, you will need to apply lean thinking and lean principles and practices to your own firm and to work with key suppliers to adopt lean as well. Each firm needs to look at not only what it can do to add value to customers and eliminate wastes and cost drivers within its own organizations as well as its internal processes and practices that create waste and cost at its customers and suppliers. Often customers are unaware of the extent that their business processes and practices, while seemingly cost-effective within their own four walls, cause risks, create and multiply waste and cost at the supplier and come back to bite them in the form of higher costs, service failures, quality problems and customer complaints.

Many firms are realizing the importance of actively addressing these relationships and find that they do not have the internal organization to readily develop and manage suppliers. Supply management is often addressed from the sourcing and buying standpoint. Once the deal is done and suppliers are on board, they are often ignored unless there is a problem. 

The wastes that are part of lean thinking are well-documented, waste being defined as anything that doesn’t add value to the customer or that a customer would not be willing to pay for. The classic seven wastes in lean thinking include: unnecessary transport, inventory, wasted motion, waiting, overproduction, overprocessing and producing defective products/services. How do these wastes manifest themselves in the supply chain? What are the causes and effects? Who is responsible for them?

Much of the waste and cost in the supply chain is attributable to business practices and processes at both customers and their suppliers. For example, a customer firm’s frequent schedule changes may unintentionally cause a chain of events that increase waste in the supply chain. Frequent schedule and order changes, particularly those that are less than lead time, may compel a supplier to carry excess inventory, may cause shortages and increase lead times as the supplier scrambles to cope with unexpected changes. The effects can become magnified and create a self-induced volatility. Schedule and order changes can increase overall cycle times at both customer and supplier, with the customer ordering earlier because of increased purchased part lead times, while continually making changes mid-cycle and keeping just-in-case inventory of its own. The situation can snowball into shortages, expediting and increasingly longer lead times. Supplier quality problems can create other cost drivers ranging from rework, shortages, and expediting at both customers and suppliers, as well as warranty returns, customer complaints and increased volume at call centers.

You need to find these cost drivers in order to eliminate them. Management typically pays more attention to visible costs than invisible costs, even though the latter are quite real, often risky, and are robbing the bottom line like invisible bandits. While no business likes rework, returns and complaints, firms continue to do things as they’ve always done them and institutionalize these invisible costs as a part of doing business. They may address them every so often, but the gremlins of the status quo always manage to put things back to the way they were before.

Next: Addressing hidden supply chain cost drivers