(Guest Post) Optimizing Value in the Economic Downturn [and Recovery]

By Dr. Olga Raskina, Lead Scientist, Emptoris

This article is the second in a three-part series of guest articles on optimization by Dr. Olga Raskina, Lead Scientist, with Emptoris, the supply and contract management solutions provider.

As we push on through the troubled economic environment, corporate leaders are laser focused on bringing supply chain management under tighter financial guidelines. An article I recently read in Supply Chain Digest highlighted the typical urgency felt by procurement managers to cut supply chain costs.

As I read the article, I thought about how the typical knee-jerk reaction to reducing costs has often had adverse longer term effects: strained supplier relationships, diminished quality and diminished reliability among them.

While managers preach the importance of strategic relationships and decisions based on total cost, we are sometimes too easily willing to sacrifice that mantra in an attempt to resolve short term financial issues. The SDC article quotes one procurement manager as saying, “Forget about all that strategic stuff. We need to lower our costs right now.”

Of course, we can identify with the urgency. However, this mindset seems to ignore the possibility of cutting the costs while maintaining good supplier relationships — and improving overall business value to the organization.

I would actually propose that the downturn can in fact be addressed in a way that is actually beneficial to an organization — specifically in achieving these seemingly conflicting goals of costs vs. supplier relationships. The key to success, I believe, is in sourcing optimization.

Let me provide a brief case. As companies become increasingly spend-conscious, of course the demand for certain products drops, leaving suppliers with more inventory than usual and an increased willingness to sell.

In this environment, many suppliers seek creative ways to improve sales (and/or decrease inventory) and are often willing to negotiate new deals. These deals may take the form of volume discounts or better non-price terms such as decreased delivery time or improved warranties. And with such offers, comes an opportunity for revision and reevaluation of the existing purchasing agreements (and strategy).

The ability to analyze all aspects of a deal is critical in taking advantage of market conditions. For example, a majority incumbent supplier might have invested in fuel efficient, alternative specifications that can meet the buyer’s requirements — while a minority incumbent may have lost a large customer giving him more capacity to meet the buyer’s volume. An evaluation based primarily on costs may ignore these supplier realities.

Optimization, part of a bigger science called Operations Research, makes this analysis possible.

Operations Research, in a nutshell, is the discipline of applying advanced analytics to help make better decisions. Optimization, in turn, utilizes mathematical algorithms to rapidly solve a business problem by evaluating “all possible outcomes” (or many outcomes) and selecting those ones that yield the best solution.

When applied to supply chain operations, optimization helps the sourcing professional simultaneously evaluate thousands of different procurement inputs. This evaluation can take into consideration the global market, specific current supply chain conditions, and individual supplier conditions, and offers solutions that address the buyer’s [and supplier’s] goals in the best possible way.

Optimization goes far beyond simple spreadsheet-like comparisons. It helps ensure that no possible scenario or solution is overlooked and no money is “left on the table.” Although it may sound intensive, with the correct application of technology it can eliminate weeks of tedious side-by-side evaluations that attempt to simultaneously analyze the inputs.

Optimization is often limited by the “human factor.” According to different studies, a person can attend to 6 to 18 factors of evaluation simultaneously. However, as you know, any company-wide supply chain initiative involves thousands of factors and parameters, each affecting the bottom line.

Optimization-driven technology allows the procurement manager to evaluate the “new best state” of their supply chain and to react promptly. This could be as simple as relaying some or all key factors that affect a decision on suppliers.

By allowing suppliers to compete on more than just cost, you empower them to be creative. Once the suppliers understand the buyer’s goals, they can offer alternatives based on their own competitive advantages, and avoid being squeezed on just price.

Offers based on these competitive advantages might include:

– Alternative Specifications
– Extended Warranty Terms
– Discounts on Packaging
– Rebates for Bulk Orders

Depending on how extensive or creative the buyer wants to get, the goals of a new relationship might also involve overhauling the supply chain risk structure. This might include, for example, contemplating a switch from a single source supplier to a multi-source scenario or a local to a global operation.

Knowing your true total cost, beyond just price, when creating an agreement is critical.

In sum, I would propose that there are three critical benefits that Optimization can impart, particularly in an uncertain economic environment and recovery:

* Rapid response to the changing market conditions, including the ability to renegotiate existing deals and quickly achieve better total costs;
* Rapid evaluation of suppliers’ capacity, including the ability to rapidly add more suppliers to the operation;
* Ability to maintain and strengthen supplier relationships.

By making the negotiation about more than price, optimization allows the suppliers to be creative and offer more complex deals, compete on different direct and indirect cost factors, and not feel pressured to simply reduce the price.

Dr. Olga Raskina, Lead Scientist, Emptoris, Inc.

Olga has been an active member of the Institute for Operations Research and Management Science (INFORMS) for many years, and serves as vice-chair on the Boston Informs and on the Informs Subdivisions Council, focusing on promoting the value of Operations Research to businesses.   Olga has Ph.D. degree in Operations Research from Columbia University.

Editor’s Note: As is the case will all guest posts I would like to stress that neither Emptoris’ appearance in the Procurement Insights Blog, nor the positions presented by Dr. Raskina in the article are to be construed as an endorsement by Procurement Insights.

PI Window on Business Special (For Want of a Nail: The Pandemic Effect)

Be sure to mark Tuesday, May 26^th on your calendars so that you will remember to tune in to the first of four PI Window on Business 90-minute Specials.  In this initial Special titled “For Want of a Nail: The Pandemic Effect,” I will be joined by Nick Kelley, a researcher from the University of Minnesota’s Center for Infectious Disease Research and Policy, and the lead author of the November 2008 white paper “Pandemic Influenza, Electricity, and the Coal Supply Chain (Addressing Crucial Preparedness Gaps in the United States), to discuss the true nature of the latest swine flu crisis in terms of its potential impact on supply chains.  It is a show you will not want to miss!

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