Strategic Sourcing for Total Cost Management:Turning Suppliers into Partners

a PLM WhitepaperPrepared by ENOVIA MatrixOne

In today’s challenging global

economy, product companies are

under intense competitive pressure

to drive top-line revenue, reduce

operational costs, increase market

share and accelerate innovation.

The most successful companies

are not going it alone. Instead,

they are looking to their suppliers

and partners to help maximize

competitive advantage through

faster time-to-market and cost

reductions. These companies are

shifting their strategic sourcing

initiatives toward Total Cost

Management, or TCM. Under

TCM, OEMs transform suppliers

into strategic partners by shifting

procurement’s focus from piece

prices and transaction costs to

total cost.

Executive Summary

• Executive Summary 2

• How Do Product Companies Improve Profits? 4

• How TCM Works 5

• The Changing Role of Procurement 6

• Strategic Sourcing and Total Cost Management 7

• TCM Requires Cross-Functional Team Collaboration 7

• Tools and Technology 8

• Strategic Sourcing & TCM in Action 10

• Conclusion 11

Strategic Sourcing for Total Cost Management:Turning Suppliers into Partners

A PLM Whitepaper Prepared by ENOVIA MatrixOne

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OEMs today must contend with intense global competition, the critical need to bring quality products to market faster and cheaper, the drive for design innovation in demanding markets and the push toward global outsourcing to low-cost regions of the world. Total Cost Management (TCM) enables OEMs to harness their suppliers’ expertise to drive top line revenue and bring products to market faster. In addition, the strategic sourcing component of TCM drastically reduces the largest cost item to hit an OEM’s bottom line—Cost of Goods Sold, or COGS.* The combined revenue improvement and cost savings delivered by TCM makes it a fast-growing improvement approach within the manufacturing industry today.

How Do Product Companies Improve Profits?

Figure 1. In a recovering market environment, increases in demand for raw materials and product inputs can make COGS increase faster than company revenues, continuing to minimize profit margins. In one such example, a major industrial and agricultural equipment manufacturer recently reported higher annual revenues of $15.5 billion with a higher annual percentage rise in COGS to over $10.7 billion. So while the top line revenue growth appeared strong, it did little to improve profitability, as COGS were not managed downward.

The chief procurement officer (CPO) for a leading OEM of electronics products and telecommunications systems recently demonstrated a clear understanding of COGS’ effect on the company’s bottom line. The CPO reported that material purchases represent the single most important cost item in the company’s profit-and-loss (P&L) statement, and that a 5% reduction in these costs would add $1 billion to the company’s bottom line.

*COGS represents expenses for commodities and direct materials paid to suppliers for the components, assemblies and subsystems that an OEM or manufacturer puts together in fabricating the finished end product.

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The incremental profits driven by a TCM approach are a result of higher quality, more innovative, and more price-competitive products entering the market. Many of today’s new products incorporate a combination of embedded systems that integrate software, electronics and mechanical packaging and have a shorter shelf life than ever before. This complexity and short product life adds up to even greater pressure on time-to-market, time-to-revenue and product profits across most industries. Hence, the performance of an organization is increasingly dependent on the overall internal productivity, effectiveness and efficiency with which it collaborates with its suppliers.

Adopting a TCM approach anchored by strategic sourcing tools that underpin it can significantly streamline the processes needed to guarantee product quality, product cost and time-to-market. TCM provides suppliers with visibility and input into an OEM’s new product design and development processes as early as possible. This

enables suppliers to recommend product designs, design features and optimal component configurations based on their own design, manufacturing, cost and delivery capabilities. With the increasing complexity of products, this close cooperation between OEMs and their suppliers is even more crucial.

While improved time-to-market for new, innovative products is the critical strategic benefit behind TCM, it is important to understand the drastic cost reduction benefits that companies realize by leveraging TCM-driven supply chains. Some of the greatest opportunities for savings presented by TCM’s strategic sourcing component come through reductions in COGS. COGS represents a huge expense for most manufacturers, with direct material costs typically comprising 50-70% of the total spend distribution, compared to only 15-25% for SG&A (sales, general and administrative fixed cost). The exact split varies by industry.

How TCM Works

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The Changing Role of Procurement

Figure 2. More mature supply-chain operations directly translate into greater business value in terms of added revenue, reduced costs, and improved profitability.

Procurement groups vary greatly in their levels of maturity. “Maturity” in this context is defined as “Procurement’s ability to contribute to revenue growth, cost reduction and improved profitabil-ity.” More mature procurement groups succeed in these areas, not by chance, but because they have instituted three core elements that help them focus on delivering business value:

• Sourcing Strategy: It is not enough for Procurement executives to understand the concepts of early supplier collaboration, design-for-supply-chain, TCM, etc. They must define the strategies to incorporate these into their company’s daily activities in a systematic way.

• Overall Organization (i.e. skills, governance, incentives and metrics): Having a strategy in place is critical, but it must be enforced by organizational structures and incentives that promote desired behaviors. When procurement teams understand the desired metrics for success and recognize that they are evaluated on those metrics, their actions and processes will align to them.

• Tools & Technologies: In order to harness all the benefits that suppliers have to offer, procurement teams must have the proper collaboration, purchasing and other tools required to streamline processes that support overall group goals. (i.e. skills, governance, incentives and metrics)

As Figure 2 below illustrates, OEM procurement groups that institute a TCM approach deliver the most business value to their companies.

In the traditional procurement and sourcing pro-cesses, the purchasing manager would get involved only in the later stages of the product design cycle. The decision-making process is one of hard nego-tiations based solely on price. Thus, the purchasing group would act purely as a support function.

Moreover, traditional purchasing processes are long and complex, requiring buyers and suppliers to invest significant time and effort searching for information to complete and evaluate RFQs. They engage in a manual back-and-forth cycle of information exchange via e-mail, FTP, mail, fax and phone, all while product requirements continue to change. Delays are rampant as suppliers must often rework their quotes, and the process must start anew.

With historical data residing in multiple information silos, companies find themselves overwhelmed with new regulatory compliance requirements, such as Sarbanes-Oxley, that demand fast access to new levels of product-related data. Add to this the typi-cal breakdowns in communications between dis-persed company and partner locations and the end results are delayed product launches, sub-optimal final products and a loss of competitive advantage.

To quickly and relatively easily eliminate some of the problems that organizations face in the tradi-tional process, many companies have implemented E-sourcing. E-sourcing (the automation of tradition-al sourcing processes) delivers a higher level of data integrity through enhanced data consolidation and reporting. It also represents the first step toward strategic sourcing, and eventual total cost management.

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A growing number of companies have elevated purchasing to a more prominent position within the organization -- often led by a C-level executive reporting to the company president or CEO -- reflecting the potential impact of purchasing on a company’s bottom line. Thus, titles such as Chief Procurement Officer and Procurement Director are emerging in the upper ranks of corporate organizational structures.

Beyond working more closely with suppliers, the purchasing group also must collaborate closely within its own enterprise across a variety of different disciplines including engineering, manufacturing and finance. Moreover, it often must spearhead cross-organizational alignment and commodity councils that put the efforts of suppliers in synch with internal groups from those areas. Executive-level commitment and direction become critical when instituting such organizational realignment in order to obtain buy-in from all necessary stakeholders. With high levels of commitment comes a high payoff:

• Direct collaboration between suppliers and OEM engineers

• Alignment between centralized corporate procurement and decentralized procurement departments

• Company-wide visibility into metrics on supplier quality and performance

• More extensive part/asset re-use and commonality across product platforms

• Supplier rationalization• Instant access to all product related data, inside

and outside the enterprise • Streamlined supplier design and sourcing

collaboration through standard electronic tools• Savings opportunity identification by

understanding the cost drivers in the supply chain

TCM Requires Cross-Functional Team Collaboration

Strategic Sourcing and Total Cost Management

Strategic sourcing, and ultimately TCM, aims to reduce COGS—not by reverse auctioning or “beating up” suppliers for lower prices, but rather by establishing systems for more effectively com-municating with suppliers and working with them on issues of quality, delivery, standardization and innovation. Such collaboration is becoming more essential as the manufacturing industry under-goes a transformation to increased outsourcing in which suppliers take responsibility for production of major components, assemblies and entire sub-systems as well as product design and assembly. For example, a leading OEM of computers and peripherals recently reported it has shifted 90% of its manufacturing to external suppliers, up from 10% in the 1980s.

In the 1990s, organizations deployed lean manu-facturing concepts to streamline their internal operations. The “lean” concept involves a strict

employee focus to eliminate waste of all types through standardization of work processes, zero defects, flawless new product launches and se-cured supply sources. Product companies are now extending “lean” to the supply chain in order to achieve TCM.

This shift gives OEMs an opportunity to take ad-vantage of supplier innovations. However, reap-ing this benefit hinges on collaborative processes that allow suppliers to provide ideas and suggest changes throughout the product lifecycle. This close collaboration is particularly important early in new product development when concepts are be-ginning to take shape and changes are made most easily and inexpensively. In fact, once a product reaches its final design, 80% of the product costs are locked into place, making early supplier col-laboration critical to controlling costs.

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Tools and Technology

Most Internet-based procurement solutions being marketed today fail to address the broad needs of strategic sourcing and TCM. For the most part, conventional tools are aimed at areas such as indirect materials (office supplies, peripheral equipment, etc.), MRO items (materials for maintenance and repair operations) and true commodities (off-the-shelf items such as fasteners, adhesives, etc.) These solutions focus on price alone, generally through auctioning, cataloging or settlement.

In contrast, strategic sourcing and TCM focus on understanding product cost drivers and expanding lean concepts throughout the supply chain. Given the need to consolidate and share a wide range of product data, the best approaches are based on Product Lifecycle Management technology.

Product Lifecycle Management (PLM) technologies enable companies to manage all of the information about their products, from initial concept through to manufacturing and after-market service, within a single information environment—a PLM environment—that ties together all product-related

processes, data and non-product documentation across a company’s value chain of customers, employees, partners and suppliers. All elements of product data (CAD designs, engineering requirements, product schedules and plans, analysis results, sourcing plans, product quality management, manufacturing inspections, etc.) are incorporated into the PLM system and tied to the critical processes and tasks undertaken by internal and external teams.

PLM stands alone among enterprise applications in its ability to integrate product design and development information from the vast array of intra-company and extended-enterprise systems. Equally important, PLM provides the necessary processes and workflow that companies must establish and adhere to in order to successfully manage their products throughout the complete lifecycle. PLM is a tremendously powerful tool as a basis for enabling TCM because of its unique ability to manage a vast amount of information throughout the product lifecycle and across dispersed locations, both within the company and throughout the supply chain.

Figure 3: With PLM as a foundation, strategic sourcing and TCM solutions overcome the limitations of conventional e-sourcing and Supplier Relationship Management (SRM) tools.

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With PLM as the foundation, strategic sourcing and TCM solutions overcome the limitations of conventional e-sourcing and Supplier Relationship Management (SRM) tools by providing functionality in several key areas:

• Consolidation of all product-related information • Secure access and real-time visibility to product

data for suppliers and internal groups• Collaboration capabilities for multi-function

purchasing teams, including suppliers• Integration with desktop authoring tools and

corporate ERP systems• Processes for handling supplier suggestions and

ideas throughout the product lifecycle• Supplier performance tracking and quality plans• Workflow and routing for review and approval

processes• Templates to standardize and improve the

efficiency of sourcing processes across the organization

Following are the critical components of a PLM-based Strategic Sourcing and TCM solution:

• Supplier Information Management: Purchasing personnel need to track and update

supplier profiles, and suppliers need to be able to access and update their own profiles. This enables purchasing to:

• Track supplier business units and locations • Maintain Approved Supplier Lists (ASLs) • Track supplier process capabilities and

certifications • Publish supplier standards • Maintain commodity teams and councils with

buyer desks

• Supplier Development Planning: Purchasing and suppliers must have the ability to access a single environment for creating, reviewing and sharing development plans. In addition, development managers and individual production facilities should be able to report and track key supplier metrics.

• Information Security: For each product part or sub-assembly, buyers must be able to assign supplier responsibilities (i.e. design, manufacture, or test). The solution should also control the levels of a BOM and

the types of data that a supplier can view. Administrators should also have the option to configure role-based access to specific information where general rules do not apply.

• Product Quality Planning: Solutions should offer part-quality plan templates with work breakdown structure so that suppliers can achieve process standardization and predictability. Detailed templates should allow for plan scheduling and completion dating, with plan dashboards for viewing status and tracking issues.

• eSourcing and Sourcing Templates: Further standardization can be achieved when solutions include RFx templates in support of commodity, program and BOM-based sourcing —particularly if the templates allow for customer, purchasing and supplier input.

• Cost Management and Estimation: To understand the various costs of each assembly, the system should capture detailed cost breakdown information for each item and support calculations and roll-ups.

• Decision Support and Analysis: Sourcing analytics are needed for profitable decision-making and award justification. Solutions should provide dynamic yet simple summary reports and dashboards.

• Sourcing Program Management: Program and project management should be

included to drive immediate savings with detailed work breakdown structures.

• Single, Unified Environment: Given the large number and varied locations of people and organizations involved in product development today, a single information environment must be accessible by all stakeholders. This is the only way to ensure that the right people view the right information at the right time. Of utmost importance is the ability to execute the sourcing process in parallel with the upfront product design phases. Without this capability, the opportunity for supplier innovations to positively influence product design cost reductions is greatly hindered.

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Strategic Sourcing & TCM in Action

Based on our experience with customers across all manufactured product industries, companies using a strategic sourcing or TCM approach can expect, on average, to improve buyer productivity by 15%, reduce material costs by 2% to 5%, lower overall product costs by 5% to 10% and shorten sourcing cycle times up to 50%. Moreover, the potential improvement in profit margins is significantly higher using strategic sourcing and TCM versus traditional purchasing methods. Following are several examples.

A major supplier of automotive systems implemented ENOVIA MatrixOne’s strategic sourcing solution with two major goals in mind: to gain a single source of product information for collaboration with each of its 120 suppliers and to improve product quality and launch speed by enabling earlier collaboration between its engineers and suppliers during prototype development. In less than one year, the company achieved a more strategic relationship with each of its 120 key suppliers and reaped a return of two-and-one-half times the entire project cost.

An automotive OEM is implementing ENOVIA MatrixOne PLM to improve its overall cost analysis when collaborating with its massive base of 2,500 suppliers. The OEM is targeting productivity improvements in excess of 30%, which will result largely from significant improvements in cost analysis and cost tracking/data retention within a single information environment. Cost analysis improvements are expected in the range of 75% by suppliers providing more accurate quotes as the result of improved visibility into product designs.

One consumer products company formerly relied on traditional paper documents to interact with suppliers around the world, causing inefficient information sharing in the supply base and excessive costs, delays and pricing problems. By implementing online sourcing and improving

suppler communications, the company was able to collaborate earlier with suppliers so that all product data and changes were visible in real-time to all key participants. Product delays were significantly reduced as a result. Furthermore, the move to online quotations resulted in an estimated $200,000 of annual savings in shipping costs.

A major supplier of industrial systems used the strategic sourcing solution from ENOVIA MatrixOne to establish a global commodity management program. The program has helped the company is on its way to achieving its goal of shortening RFQ process time by 75%, reducing warranty costs by creating and tracking quality metrics for suppliers, strengthening relationships with key suppliers and reducing overall cycle times through enhanced supplier communications.

As noted earlier, the largest gains are achieved when communication is improved early in the new product development process, when concept designs are just being formed. By collaborating more effectively at this stage through strategic sourcing, a manufacturer of electronic controls was able to significantly reduce product launch costs by improving on-time supplier PPAP (Production Part Approval Process) from 28% to 90% over two years. Conservative tangible cost savings from this area of the solution alone is resulting in savings of $1.5 million annually.

Finally, a major High Tech company leveraged strategic sourcing and TCM to perform design-for-supply-chain. By providing a single, unified environment for internal design engineers and external suppliers, the company has been able to drastically reduce communications errors in the earliest design stages. As a result, design change iterations have been drastically reduced, saving the company more than $10 million per year.

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Conclusion

Strategic sourcing and Total Cost

Management provide product

companies with tremendous

benefits by transforming suppliers

into partners throughout the

product lifecycle. With purchasing

expanding its focus from solely

pricing to strategic alignment and

information exchange, companies

are realizing improved profit

margins and earnings per share

through cost reduction, quality

improvement and rapid product

innovation.

Only recently have the tools and

technologies become available for

implementing strategic sourcing

and TCM solutions capable of

generating these types of ROI

and transformational business

benefits. While many companies

have continued to rely on tactical

tools for sourcing and supply chain

management, more and more

C-level executives recognize the

tremendous power of strategic

sourcing and TCM and are

leveraging them to position their

companies to dominate their

markets for years to come.

SouWP-0609

MatrixOne, Inc. was acquired by Paris-based Dassault Systèmes in May, 2006 and today is part of its ENOVIA PLM Collaborative Environment family of solutions. The ENOVIA MatrixOne solutions enable companies to accelerate product innovation to achieve top line revenue growth and improve bottom line profitability. ENOVIA MatrixOne is focused on helping companies across the automotive, aerospace & defense, consumer, machinery, medical device, semiconductor and high-tech industries solve their most challenging new product development and introduction problems. More than 850 companies use ENOVIA MatrixOne solutions to drive business value and gain a competitive advantage, including industry leaders such as BAE Systems, Bosch, Comau, General Electric, Honda, Johnson Controls, Linde AG, NCR, New Balance, Nokia, Philips, Porsche, Procter & Gamble, REI, Sony Ericsson, STMicroelectronics and Toshiba. ENOVIA MatrixOne (www.matrixone.com) is headquartered in Westford, Massachusetts, with locations throughout North America, Europe and Asia-Pacific.

210 Littleton Road, Westford, Massachusetts 01886 978 589 4000 MatrixOne.com

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