Due to the positive response we received from Jeffrey Wincel’s post, The Illusion of Six-Sigma, we have invited him back as a guest blogger. In this post, Jeffrey, principal at LSC Consulting Group, tackles the issue of evaluating cost drivers within a company’s supply chain.

In the supply chain consulting world I normally encounter two primary types of clients. The first are those companies who haven’t really been able to engage supply chain as a serious player in their organizational effort to deliver profits; and the second are those who know and have played the “big game” in SCM and are now ready to take the next step to become even better. Each has its own unique characteristics and are often equally challenging to work with, yet both usually have a common problem – how to really evaluate and understand the cost drivers within their supply chain.

In the manufacturing sector, procured materials and services make up 50-70+ percent of the total cost of goods sold (COGS), and therefore have the single largest effect on profitability. Because of this, it is essential that the cost drivers of the procured products and service be fully understood – this means more than purchase price. Effective procurement initiatives are doing more than running to the low cost regions of the world and making purchasing decisions by “3 quotes and a cloud of dust.” They understand the material, labor, SG&A, overhead, engineer content, etc. that make up the cost drivers leading to price. The ability to effectively improve the cost structure in a sustainable way is knowing and managing these elements.

Unfortunately, most suppliers view the sharing of cost data as an effort to manage their profits, having nothing to do with controlling costs. They most often claim that their costs are proprietary or that their management is unwilling to disclose the information. Suddenly the buy/sell relationship is engaged in a struggle. Suppliers believe that the customers look only at price in making their procurement decisions; the buyers believer that their suppliers must be hiding something if they don’t want to disclose price, so they actually do resort to buying only on price. In this environment there is no way that there can ever exist a customer-supplier collaboration or partnership.

On the question of whether to “share or not to share,” my answer (from both sides of the table) is to share. Of course there have to be ground rules in this process, such as NDAs, concurrence on cost drivers, commitment to evaluate cost versus profit margins, and how to equitably share in the benefits derived from cost improvement initiatives. In response to Tim Minahan’s recent post regarding global competition, Michael Lamoureux wrote: “the answer is not low-cost country sourcing or right country sourcing, but home country sourcing. Whomever can do that competitively will be the long term winner!” I agree with Michael, but the only way in which we can make home sourcing competitive is to actively and aggressively manage the cost elements which make up price while allowing the opportunity for both buyer and seller to remain profitable.