Based on market conditions, research and their real-time visibility into sourcing events, Category Managers in our GSO group identified the Top 5 Categories to Source Now and presented their findings in a Sourcing Interest Group (SIG) webinar yesterday. I’ll highlight some of their key findings and recommended strategies for each of the categories here over the next week or so.

#5 on the list is … Direct Materials.

The case for sourcing direct materials started off with Pat Furey stating “in all my time in manufacturing, I’ve never seen direct materials spike up this quickly.” Scary thought considering that in the audience poll, 55% ranked the impact of direct materials prices on procurement “High” or “Very High.” But with the right strategy, cost pressures to these mission critical inputs can be minimized.

So, what strategies did Pat and his team recommend for sourcing and dealing with supplier proposed price increases?

• Identify labor intensive processes and components with high value add content (i.e. assemblies, stamping, injections, molding, etc.). These materials are relatively least impacted by high commodity prices and therefore less susceptible to rising commodity prices.
• Insist on detailed cost breakdowns. Armed with information on the percentage of raw material costs incurred by suppliers, you’ll know just how valid their ‘necessary’ price increases are. For example, if a commodity, say steel, makes up 30% of a vendor’s costs, that is the only portion of their price they should be asking to renegotiate. According to Pat, you MUST know this level of detail with suppliers and actively use the information in negotiations.
• Build the right type of price adjustment clause into your contracts. There are numerous options for how these clauses are structured and they should reflect the type of direct material being sourced. For example, an input with a low percentage of raw materials making up the cost, should have a fixed price with only a ‘catastrophe clause’ to account for a major market changing event. On the other end of the spectrum, copper or resins might be tied directly to their market index in order to ensure continuity in the supply chain.
• Resist surcharges … unless the vendor justifies them. Require that your suppliers have an ‘open book’ policy on their costs. Although they may balk at providing this information, it’s worth a try. And often stating that you empathize with the cost pressures they feel and want to work with them to find common ground will go a long way towards opening their books.
• Source in the region of use. Rising fuel/transportation costs and a declining US$ are factors in the ‘nearshoring’ trend we’ve discussed here for quite some time. And as former low-cost countries evolve into emerging consumer markets, this will become a larger and larger opportunity for savings.

The final recommendation for sourcing savings on Direct Materials was … look elsewhere for savings. Direct Materials will continue to feel the squeeze from high commodity prices, the weak dollar and inflation. So, other categories - such as those ranked 4th through 1st on our countdown - may provide greater opportunities for savings.

Justin Fogarty is Managing Editor of Supply Excellence. For any questions or feedback on the blog, please email Justin at jfogarty[at]ariba.com.

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