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“Smart Sourcing” In the Global Environment

Global sourcing is a procurement strategy aimed at exploiting global efficiencies in production, and a standard step in the global expansion of firms. The advantages of global sourcing include identifying alternate supplier sources, utilizing buffer capacities and taking advantage of specific geographic talent pools. Global sourcing may reduce and control costs, free up internal resources, gain access to world class capabilities, increase revenue potential, reduce time to market, increase process efficiencies, follow company philosophy of outsourcing non-core activities and compensate for lack of appropriate skills.

Organizations, however, are recognizing the real costs and inherent risks of outsourcing. Instead of simplifying operations, outsourcing often introduces complexity, increased cost and friction into the value chain, which require more senior management attention and deeper management skills than anticipated. Two major challenges facing organizations that outsource the fabrication of their products are in understanding the correct price that should be expended for any given outsourced commodity and understanding the total cost of that commodity in real terms.

In the manufacturing sector, global procurement organizations, or commodity management teams, are essential elements of a company’s global sourcing strategy. These procurement organizations are primarily responsible for identifying and developing key suppliers across sourcing categories and helping satisfy periodic sourcing requirements of the parent organization. These procurement organizations deal directly with the supply chain, spending significant time in negotiations to obtain the best product price. This is a critical function, as the impact on profitability can be significant over the life cycle of a program. During the negotiation phase, focus on employing a “should cost” model provides a significant value proposition, providing the procurement/commodity manager the necessary information that can be leveraged to obtain the best possible pricing.

Whether an organization has personnel with experience in the manufacturing process or not, global sourcing is critically important, particularly when assessing vendor quotes and/or discussing cost improvements by various manufacturing process trade-offs. There are multitudes of parameters that contribute to the ultimate cost of producing a given part or assembly, which may create a challenge for any one individual to be a process expert and/or to address the volume of commodities that are being outsourced to a variety of companies in the vendor pool.

In order to perform “should cost” analysis, a procurement organization requires tools and methods to accurately determine the fair price it should pay for a given commodity, from a given vendor. Parametric cost estimating models, such as SEER for Hardware, Electronics & Systems™ (SEER-H) and SEER for Manufacturing™ (SEER-MFG) from Galorath Incorporated, provide the necessary knowledge, data and framework to empower a procurement organization with the necessary information to determine fair market pricing when negotiating with outsourced vendors.

By arming the procurement personnel with “should cost” model templates produced in models such as those from Galorath, procurement managers enhance their supplier negotiations and maximize profitability through the optimization of different critical parameters. These parameters include selection of optimum materials, manufacturing processes / operations, set-up and tooling amortization, lot sizes and automation levels. The SEER® models provide the commodity managers with access to these variables. These templates increase the user’s ability to evaluate product pricing from different perspectives and interactively obtain the best price possible.

Debbie Wilson, now with Gartner Group, said it best. Ms. Wilson stated: "When price negotiations are conducted with accurate cost models in hand, I firmly believe that they yield superior results. That's because fact-based discussions support joint problem-solving and relationship building with key suppliers far better than just using a heavier hammer or an alternative supplier's hard luck (and consequent willingness to do business at a lower margin) to drive savings. Furthermore, cost modeling provides the basis for continuous cost reduction and waste elimination. It puts RFPs and sourcing projects back in their appropriate place, which is assessing potential suppliers in the marketplace…”

To create the estimates, each product family is examined with various weighting factors, which are applied to establish a baseline. These factors include geometric complexity, the manufacturing processes involved, including programmatic sizing and quantity adjustments such as production quantity, lot size, and set-up and tooling amortization quantities. If available, programmatic data and historical pricing data improve the accuracy of the estimates. This data also affords the commodity manager the ability to formulate the best economies of scale from a cost view point, which can be used to leverage a “best price” in the negotiation process, weighted by vendor commitment of resources.

The major benefits associated with “should cost” modeling in the supplier negotiation process include: access to many variables not normally available, such as process optimization, i.e., the cost variance between castings and forgings; bar stock machining and castings; adjustments in tight tolerances; and selection of various materials. “Should cost” models rate the manufacturer from a capability standpoint, which includes machinery automation levels, machinery condition and types, staff skill levels, and experience with the specific type of work in question. “Should cost” models also allow performance of trade studies for programmatic data, such as set up amortization, lot size modifications, etc.

“Should cost” modeling should be the cornerstone for any company that outsources manufacturing. A capable “should cost” model provides credible and defendable estimates of manufacturing and assembly costs, and allows for the evaluation of alternatives that directly impact the cost to manufacture. “Should cost” modeling facilitates proactive, real time cost impact assessments of design alternatives for today’s global sourcing environment.

Joseph Falque is Product Director of Hardware Models for Galorath Incorporated, a leading developer of cost estimation software models for hardware and software development projects and IT infrastructure projects. Learn more at www.galorath.com.

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