even though they were no longer required or they
weren’t needed yet. When the company fixed
this situation through instituting better controls,
including requiring approval for and exercising
more discretion over the use of premium freight,
it netted a US $680,000 savings.
5 Cost of inappropriate sales and opera- tions planning (S&OP). There are signif- icant costs associated with sales and operations planning in an outsourced environment,
where additional complexity increases both risks
and costs. For example, because outsourcing
has lengthened the fulfillment pipeline, schedule
changes tend to have a much larger impact than
in the past, when a manager could walk out to
the plant or drive down the street to visit a supplier in order to find out what was going on and
make adjustments if needed. In addition, having
to manage multiple demand streams among a
network of contractors has added complexity.
Yet many companies fail to recognize the need
to modify the S&OP process when outsourcing is
involved.
Here is an example of what can happen when
S&OP processes do not take the complexities of
outsourcing into account. One of our clients was
having serious delivery-performance issues with
a contract manufacturer in China. It turned out
that several business units were using the same
contractor, but each division was only interested in its own needs, and they did not talk to
each other. As a result, they were unaware of
the demand the company as a whole was placing on the supplier and that the order volumes
were straining the contractor’s capacity. Then,
when the supplier began to have trouble meeting
delivery requirements, each unit added more
buffer to its demand—which put the contractor
further behind and increased lead times. When
we reviewed their aggregate order and production
schedules with all of the business-unit planners,
we learned that 40 percent of the demand being
placed on the supplier was not actually needed.
If the buyer had managed its S&OP so that it had
an accurate picture of its overall requirements,
then that logjam could have been avoided, and
the company would not have been saddled with
the cost of the unneeded inventory it had ordered.
A thorough understanding of the hidden costs
directly related to S&OP and their root causes is
the first order of business. The goal is to get to
more realistic schedules, continuous customer/
supplier communication and collaboration, and
frequent performance reviews to reveal the true
issues hiding in the S&OP process.
6 Cost of poor or substandard quality. The total cost of inadequate quality typically represents 5 percent to 12 percent of the
buyer’s revenues. But depending on how quali-ty-conscious—or unconscious—an organization
is, it can represent as much as 20 percent of those
revenues.
It’s often difficult to find and quantify quality-related costs, which means that the majority of
these costs are hidden. The obvious ones (scrap,
rework, repair, and so forth) can be obtained
from the contractor’s financial statements. The
remaining costs (prevention, detection, internal
failure, and external failure) are more challenging
to identify and require making assumptions and
employing a good activity-based management
approach to classifying both the real and hidden
cost of poor quality (COPQ). The best way to
avoid quality-related costs, of course, is to practice
proactive prevention rather than deal with them
after the fact.
7 Cost of warranty, returns, and allowances. These are costs associated with out-of-box quality. Warranties require product repairs
or replacements at no cost to the customer, customer returns equate to lost sales, and allowances
are discounts for blemished but fully functional
products. For many companies, covering these
costs has become an institutionalized way of
conducting business. Many organizations “solve”
warranty, returns, and allowance problems by
allocating reserves to cover the anticipated costs
each year. This approach does not address the
root causes of those costs, which are traceable and
assignable with the right improvement analytics.
These costs are also avoidable through predictive
analytics that allow early identification of patterns
of warranty issues, followed by the right preventive actions early on, before a developing problem
becomes a huge problem.
