How to Reduce Product Costs by Collaborating with Suppliers

How Supplier Collaboration Results in a Competitive Advantage for All Stakeholders

Lily Thomas: Hello everyone, and welcome to Turning Potential Savings Into Realized Savings. My name is Lily Thomas, and I’m an applied services consultant at aPriori. Today, we’re going to cover tips to use aPriori cost data to work collaboratively with suppliers to uncover mutual cost savings.

I’ll give you a little bit more background about myself. Before joining aPriori, I held positions in manufacturing and supply chain management for a division of GE, which was later purchased by Baker Hughes. I spent most of my time there as a commodity manager for PCBAs, assemblies, plastic parts and wire harnesses. Today I work with aPriori’s customers to help them analyze the cost in their parts to identify the parts most likely to have cost savings and to prepare for strategic supplier discussions.

So many of you are probably in the situation where you’ve found a part, you think has savings, but now what? Or you’ve designed a part and the quotes are coming back, very different than you expected, and you don’t know why. Industry leaders recognize that there is a limit to the amount of savings that can be achieved by beating suppliers up on price alone. The company must make it a true business strategy to focus on collaborative efforts with suppliers to realize true profitability.

Collaborative Relationships Build Trust and Can Result in Significant New Product Cost Reductions

As this McKinsey article posted in July 2020 shows, “Companies unlock more savings if they find ways to unlock new sources of value that benefit both buyer and supplier.” But finding those mutually beneficial savings is much easier said than done. Suppliers and commodity managers are busier than ever, managing chip shortages, bottlenecks getting parts shipped, rising material rates and suppliers don’t have time to weigh through all of the parts that you purchase from them and come up with Kaizen projects for you.

Data is the Key to Optimizing Your Supplier Relationships

So, how can aPriori help you and the ecosystem of suppliers unlock these mutually beneficial savings faster and result in higher growth? The way we can is by providing data. Data makes the difference between a traditional negotiation and a cost collaboration. In a traditional negotiation, the buyer doesn’t know the right questions to ask, to uncover where the cost drivers are, and they have no benchmarks to vet any information they do uncover.

And I don’t just mean a benchmark on the overall piece part price, I mean benchmarks for all the parameters that make up the cost of a part. Labor rate, raw material utilization, cycle time, etc. Without rich data to select which parts actually have savings potential, you could be wasting both yours and the supplier’s time by negotiating parts that are already priced right. And finally, if you have no data to negotiate, then the supplier is negotiating from a stronger position because they have all of the information. When the customer has real-time data and metrics at their fingertips, they know which questions to ask a supplier and can determine if the responses are fair and reasonable for them both and can result in lower costs. Through this collaborative process, the buyer can learn about supplier capabilities and incorporate that information into future estimates, and future discussions will be faster, creating a win-win for the relationship. Learning about your suppliers’ capabilities also allows you to have them quote the price they’re best suited for in the first place. I’m sure any suppliers on the line can attest to how frustrating it is to receive RFQs that you’re not well suited for, and then be told that your pricing isn’t competitive.

Step by Step: How to Use Data in Cost Reduction Discussions

So, here’s a step-by-step guide on how to use the data in cost discussions. First, you’ve got the aPriori estimate, and we encourage you to use it to understand the cost drivers of your parts. You have to see where aPriori is saying the cost drivers are. Is it mostly material cost? Is it mostly in labor cost? If you go into the discussion knowing most of the cost is in material and the supplier mentions that they have high labor rates, then you know that shouldn’t impact the cost too much. You can also familiarize yourself with the rates the model is using, and even tweak the values ahead of time to get a target cost range that you’re comfortable with. For example, check how the cost changes, if you double the cycle time or double the labor rate, now you’re equipped to address supplier questions. You can also contact the supplier ahead of time, to check if the routing that aPriori picked, matches how they’re actually making it.

We recommend that you let the supplier know that you’re trying to understand the cost drivers of this part and why. Is there pressure from your customers to reduce cost? Will volumes go up if you can get cost down? Make the goal of getting costs down compelling for the supplier, so they are a partner in the effort to reduce cost and then request the cost breakdown from the supplier. Compare the supplier’s cost breakdown to the aPriori breakdown, and look for where the biggest differences are. When you find the differences, use the “five whys” technique, or root cause analysis, to get to the root cause of the difference in cost, and that’s where the mutual savings can lie. For example, you may uncover the supplier labor cost per part is higher than your aPriori estimate, and so you ask, “Your labor cost is different, why? What labor time are you quoting? What tasks are adding most of the time? What’s the labor rate?” You can compare all of these data points to what’s in your aPriori, and uncover the true root cause of the difference in cost.

Supplier Relationship Management Case Study

I had a supplier whose labor class was high because they were manually masking off parts when they did conformal coating, but we were assuming they were using masks, reusable masks, and so we split the cost of reusable masks and we reduced their labor cost for future builds, it’s a cost savings for us both. As the supplier provides answers to your five whys, you have to decide if what you think they’re doing is fair and reasonable, if you do, then update the model to account for it. For example, you’ve costed the part in aPriori USA, but the supplier is located in Massachusetts, so they say the labor rate is hirer, update the labor rate and re-cost it, if that closes the gap between their cost, and the aPriori estimate. If it does not, then you have more investigation to do, if it does, then you’ve improved your model.

The Surprising Benefits of Supplier Collaboration

Finally, keep in mind that you may uncover something that you as the buyer need to do differently. For example, I worked with a supplier who said, “Our machining time is more than your estimate. The longest step in the machining is keeping this height tolerance on the part, if you could relax that, then we could reduce the time.” I knew that part had to fit into a housing, it was tight width-wise, but not height-wise, so the engineer agreed to relax the tolerance. And you may be thinking, “This strategy sounds great, but I don’t get cost breakdowns from my suppliers.” And we’ll discuss that in a minute. I mentioned all of the detailed information that aPriori generates, it has all the details about rates, cycle times, set up times, etcetera. So as you’re using the five whys, you can compare the estimate details to the supplier’s details. So you can tell the supplier, “I’m estimating a material cost of $20, which is different from your quote.” You can say, “I’m assuming a utilization rate of 69% and a material rate of 171 per kilogram, and here’s the sheet size I’m assuming.” And then you can check on each of these points where is the supplier different.

For example, you may find out that they’re using a different blank size. Whatever difference you uncover, you and the supplier have to evaluate if it’s fair and reasonable or not. If it is reasonable, reasonable, you can update aPriori to see how it impacts the cost. For example, say they’re using a different blank size, make that change in aPriori and see if that closes the gap between your estimate and their quote, If not, you haven’t found the true root cause and you have more investigation to do. Okay, the supplier won’t give a cost breakdown or doesn’t have the time to generate a cost breakdown then what you can do is, you can go line by line in the aPriori cost summary and ask, “Is this estimate close to your actual costs?” And when you get to an item and they say, “No, that’s not close to the cost”, that’s when you stop and do the five whys. We had a customer, that did exactly this, the supplier couldn’t give a cost breakdown, so they went through the aPriori estimate line by line, and asked the supplier if their estimate was close to the quote.

When the customer got to the direct overhead line item in the cost summary, the supplier said that their direct overhead was much higher. So, the customer stopped and said, “Okay, well, here are the assumptions that go into direct overhead. The machine type, cycle times, the machine cost.” And the supplier said, they were using a larger machine than aPriori estimated. It turns out, they did not own a smaller machine, the supplier said, “We don’t really know why you’ve had us quote this part, we make all huge parts for you, but you’re a good customer, and so we wanted to give you the business.” So, in that instance, the customer had to make a decision if they wanted to find a supplier that was better suited for the part. If the supplier says they don’t even have time to let you go through your estimate and indicate if the estimate is close to the actual costs, then you can at least go through the manufacturing steps to make sure you have everything captured. Maybe you’ll uncover the supplier uses different machines or a different process than aPriori shows.

Or you might find out they’re outsourcing an operation. And by the way, that happens. And now you’ve learned something about the supplier capabilities, so you’ll be able to make estimates and get quotes from them, much better in the future, and you’ll be able to have them quote parts they’re best suited for in the future. You can also use the data to guide you to ask for specific pieces of information, if they’re not able to share a cost breakdown. For example, if aPriori says most of the cost is in the overhead, you can ask them to confirm the machine they’re using. Or if most of the cost is in labor, you can ask them to confirm the labor time. Or you could start by asking them if they agree that labor is the biggest cost driver. If they’re coming to you with a price increase due to material rates increasing, then it’s the perfect time to confirm the material rate they’re using, if you don’t know already. So, use the data and the cost drivers in aPriori to inform how you navigate the discussion.

And as always, decide if the supplier’s answers are fair and reasonable and if so, incorporate it into the model. If the gap is still not closed, then continue the investigation. And when you’re in these cost discussions with suppliers, you will likely uncover things about their capabilities, that you want to update the model to reflect, and it’s critical to incorporate this new information to the model for a number of reasons. One, incorporating fair and reasonable supplier feedback into the model, demonstrates to the supplier that you are indeed here for a collaborative conversation. Two, now that you’ve updated the model, you don’t have to repeat this part of the root cause analysis in future discussions, and you’ll save time in the future. Three, you and the supplier get a step closer to agreeing on the validity of the model, which means four, your future should cost, for their parts will be better, in all of these will be to faster discussions in the future.

Open Communication Can Lead to Increased Supplier Performance

So don’t be afraid of uncovering new information, because it’s a critical part of the process of the cost collaboration process. Like many other new skills, the more you do it, the easier it gets. The first time you have this type of discussion with the supplier will be the hardest, you’ll have to explain what aPriori is, maybe where it gets its data and underlying rates, and it may be the first time you’re even asking for a cost breakdown. Once you get over the hurdle of the first discussion then, you and the supplier on the same page for future discussions and you wind up with a circular process where the more you have these conversations with the supplier, the more you’ve learn about their operations and capabilities, so the better you can create estimates for them and vet future quotes. And the better you can place parts with them that they’re well-suited for. So all of that means, the less you’ll need to discuss costs in the future.

We had a customer say she used aPriori data to negotiate quotes for brand new parts a few times, and after a few times negotiating, the supplier quotes started coming in line with the aPriori estimate on all other parts, so she didn’t have to negotiate anymore. The more you do this process with the supplier, the easier it gets, because you refine your model, you learn their processes, and they learn that you have this new tool, and eventually you may approach a zero RFQ process, where you and the supplier agree on the aPriori model and you are just issuing purchase orders at the estimate. One of our customers does this today. Let’s go through a real example from beginning to end. So, this customer had a painted sheet metal part and the aPriori cost did not match the supplier quote. So they requested a break down and they saw that the material costs matched. The batch set up costs matched, the direct overhead and labor costs of the quote matched and the routing matched, they could see by comparing the aPriori line items to the supplier’s breakdown that the difference was in the painting costs.

So they didn’t waste any time at all asking for all of the details on material costs, they didn’t confirm the blank size or the material rate. They didn’t have to confirm the routing the supplier was using, they immediately dove into the powder paint cost, so right there, that saves time. Now, let’s say the supplier didn’t provide a cost breakdown, instead what the customer could have said is, “Okay, well, aPriori estimates that most of the cost is in material, does that match reality?” And the supplier would have said, “No, most of the cost is in the painting.” And then the customer would have identified the paint cost as the big difference and dove into it that way. So the next step was to begin the root cause analysis of the paint cost difference. So with the help of an aPriori consultant, they investigated the assumptions behind the paint cost that aPriori uses, and they shared that with the supplier.

So they said, “Okay, we were assuming a paint cost of $7 per kilogram. We’re assuming half a kilogram is used per part, and there’s a 100%… No, sorry, half a kilogram is used per batch, and there’s a 100% yield on the paint process.” At that point, the supplier to bring in their sub-supplier, because it was an outsourced operation and the sub-supplier said, “We have both a different cost per kilogram of the paint and a different quantity of paint used.” So, now the customer had to determine if this was fair and reasonable. So, the customer had a spec, about a specific heat-absorbing paint, which cost $50 per kilogram. Way beyond the standard selection of paint and out of the box of aPriori, which goes upto $7 per kilogram. So, the customer verified the paint costs with the paint manufacturer and updated the paint cost in the model, but there was still a gap between the supplier’s quote and the aPriori estimate even with updating the paint cost.

So the next piece was to decide if the… The supplier said that they were using a kilogram of paint per batch and aPriori was modeling at half a kilogram. So now the customer had to decide if that was fair and reasonable. So they investigated how aPriori comes up with half a kilogram of paint and explained to the supplier, he didn’t think it was reasonable that double the amount would be used, given that the amount of paint is a pretty simple formula to determine. The supplier looked back at their records and agreed that they could re-quote with half a kilogram instead. So in this case, the customer made an update to the model on one parameter, and pushed back on something that they didn’t think was fair to get their savings. Now, was the supplier blatantly over-charging with the amount of paint used? Maybe. Or maybe whenever the customer initially asked for a quote, they asked for it ASAP. I’m sure a number of us have been in the situation, where you need to place an order right away, and in that case, the supplier may not have had time to accurately quote, so they put in a buffer.

So this is a great example of deciding which feedback is fair and reasonable. They verified the cost of the paint was reasonable, but they pushed back on the quantity. And then incorporating the reasonable feedback into the model, and now they can accurately cost other parts that require this coating and they won’t have to do this part of the investigation in future discussions.

Data Supports Successful Supplier Collaboration and Negotiations

So in summary, the steps that we outlined turned potential savings to realized savings are: First, familiarize yourself with the cost, give the supplier a compelling reason to collaborate, focus on the differences you find between the estimate and the supplier quote. That’s where the good stuff is. Keep calm when you find out the supplier reality is different from the model and decide if it’s reasonable. And if so, update the model, and pat yourself on the back for learning something about that supplier’s processes. If You don’t think it’s reasonable, then explain why.