As we look out across the global manufacturing landscape of the next few years, we see many reasons to be excited. In fact, the next few years will be an opportune time to explore new cost reduction strategies in manufacturing procurement, with one key opportunity arising in the form of diversifying supply chains specifically with cost reduction in mind.
First, let’s set the current stage: Developing regions are joining the offshoring network, adding much-needed lower-cost capacity. Incredible new technologies are seeing rapid commercial adoption, driving widespread production and operational improvements. And perhaps best of all, increasing competition is upsetting supplier monopolies, a good step towards the return of a domestic buyer’s market.
While the upsides look positive, there are some lingering unresolved concerns impacting supply chains (from geopolitical instability to inflationary trends). Still, we’re optimistic overall.
Now, back to the opportunities available in diversifying supply chains to help reduce costs. Because the phrase “supplier diversification” can mean many things, let’s clarify how we’re using the phrase. Supplier diversification is a procurement strategy that targets three goals:
- Identifying, vetting and engaging with more than one supplier for each product or production process purchased, so that if one supplier fails to perform, the other suppliers can fill the gap and avoid disruptions.
- Looking beyond production processes, full supply chain diversification aims to identify and engage multiple upstream options for every step involved in acquiring goods. This can include raw material suppliers, labor centers, logistics and shipping vendors, and so on.
- When and if a supply chain disruption does occur, the buyer’s business is sufficiently insulated from material harm, ideally to the point that their end-use customers are never aware of the issue at all.
Supply chain diversification is often described as one of several generic procurement cost reduction strategies, but is hardly ever backed up by actual examples of how to achieve such savings. Well, we’re here to provide tangible examples from our own experience in managing global supply chains, so read on.
Cost-Cutting Applications in the Real World
On the surface, adding redundant supply chain nodes feels like it should bring about cost savings, but when scrutinizing how that plays out in practice, the concept tends to fall short. Industrial buyers often have a limited view of diversification, thinking of it as a transaction function only.
For example, many organizations use diversification simply as a means to add multiple bidders to their RFQ (request for quote) process, assuming that this larger bidder list will drive price competition. Buyers then save the names of the non-awarded bidders in case they need to call in alternatives should the awarded bidder fall through. This is a great process for the bidding stage, but doesn’t utilize the full spirit of diversification alongside the company’s actual cost-reduction strategies.
To reach the wider view of diversification, let’s consider the four examples below that show diversification as a tool that can be used when designing supply chains, as well as when managing ongoing operations.
1. Tapping Into Specialization
When deciding on the manufacturing steps in a given supply chain, one criterion for selecting partners is to categorize suppliers as job shops or specialized shops. Job shops typically perform more services in-house, aiming to produce completed products entirely themselves at the potential expense of having higher overhead and less expertise in any one given production process.
On the other hand, specialized shops are built around performing a given production process at a world-class level, though this introduces the need for more processes to be performed elsewhere to complete a product. Very often, it’s less costly overall to use a job shop for most production steps in a process and then turn to a specialized shop for a few key steps where their quality, speed and cost for that process are much more competitive.
For example, when producing an electronic chassis, you could use a sheet metal fabrication job shop to perform most of the assembly steps except for final finishing. You could then send the near-completed chassis to a powder coater that can coat the chassis instead of the job shop’s only option of painting. In this instance, powder coating would deliver a higher quality end-product at a lower total cost (even with the added shipping step considered).
2. Reducing Manufacturing Steps
From the above example of using specialization to find savings between computer chassis painting versus powder coating, we can consider that there can be multiple options at each production step that would satisfy the buyer’s requirements. For example, painting involves more steps than powder coating, which leads to higher costs and longer production times.
Through diversification, multiple vendors can be employed to optimize production steps, and in turn, directly lower costs.
3. Driving Competition
Most buyers’ first thought on diversification is that it’s a path to negotiating pricing down by pitting suppliers against each other at the bidding stage. Admittedly, this does produce some results, but is not the most virtuous tactic available. In a perfect market, competition is the downward pressure on pricing that keeps runaway profit maximization in check, but does that mean competition can only be used as a threatening tactic? No, it does not.
Let’s think again about our computer chassis example. If Supplier A offers job-shop level painting in their price to a buyer because it is their standard offering, and the buyer knows of a Supplier B within their diverse supplier pool that can powder coat at a lower price, then Supplier B might in fact be a viable option that Supplier A could pursue to roll into their offering.
Supplier A reaches out to Supplier B and finds that the cost to powder coat is lower than their internal cost to paint, which creates internal competition. Supplier A is now pitting their internal pricing against this new external option from Supplier B.
After crunching numbers, Supplier A determines that they can engage Supplier B for their powder coating option at a net lower cost for themselves, while Supplier A can make a better margin on the pass-through service, and can share a part of the savings with the buyer as well.
Everybody wins, all because the buyer had a diversified supplier pool they could use to drive friendly competition and create new partnerships.
4. Capitalizing on Tactical Opportunities
Another advantage of having a diversified supply chain is found in the additional production capacity available to be spun up should a tactical opportunity arise. A buyer’s main suppliers may be busy working on current orders and unable to increase production volumes on short notice. Turning to known alternative manufacturing choices means the buyer has a good chance of finding available capacity.
In this situation, the buyer is able to take on additional orders, which in turn allows the buyer to sell through additional volumes that weren’t previously expected. As for the cost reduction component, turning to a diversified supply chain to find pre-qualified vendors that better fit these tactical opportunities often results in lower marginal unit costs compared to main suppliers.
The Key to Cost-Reduction Strategies
These are just a few ways that supplier diversification can be implemented as one of many cost-reduction strategies in industrial contract manufacturing. Overall, diversification is an excellent tool that reaches far beyond simply inducing price competition, but also as a very tangible solution toward mitigating risk and improving the cost of doing business.
Are you looking for new opportunities in your manufacturing supply chain? Contact us to talk about options you may not have considered before.
