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Understanding Total Cost

by Jamie Flinchbaugh on 10-14-09

Do you know what your supply chain really costs you? Most companies don’t. They do know how much they spend on suppliers, but that’s just the transaction costs. There are many other true costs in your organization that are affected by the design of your supply chain. The design affects communication costs, alignment in decision making, speed to problem recognition and correction, ability to make mid-stream changes in volume or mix, and so on. Take as an example the cost of your speed in problem recognition and correction. Most organizations, when designing systems or costing them, just assume that they will have no problems. But this is obviously a fool’s errand. A problem that doesn’t get caught until a whole ocean-full pipeline of product exists will cost drastically more than one caught the next day after occurrence. But since we don’t exactly what problems might exist, we just don’t enter this into our total cost calculations. As a result, many of the costs that are affected are never considered, and supply chains end up less efficient than ideal.container-ship.jpg

This recent article by Editor-in-Chief Steve Minter in Industry Week highlights that some companies are learning this, titled Moving Sourcing Closer to Home. While not everyone has begun to insource again or even move back within the United States, but they at least understand how distance affects their value stream and their total cost. Here was some of the advice from that article:

Know the business environment. Miller says companies may put so much emphasis on low-cost sourcing that they ignore the business environment into which they are moving. He urges clients to consider issues such as legal contract enforcement, shipping barriers, infrastructure, labor and environmental practices, and degree of control they will have over what goes into the products they are buying.

Know your business partners. “Getting into bed with the wrong partner will cause a lifetime of grief and anxiety and runs the risk of losing revenue and customers,” Miller warns. He says companies should learn as much about their potential partners as they can through social media sites, other companies that have worked with them, and government agencies and trade organizations.

Know what your risk tolerance is. Miller says companies need to carefully consider not just the cost advantages of any outsourcing but also the risks, such as poor environmental practices, transportation delays, language barriers and corruption.

Know the total cost of ownership. “This is the one where the most organizations miss the boat,” says Miller. Companies can see initial contract savings quickly evaporate if they are faced with unexpected charges for shipping, storage or customs duties.

Costs are not just transactions, yet understanding costs has a huge impact on the decisions that people make in designing their system. There are ways to develop better costs, but you still shouldn’t rely on this. The only true way to make good decisions is to understand how the system itself is working, and how it impacts your performance. How has your company dealt with insourcing, outsourcing, and offshoring? I would love to hear your comments.

Comments

  • Jamie,
    Great post on supply chain costs. Another thing to consider with a long supply chain is storage cost including inventory amounts. The longer the supply chain the more inventory is stored to buffer a supply chain interuption which results in greater cost to fix a problem or a longer delay to “burn off” the existing inventory before good product can be used.

    Shawne Van Deusen-Jeffries October 14, 2009 at 7:58 am
  • Jamie,
    Great post on supply chain costs. Another thing to consider with a long supply chain is storage cost including inventory amounts. The longer the supply chain the more inventory is stored to buffer a supply chain interuption which results in greater cost to fix a problem or a longer delay to “burn off” the existing inventory before good product can be used.

    Shawne Van Deusen-Jeffries October 14, 2009 at 7:58 am
  • Jamie,
    Great post on supply chain costs. Another thing to consider with a long supply chain is storage cost including inventory amounts. The longer the supply chain the more inventory is stored to buffer a supply chain interuption which results in greater cost to fix a problem or a longer delay to “burn off” the existing inventory before good product can be used.

    Shawne Van Deusen-Jeffries October 14, 2009 at 7:58 am
  • Thanks Shawne.

    Where else have people found some of the hidden costs of supply chain design?

    I’ll give you one – problem solving response time. Depending on when a problem is found, the lack of visibility and time zone differences can turn hours into days. The cost of a slow response can be staggering.

    Jamie Flinchbaugh October 14, 2009 at 8:08 am
  • Thanks Shawne.

    Where else have people found some of the hidden costs of supply chain design?

    I’ll give you one – problem solving response time. Depending on when a problem is found, the lack of visibility and time zone differences can turn hours into days. The cost of a slow response can be staggering.

    Jamie Flinchbaugh October 14, 2009 at 8:08 am
  • Thanks Shawne.

    Where else have people found some of the hidden costs of supply chain design?

    I’ll give you one – problem solving response time. Depending on when a problem is found, the lack of visibility and time zone differences can turn hours into days. The cost of a slow response can be staggering.

    Jamie Flinchbaugh October 14, 2009 at 8:08 am
  • You’ve both touched on one of my favorites. The suboptimal supply chain almost always results in suboptimal quality. Here’s the scenario… A problem has been identified. The supply chain is full. We may be weeks or months away from getting replacement product. The customer needs product today. What do you do? In the name of serving the customer, we sometimes ship product that we ordinarily would not, only because the supply chain lacks the necessary agility. By the time we finish dealing with the issue, we likely will have touched all 7 forms of waste!

    Don Nelson October 14, 2009 at 12:36 pm
  • You’ve both touched on one of my favorites. The suboptimal supply chain almost always results in suboptimal quality. Here’s the scenario… A problem has been identified. The supply chain is full. We may be weeks or months away from getting replacement product. The customer needs product today. What do you do? In the name of serving the customer, we sometimes ship product that we ordinarily would not, only because the supply chain lacks the necessary agility. By the time we finish dealing with the issue, we likely will have touched all 7 forms of waste!

    Don Nelson October 14, 2009 at 12:36 pm
  • You’ve both touched on one of my favorites. The suboptimal supply chain almost always results in suboptimal quality. Here’s the scenario… A problem has been identified. The supply chain is full. We may be weeks or months away from getting replacement product. The customer needs product today. What do you do? In the name of serving the customer, we sometimes ship product that we ordinarily would not, only because the supply chain lacks the necessary agility. By the time we finish dealing with the issue, we likely will have touched all 7 forms of waste!

    Don Nelson October 14, 2009 at 12:36 pm