Understanding Total Cost
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.
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.