By Michael Zimmerman CQM, CQA

&

Steven J. Troch, P.E.

July 10, 2000

Present day gas utilities are faced with a multitude of challenges. We are now part of a competitive industry. Today’s business environment is focused on minimizing operating cost while maximizing operating efficiency. In 1996, Baltimore Gas & Electric Company (BGE), a combination gas and electric utility serving approximately 600,000 customers in central Maryland, recognized the changing utility business outlook and undertook a complete analysis of its procurement practices. The objectives of the analysis were to:

• Reduce Procurement Outlay
• Remove Barriers to Customer Service (Business Units)
• Simplify Procurement Process
• Accommodate Future Corporate Structures

The overall goal was to develop strategic procurement programs tailored to each of the company’s business units. Each business unit (Division) was to develop and direct a materials resource plan.

Typical utility purchasing policies focused only on purchase price, while costs associated with quality, maintenance, reliability, delivery, etc. were adsorbed (somewhat invisibly) in operating expenses. Procurement in a competitive business must address the entire cost of a material to the company and in particular the line of business. Terms such as; "life cycle", "quality management", "supply chain", and "value added", are all parts of effective procurement. These concepts are all rooted in determining and recognizing all the costs associated with using materials.

The analysis indicated that a new approach, based on competitive industry "best business practices", should incorporate:

• materials should not be treated equally or procured in the same manner
• quality must be a fundamental requirement
• all cost factors (BGE and supplier) must be determined
• effectiveness must be measured long term

While BGE at the corporate level made several process changes including adopting procurement cards, raising purchase order limits, and deploying purchasing staff to "customer" locations, the Gas Division established the "Supplier Quality Program" (SQP) to address the needs of the gas business. The goal of this initiative was to focus on supply chain/life cycle costs, be an ongoing dynamic team process, and be based upon competitive industry best practices. The SQP consists of three parts:

Quality Management

Inventory Management

Supplier Management

Quality Management: In the gas distribution business, product quality is an essential factor in safe operation, long term performance, and regulatory compliance. Poor quality costs both the operator and supplier. The process costs involved with inspection, testing, rejection, and replacement of unacceptable material are significant to any business. In order to effectively address product quality the SQP established requirements for supplier certification. Suppliers who participate are required to have a formal quality program, be technically competent, have production capability, be competitively priced, and offer superior delivery and service. At this time we do not specify a quality standard (such as ISO) to which the manufacturer must adhere, but such industry programs are acceptable under the SQP. Supplier certification (and re-certification) will verify a supplier’s ability to meet BGE and industry standards. Both standards compliance and quality programs will be subject to audits in order to verify compliance to the requirements. In addition, the program includes a quality monitoring program (associated with a material rejection database), performance reporting, and an audit schedule based on product criticality.

The program is used as a maintenance tool for monitoring certified supplier quality and is developed around both technical and commercial quality issues.

• Technical Quality: is defined as ‘quality of product’
• Commercial Quality: is defined as ‘quality of service’
• Performance Reports: a report card benchmarking technical and commercial quality performance

Recertification will be based on a series of evaluations of the supplier and their product. Each supplier is notified of their criticality ranking and provided an audit schedule. All audit results are provided to and reviewed with the supplier.

"…..build quality into the product"

Inventory Management:

The overall objective of the inventory management initiative is to identify and define a robust set of inventory management strategies which can be applied individually or in combinations to specific inventory categories in order to achieve desired levels of customer service, product quality, and total cost management.

The intention is to develop strategies that are particular to a group of inventory items based on the results of individual item stratification. Individual component strategies will be bundled together to create a consistent coherent inventory strategy for each group. The material stratification will serve as a logical foundation for applying inventory strategies; however, the stratification should not be viewed as a rigid structure that does not allow for variance in addressing the particular needs of individual items. For example, in the case of the Gas Division, it was determined that the stratification closely coincided with existing commodity codes. Items that were exceptions in terms of operational or economic significance were "taken along for the ride" with the rest of the items in the commodity group.

The first focus in this area was the reclassification of all system materials based on critical factors. It was determined that standard Pareto principles applied. Approximately 20% of our items comprised 80% of demand. By focusing our resources on the items with the greatest impact on our business we were able to implement specific inventory strategies by material group classification. This same evaluation is also routinely performed for all new materials. In addition, items were stratified based on critical and economic factors. Results showed that approximately 8% of our items were "strategic". These items were supplied by only 17 manufacturers. Specific initiatives were developed with each of the critical suppliers such that we were able to reduce inventory levels while increasing our internal service levels. Thus, we were able to "shift" the warehouse service level/inventory value curve. Strategies utilized for critical item suppliers included; strategic alliances, alternate stocking, scheduled delivery, evaluated receipt, access to inventory data, ERS, and demand forecasting. This way, all cost components can be identified and total costs can be reduced. Internally, a new "materials planning" process was started which gave better advance notice of major material usage. This involved being aware of material needs at the time of job initiation rather than when ordered from the warehouse. Supplier delivery performance is closely monitored and reported back to the supplier monthly. This type of statistic is used to establish a "rating" which is subsequently used in contract evaluation. Inventory "turns" are tracked by item and by commodity for all gas materials. The comparative statistics of inventory value, turns, service level, and number of items provide a balanced evaluation of program progress.

A corresponding initiative of Inventory Management is the standardization of material items. In many cases individual utilities have special items manufactured due to carryover of past practices. Such "special" items are typically supplied at a cost premium. Thus all material specifications and special items are routinely reviewed against market "standard" products. This facilitates product consolidation, supplier competition, and lower costs. Inventory carrying costs, field installation standards, and production lead times are all factors associated with "special" items, which effect life cycle costs.

All of these points will make it possible to achieve higher levels of

service without exploding the budget: "shifting the inventory curve"

 

Supplier Management: Based upon our ranking of materials, the status of our suppliers was determined as critical, strategic, or commodity. The goals of this part of the program include:

• Focus attention on suppliers of critical items
• Minimize internal process costs
• Establish two-way communication and information sharing
• Ensure goal alignment between the utility and its suppliers
• Share the burdens and benefits
• Identify cost components and reduce total cost

Specific procurement strategies were applicable to each supplier status. Critical suppliers were evaluated for alliance type agreements or long term ‘evergreen’ purchase orders. This area is also a focus for supplier consolidation due to standardizing materials. Each supplier is held to very high service level goals, requirement coordination, and continuing new product development. Suppliers are provided report cards, which are used to document performance and communicate efforts. In an interesting twist, BGE also requests report cards from the supplier on its performance. Communications with this class of supplier is very important. Regularly scheduled coordination meetings are held and we also provide a yearly direction setting forum for these suppliers as a group. As opposed to typical purchasing adversarial relationships, these strategies are based on cooperative business practices which do not ignore the total costs involved with procurement and use in the field. In the words of a major supplier:

"Resources go to those we work with, not those who beat us up"

Strategic suppliers are also provided service level goals with performance report cards. Typically, blanket purchase orders are utilized with mid to long range contract periods. Market volatility is watched closely and appropriate indexes coordinated with contract terms. Accordingly, the utility must be acceptable to sharing the benefits and risks of dynamic type agreements.

Commodity type suppliers are best suited to agreements, which involve one-time high volume transactions, auto replenishment type conditions, or on-call/pick-up arrangements. The typical focus is on minimizing materials management efforts and costs. These items are characterized as low value/low criticality.

Results of the Supplier Quality Program

The adoption of SQP at BGE resulted in a significant change in the way we approached our business and represented a major "culture change" for purchasing processes. We saw significant value in the operating area responsibility for program development and direction setting.

Since our adoption of the program in 1997-1998, we have achieved:

• Critical and strategic materials service level increased to 99.8%

In establishing variable service levels based on criticality we were able to achieve significant improvement in availability of those items which effected our daily production and efficiency. Any unavailability of these items is treated as an emergency and is usually resolved within 24 hours.

• Inventory reduced by 25%

Although many gas distribution system items are in stock for emergencies, our overall average for inventory turns was increased with our high demand items approaching 6-7 turns per year with no stock-outs. In addition, product standardization resulted in decreases in "special" inventory items.

• Realized over $4 million in procurement cost savings to date with an additional $4 million in documented future savings.

This represents material costs, shipping, warehouse expenses, and discounts. In addition, internal process efficiencies such as; ERS, long term/blanket contracts, and reduced expediting have been achieved

• Established successful alliances

We have developed a comprehensive communications process with our critical suppliers which allows an open two-way information flow while affording us up to date marketplace data

 

These results have been achieved utilizing our existing operating/engineering and purchasing personnel. The BGE "Process Improvement Team" responsible for the day-to-day operation of the initiatives consists of engineering staff, purchasing personnel, and materials specialists. The team works together on-site and continuously plans and updates our focus/action items. This change in our business practices has resulted in a reallocation of resources but the resulting personnel requirement has not increased.

Utilities are facing a very different business environment in the coming "competitive" business world. Each utility must determine a strategy for adapting to a competitive marketplace. Obviously, we as an industry will need to progress a long way in a short time to actually prosper in the new world.

The cornerstone of the Supplier Quality Program is quality; there must be a very dedicated focus on quality of product, quality of service, and quality of personnel. The SQP business approach involves a significant concept change from past "traditional utility purchasing" practices. Thus the program must involve those who are passionate about quality, open to change, and comfortable dealing with total business costs. It is equally important to recognize that the success of such dramatic changes hinges on the leadership of the program. This is a long-term commitment which will only succeed through the dedication of the staff and their belief in the approach. It is important to constantly sell the program to the team, to the suppliers, and to management.

Effective, open, and honest communications are the key to establishing credibility of the personnel involved. Quotes such as "showing all your cards" and "it all goes into the rate base anyhow" will not be very applicable in defending past practices. Internal teamwork is a must. Our suppliers can easily tell when internal conflict dilutes lofty objectives. There must always be a win-win outcome to ensure that all parties are motivated.

While there is no "roadmap" to success, the commitment to the concepts presented have achieved measurable results at BGE.