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| Michael presented this paper at the 2002 'ASQ Customer Supplier Annual Conference'. The conference was held from Sept 30th 2002 to Oct 1st, 2002 at the Galt House in Louisville KY. The following is a copy of the paper. For more information please contact Michael. Reproduction or reuse without the express written consent of Michael is strictly forbidden. DEVELOPING ALLIANCES IN THE
UTILITY WORLD Michael C. Zimmerman Total Cost Solutions, Inc. Severna Park, MD. 21146 SUMMARY Historically both customer and supplier have
maintained an “arms length” relationship with a primary focus on
product purchase price. In developing successful partnerships an
approach where product quality, service performance, shared programs,
and total ownership cost have an equal if not greater value than
purchase price. A Supplier Program that offers certain ‘critical’
suppliers the option to enter into a relationship that truly
opens the door to a value added program and a true alliance would
benefit all parties in the supply chain. KEYWORDS Alliance, Communications, Continuous Improvement, Feedback, Savings TEXT Historically,
both customer and supplier have maintained an “arms length”
relationship with a primary focus on product purchase price. In
developing successful partnerships, an approach where product quality,
service performance, shared programs, and total ownership cost have an
equal if not greater value than purchase price. A customer/suppler
partnership or alliance results in a systematic approach to a
relationship that adds value through continuous process, product, and
service improvement. It fosters a relationship that reduces the ‘total
ownership cost’ (for all parties) while maintaining competitive levels
of quality, safety, service, and technology. Parties to the partnership
must be open to adopt culture changes and be willing to share in the
‘risk’ as well as the ‘reward’. The goal is to develop a supply
chain initiative where all parties involved achieve bottom line profit
improvements. The utility industry, being very mature, is
no exception to stereotypical purchasing methods of old.
Historically, purchasing decisions were based on the unit cost of
product. The longer-term cost associated with product maintenance and
opportunities related to a customer suppler relationships were ignored.
A typical utility purchasing cycle prior to competition consisted of: ·
Identify a requirement ·
Relay requirements to the Purchasing Department ·
Issue a request for quotation ·
Analyze bids ·
Award based on lowest unit bid cost Some utilities have
attempted to address inefficiencies in this process by developing
blanket purchase orders. A blanket purchase order would typically group
a supplier’s material into one purchasing vehicle and contain a
year’s worth of requirements. This philosophy allowed manufacturers to
forecast material requirements for longer periods of time and allow them
to more efficiently schedule work and component part logistics. Being
offered ‘longer term’ commitments and the resulting knowledge about
future requirements allows manufacturers to quote better pricing
options. While
this scenario offered major improvements over typical purchasing
practices, it still does not address the best business practices of a
competitive industry. Being a utility and having the ability to
‘pass’ the cost of inefficient process to the customer fostered an
environment of complacency. The end result still revolved around unit
cost, and the ‘total cost of ownership’ was not being evaluated.
Other utilities have developed third party purchasing strategies. These
buying consortiums are supposed to offer leverage and clout within the
supply chain. While the strategy is sound, the process struggles with
the inherent differences between the members. The consortium must be
able to achieve a number of process and product related efficiencies
before it will be able to achieve its goals. With
utility deregulation on the horizon, another
utility decided to take even another road and investigate ‘best
purchasing practices’ of competitive businesses. Upon analyzing the
practices of leaders in competitive markets, they realized that their
current ‘mode of operation’ would never be effective in the new
world. In order to develop the market knowledge required for the
analysis, they put a cross functional team
together. This team consisted of members from the Engineering and The
Purchasing & Materials Management Department. This “Process
Improvement Team” (PIT)
was charged with developing process improvements that would allow the
utility to become a leader in developing procurement strategies in the
materials supply chain. The
team developed a program that identifies and addresses inefficiencies in
the supply process. In particular, the program addressed inefficiencies
in quality management, materials management, and supplier
management. One of
the most dynamic philosophies developed by the team redefined customer /
supplier relationships. The age-old practice of keeping suppliers at
arms length and operating as if customers and suppliers cannot trust
each other was about to change. The supplier
management portion of the Program would introduce a style of business
that would require the people involved to make business decisions
that historically went against corporate utility strategies. These
practices require participants to work in a collaborative environment,
to analyze life cycle cost, to share savings as well as risk, and to
work in an environment that was open and honest. The PIT
team embarked on a journey that that would introduce Customer / Supplier
alliances to an industry that not only didn’t understand the
philosophy but one very mature with no desire to change.
When
developing the new strategy, the team understood that there was a need
to make sure that the transition was as simple as choosing ‘motherhood
and apple pie’. The team took a very structured approach to the
development of the strategy to be employed. The team developed the plan
and began collecting data related to how successfully operated
competitive businesses are run. Once the data was collected, the team
began the analysis, and the team’s eyes turned toward home.
The supplier management portion of the program was the last
section to be analyzed. This allowed the team to utilize strategies from
the other two sections. The team began
by determining what items were critical to its system operations. Upon
identifying the items that supported daily operations, these items were
‘stratified’ and categorized based on 9 factors. The
factors utilized in the analysis related to: ·
3 Criticality factors ·
3 Risk factors ·
3 Economic factors Using these factors, a
nine-cell matrix was developed to categorize each item. These groupings
were utilized to identify material criticality, service level position,
and purchasing strategy. We had already determined that “all material
is not alike and should not be treated in the same way”. The PIT took
this information, did a Pareto analysis, and determined that 20 % of the
items fell into the ‘critical’ classification. The team also
determined that the balance could be stratified in a number of lesser
classifications. The next logical step was to address the procurement
philosophy for each classification. The philosophy revolved around how
the different cells would be addressed. The team took the nine-cell
matrix and broke it into four groups consisting of Critical, Strategic,
Important, and Expendable items. The PIT then
embarked on developing strategies for each classification that could be
employed effectively and efficiently. After reviewing the ‘Best’
Business Practices of successful competitive companies, it was evident
that these suppliers and their customers were creating business
relationships called ‘Alliances’. These relationships focused on the
potential for future process improvements and were good business fits
– never forced. These
relationships can be defined as: ‘A formalized long term relationship with select suppliers. These agreements provide the framework for how two or more companies will interact in order to increase each other’s operational efficiency and profitability. Typical provisions address issues related to total product and service cost, performance metrics, information sharing and reporting, quality process audits, contingency planning, confidentiality, partnership evaluation, and dissolution conditions. The goal of an alliance is to create a win-win situation in which all parties benefit from closer interaction with each other. The benefits are realized in areas related to product and process quality, process improvement, and total cost management’. The PIT
wanted to employ the practice of participating in Customer/Supplier
alliances and began to work on a strategy that could be rolled out to
the corporation. There was a need to show management that extra value
could be put into the relationship through superior service and process
improvements. Not only would the team need to develop and communicate a
new strategy, all of the 'change management' issues involved in this
type of project would also need to be addressed. the corporation would
not consider a change of this magnitude unless the savings would be substantial. The initial strategy was to
select the group of vendors supplying the most critical items and
develop a relationship where both parties become true business partners.
This would allow everybody to share in both the rewards and risks
involved in a closer working relationship.
The objective would be to create a dynamic ‘program’ designed
to foster development and interaction with the supply base.
The goal would be to implement a new set of supply chain
management initiatives that would show ‘profit’ improvement by: · Ensuring high levels of product and process quality ·
Achieving inventory cost reductions through leveraged
purchasing, shared planning, and simplified process administration ·
Establishing a frame work of supplier performance ·
Supporting the qualification and selection criteria of
suppliers ·
Providing mechanisms for improved communications between
customer and supplier ·
Greatly contributing to bottom line profit improvements The
team began to analyze the suppliers who met the criteria that our
strategy defined. In order to implement culture change of the magnitude
the team was after, it would be critical that the partner had the same
philosophy. The team knew that picking the wrong supplier would be a
silver bullet to the program. When talking about total procurement cost,
performance measurements (all parties), life cycle cost, process
improvement, and follow up, there was an agreement that these items were
critical to success Unfortunately, for most of the companies analyzed,
issues like this were not in the forefront of their business models.
With the analysis completed, the team decided to start developing a
program with the highest dollar volume supplier. Over the next two
years, the program expanded to include 3 other companies who supplied
critical material. The team is currently
developing the fifth alliance and is analyzing the possibility of
working with 2 other suppliers. The strategy as it is currently defined
will probably not have the team recommending any other alliances. This
would mean that under our current philosophy the team has determined
that only about 5% of material suppliers are able to support this
program. The
current supplier base consists of only 4 true alliances. The
research and development phase of the alliance strategy indicated that
each relationship needs to be developed independently and focused on the
specifics of the relationship. It was very clear that “one size
doesn’t fit all,” and each alliance is very different not only in
form, but also in function. The
highest volume alliance is a direct relationship with the manufacturer.
This alliance employs strategies that are based on setting goals
and objectives, which are based on process improvement. The relationship
brings to the table a level of communication and process improvement
projects that could never have been achieved without all parties having
a thorough knowledge and understanding of team concept.
As a partner, the supplier has been allowed to test product on
the company’s system, and the company has helped the supplier bring
new product to the market. Along with the routine partnering objectives,
the company has also helped the supplier market product to other
utilities and industries. This relationship has allowed
the company
to achieve a ’favorable’ pricing
clause, a JIT approach to materials management (inventory reductions),
and a ‘heads-up’ on new product development. Major
savings have also been achieved through product standardization. Having
a standardized product on the system has allowed the company to save
money by standardizing the training program. The second alliance
developed offers yet another perspective.
While this alliance is also a direct relationship with the
manufacturer, it brings to the table another set of objectives. While
the basics of lower prices and coordinated shipments are focal points,
the company and the supplier also strive to work together to develop new
product and eliminate any non-value process in the relationship. This relationship was one of the first attempts to process
map the interaction between the companies to eliminate non-value
process. The first attempt to eliminate non-value added process revolved
around the invoice payment process. It was determined that the
relationship could be structured so that the invoicing mechanism could
be eliminated. Then, the partnership employed
a process called ERS – Evaluated Receipt Summary. ERS lets the
company pay bills upon receipt of material, without an invoice
process. The receiving receipt is entered into the purchasing system,
and a payment is sent or transferred. This process is achieved without
any invoice being processed. The company had
averaged over 250 invoices per year with this supplier, and the new
process generated substantial savings for both companies. The team is
currently looking at what product is critical (possible road
blocks) in the manufacturing process and comparing it to the company’s
critical material requirements. By analyzing this relationship, the team
can develop a supply chain strategy that will be mutually beneficial to
both companies. The
other two alliances bring a distributor into the process. These
relationships are developed around a three-way communications model.
These partnerships, while similar to the direct relationship models in
objectives and goals, are quite different in structure.
In one case, the goals are achieved through the use of a
third-party stocking distributor, and in the other the company utilizes
the distributor’s market share to benefit the company’s
requirements. In the first
case, the manufacturer was not structured to achieve the alliance goals.
When approached with the programs concept, the supplier was able to
visualize the benefits to their system even though the supplier was not
structured to adopt the program. This manufacturer then came back with
the idea of using a third party that has the ability to buffer the
process. While there is a premium associated with this concept, it was
justified by splitting the cost through total life cycle cost
reductions. The distributor
stocks a buffer inventory, which has allowed
the company to reduce our on- hand inventory of system- critical
materials by more than 50 percent.
The distributor also acts as an inspection point, allowing
the company to eliminate the
incoming material inspections. This relationship has also offered a
level of customer support in areas related to training, equipment
servicing, and field representation that would never have been achieved
from a supplier located half way across the country. Not only does this
distributor support the utility, but it has been instrumental in
providing the utility’s contractors the same level of support.
Over the term of this relationship, the company and the supplier
have also eliminated the invoicing mechanism (using ERS) and increased
the scope of the relationship to other products from the original
manufacturer as well as one of the manufacturer’s subsidiaries.
The final alliance
that the utility entered into also utilizes a distributor. The company
was able to utilize a third-party distributor to achieve market
leverage. This relationship has evolved to be one of the
strongest and most beneficial partnerships developed to date. Due
to changing technology, the volume of business with this distributor has
declined over the years, but the relationship has evolved and is
stronger than ever. This
distributor has been the utility’s eyes and ears in a market that is
in as much turmoil as the utility industry. Savings were achieved by
having the partner couple material requirements with the requirements of
other customers. The company now has access to material that it could
never have had with normal industry relationships and at prices that are
not artificially inflated. This supplier also coordinates a
manufacturing process for us that is required with this material. Not
only is the supplier able to coordinate this process, it eliminates all
the administrative functions which would be required in administering
multiple orders. The distributor also performs the purchasing function.
This eliminates the associated cost and supplies product at better
pricing through market leveraging. Another benefit of
this distributor is its ability to market excess inventory. There have
been occasions when the utility found itself in an over inventory
position, and the distributor was able to source the excess product at
market prices. Process improvements, coupled with the market leverage, have
allowed savings that would never have been achieved without the alliance
relationship. Alliance
relationships should be developed to be evergreen in nature with
continuous price adjustments. Price adjustments based on changing
markets, process improvements, volume, and changes in technology allow
the relationship to continue without interruption. These alliances have
enabled the utility to achieve a necessary level of performance to enter
into a competitive world. Over the last 4
years, these programs have allowed the companies to achieve higher
operational performance while minimizing procurement cost by: ·
Putting Quality in product and process ·
Standardizing product and process ·
Employing best business practices ·
Focusing on critical suppliers ·
Creating a two- way communication path ·
Sharing burdens and benefits – Risk management ·
Analyzing cost components and implementing change ·
Eliminating non-value added process ·
Employing honesty and integrity While achieving the benefits
of procurement cost reductions, there were some lessons learned. You
must be sure that the partner you choose is the right partner and that
the partner views the partnership as part of its corporate operational
strategy. Honesty and integrity play a major role when entering into
this type of relationship. Since you are eliminating the age-old
‘guard dog’ – competition - you must have the ability to be in
touch with the market. The other suppliers in the market will continue
to develop their market share with new and improved products and/or
enhanced technology. It
would be detrimental to your overall business strategy to become
complacent and put yourself into a position where you cannot take
advantage of new product or technology.
These programs are long term commitments to process improvement,
and all parties involved must be willing to invest the time and
resources required to keep it moving forward. One of the biggest problems we
have identified was ‘stagnation’. In order to produce a successful
program, you must publish a clear objective and identify goals (for all
parties) that can be benchmarked. These goals should be designed to
promote forward momentum and be used to keep the team from
‘stagnating’. If one of the parties is not in sync, it will be
obvious to all other participants. If this happens, objectives will be
diluted, and the message delivered will be contrary to the goal you are
attempting to achieve. This is a continuous process improvement model,
and both customer and supplier must be able to show management process
and product savings. These programs commit resources, and if savings
cannot be continually achieved, resources will be reallocated elsewhere.
For maximum motivation, alliance programs must have a ‘win-win’
outcome for all parties involved. While the road to success has had its
ups and downs, the commitment to the concepts by all parties involved
has allowed us to achieve measurable results. The savings that have been
achieved include not only reduced product prices but also process
savings related to the elimination of non-value added services.
To date, the utility has achieved in excess of $6 million in
savings with another $3 million pending.
Alliances have allowed the utility to achieve what all the text
books say is impossible: Reducing inventory by approximately 25% while
increasing customer service levels from 93% to 99.8%.
Process savings have been achieved in areas related to invoicing,
materials management, new product development, and logistics. The
company has eliminated the requirement for ‘Alliance’ suppliers to
send any invoices. By implementing ‘Evaluated Receipt Summary’, the
company has completely eliminated the invoicing process, which saves
both parties approximately 50% of the invoicing cost. This automated
system also means that all bills are paid on time and the supplier debt-
to- collection ratio is improved. Materials management functions
have also been fine-tuned. Product scheduling has allowed the utility to
better manage its inventory flow. This has increased inventory turns
while allowing the supplier to economize the manufacturing process
through better production scheduling and the purchase of raw material.
Savings have also been achieved through the reduction of material
rejections. Product standardization, cleaner specifications and open
communications have allowed material requirements to be communicated
efficiently, thus reducing the amount of ‘noise’ in the supply
chain. This improvement has meant a significant reduction in incorrect
material shipments. One area where the utility has been able to really
help its alliance partners is through the use of the distribution
system. By allowing new product to be field tested on the system, the
manufacturer has the ability to monitor performance in an actual field
application. This gives the manufacturer an area to do product testing
that historically was not available while keeping the utility
on top of new technology. Communications have also offered the
partners savings in other areas. In some cases trucks are now loaded
more efficiently, engineering units from both customer and supplier
areas communicate on product issues, material managers have contacts
in-house at either company, and upper level management sponsors have the
vehicle to communicate issues both vertically and horizontally through
the supply chain. CONCLUSION A customer/supplier
partnership or alliance results in a systematic approach to a
relationship that adds value through continuous process, product, and
service improvement. It fosters a relationship that reduces the ‘total
ownership/operating cost’ (for all parties) while maintaining
competitive levels of quality, safety, service, and technology. Parties
to the partnership must be open to adopt culture changes and be willing
to share in the ‘risk’ as well as the ‘reward’. The goal is to
develop a supply chain initiative where all parties involved achieve
bottom line profit improvements.
Note: This paper has been formatted for web publishing. For a Microsoft Word document to be e-mailed to you, please contact Michael. For information on ASQ follow this link: For Customer/Supplier Division information follow this link: This division is a must for anyone who wants to learn how to improve supplier performance and increase customer satisfaction!
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