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Dealing with Rising Supply Chain Costs
Relationships are important, especially the ones you have with each and every member of your supply chain. But sometimes, as our guest on this edition of "Deal Talk" might tell you, our long-term relationships can cloud our judgement when it comes to the bottom line. When was the last time you audited your distribution network, or your supply chain as a whole? How much have rising costs chewed into your profits? When was the last time you put your materials or distribution needs up for bidding? Tim Van Mieghem, partner at The ProAction Group in Chicago, has seen it all. Jeff Allen speaks with Tim about the warning signs and what you can do to help get your supply chain costs under control so more money goes to your bottom line.
Questions Answered For You
- Where are some areas within the supply chain where businesses tend to lose the most money?
- Why do so many business owners fail to take note of issues in their supply chain that could be holding them back from continuing to grow as an organization, and continuing to improve that value over the long run?
- How does a business owner take stock of the supply chain in order to start to make some improvements that are going to get the results that they’re looking for?
- What does the process of re-evaluating the supply chain entail?
When we do an assessment and we talk to the people who negotiate purchasing contracts in a company, the more hardcore they are in terms of talking about getting the best price, the more we find that we can help them dramatically improve the cost structure.
Key Takeaways To Remember
- Businesses can benefit greatly by taking a systematic and critical approach to negotiating their contracts.
- It’s important to understand that the relationships that business owners have with their supply chain members are in fact partnerships, they go both ways.
- When evaluating your supply chain, first look at the performance of your current suppliers then look at agreements with the suppliers.
- Talk to other companies and find out who they're working with, what they liked about them and what's effective.
From our studio in Southern California, with guest experts from across the country and around the world, this is "Deal Talk," brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.
Jeff: Welcome to the web's number one content source for small business owners committed to building a business for eventual sale. Here on "Deal Talk" it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value .
Joining us back here on the program to talk all about supply chain management and how to heal those relationships, or if they're not broken at least improve them, is Mr. Tim Van Mieghem. He is a partner at the ProAction Group in Chicago, Illinois. Tim, good to have you back on the program, sir. How are you?
Tim: I'm doing well, Jeff. It's good to be here with you. Thank you.
When I negotiate every dollar of benefit that I negotiate for myself is a dollar out of your pocket and vice versa, there's no value created. When we're negotiating between two companies to provide a product, we can negotiate many items beyond price. … We can negotiate those issues and develop a contract where we actually create value.
Jeff: Thank you. Today we're talking about supply chain logistics. When we think of supply chain, many of us immediately consider manufacturers first and foremost. But might this discussion that we have today, Tim, also be helpful to other types of businesses and industries as well?
Tim: Yeah, absolutely, Jeff. And certainly when you think about cost of goods sold for a manufacturing company the cost of direct materials can be 60% to 80% of the cost of goods sold. So clearly for manufacturing companies negotiating good contracts with our suppliers is absolutely critical.
Distribution is the same. And one thing that I would add to it there's a complication with distribution companies. Oftentimes they're selling products that are branded and their customers are committed to buying a certain brand. And a lot of distributors we work with think that if their hands are tied because of that pull-through, and that perhaps their ability to negotiate a better deal is limited.
Health care is another great example of a company that can benefit greatly by negotiating contracts. And to some degree as well it may not be the largest item on the income statement , but even professional services and service-based companies are still spending money every month that can be improved, sometimes dramatically, by taking a systematic approach and critical approach to negotiating their contracts.
Jeff: So we're really talking about supply chain as far as... This is part of a company is doing business every single day. A portion of your supply chain is affected by what you do and your business is in turn affected a little bit by what they do, by the amount that they charge you by delays in service, by breakdowns. Whether any number of things that could influence the cost that you pay both in the short run and in the long-term because these costs that you end up paying, these expenses could really mount up, Tim, I think that you would agree.
Why is that, do you think, just kind of based on your travels and dealing with your clients, that so many business owners fail to take note of issues in their supply chain that could be holding them back from continuing to grow as an organization, and continuing to improve that value over the long run?
Tim: That's a great question, Jeff. And I think there's a couple of really important pieces here that prevent people from really evaluating it, knowing what's possible. The first one is I think it's the basic tendency that many of us have to look at price as the primary issue when negotiating with our suppliers and looking at our supply chain. And that is such a limiter.
And actually one thing I will tell you that's kind of counterintuitive is that when we do an assessment and we talk to the people who negotiate purchasing contracts in a company, the more hardcore they are in terms of talking about getting the best price the more we find that we can help them dramatically improve the cost structure.
And when we sit down and we work to become a good customer to a supplier, and we sit down and we have a rational, thoughtful conversation about who should do what to minimize the total cost of the supply chain, we can create a ton of value for our collective supply chain and how we serve our collective customers.
Tim: Yes. When people talk about how they have a really hardcore negotiator it's often an indicator that they've been focusing on price and that there's great opportunities to improve. There's a second one too which is, it's that old comfort zone issue.
And here's what I'm talking about here. Our biggest dollars when we're looking at what we buy in our supply chain are what I would call direct materials. It's the items that go into our product. So for a manufacturing company it's our raw materials, our ingredients, our purchased goods and services. If we're a distribution, it's the products that we sell to our customers.
These are oftentimes they're strategic relationships. And what I found is that people get comfortable with their existing supplier and they do not like having a difficult conversation periodically that we're going to be putting it out to bid. And in fact they're concerned that they could disrupt their supply chain if they go down that path. And so there's a certain level of fear of change and of unknown that kind of prevents people from taking a deeper dive.
Jeff: And also, too, I think that there could be a comfort factor with the fact that you might believe that, "Hey, I've been with this guy for years. He's given me the best possible deal I could possibly get from anyone," when in fact that deal may be on price but there may be certain limitations that you don't understand that exist that maybe the guy down the road or someone across town may not necessarily be limited to providing you. And it may be better deliver time, shorter delivery times, maybe more trucks on the ground. It could be any number of things, right?
Tim: I'll give you an example. We just completed an assessment of a client spend for labels. It's a healthy spend, $2 million a year. And they've been buying from the same company for almost 20 years. And we put it out to bid and have looked at and received bids from alternative suppliers and here's what we found. There are suppliers who have different technology than the supplier we're using today.
We also have different locations. You can serve in a different way the different plants and factories that our customer has. And in fact what we found is that the alternative suppliers that we're talking to can provide the same or higher quality product. And I'm talking about a 25% to 28% cost reduction. So this is something that occurred over time. We had a supplier that worked for us when we were a certain size, and a certain area, and a certain location. And over time they became less relevant and we never looked at it until very recently. And now when we look at it we find a tremendous opportunity, and you hit on a really important topic.
Back in the old days, it was the good old boys club. One of the primary methods that people use to select their suppliers was who they have a good relationship with. And then they then worked with that supplier and do the best they can. What we're doing today, it seems a little cold, but it's so much more effective, is you find the company with the right infrastructure that has the ability to serve you and your customers in the lowest cost and in the best, highest quality methodology possible. And then you build a relationship with that company. It's completely flipping the model on its head, and it works.
Jeff: And so really though, one of the keys I would think though is you've always got to have added value in mind, what is it that this next company over here can provide me that I'm not getting over here? Maybe it's for the same price, maybe it's for slightly more. But this is all business, this isn't personal here. We're trying to do things to help us get that ...
I've got a plan to sell my company about 10-15 years and obviously I want to get as much for it as I can. But if I'm losing money here, and all of it seems to be invisible to me, I've got a guy, Jerry here has been great to me. He's fantastic. We've been working together for many years, that doesn't make any difference at the end of the day really because ...
Tim: Here's another quick story for you, Jeff, that tells this pretty well. We negotiated for a company a whole bunch of different things but including their outbound freight, their truckload shipping. And it wasn't a big spend. It was about half a million dollars a year, and the person who was doing it currently was a personal friend. And in fact their kids stood up at each other's weddings. And they had a long-term relationship. As it turned out we found an alternative that would save him $100,000 a year. And you know what the conversation was between the CEO of the two companies?
Jeff: What's that?
Tim: He said, "I love you, man, but I'm not going to write you a check for $100,000 a year."
Jeff: How did that go?
Tim: I'm sure it doesn't always end this well, but in this case the guy said, "That's the right choice. They're a different company, they're set up to serve you, and I understand." And it was truly the right decision. There are many times where companies decide to stay with the current supplier, but here's what I want it to be is a conscious choice with the facts on the table.
Jeff: Tim Van Mieghem is with us and he's been with us before here on “Deal Talk.” He's a partner at the ProAction Group, and we're talking about supply chain. We're talking about improving those relationships in your supply chain. And in fact Tim Van Mieghem is the author of a book, textbook, “Implementing Supplier Partnerships.” And this is really important because we don't tend to think of our partnerships and our relationships as partnerships with the suppliers and our vendors so much I think as much as we need to because really it's a two-way street, we're helping each other here, right, Tim?
And so you've got this book, “Implementing Supplier Partnerships.” Tell me, Tim, in your studies of kind of the improvements that are required, the relationship building that is necessary, in order to get the best value out of the partnerships that you should have with your suppliers and all of those vendors and people along the supply chain, what are two or three of the areas within that supply chain where businesses tend to lose the most money whether due to high cost or losses resulting from inefficiencies?
Tim: Sure. Another good question. Let me provide a little bit of a thought background on this, too, because we talked about price before. Here's the one big aha that really helps to paint a picture of why this is so effective. When we negotiate, for example, for a used car and it's a one-time deal it's a zero sum gain negotiation.
When I negotiate every dollar of benefit that I negotiate for myself is a dollar out of your pocket and vice versa, there's no value created. When we're negotiating between two companies to provide a product we can negotiate many items beyond price. We can negotiate inventory programs, hedging programs, pricing terms, quality, new product development, when does title pass, how do we ship the product, and 20 other issues. Here's what's wonderful about it, is that we can negotiate those issues and develop a contract where we actually create value.
One of my favorite examples comes back to a tour I took of a forklift factory. One of the stories that came up was a supplier was coming through a factory that provided the wheels for the forklift company, the steel wheels. And they noticed that when they brought the wheels in the first thing that happened is they went over to a drilling station. And the representative from the supplier asked them, "What was going on here? Because once we receive your wheels we bring it over here and we've changed our drawings and we've added some things that we needed to put a couple of additional holes in these areas for this new application that we have." And the supplier said, "If you let me know, I can do that and I can actually design it into our computer, design our CNC machines and have it done automatically."
This might seem like an obvious example, but, Jeff, I'll tell you, one, it happens all the time because people don't have time to review every process and have these kind of aha's. But what this exemplifies is that if you move a step to the right part of the supply chain you can dramatically change cost structure. And when we sit down and we work to become a good customer to a supplier, and we sit down and we have a rational, thoughtful conversation about who should do what to minimize the total cost of the supply chain, we can create a ton of value for our collective supply chain and how we serve our collective customers.
And that's the first half of our negotiation. Our negotiation process is set up to understand that dynamic and to negotiate to provide the best cost structure and service to our collective customers. Then the second part of our negotiation is how do we divide up that value, and that's where we have the negotiation about things like price and what terms do we get and what do we give to the supplier. That process is where a lot of the value to the company can come from sourcing.
Jeff: This is a really important conversation we're having here, Tim, and I hope that our business owner audience, our listeners do take note of some of the things we're talking about because I think so much of it can't be taken for granted, particularly when you might think that you've already got some very, very strong relationships that are built on trust over the years. But there are always things you needed to do and take some time to re-evaluate particularly if you own a business where the supply chain plays such a vital role and such a vital part of your being able to satisfy your own clients.
My name is Jeff Allen. I'm going to be back with Tim Van Mieghem. He's partner at the ProAction Group in Chicago. We're talking about supply chain management or supply chain rather partnerships and your relationships with your supply chain members. And we're going to do more of this when we return on "Deal Talk" right after this.
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Jeff: I'm Jeff Allen with my guest Tim Van Mieghem, partner at the ProAction Group. We're talking about your supply chain and how you should work toward kind of bolstering those relationships with your supply chain partners. And really it's trying to have that mindset, maybe change the mindset that you might already have to understanding how these relationships that you have with your supply chain members are in fact partnerships, they go both ways, OK. But you need to really think first of all about your own business first. Are you really getting the value that you need to get from these partnerships, from these relationships to keep cost manageable while continuing to bring that value of your company up and delivering to your clients in an efficient way that helps them get what they want, you get what you want, your supply chain members they get what they want? Everybody is a winner across the board. I think, Tim, at the end of the day that's what we all want.
Jeff: I would like to ask you about the process. I'm a business owner and I am re-evaluating my supply chain from top to bottom. Walk us through the process. How do we start to take stock of things where a supply chain is concerned in order to start to make some improvements that are going to get us the results that really we're looking for?
Tim: Sure, good question. Here's what we do. If somebody asks us to look at their company, here's what we look for to find the smoke that tells us there's fire, the indicators that there's opportunities to perhaps get more value out of our supply chain.
The first place to start is to look at the performance of our current suppliers. Here, I'm going to start with things like inequality issues and returns. What kind of support are we getting from our suppliers for new product development? And I'm going to talk to the people in my company in each of the different departments and I'm going to ask them questions about which suppliers are your favorite, why are they your favorite, which suppliers make it more difficult for you to do your work, which ones would you prefer to not work with again, which ones would you like to work with more?
It's amazing what you learn. It's like that old Yogi Berra quote, it's amazing what you see when you look. And by looking at this and asking questions we find out so much where there's pain that we may not have known about it before.
The second thing we like to do is actually look at our agreements with our suppliers. And this first assumes that there are documented agreements. If there are not documented agreements, then that is a meaningful sign that there's an opportunity. If we are not measuring something, then it's difficult to know that we're doing it well. So that would be the next piece.
And here's a real important tip when we look at our agreements. There's two kinds of agreements that we consider to be technical and ineffective. One, our agreements that are less than a year where we're essentially negotiating each need as we go. And the other one is what I consider evergreen contracts which are ones that essentially just go on infinitum. Neither of those provide value.
A supplier, what they want is commitment. They want to know that they're going to have your volume over a period of time. That is how they can evaluate their ability to invest in you as a customer. So if we're simply negotiating for the next order or for one year, that's a very short period of time that they are getting a return on any investment they make in you as a customer.
If it's a very long term contract where it continues to just get renewed, then in a sense it's never being reviewed. And it becomes a cash cow for the supplier. It becomes something that they assume. What we want, what typically makes sense in many cases a 3-to-5-year contract that provides a real window for the supplier to get a return on their investments in us as a customer. And it gives us a real window to go back to the market and test our agreement, and see is this still the best supplier, is this still the hungriest supplier, is there someone out there who's better for us, and for our customers, and for our shareholders? And many times we end up staying with the incumbent and we simply improve our contract, and there are other times that we change.
Another step that we take is we talk to our suppliers. And we ask them how good are we as a customer to you, what could make us better, what are your best customers doing, and what do we have to do to be a better customer? What do we have to do to get the best deal that you offer? And it's amazing what we learn by asking these questions.
Here's the basic premise, Jeff, on this line of thinking, is that if we want to get more value out of a supplier relationship, we want to be the customer that we can. We want to be easy to work with, we want to be dependable, we want them to be able to count on us and to have good transparency. And to be flexible in allowing them to solve our issues in the most efficient way possible. We could tell stories all day long about examples of this but having those conversations is a great place to start.
And the final one I'll mention is talking to peers. Talk to other companies and find out who they're working with, what they liked about them, and what's effective.
Jeff: Tim, do you have any other maybe examples or stories for us of maybe some clients that you've worked with who had some what you might consider somewhat common or... I won't necessarily say every day, but maybe a situation with the members of their supply chain regardless of exactly what function that they perform where they had this issue. It was something that was longstanding, they couldn't see it, but they were able to make a small change, or maybe even just through conversations or something, able to turn their situation around and save them a lot of money.
Tim: Here's a great example. This is a food client that manufactured a retail item that people would consume and eat, and their negotiations with their packaging suppliers. So suppliers have provided labels and the cardboard packages with graphics, and the boxes that you use to ship.
What was happening is that, and this is one of the examples of a client that had a really tough negotiator, negotiating with suppliers and prices all the time. And one of the things that ended up that they did to negotiate a good price is that they would commit to buying an entire season's worth of packaging at a time.
So they would commit to... Let's say the next three months they would commit to a volume and they would have three months to take it over time. What ended up happening is we looked at their inventory, they had inventory left over from last year, very often. And here's the problem with that, is labeling requirements change every year. Products change every year.
So they're getting a good price. And actually in their income statement, based on what they actually sell, they're able to show a good profit margin. But for a company as a whole they've got this balance sheet with items on it that they can never use, that they're going to have to write off at some point, and it's going to hit their income statement anyway. But it doesn't hit the regular cost of goods for the items that they're selling.
Here's the reality. Packaging suppliers today, many of them have gone through the lean manufacturing transformation. And they have improved their processes, they've changed over times, and now there are suppliers out there who offer the good pricing without requiring that you buy a whole year's worth of product at one time, or a whole season's worth at one time.
Here's what we're able to negotiate. Their inventory levels went down by 80%. Every single week they would simply let the supplier know what they used, and that supplier would replenish that and send out a shipment every week. So their inventories fell through the floor. And their cost per unit was down by 20%. So we negotiated a 20% improvement and we eliminated this obsolescence issue and excess inventory issue that we were fighting with the whole time.
This was a great example of stepping back and looking at the market to find a supplier who had the actual capabilities to supply what we needed.
And what I found is that people get comfortable with their existing supplier and they do not like having a difficult conversation periodically that we're going to be putting it out to bid. And in fact they're concerned that they could disrupt their supply chain if they go down that path. And so there's a certain level of fear of change and of unknown that kind of prevents people from taking a deeper dive.
Jeff: There are cases, Tim, where it's just not always really that obvious, right? You could be losing some money and you could be scratching your head thinking, "I'm not exactly sure where this is going or why this has become such a problem?" But it's true that you sometimes kind of have to step outside yourself and have a third party come in and kind of take a look at the environment, don't you?
Tim: I think that's a very good example. I always would start with our internal pain, what pains do we feel and let's make sure we address those. But the other piece of this that's so easy to forget is good companies can get to become great companies by challenging even the things where they're not obvious, where they don't have pain, and just by simply talking to their peers.
And of course I love the idea of bringing in external consultants who can help identify areas that may not have been obvious for other reasons.
Jeff: Tim, we've no doubt got people out there in the audience who will probably taking a look now at their own particular situations with regard to their supply chains trying to get on top of any issues that potentially they could be facing right now or determine whether or not that there any concerns they might have. But if someone wanted to kind of pick your brain and maybe potentially talk to you about their particular situation and having your company help them deal with issues that they might be having, how can they reach you?
Tim: Well, they can certainly go to our website, which is www.proactiongroup.com. They can send me an email at any time, which is firstname.lastname@example.org, or call our company at 312-726-6111.
Jeff: Tim Van Mieghem, once again I appreciate your time and you taking just kind of a moment out of your schedule to chat with us a little bit about a very important topic indeed. And we hope that at some point we'll able to revisit with you one more time.
Tim: Thank you, Jeff. It was such a pleasure to be here with you today and I look forward to talking to you soon.
Jeff: There he goes, Tim Van Mieghem, partner at the ProAction Group has been my guest and we hope you enjoyed this discussion.
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"Deal Talk" is presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. Learn more at morganandwestfield.com. My name is Jeff Allen. Thanks so much for listening and we'll talk to you again soon.
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