LTAs: Price vs Total Cost of Ownership

Published November 15, 2012

A major food company hired me to find out why their MRO inventory was increasingly out of control. Upon investigation, I determined that their Corporate Procurement was very strong in that all plants must use the Long-Term Agreements (LTAs) negotiated for the five categories of MRO. Severe penalties occurred if there was non-conformance, i.e. buying around the established LTAs.

Now I found that the LTA provider for electrical supplies was working on 4% mark-up; the nearest branch of that particular electrical distributor was over 100 miles away. At 4% mark-up, the distributor first filled the orders to customers where the margin was profitable, then filled the food company’s orders last.

Meanwhile, the plant manager’s lights needed replacement. Plant Purchasing had to order stock from the local electrical distributor to get the lights on. In order to get anywhere near the LTA price, Purchasing had to order five boxes of lamps which were delivered the next day. Subsequently, the stock order came in from the 4% LTA supplier (that would be two pallets of lamps). The increase in inventory occurred because the LTA supplier had quoted low but had little incentive to perform. The local distributor shipped next day.

It all gets down to total cost value vs price considerations. The low-price bidder does not perform (produce the value) because they will focus on their clients that produce the most profit.

When the plant manager cannot see, someone will provide the light. When maintenance cannot provide reliable equipment, they will find a way to get the parts needed by going around the inefficient non-reliable MRO storeroom. In this case, it was easily replaced light bulbs; where critical spares are involved the situation becomes much more serious with downtime consequences.

The low price benefitted Corporate Purchasing; they received the credit. The cost of the additional inventory, paper processing and the angst of having the plant manager in the dark (in more ways than one) was borne by the local plant.

Obviously, the low-price LTA supplier should have delivery performance in their contract. Where it is lacking, the plants suffer… the lights go out.