The Real Cost of Low Price Suppliers: Final of a Four-Part Series of Case Studies Depicting Increased Cost Burdens Effected by Using ‘Low Bid’ MRO Suppliers

Published April 13, 2017

The process of selecting a MRO supplier based on “lowest bid price” is flawed in that the process results in a higher total cost to the company when MRO inventory is consumed.

In most companies, the procurement department is responsible for soliciting quotes [RFQ] for MRO materials, assessing the quotes, and selecting the suppliers. Although there are usually performance factors set forth in the RFQ, low price is the first factor that is assessed and the main factor in the selection process. Procurement’s goal and the standard to which the department becomes evaluated is, “How much did you save?” … not how did you lower our total cost … “How much did you lower the PRICE we paid?”

By selecting the lowest price bid, procurement fulfills its mantra from management and falls in line to receive positive performance reviews.

What about the other unforeseen and unaccounted costs that accrue from the “low bid” supplier that shift to other departments who now have the additional cost [not price] burdens?

CASE STUDY #4:

Timing in milk processing is critical, since milk curdles over time, refrigerated or not. A West Virginia milk processing plant has agreements with various dairy farmers to process milk produced by the farmer’s dairy cows. Cows must be “milked” every day, ergo, there is a continuous flow of milk that must be processed to a time schedule, or there is a loss of milk processing production not to mention the actual loss of the milk itself.

The MRO storeroom places requisitions to plant purchasing to replenish MRO inventory for all categories in anticipation of what maintenance needs to deliver a reliable plant to the plant manager. The min/max for each SKU is set by maintenance managers and plant engineers who are mostly concerned with critical spares [those SKU’s that could cause production shut downs].

The MRO storeroom at this particular plant, is generally considered to be unreliable [sometimes referred to as a “Storm Room”]. Therefore, it was common practice for a given maintenance manager to establish identical stock units of critical spares under different descriptions as insurance against a stock out [no one else would requisition the part, because no one else knew what is was or where it was used].

When it came time to ask suppliers for quotes on the various MRO categories, it was relatively easy for the Purchasing Department to evaluate the commonly used MRO inventory and select the low bid supplier. But, picking a supplier of the necessary critical spares proved more difficult in meeting the department’s goal of price reductions [the procurement mantra].

Suppliers were chosen and critical spares were added to agreements in the mechanical and power transmission arenas. Price savings were not forthcoming from the original equipment manufacturers [OEM] because the OEM’s do not have a distributor’s discount structure; the price is what it is. Procurement, instead, hoped to earn price reductions for critical spares by going to MRO distributors via commercialization of OEM parts.

One Friday night, the plant manager is called at home and informed that milk is leaking from a major processing line. Maintenance had replaced the “needed” part , but the milk was still leaking. The plant manager leaves home, enters the “storm room”, and finds the “correct” part after searching two hours. The part is installed and the plant manager returns home. At 2 a.m. the plant manager is called again and informed that the line is no longer leaking; it is spewing. Back went the plant manager to witness milk all over walls, floors, and people. The line was shut down until the OEM engineer could get to the plant, assess the problem, obtain the correct part, and see that it was installed properly.

What happened? The chosen distributor had supplied what was thought to be an acceptable part based on the description given, and supplied it without obtaining authorization. It was done to get the bid agreement. Purchasing received credit for price reductions; however, production goals were not met, there were no bonuses given, and the cows kept giving milk. The cows did not care a whit about critical spares.

What was done to correct the situation? The “storm room” was outsourced to a provider with MRO management as its core area of expertise. The new provider established a bill of material [BOM] coinciding with each asset in the plant; this BOM effected inventory consolidation, i.e. reduction, optimum MTTR [Mean Time To Repair], price containment, and 100% parts on hand for critical spares. MRO management went from “storm room” to world class MRO inventory operations providing plant wide support for reliable plant goals.

In conclusion: There is a theory in the MRO procurement arena that all major MRO distributors provide the same level of service and total cost of ownership value; therefore, selecting the lowest price supplier is the optimum total cost position for the company. As shown in these four case studies, this theory is not only false, it is dangerous and can have negative effects on a wide range of operations, plant profitability, and the economic stability of plant personnel.

Be careful of RFQ rewards; beware of the low bid offerings.

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