Published March 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 is 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 #1. FRIEGHT AND THE LOW BID SUPPLIER
A food processing company consumes large quantities and a large variety of pipe, valves, and fittings [PVF]. Procurement decided to go out for bid for the PVF commodity to get a lower price for the MRO inventory stocked in the storeroom. A lower price would help fulfill the purchasing department’s direction of X price savings for the year.
A supplier was awarded the contract based on a 9% overall price saving for which purchasing received accolades. The contract stated that the company would place orders for SKU’s that reached predetermined minimums on a twice per month schedule to minimize purchase order cycles. This resulted in the placement of orders containing two and three pages of SKU line items. Since the low bid supplier was working on low margins [to get the contract], they did not ship materials from stock; instead they placed orders with various sources when they received scheduled reorders from the client. When the parts came in from their sources, the supplier turned them around and shipped to the food company without moving the parts to inventory. The result was multiple shipments to the client, many of containing freight charges, higher than the value of the materials shipped [minimum UPS charges $12 – $15].
In addition, since many projects required immediate supply and larger quantities than those ordered, local suppliers were used by plant maintenance via P-Cards to obtain the needed parts, which, in turn, increased inventory because of package quantity requirements.
So, procurement was credited with price reductions, while operations assumed the additional incoming freight costs because of the multiple shipments. Finance assumed the additional cost of increased inventory, maintenance had to spend time going to local suppliers [at a higher price], and accounting had the burden of multiple shipments and invoices to process.
What happened to the benefit of selecting the “low-price “bidder?????
In the second of a series of four case studies concerning the “Real Cost of Low Price Suppliers”, a heavy equipment manufacturer is faced with growing MRO inventory with no increase is plant activity. How was this happening? What was the cause? Please stay tuned.