Published March 22, 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?
MRO INVENTORY CONTROL AND THE LOW BID SUPPLIER
A heavy equipment manufacturer has long term agreements [LTA’s] with each of six major categories of MRO materials: Electrical Equipment, Power Transmission, Fasteners, HVAC, Safety Supplies, and Pipe, Valves & Fittings. The company’s central procurement department administrates each LTA and goes out on quote [RFQ] every two years. When it was time to create an RFQ for electrical supplies, seven potential electrical distributors with national stocking facilities were selected to participate. There was a list of requirements including a market basket protocol to compare price proposals. Based on the market basket price sample, the lowest price bidder was selected to be the LTA supplier for electrical supplies.
As time went by, the plant CFO noticed that MRO inventory was increasing while the plant had no discernible increase in activity. The CFO went to plant purchasing to find out what was causing the increase; purchasing had no answer, “I just agree to the LTA and get credit for the price decrease; I do not requisition from the supplier much less worry about the inventory that maintenance orders.”
The CFO hired a supply chain consultant to find out what was happening to the inventory. Here is what was uncovered:
- Yes, inventory was increasing mostly from the electrical supplies category
- The electrical supplier’s closest stocking location was over three hours away from the plant
- The supplier cut its margin to under 6% for stock items to win the bid. The hope was to make up for the margin shortfall with better incoming prices because of increased volume as well as higher markups on spot buys that were outside the LTA.
- When this LTA supplier received a requisition, there was no priority assigned because of the low-low margin. Higher margin orders had priority, especially for orders being picked from the supplier’s inventory. In addition, shipments were held waiting for larger quantities to justify the six-hour round trip.
- Meanwhile, back in the storeroom, MRO inventory stock-outs increased, maintenance reliability suffered, and acrimony prevailed
- The corporate dictate required that the LTA supplier be utilized for restocking to the company’s min-max schedule; however, a maintenance purchasing card was available for local supply
Due to the lack of service from the LTA, the purchasing card was utilized locally to support the immediate needs of maintenance who had to buy package quantities to get even a reasonable price [higher that the LTA pricing]. The parts needed were utilized and the excess was placed into inventory. Subsequently, the stock order arrived from the LTA causing over stocked bins and congestion in the aisles of the storeroom; hence the reason for the inventory increases.
Conclusion: Selection of the “low bid’ supplier assumes that all the services needed are uniformly forthcoming from all suppliers selected to compete for the bid. This is just not the case. Suppliers give preference to those clients who return the most margin.
In this case, the company assumes the additional cost of increasing inventory — congested storeroom [not a small thing], idle workers waiting for parts, the plant manager screaming that his lighting was humming, and maintenance jobs awaiting attention. These costs, although indirect, should be measured and deducted from the price savings offered by the “low bid” winner of the LTA RFQ.
This is another case supporting MRO consumers getting out of the MRO storeroom business and leaving MRO supply chain management to experts…The New Integration.
Coming up is the third in a series of case studies on the real cost of low bid suppliers describing how changing sourcing to the lowest bid provider contributed to the closing of a foundry operation and the loss of jobs.
Please stay tuned.