The Real Cost of Low Price Suppliers; Third in a Series of Four Case Studies Depicting Increased Cost Burdens Effected by Using ‘Low Bid’ MRO Suppliers

Published April 4, 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 #3:

A foundry in Alabama outsourced the management of its MRO supply chain to a provider with MRO supply chain expertise as its core function. This supplier provided all the necessary functions for the foundry to realize maximum value from the internal distribution of MRO materials.

These functions included:

  • Master Data Leadership: Proper and sustained naming of all parts to eliminate duplicated SKUs, reduce inventory, and to provide the correct part for the needed function.
  • Reliability engineering applications designed to analyze production processes to deliver a reliable plant and to establish correct bill of material coordination with MRO storeroom management.
  • A personalized CMMS procedure to properly control all aspects of work orders, charge backs, and audit trails.
  • Implementing an on-site MRO supply chain management team to coordinate all MRO functions allowing plant maintenance to fulfill reliability goals at optimum cost…The New Integration.

After a time, corporate finance saw there was considerable dollars being spent with the MRO provider and directed procurement to go out on quote. It is interesting to note that the spend on MRO inventory previously spread over 137 suppliers did not draw any attention from Finance; now that MRO inventory management had been maximized by the MRO expert company and consolidated into the benefits of an expert single source, the process was now out for bid.

The RFQ was formalized by procurement and sent to an array of traditional distributors without reference to the many advantages the existing supplier provided. The RFQ contained the standard requests for quote, i.e. price samples, delivery, terms, etc.,etc. Most procurement decisions are made on price comparisons, and the low bid almost always gets the contract. This was the case at the Alabama foundry, and contracts were awarded to multiple, low-bid distributors based on various MRO categories. In time, when as non-stock suppliers were added to the supplier base, the supplier count returned to over 100 with a corresponding increase in P.O.’s, receipts, and invoice processing costs.

A new CFO was hired and noticed that, at one time, there were multiple files containing a plethora of paper work mostly all from MRO suppliers, and then there was a period when there was hardly any which was during the period when the on-site provider was the supplier offering just two invoices per month. When the on-site provider was terminated, there was a return to a massive amount of paper filled files coming from the multiple low-bid suppliers. The CFO determined that the price savings were short lived, because it was impossible to control prices with that many suppliers; therefore, the savings did not materialize as predicted.

Conclusion:  In this company, actual costs soared, a direct result of the increase in the need to process all the additional paper trails effected by the low-bid supplier selections; MRO inventory control was lost. When the CFO finally recognized the significant cost increases effected by the low-bid supplier cadre, was the foundry directed to return to the optimum cost situation previously provided by the on-site supplier? No. The debacle was ignored [covered up] and, eventually, they closed the plant because of the inability to control operational costs. 622 families lost their income.

Price is not synonymous with cost.

 

In the fourth case study [of four], a milk processor loses production, loses bonuses, causes milk prices to increase, and milk to curdle.

Please stay tuned.