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Fulton Supply president offers ways to cut costs in new book
By Susan Avery -- Purchasing, 5/8/2008

Joel Roth wants to talk about MRO.

Looking to open up discussion between purchasing and distribution, the president of Fulton Supply Co. in Atlanta, has written a book based on his experience in the industrial distribution business called The 20% Solution: A Practical Guide to Dramatic Cost Reduction in MROP Procurement. (MROP stands for maintenance, repair, operations and production.)

And to really spur the conversation, Roth is making the book available free for download at http://www.the20percentsolution.com/ .

“MRO is one of the best and biggest untapped areas I know to achieve significant cost reduction,” he says. “But many companies never glimpse its true potential.”

That's because MRO typically makes up 20% of a company's annual buy and conventional thinking is that the dollars are “peanuts” compared to spending on raw materials and purchased components. But these areas tend to be ones that are mined over and over for savings and are probably tapped out. And companies today may be looking for new areas for savings in this uncertain economic climate.

How to reduce cost. In the book, Roth offers common-sense advice for managing MRO costs. The first step is relatively simple, but often neglected by purchasing, and that's to develop a set of objectives. “Saying you want to reduce costs by 10% isn't good enough,” he says. “Neither is saying you want to improve quality, delivery or service. You need substance behind those statements.”

In his role at Fulton Supply, Roth often meets with MRO buyers. Most, he says, don't really have a good idea of what they expect to accomplish with MRO, nor do they have a clear picture of what makes up the spend. “If you don't know what you spend, if you don't have good information to work with, you are at a handicap,” he says. That's the substance.

Roth suggests MRO buyers approach their suppliers for help with mining information on spending. He says suppliers can provide data fast, professionally and accurately. “But purchasing has to be willing to work with suppliers, and not treat them like the enemy. There are good partnerships between purchasing and distribution, but mostly it's still us against them [with suppliers]. It's not logical. The success of any good supplier is tied up with the success of its customers.”

For example, Roth says the purchasing operation at one company put its MRO requirements out to bid and received responses back from 15 suppliers, including Fulton Supply. Not hearing back, Roth contacted the buyer who was trying to make sense of it all. “We found out there was a lot of derisiveness across the company,” he says. “Corporate and the plants couldn't agree. We talked with them and helped crystallize and focus their thinking.”

Once purchasing decides upon its objectives, Roth suggests buyers select a small number of pre-qualified suppliers. “Bring in those you know are competent and whose core competencies fit with what you want to achieve,” he says. “Provide them your objectives and data. But boil it down to meaningful figures. Don't clutter it up with one-time buys or obsolete items. That only makes it more difficult to get to the kernel of truth.”

He advises buyers not to put limits on suppliers. “You take away a lot of potential ideas and knowledge that can help you,” he says. “Let suppliers come back with what they propose in terms of approaches and programs, and see what they have. It doesn't cost a penny.”

At this point, purchasing should be able to see which suppliers understand its needs. Then comes time for real negotiation to begin. But there's no need for purchasing to make any change instantaneously, says Roth suggesting that purchasing create a task force of employees, interns or suppliers to research the ideas.

“Although the process sounds time-consuming and laborious, it's not because purchasing really is letting suppliers do all the work,” he says. “Purchasing still controls the process. Just poke your head in once in a while to ensure the company is getting what it wants and is on the right track.”

According to a new book by Joel Roth—The 20% Solution: A Practical Guide To Dramatic Cost Reduction In MROP  Procurement—many organizations continue to spend as if still in a booming economy, without regard to real needs. Here are some of the reasons why:

•    Automatic reordering systems (such as preset reorder quantities, reorder points or economic lot sizes) have not been reevaluated to account for reduced usage, forecasted decline in activity, elimination or down-sizing of facilities and equipment, personnel lay-offs, etc.
•    Inventory records are not reviewed (or maintained) to determine if identical or similar materials are available within the organization.
•    New items are bought, when excellent used items meeting the same or higher specifications have been dumped on the market at a fraction of the cost.
•    Materials are replenished even though they can be recycled at little or no cost.
•    Custom or non-standard items are purchased, although standard on-the-shelf products are functionally equivalent at much lower cost.

 MRO COST REDUCTION GOALS

An old axiom states that “If you don’t know where you are going, any path will

take you there.” Most organizations have no specific objectives for MRO. When

asked, procurement managers offer vague statements like “lower costs, better

service, higher quality.” Or, “ I’d like to cut prices by 10 percent.”

    A vice-president of indirect materials for a multi-billion dollar corporation

recently told us that he was satisfied with his present spending since it was within

budget and below inflation rates. This reflects confusion between cost control and

cost reduction. Cost control is about maintaining costs within such  established

standards as historical levels, budgets or inflation rates. It deals with the past and

present. Cost reduction challenges the standards and seeks to lower them in the

future.

    MRO cost reduction goals must be specific, measurable, realistic and

            challenging.  

•    Specific—Better service or higher quality are not meaningful. Reduce

the number of SKU’s by 35 percent in 18 months by product and

brand consolidation is specific.

•    Measurable—In the above example, do you have the database and

management  information system to identify the number of SKU’s?

If not, can your suppliers provide it?

•    Realistic—If your production rate is increasing 20 percent and you’re

opening two new facilities,  it is unlikely  that you can reduce MRO

spend by 25 percent.

•    Challenging—Follow the money.  Don’t spend time and effort on

$1,000 per year for ladders when spending on tape is $50,000. And

don’t aim for a 10 percent  cost reduction because it sounds right,

when the potential is 35 percent or more.

•    Cost Drivers—An important basis for MRO objectives is to identify

the key unit(s) of activity that influence MRO spend.  In a steel firm,

it might be tons of metal poured; in a brick works, number of bricks

molded; in an insurance company, the number of policies under-

written;  and at Habitat for Humanity, square feet of rooms built.

   For meaningful cost reduction, it is essential to find the cost levels for best (or at

least better)  practices. These benchmarks might be obtained from industry trade

associations, competitors’ financial statements or a comparison of costs within

your organization. Probably the best source is your MRO vendors, their suppliers

and their competitors who seek your business.  Try asking them for the lowest

costs available for a given commodity or application if they were free of all

constraints.

    A large Southern electric utility asked six major MRO suppliers to estimate the

potential cost savings that they could achieve within their functional area if they

had no limitations.  Their estimates ranged from 8 percent to 30 percent, and

averaged 19 percent.  As a result, a key objective for the power company’s MRO

program was to cut  spend by 19 percent, per million KWH, over 3 years.

    Many other suitable goals might be considered besides reduction of MRO

procurement costs per unit of production, such as:

•    Reduce the number of purchase orders by 35 percent over 24 months

by vendor consolidation and product standardization.

•    Reduce the number of invoices by 70 percent within 6 months through

consolidated billing.

•    Reduce MRO inventory investment by 75 percent within 3 years with

vendor-consigned stock.

•    Streamline the MRO transaction cycle time by 50 percent within 12

months by eliminating non-productive tasks and automating the rest.

The Strategic Value of MRO Cost Reduction Goals

We are now in the second year of a serious and widespread recession that

spans virtually all sectors of the economy. Most economists, business leaders and

government officials are predicting a continuing decline through all or most of  

2009—reaching depths not seen since the Great Depression of the 1930’s.

As a consequence, organizations of all kinds—manufacturing, service,

health care, government and others—are aggressively acting to reduce costs and

conserve cash flow. This has caused dramatic layoffs and rising unemployment

and underemployment.  General Management looks at declining volume of

activity and seeks to reduce staff on the premise that fewer people are needed.

This is rational with regard to many functions ranging from production to ship-

ping to accounts payable.

However, the procurement function should not be cut under these

conditions because it can play a leading role in changing the cost paradigm of

the organization.  That is, the procurement team should be reoriented from

processing a declining volume of routine purchasing transactions to intro-

ducing innovation into procurement activities.  By doing so, procurement can

identify and obtain far greater cost reduction than the incremental cost of

maintaining purchasing staff.  Moreover, the reduced  transaction volume

can free the personnel  man-hours to accomplish this.

Here is a simple example. Assume that a company buys a large amount of

steel strapping, seals and tools. By working with selected distributors and mills,

they might assemble a database of strapping requirements and usage to examine

the following potential cost reduction areas:

•    The sizes and specifications of strapping currently used and the possibility of standardization and consolidation.

•    The potential for a consolidated mill contract, with an agreed markup for local stocking distributors or, alternatively, central TL shipments to
      selected plants for internal redistribution.

•    Laboratory analysis of joint strength to determine if specifications are
                              appropriate.

•    Analysis of tool repair costs and whether (or why) they may be excessive, as well as the opportunity to acquire refurbished tools with new tool warranties.

With these and similar techniques, we have seen strapping costs reduced by hund-

reds of thousands of dollars in larger organizations.

Through an analysis of  top line-item expenditures—with help from key suppliers

--realistic savings objectives can be obtained.  These goals can then serve as a basis for

projecting to top Management how the procurement function can better serve Company

financial goals and the impact of MRO cost reduction on overall corporate results.

Here is a typical set of parameters:
•    Annual MRO spend--$12 million
•    MRO cost reduction goal—24% (hard dollars); 12% (soft dollars)
•    Estimated MRO cost reduction--$4,320,000
•    Corporate sales--$6 billion
•    Net profit before tax--$750 million
•    Net worth--$4 billion
•    Debt--$3 billion
•    Total investment--$7 billion
•    Estimated reduction of purchasing—12x$60,000 = $720,000/yr.

The presentation to Management would key to the following:

The MRO cost reduction goal is $4,320,000 annually. By reorienting, rather than cutting purchasing staff, the leverage is 6:1 ($4,320,000/$720,000). The program will generate the equivalent of $34.6 million additional sales with no additional sales or marketing expenditure or risk. The program will generate the equivalent profits of investing an additional $40.4 million without borrowing or investing or incurring any risk.

Material in this article is drawn from The 20% Solution: A Practical Guide to
Dramatic Cost Reduction in MROP Procurement, available at www.the20percentsolution.com.

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