From Reactive To Proactive Procurement: A Case Study
Richard L. Pinkerton, Ph.D., C.P.M.
Richard L. Pinkerton, Ph.D., C.P.M., Chair, Marketing and Logistics, Sid Craig School of Business, California State University, Fresno, Fresno, CA 93740, 209/278-7830.
Kathleen A. Pettis
Kathleen A. Pettis, Purchasing Supervisor, ILC Technology, Inc., Sunnyvale, CA 94089, 408/745-7900.
82nd Annual International Conference Proceedings - 1997
Abstract. This paper documents the efforts of a medium sized hi-tech manufacturer of laser lamps and power sources to move from a reactive purchasing operation based on repetitive purchase orders with many suppliers to purchasing by long term contracts with a few key suppliers based on partnerships. It includes the analysis of the costs of the old paper driven system and conversion to negotiation by cross functional teams using a strategic-proactive approach. The sequence of events from evaluation of the old system to the training of personnel involved with material acquisition is covered including the first reports of initial annual dollar savings of approximately $260,000.
The Company. ILC Technology in Sunnyvale, CA. is a firm of about $60 million annual sales, approximately 300 employees and 3 subsidiaries: Precision Lamp in Cotati, CA., Converter Power, Inc. in Lpswich, MA., and Q-ARC, Ltd. in Cambridge, England. It manufactures and sells globally replaceable high-performance light source products for the medical, industrial, communication, aerospace, military and entertainment industries. Total annual purchases are approximately $27 million under the control of a purchasing dept. consisting of one supervisor, 3 buyers and 1 administrative assistant. The department reports to the Director of Materials and Logistics who is also responsible for inventory-production control, stores and quality assurance. ILC Technology, Inc. is traded on NASDAQ as ILCT.
The Situation Report. During the early part of 1994 the professor co-author of this paper (hereafter called the consultant) conducted twelve indepth interviews with key managers, examined various computer printouts of purchasing activity, visited several key suppliers and of course, held several discussions with the purchasing personnel. You will notice we use the planning term "situation analysis" rather than the traditional term, purchasing audit. The president and CEO of ILC wanted to reengineer the entire purchasing operation as opposed to the traditional implication of the purchasing audit which focuses on compliance to existing policy. In other words, he wisely wanted a status report which would compare current practice with benchmark or state of the art proactive purchasing practices.
After the president approved the situation report on July 29, 1994, he asked the then purchasing manager (no longer at ILC Technology) and the consultant to hold a general management meeting to present the findings of the situation report. After the introduction and endorsement by the President, the consultant listed the following major findings:
A. Too many suppliers for the same material. It was not unusual to have 5 to 8 suppliers per part as a result of lack of planning, multiple preference by engineers, back door buying by engineers, and a reliance on repetitive purchasing versus long term contracting. ILC had few, if any, real partnerships with key suppliers.
B. Too many total suppliers. During a 12 month period 1993-94, ILC had a total of 360 direct material (material that becomes part of the finished product) and 2,879 indirect suppliers for a total of 3,239.
C. Too many purchase requisitions and purchase orders. As a consequence of an excessive number of suppliers and lack of long term contracting, non value added paper costs were very high. For example, the supplier with the most purchases in $ volume, a precision machine shop, required 442 purchase requisitions (PR's) and 442 purchase orders (POs) for a total of 884 transactions or 4 per day (based on 200 workdays per year) during a one year period. The controller estimated the processing cost per PO at $50.00 which meant ILC had spent $22,100 in one year just for the initial transaction cost for this one supplier. In addition, we actually counted a total of 5,456 POs during a one year period for just direct material from all suppliers at a transaction cost of $272,800. This was the classic case of way too many purchasing cycles with far too many suppliers. The buyers in the purchasing department were largely regulated to paper pushers checking for proper product codes, tax accounting codes, and correcting mistakes.
D. Unrealistic lead times given to customers. Marketing and others in the engineering design departments often either ignored or failed to understand the elements of lead time. This often occurred for standard products but was especially abused when converting prototypes to production runs.
E. Inaccurate forecasting and failure to follow forecasts lead to a failure to have a master production schedule. This finding along with finding D caused serious delivery problems.
F. Excessive engineering and other related changes created delivery, quality and supplier performance problems. Poor document control and failure to lock-in design prior to production resulted in many engineering changes, print revisions, changed delivery dates, and other corrections which caused excessive rework, returns and major confusion in house and with suppliers.
All of the above factors created a rush-rush atmosphere with frequent corrective paperwork plus a huge number of PR's and PO's to document the changes. In addition, the many repeat-small orders diluted our negotiation clout and resulted in high prices paid to suppliers who were never quite sure if they had future business with ILC.
The Corrective Action. After many revisions, a new procurement policy was issued in compliance with ISO 9000 standards with the following key provisions.
- All purchasing will go through the purchasing department, no more back door buying by engineers.
- Material needs will be consolidated based on a minimum of one year requirements.
- Buying will be accomplished based on long term contracts for at least one year with additional periods as the firm gained experience.
- The supplier base for direct material will be reduced wherever possible, to one prime and one back up supplier on the approximate basis of 80% of the physical volume to the prime, 20% to the back up. All suppliers will be surveyed and certified by a documented procedure.
- For indirect material such as MRO items, one supplier (whenever possible) will be selected to manage ILC inventory, including restocking on the bases of systems contracts for entire families of products such as office suppliers, hardware, tools, standard electronic components and other such material commonly available from distributors.
- Negotiation will be accomplished by cross-functional commodity and design teams and will include representation from purchasing, planning, production, engineering, quality assurance and others as needed such as stores. All individuals will receive training in negotiation and team building. Department managers will form the teams with assistance from purchasing.
- After the contract is issued, planner-schedulers in the manufacturing departments will order quantity releases direct to the supplier via fax and eventually by EDI or internet. Purchasing will only be involved when there is a problem and there will be no PR's or PO's for releases of direct production material and selected indirect material suppliers.
- Purchasing Credit Cards will be used by selected personnel for "odds & ends" of small dollar value.
- Marketing and production planning will establish a new forecasting system with accurate lead times. Change orders will be minimized.
- We will treat our suppliers as "partners" with early supplier involvement at all stages via scheduled meetings.
- Purchasing will move from only checking and preparing forms to professional sourcing investigation in order to be a major resource for the cross functional teams.
- Formal training sessions will be conducted to help install the new system.
The Results. As one might expect, initially the teams struggled but finally developed their negotiation and team skills. This process took approximately 18 months and one team had to be replaced with more effective members. There are four major teams, Quartz (raw material), equipment (machining-painting), Cermax (product line), and packaging with several smaller teams for MRO items. As of June, 1996, the documented cost savings for 1997-98 will be at least $260,000 plus the elimination of 1,400 PO's for an additional reduction of $70,000 in paperwork for just eight suppliers alone. We anticipate eventual yearly savings of $350,000 but documentation continues to identify all savings. At the time this paper was written, the reduction in the number of suppliers was being calculated but we are confident it will be at the 10% figure for the start-up period and should go to 25% in another year.
Because ILC engages in a great deal of R & D special projects still create lots of initial PR's and other paperwork. The purchasing department will have to devise a system to cope with this aspect of supply management. The entire company is reviewing and changing the forecasting-lead time procedure and it is too early to calculate the reduction in change orders. However, the new procurement system forced several management changes and brought attention to bear on the problem. We do have much better communication with our suppliers and have better pricing, delivery and quality as reflected in the $260,000 direct savings. The purchasing department is very excited about their new role as a proactive force adding value rather than cost. The contract system and direct release policy has given the purchasing department the time they needed to manage material rather than just purchase it.
A Purchasing Manager's Guide To Strategic Proactive Procurement by David N. Burt and Richard L. Pinkerton , N.Y., N.Y., Amacom Division of the American Management Association, 1996.