You have been tasked with the job of identifying options for purchasing products from 3rd party manufacturers. You have completed the comparisons on the basis of total supply chain costs and as a consequence of this you have decided on a supplier. This article uses an example to demonstrate how involving the production department can actually reduce your total outsourcing costs.
To illustrate our approach we have used an example from “Factory Physics for Managers: How Leaders Improve Performance in a Post-Lean Six Sigma World”, by Edward S. Pound, Jeffrey H. Bell and Mark L. Spearman, McGraw-Hill 2014.
A supply director of a food manufacturing company needed to service additional demand from an important customer however, due to a variety of capital expenditure delays, one of the company-owned production lines for these products was now out of capacity. The director knew he could out-source to a 3rd party food processor who charged by the kilogram.
The director had gone through a robust total-cost-to-serve analysis and had decided on which supplier gave the most advantageous (per kilogram) price in the context of total supply chain costs (including transportation and inventory costs).
The price charged by the food processing supplier differed by product so the supply director planned to outsource products for which the supplier charged the lowest price per kilogram. After learning about how important the bottleneck was in a manufacturing facility, the supply director arranged a meeting with the plant manager to understand the operational characteristics of the products on the constrained, company-owned production line.
After some discussion the supply director and the plant manager decided on a reasonable utilisation level to target at the bottleneck on the constrained line, thereby managing cost and response time for the entire supply chain. They also agreed to investigate outsourcing on the basis of “time at bottleneck” as well as lowest price. The results are shown below.
| Kilograms | $/Kilo | $ | ||||||
| Item 4 | 7,033 | 0.1975 | $1,389 | |||||
| Item 5 | 24,125 | 0.17 | $4,101 | |||||
| Kilograms | $/Kilo | $ | Item 3 | 175,020 | 0.15 | $26,253 | ||
| Item 1 | 295,541 | 0.1475 | $43,592 | Item 6 | 71,025 | 0.18 | $12,785 | |
| Item 2 | 66,650 | 0.15 | $9,998 | Item 7 | 11,000 | 0.155 | $1,705 | |
| Item 3 | 20,020 | 0.15 | $3,003 | Item 8 | 7,003 | 0.22 | $1,541 | |
| 382,211 | $56,593 | 295,206 | $47,774 | |||||
| Outsourced by Lowest Price | Outsourced by Time at Bottleneck | |||||||
The Lowest Price policy cost $56,593 while the Time at Bottleneck policy cost $47,774 a saving of 15% for the business. Both policies maintained the same utilisation levels at the company-owned production facility its just that, by focussing on the Time at Bottleneck, the additional price, in $/Kilo, was more than offset by the lower kilograms required from the 3rd party manufacturer. These savings showed up directly on the outsourcing line in the Profit and Loss statement.
The new strategy also maximised the Contribution Margin per hour of crewed time (ie. Octane) at the bottleneck. If you would like more information on Contribution Margin and Octane please go here: Why use Contribution Margin and Octane measures rather than unit costing when comparing options for operational change?