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The Total Cost Consideration

As most procurement executives will reveal, one cannot forget that the cost of moving raw materials, work-in progress, and final assembling constitute elements of a larger cost in itself. One which is taken more seriously now.

Fads come and go in our industry. Things like applying excessive plastic cladding, shoehorning a V8 in every possible application, and seeking the globe’s lowest cost country to source a component. Let’s focus on the last fad because thankfully, both exterior design and engine packing are now following a more minimalist ideology.

Procurement executives are singing a somewhat different tune these days when component cost is involved. Total landed cost—not just production cost—is now considered the gold standard which guides sourcing decisions. A couple decades ago, as several global OEMs expanded to markets such as China, India and even Brazil, they couldn’t help but notice the low wage rates in these new locations when compared to established sourcing patterns back home. This apparent revelation triggered massive cost reduction and resourcing efforts—the resourcing bonanza was in full stride and OEMs were rubbing their hands together in glee. The eye was on the final production cost—not the total landed cost. There is a subtle but important difference. As most procurement executives will reveal, one cannot forget that the cost of moving raw materials, work-in progress, and final assembling constitute elements of a larger cost in itself. One which is taken more seriously now.

The natural disasters over the past two years are a constant reminder that that distance (a proxy for inventory held), the sourcing of key global components from a few concentrated regions/suppliers (read: semiconductors, complex assemblies, and specialty chemicals) and the impact of logistics matter greatly to the industry’s bottom line. No longer can logistics be a cost equation afterthought. Intertwined into the argument of examining the entire cost equation for components and vehicles is risk. Understanding, controlling or mitigating risk is now a major consideration.

One example of risk consideration comes to mind. A number of years ago a major OEM decided to ship rear seats for a U.S.-built vehicle from India. This sourcing head scratcher likely did not fully consider a number of basic factors. A greater distance means much more inventory in transit and a larger buffer in case a transportation snafu occurs. Additionally, if a quality containment issue arises, several weeks’ worth of inventory on the water needs to be remedied or scraped. Overtime and premium shipping (a euphemism for a more expensive fashion to ship the same part) are required to support final production—costs which often are not considered up front.

Logistics have rightly gained an important seat at the sourcing table. This is not only limited to component source, but final vehicle sourcing, as well. Vehicle transportation capacity issues, clogged ports and rising sea shipping costs are dogging OEMs trying to efficiently utilize a more flexible global production footprint.

Several factors not fully considered in the past are now on the component sourcing checklist. These include: the stability of the production currency versus the destination currency; state of the logistics linkage; packaging costs; dunnage exposure; total supply chain inventory; handling dynamics; and potential damage en route. Understanding these dynamics and the long-term cost impact for the sourcing relationship is critical.

This is where risk enters the equation. OEMs are reviewing current and future sourcing relationships for what variables could interrupt supply or cause unintended costs. If dual sourcing defrays risk and is cost effective, these alternatives are being seriously considered. With longer supply lines, variability and risk increase. Quietly, OEMs are seeking supply of major components that have relatively high shipping costs (e.g., large and/or heavy parts) to within 50 miles of the final use destination.

In the end, efficient logistics will be another differentiator to support an optimized supply chain and thus a cost-side contributor. Quality, design, fuel efficiency, technology, vehicle availability, and value will determine success on the revenue side. Long-term profitability requires performance not only in those areas, but in the logistics arena, as well.

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