strategic cost management in the supply chain: a purchasing and supply management ... · 2012. 8....

Strategic Cost Management in the Supply Chain:

A Purchasing and SupplyManagement Perspective

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by

Lisa M. Ellram, Ph.D., C.P.M., C.M.A.

Professor of Supply Chain ManagementBebbling Professor of Business

Arizona State University

CAPS RESEARCH

2002

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Strategic Cost Management in the Supply Chain:A Purchasing and Supply Management Perspective

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by

Lisa M. Ellram, Ph.D., C.P.M., C.M.A.

Professor of Supply Chain ManagementBebbling Professor of Business

Arizona State University

Copyright © 2002 by CAPS Research. All rights reserved. Contents may not be reproduced in whole or in part without the express permission of CAPS.

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Nearly everyone in business today would agree that cost management is important.Cost management continues to increase in importance as the economy slows and salesdecline. When research for this study began, the economy was entering a downswingthat continued to builsd as the study progressed. The comments, practices, andattitudes reflected in this study are those of organizations under strong and growingfinancial pressure.

The goal of this study was to examine triads in the supply chain: units of threecompanies that work together in the supply chain, such as a manufacturer, one of itskey suppliers, and a key customer. The research method was to begin with anextremely in-depth perspective of one of the companies, then use a snowball method(Kuzel, 1992) working with that core company to identify a key customer and a keysupplier with whom that organization had worked effectively in cost management.The goal of the research was to report on best practices in supply chain costmanagement from the perspective of purchasing and supply management (PSM),rather than look at a typical case of effective cost management within an organization.The organizations studied were allowed to select what they viewed as their bestpractices in cost management. Best practices were self-defined by the companies basedon where they believed they had been particularly effective in cost management.Despite numerous attempts of the researcher and core company to make contact withsecondary companies and conduct research from this triadic perspective, it was notalways possible, delaying the completion of the research. Part of the difficulty inengaging potential participants was the recession that took place during the time thiscase study research was being conducted. While none of the secondary companiescontacted ever refused to participate in the research, meetings were cancelled anddelayed, and people changed positions, were laid off, took early retirement, orchanged companies. Thus, contacts were lost. In the interest of the timeliness of theresearch and maximizing the potential value of the extensive data provided by theparticipating companies, the researcher decided to complete the study, even thoughonly dyadic data is provided in four of the five supply chains studied.

Cost management is a broad issue that cuts across all areas of the organization.Purchasing and supply management (PSM) are looked to by most organizations as asignificant contributor to the organization’s cost management approach, as cost ofpurchased goods and services makes up 50 percent or more of the cost of sales ofmost manufacturers today. The focus of this study was thus on manufacturing firms asthe core company to be studied in depth. Previous research indicates that costmanagement of purchased items receives greater emphasis in manufacturing firmsthan it does in service firms, simply because manufacturing firms spend relatively

Preface

2 Strategic Cost Management in the Supply Chain: A Purchasing and Supply Management Perspective

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more on purchases. Nevertheless, cost management in and of itself is not enough tomove organizations ahead in this competitive global economy. Recent studies indicatethat CEOs are increasingly relying upon PSM as a source of innovation and economicvalue-added (A.T. Kearney, 2001). These measures have much broader strategicimplications than simple cost management or the traditional price management focus.As a result, this study attempts to look at what PSM is doing in the arena of strategiccost management, going beyond the price mentality to understand the long-term valuethat PSM can bring to the organization.

In understanding cost management from a strategic perspective, this research exploredissues such as who is involved in costs management efforts with PSM, how PSMengages suppliers in cost management efforts, and how PSM understands thecustomer value proposition that it is trying to support. Thus, many areas outside ofPSM were interviewed to gain their perspectives. Organizational relationships andaccountabilities were explored. It is the hope of the researcher that the reader will beable to take away a valuable perspective on how to successfully work with strategiccost management both within and outside of the borders of his or her organization.

3Center for Advanced Purchasing Studies

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The researcher thanks executives from all of the organizations that participated in thisstudy for taking the time to share their perspectives and experiences, and forproviding contacts and entrée into their own and other organizations. In the interest ofconfidentiality, the participating organizations are not listed here. The researcher alsothanks those from industry and academia that shaped the ideas that went into thisstudy. This includes members of the National Initiative for Supply Chain Integration,including Donna Edwards of Intel; Tom Hayman, now retired from Procter andGamble; Jeff Trimmer, now retired from Chrysler Corporation; Dave Nelson of DelphiCorporation, formerly of Deere and Company; Paul Novak of the Institute for SupplyManagement; Gary Swinden and Donna Krandel of Amkor; and Mike Doyle fromNISCI. From Arizona State University, I thank Baohong Liu, Ph.D. student, andSupply Chain Management staff members Helen Burns, Christina Brown, JasmineHemery, Nicole Junkins and Brian Pope, who helped in data entry and typing andformatting the study. The researcher also thanks the staff at CAPS Research, withspecial recognition to Phil Carter and Carol Ketchum for their patience andconstructive feedback. Without the joint financial support of CAPS Research andNISCI, this study would not have been possible. I also thank my husband, Jeff Siferd,for his patience, support, and understanding during the many months that I spentgathering data and preparing this study. Finally, the researcher takes sole responsibilityfor any inadequacies or inaccuracies in this manuscript.

Acknowledgments


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Table of Contents

Preface. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2Acknowledgments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Overall Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9Research Questions and Major Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13Implications of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Organizational Support at all Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18Supplier Cost Management is a Good Investment. . . . . . . . . . . . . . . . . . . . . . . 18Strategic Cost Management in the Supply Chain is a

Process and a Philosophy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19Credibility in Reporting Results. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19Supply Chain Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19Supplier Perspective on Strategic Cost Management in the Supply Chain . . . . 19Suppliers’ Management of Their Suppliers . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19Support for Strategic Cost Management Theory . . . . . . . . . . . . . . . . . . . . . . . . 19Characteristics of Companies with Effective Supply Chain StrategicCost Management Approaches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Design of the Study. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22Design . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Sample Selection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22The Role of Purchasing and Supply in Strategic Cost Management in the Supply Chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Introduction and Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24Discussion of the Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Research Question 1. How Important Is Strategic Cost Management in the Organizations Studied, and Why? . . . . . . . . . . 24

Research Question 2. How Are Firms Organized Effectively to Achieve Strategic Cost Management? . . . . . . . . . . . . . . . . . . . . 25

Research Question 3. Who Is Responsible for Conducting Cost Management in the Organization, and Who Is Accountable for Delivering Results? . . . . . . . . 26

Research Question 4. How Do Organizations Determine the Focus of Their Cost Management Efforts? . . . . . . . . . . . . . . . . . 30

Research Question 5. What Specific Cost Management Tools Do Organizations Use to Support Strategic Cost Management? . . . . . . . . . . . . . . . . . . . . 33

Benchmarking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33Target Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34Should-Cost Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35Total Cost of Ownership (TCO) Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

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The Impact of Information Technology on Cost Management . . . . . . . . . . . . 40Approaches to Support Specific Types of Purchases . . . . . . . . . . . . . . . . . . . . 40Sources of Cost Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41Research Question 6. How Are the Results of Cost Management Efforts

Reported? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41Research Question 7. What Other Factors Contribute to the Success of

Strategic Cost Management Efforts in the Organization? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

The Potential Contribution of Finance or Cost Management Experts to Strategic Cost Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

Special Approaches to Cost Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47Research Question 8. What Impact Do Supplier Relationships Have on

the Organization’s Cost Management Approaches?. . 48General Approach to Supplier Relationships . . . . . . . . . . . . . . . . . . . . . . . . . . 48Supplier Development. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49Sharing Cost Savings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50Research Question 9. What Is the Supplier’s Perspective on the

Organization’s Cost Management Efforts? . . . . . . . . . 51Impact of Customer Cost Management Pressure on Suppliers . . . . . . . . . . . . 51Customer Relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52Customer Influences on its Cost Management Efforts. . . . . . . . . . . . . . . . . . . 53Supplier Relationships with Their Suppliers . . . . . . . . . . . . . . . . . . . . . . . . . . 53Research Question 10. What Impact Do Customers Have on the

Organization’s Cost Management Approaches?. . . . . 54Impact of Customer on Cost Management . . . . . . . . . . . . . . . . . . . . . . . . . . . 56Research Question 11. Does the Organization Take a True

Supply Chain Management Perspective of Strategic Cost Management? . . . . . . . . . . . . . . . . . . . 56

Second Tier Suppliers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57Research Question 12. What Are the Key Success Factors and Barriers

to Strategic Cost Management? . . . . . . . . . . . . . . . . . 57Barriers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58Success Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58Research Question 13. What is the Future of Strategic Cost Management

in Your Organization? . . . . . . . . . . . . . . . . . . . . . . . . 60Summary and Conclusions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

Implications of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68Organizational Support at All Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68Supplier Cost Management is a Good Investment. . . . . . . . . . . . . . . . . . . . . . 68Strategic Cost Management in the Supply Chain is a Process

and a Philosophy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68Credibility in Reporting Results. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69Supply Chain Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69Supplier Perspective on Strategic Cost Management in the Supply Chain . . . 69Suppliers’ Management of Their Suppliers . . . . . . . . . . . . . . . . . . . . . . . . . . . 69Support for Strategic Cost Management Theory . . . . . . . . . . . . . . . . . . . . . . . 69Characteristics of Companies with Effective Supply Chain StrategicCost Management Approaches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

Center for Advanced Purchasing Studies (CAPS Research) . . . . . . . . . . . . . . . . . . . 141


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Figures

Figure 1: Strategic Cost Management Process 10

Figure 2: Strategic and Tactical Elements of Supply Chain Cost Management . . 11

Figure 3: Reporting Cost Savings: A Deere Example . . . . . . . . . . . . . . 42

Figure 4: Strategic Cost Management Theory 63

Figure 5: Organizational Chart of Deere . . . . 72

Figure 6: Divisional Organizational Structure 73

Figure 7: Divisional Supply DevelopmentOrganization. . . . . . . . . . . . . . . . . . 74

Figure 8: Chip’s Corporate Structure. . . . . . . 79

Figure 9: Chip’s Materials Structure. . . . . . . . 80

Figure 10: Tele Procurement Organizational Chart . . . . . . . . . . . . . . . . . . . . . . . 93

Figure 11: Tele Strategic Supply Chain Process . . . . . . . . . . . . . . . . . . . . . . 97

Figure 12: GPMM Organization September 2001. . . . . . . . . . . . . . . . . . . . . . . . 100

Figure 13: The Path to Supply Chain Excellence. . . . . . . . . . . . . . . . . . . . 101

Tables

Table 1: Key Characteristics of Core Case Studies . . . . . . . . . . . . . . . . . . . . . . . 12

Table 2: Tools and Processes Supporting Strategic Cost Management . . . . . . . 12

Table 3: Ideal Organizational Characteristics for Strategic Cost Management. . . . . 20

Table 4: Case Study Participants . . . . . . . . . . 22

Table 5: Tactics Used to Increase Validity . . . 23

Table 6: Reasons for the Increasing Importance of Strategic Cost Management in the Organization . . . 24

Table 7: PSM Function Organization Structure. . . . . . . . . . . . . . . . . . . . . . 25

Table 8: Responsibility for Conduction Cost Management/Cost Analysis . . . 26

Table 9: Functions That Are Primarily Responsible for Delivering Supplier Cost Savings . . . . . . . . . . . . . . . . . . . 28

Table 10: Cross-Functional Team Membership in Supplier Cost Management . . . . . 29

Table 11: Types of Cost Management ToolsMentioned . . . . . . . . . . . . . . . . . . . . 33

Table 12: Factors Influencing the Type of Cost Management Approach Used . . 34

Figures, Tables, and Appendices


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Table 13: Cost-Related Issues Firms’ Benchmark . . . . . . . . . . . . . . . . . . . 34

Table 14: For Which Purchases and in WhichSituations Do Companies Use TargetCosting? . . . . . . . . . . . . . . . . . . . . . 35

Table 15: Purchases Supported by Should-CostAnalysis . . . . . . . . . . . . . . . . . . . . . 36

Table 16: Why Do Organizations Perform Should-Cost Analysis? . . . . . . . . . . 36

Table 17: Type of Purchases Supported by Total Cost of Ownership . . . . . . . . 38

Table 18: How TCO is Used in the Organization. . . . . . . . . . . . . . . . . . 38

Table 19: Total Cost of Ownership Decision Focus . . . . . . . . . . . . . . . . . . . . . . . 38

Table 20: Approaches for Managing Specific Types of Purchases . . . . . . . . . . . . . 40

Table 21: Sources of Cost Information. . . . . . 41

Table 22: Buyer-Supplier Dyads. . . . . . . . . . . 51

Table 23: Barriers to Successful Strategic CostManagement in the Supply Chain . 58

Table 24: Key Success Factors in Strategic Cost Management . . . . . . . . . . . . . 59

Table 25: Ideal Organizational Characteristics for Strategic Cost Management . . . 62

Table 26: 29 Supply Management Initiatives. 75

Table 27: Total Delivered Cost Breakdown . . 87

Table 28: Corporate Profile: Praxair Inc. . . . . 99

Table 29: Buyer-Supplier Case Study Relationships . . . . . . . . . . . . . . . . . 124

Table 30: Case Study Participants . . . . . . . . . 137

Table 31: Tactics Used to Increase Validity . . 138

Appendices

A: Case Studies of Buying Organizations . . . . . 71

B: Research Proposal . . . . . . . . . . . . . . . . . . . . . 109

C: Interview Protocols, Cover Letter and Abbreviated Research Proposal . . . . . . . . . . . 114

D: Request to Review Study Letter . . . . . . . . . . 123

E: Case Studies of Suppliers and Customer . . . 124

F: Literature Review . . . . . . . . . . . . . . . . . . . . . 133

G: Research Design . . . . . . . . . . . . . . . . . . . . . . 135

H: References . . . . . . . . . . . . . . . . . . . . . . . . . . . 139


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The purpose of this study was to explore best practices instrategic cost management among leading edgepurchasing and supply management (PSM) organizationstoday. While PSM spends more money than any singlegroup, and is held to a high level of accountability forspending, there has been limited literature explicitlylinking strategic cost management with supply chainmanagement in general, and with the role of supplymanagement in particular. This study:

1. Identifies and studies a number of best practiceorganizations across several industries.

2. Explores both upstream and downstream strategiccost management issues and practices.

3. Synthesizes these best practices.4. Develops a prescriptive model for world class cost

management in the supply chain.

This is a broad and unstructured topic. It examines notonly the practices that PSM uses to manage cost, but howPSM interfaces with others inside and outside theorganization in delivering savings. Figure 1 provides ahigh level overview of the strategic cost managementprocess.

Five organizations participated as core case studies forthis research project. The strategic cost managementprocesses were viewed from the perspective of the PSMorganization, from inside the core firm. The researcheralso studied one key supplier for each core organization,which the core organization identified as a supplier withwhich it had effectively engaged in cost management. Thecore companies included in this study were John Deere& Company, a manufacturer of farm and constructionequipment, and home and commercial lawn careequipment; Chip, a major high technology electroniccomponents and OEM manufacturer; LCP, a largeconsumer products manufacturer; Tele, a major regionaltelephone carrier; and Praxair, a large supplier ofindustrial gases and chemicals. All of these companieswere large Fortune 500 manufacturers, with sales ranging

from around $5 billion to nearly $50 billion. Some of thekey characteristics of these organizations relative to thisstudy are shown in Table 1. Detailed case studiessummarizing the strategic cost management practices ofeach of these organizations are included in Appendix A.

Overall Framework

In the course of this study, it became clear that effectivestrategic cost management has both strategic and tacticalaspects that must be well executed in order to deliverresults. The strategic framework and tactical elements ofcost management as they affect PSM are shown in Figure2, which also shows the soft and hard results of effectivecost management as related to PSM. The actual processesin which cross-functional teams engage to supportstrategic cost management include many tacticalelements. In most organizations studied, the strategic costmanagement process occurs as an integral part of the newproduct development process or the strategic sourcingprocess. It is not a “stand-alone activity,” but rathercentral part of supplier selection and supply basemanagement. Some of the processes and tools that arepart of the strategic cost management process are listed inTable 2, and presented in more depth in the body of thereport.

A cross-disciplinary team of two or more individuals,including PSM, was the norm for carrying out strategiccost management in the five core organizations studied.Often, the cost management activities were part ofanother, larger process, such as a strategic sourcing event,a new product development process, or part of an on-going continuous improvement effort. In exploringFigure 1 in detail, it is clear that the cross-functional teamthat works on strategic cost management has numeroushigh-level issues that it must consider. First, the price andfeature needs of the ultimate customer must be heavilyweighted, or the result will be a product that customerscannot afford, that does not meet their needs, or both.

Executive Summary


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Figure 1Strategic Cost Management Process

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Table 2Tools and Processes Supporting

Strategic Cost Management

On-Line AuctionsTotal Cost of Ownership

Should-Cost AnalysisTarget Costing

Supplier DevelopmentBenchmarkingStandardization

Supply Base RationalizationVolume Leverage

The customer information comes to the team through asecondary source, often filtered through the eyes ofmarketing, sales, or a customer relationship manager. Thecorporate objectives regarding strategic cost managementand cost savings goals must also be considered in termsof meeting the objectives of the team and the businessunit or units that the team supports. Next, eachorganization utilized cost management specialists, forwhom all or a major part of their jobs was to supportcost analysis, help develop models, and ensure integrityin the data and the analysis results. In some cases, theseindividuals reported to PSM; in others, they reported tocorporate or business unit finance. The key commonalityacross cost management specialists in these organizationswas the expertise, credibility and charter to supportsupplier cost management. Even with the first three

direct inputs, a fourth is needed: a reward andmeasurement system that supports cost management.The extent to which such a system exists is a function ofthe corporation’s cost consciousness culture. Is everyonein the organization held accountable for costmanagement? Is it part of their performance reviews,annual goal setting, and overall expectations? Thestronger the cost-consciousness culture, the greater thesupport for the team and the commitment to its results.

In the center of Figure 1, the cross-functional teamengages in activities designed to reduce the organization’scost, such as identifying cost drivers and changingprocesses using a total cost of ownership approach,engaging in on-line reverse auctions, or working withsuppliers on development. The way that the organizationsstudied use these processes is detailed in the body of thereport. Based on the strategic cost management processes,they aim to achieve a better supply base, defined as onethat has a lower cost (sometimes only a lower price), andperforms as well or better than it did before the strategiccost management process. The process should alsosupport customer satisfaction by resulting in the same orlower prices for the same or better quality and service.This should in turn lead to measurable, bottom linesavings, which should translate into higher profit, highereconomic value-added for the firm, and higher earningsper share. In general, when PSM thinks about achievingresults, the focus is still on bottom line cost savings ratherthan how its performance is reflected in the overallcorporation’s results.


Table 1Key Characteristics of Core Case Studies

Core Company Industry PSM Organizational Supplier Cost AnalysisStructure Supported By

Deere Industrial and farm equipment Mix of centralized and Cost specialists who report todecentralized; primarily PSMcentralized

Chip Semiconductors and other Centralized Finance professionals who reportelectronic components to corporate finance

LCP Household and personal Mix of centralized and products decentralized; primarily Finance professionals who report

centralized to product supply or business unit

Tele Telecommunications Centralized Cost/Finance specialists who report to PSM

Praxair Chemicals Centralized Finance professionals who report to PSM

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Research Questions and Major Findings

With this framework in mind, we turn to the researchquestions that formed this study. Much more informationto support each of these research questions is provided inthe body of this study.

Research Question 1. How important is strategic costmanagement in the organizations studied, and why?

1. All of the core and supplier organizations thatparticipated in this study indicated that costconsciousness is a way of life in their organizations.This philosophy is felt and lived from the chairmanof the board to the administrative staff to theworkers on the manufacturing floor.

2. Cost management is not a passing fad; it is a way oflife that will continue, and perhaps grow even moreimportant.

3. All of the core organizations studied believe that theyhave been very successful in supplier costmanagement, as shown by the significant,documented savings supplier cost management hascontributed to the bottom line of the organization.All reported savings ranging from millions of dollars,to tens of millions of dollars per year, and savingsranging from about 5 percent to over 10 percent inannual expenditures.

Research Question 2. How are firms organized toeffectively achieve strategic cost management?

1. All five of the core companies studied hadcentralized, or a mix of centralized anddecentralized, purchasing organizations. There waswidespread agreement among the firms studied thatat least some degree of centralization was required toget visibility of purchases in order to gain leverageand properly manage the supplier relationships andcost issues.

2. Purchases that were unique to particular businessunits were managed at a business unit level in two ofthe five organizations studied.

Research Question 3. Who is responsible for conductingcost management in the organization, and who isaccountable for delivering results?

This question has several, related answers.

1. PSM is held highly accountable for the delivery ofcost savings in all of the organizations. It has specificgoals for bottom line savings at functional,

commodity and individual levels. There may also bespecific commitments made to support specificbusiness units, certain product lines, or newproducts.

2. Cost management specialists, either from within thePSM organization or from the finance organization,are the focal point for supporting supplier costanalysis, building cost models and should-costanalysis, and validating results.

3. Everyone in the organization appears to have somelevel of accountability for, and commitment to,supporting strategic cost management and reducingthe organization’s cost. It is part of individual andfunctional performance appraisals and bonuscalculations.

4. Strategic cost management is generally notconducted by a single individual. Depending on themagnitude of the analysis required, cost analysis maybe performed by an individual in PSM andsupported by a cost management specialist, orconducted by a cross-disciplinary team. When ateam is involved, it generally becomes involved withstrategic cost management in conjunction with otheractivities, such as developing a sourcing strategy,working on new product development, orcontinuous improvement initiatives. The cost modelsused by individuals within PSM or teams aredeveloped and supported by cost managementspecialists, who may reside within purchasing or bepart of the finance organization.

Research Question 4. How do organizations determinethe focus of their cost management efforts?

1. All of the organizations studied stratify theirpurchases, considering factors such as the magnitudeof the spend, market conditions, stage in product lifecycle, and the importance of the supplier in selectingtheir approaches to strategic cost management. Theapproaches used vary among the organizationsstudied based on their product life cycles, the currentmarket conditions, and internal resources available.

2. In considering the overall approach to strategic costmanagement, the organizations studied apply thefollowing rules of thumb:

a. Always consider the potential cost versus thepotential benefit of the cost/price analysisapproach employed.

b. Stay in touch with the market and use pertinentmarket information in analyzing and negotiatingcosts and prices.


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c. Make sure that you have people with the rightexpertise involved in any sort of complexanalysis. This generally means finance people orcost management specialists.

d. Cost management is an integral part ofcommodity management.

3. Cost management must be an integral part ofsupplier selection, commodity management, andongoing planning in order for it to be effective. Theorganizations studied link strategic cost managementefforts closely with their other supply managementand new product development processes, to ensurethat cost management is always in the forefront ofsupply decisions. Effective cost management is not aone-off approach that the company takes when itreally needs to reduce its costs, but an ongoingexpectation that is built into supplier relationshipsand the organization’s reward and measurementsystem.

Research Question 5. What specific cost managementtools do organizations use to support strategic costmanagement?

This question explored the major cost analysis tools thatorganizations use to support their strategic costmanagement efforts.

1. Benchmarking is used extensively for costmanagement purposes by all of the organizationsstudied. These organizations use two types ofbenchmarking: benchmarking prices andbenchmarking processes. Benchmarking pricesinvolves looking for sources of information availableto corroborate pricing information. The other type ofbenchmarking centers on understanding coststructures and processes rather than prices. Thisprocess-centered benchmarking focuses onexamining effective methods across the supply chainand in unrelated or competitive companies andindustries to understand best practices. Thisknowledge is used to identify and implementopportunities for cost and process improvement,both internally and externally. Data frombenchmarking supports virtually all the other costanalysis and management approaches that theseorganizations employ.

2. All of the companies studies use target costing toensure that all of the functions involved in newproduct development understand the customer’sneeds as well as the cost and profitability goals, andare all aiming for the same objective. This is astrategic as well as a tactical approach. It is strategicin that it links all the functions within an

organization to support a common goal for newproduct development or for capital acquisition.Target costing is also tactical in that it provides aspecific framework for action and procedures forachieving goals and tracking progress towards thosegoals throughout the target costing cycle.

3. Should-cost analysis is a cost managementmethodology whereby the buying organizationdetermines what a product, service, or piece ofequipment should cost. This type of analysis is usedfor purchases of all types, from commodities tocapital equipment and new products. The should-cost figure becomes a benchmark for whether asupplier quotation or bid is reasonable as well as forunderstanding potential improvement opportunities.Should-cost analysis is used in many ways within theorganizations studied, such as to facilitateimprovement both within the organization and withsuppliers, to increase the organization’sunderstanding of costs, as a tool to work moreclosely with suppliers, and to help supportevaluation of other cost analysis approaches, externaldata, bids, and other items. It is a very richapproach, and one that the case study organizationsare using more frequently today than in the past.

4. Total cost of ownership (TCO) is used by all thecompanies studied in some fashion in varyingdegrees. Total cost of ownership analysis is definedas an approach for understanding and managing thetrue costs of doing business with a particularsupplier, of a particular process, or an outsourcingdecision. It covers a whole gamut of situations, fromstrategic purchases such as outsourcing and capitalequipment to tactical purchases such as indirectmaterials. TCO analysis is used to understand andimprove upon both internal and external costdrivers. It is also used to look at the costimplications in very specific, isolated situations aswell as cost implications across the supply chain.

5. The impact of information technology on costmanagement is also critical. The organizationsparticipating in this study noted two informationtechnology issues in particular that had significantimpacts on their cost management and analysisapproaches: The ability to access and understandspend data is a critical success factor, andinformation technology can be very helpful inanalyzing/building cost models. Thus, information isdefinitely a facilitator of effective cost management.In addition, the organizations found that one e-technology in particular, the use of reverse, on-lineauctions, was very helpful in reducing the pricespaid on certain competitive commodities where they


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would otherwise employ a bidding process. Savingsoccurred both due to process transparency andintroduction of new players into the bidding process.

6. Organizations do use specific approaches to supportspecific types of purchases. Most of the discussionwith the organizations studied focused on costmanagement and analysis of raw materials, becausethey are often the largest spend category and havethe most mature cost management models. However,there was also extensive discussion on themanagement of capital, indirectmaterials/maintenance, repair and operatingsuppliers (MRO), and to a lesser extent on services.In the area of indirect purchases, the overallphilosophy followed by these organizations is tostandardize and reduce the number of transactions,focusing on TCO issues as much as on price.Services follow a similar approach in terms ofunderstanding the value and taking a TCOperspective. For capital acquisition, TCO analysis isthe key approach used. This includes understandingthe net present value of all the costs associated withacquisition, start-up, use, maintenance, and ultimatedisposal of a piece of equipment, including yieldissues, volume capability, and down time. The levelsof complexity and sophistication of these modelsvary in direct proportion to the levels of spend andcomplexity of the equipment purchased.

7. The organizations studied use a wide variety ofinternal and external data sources to support theiranalysis. The key to using data effectively is totriangulate, using multiple data sources to supportthe analysis.

Research Question 6. How are the results of costmanagement efforts reported?

1. The key issues related to reporting of cost savingswere that the reporting must be done by someonewho has credibility, and that those outside of supplymanagement must agree to the reporting method. Inaddition, cost or price savings is never the singulargoal of purchasing. Cost/price savings is alwaysbalanced by other important metrics such as quality,reliability, and so on.

2. All the organizations studied were very careful toseparate hard cost savings that could be traced to thebottom line from other types of cost savings orefficiency improvement. In all cases, the hard savingsare emphasized. In most cases, the soft savings arenot reported outside of PSM in the same way as arethe hard savings.

3. Renegade purchasing and getting internal clients tocomply with contracts and use PSM’s established

relationships was noted as an issue for all of theorganizations studied, for a variety of reasons. Theway this was managed varied among theorganizations. Some focused on getting such goodcontracts and demonstrating so much savings thatinternal clients would want to use their contracts. Inone case, the organization has a policy to reducebudgets based upon documented purchasing costsavings. In this organization, the business unitswelcome PSM’s support, because they are heldaccountable for reducing their expenditures with orwithout the support of PSM.

Research Question 7. What other unique processes ororganizational structures contribute to the success ofstrategic cost management efforts in the organization?

1. All the organizations studied utilize finance or costmanagement experts to support supplier costanalysis. These individuals might have supplier costmanagement as a significant part of their jobfunctions, or might be dedicated exclusively tosupporting supplier cost management and analysis.These cost management specialists participate on thecross-functional teams, and help develop andimplement the cost models. They have generalresponsibility for helping to identify, measure andmonitor cost-savings initiatives. There are twogeneral approaches for the reporting relationships ofthe cost management specialists, as highlighted inTable 1. The cost specialists might report directly tothe PSM group, either in a controllership function oras cost management specialists. The other approachis to have the cost management specialist report tothe finance/controllership function of the businessunit or the corporation. Neither approach appearedto have an advantage over the other, in that the costspecialists and their reporting and analysis wereviewed as credible regardless of reportingrelationship, and because the supplier costmanagement and analysis aspect of the job wasviewed as important enough to receive a great deal ofattention, regardless of the reporting relationships.The use of cost management specialists to supportthe analysis was viewed as very important, becausein many cases, PSM specialists simply did not havethe time to dedicate to the level of analysis that wasneeded. In other cases, they did not have theexpertise. In still other cases, their results might beviewed as biased, since they were both executing theanalysis and measuring the outcome.

2. One unique approach to cost management used byTele was creation of an internal consulting groupdedicated to supporting costs management andspecial project analysis for that organization. The


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specific focus of this group was to view all of theirproject analysis from a TCO perspective. In addition,because members of the internal consulting groupare not part of the project execution, they have anunbiased perspective.

3. Deere also created an internal consulting groupcalled “compare & share” to help understand andreduce parts proliferation and increasestandardization. This team compares parts withsimilar features/functions among and withindivisions to determine which part/supplier providesthe best value, and educate engineering and otherdecision makers. The initial charter was for thegroup to be together for two years to accomplish thistask.

Research Question 8. What impact do supplierrelationships have on the organization’s cost managementapproaches?

This question views supplier relationship managementfrom the perspective of the core, or buying organization.

1. All of the core organizations studied agree that theirsuppliers, and the relationship with their suppliers,are becoming more important in general, as theorganizations become more dependent on suppliersfor a larger proportion of their cost of goods, as wellas for improvement opportunities.

2. The organizations studied rely heavily on long-termrelationships with key suppliers. However, some ofthe organizations believe that they have excellentrelationships with their suppliers, while others donot. In all cases, the buying organizations studied arevery large players, and wield substantial purchasevolume in some markets, putting them in a positionof relative power over their suppliers. The twoorganizations whose products are sold primarily inconsumer markets, or to OEMs that sell toconsumers, Chip and LCP, seem to feel the greatestcost pressure and pass that along to their suppliers,even their key suppliers, most directly. Theseorganizations admit the greatest strain in supplierrelationships, although they are both working toimprove those relationships. The other three cases,Deere, Tele, and Praxair appear to have betterworking relationships with their suppliers, in terms ofa true continuous improvement approach, rather thanan approach that borders on adversarial at times.

3. All the organizations in this study engage in supplierdevelopment to varying degrees. Supplierdevelopment involves working with key suppliers tohelp the suppliers improve their performance. All of

the organizations expect their suppliers tocontinuously improve. Some have formal programsto support this, such as Deere’s supplier developmentand value improvement programs, and Praxair’sTARGET program. The other organizations approachsupplier development on an ad hoc basis, devotingresources to suppliers when they can see asignificant, generally immediate benefit. All of thesupplier development efforts are focused on first tiersuppliers.

4. Despite all of the popular press, the concept ofsharing cost savings with suppliers is not a commonpractice among the organizations studied. If thesupplier contributes significantly to the developmentand execution of the cost saving approach, there is ahigher probability that cost savings will be shared. Ingeneral, the organizations studied felt such anintense pressure to reduce costs that the cost savingswas often passed along to the end customer, orretained to offset other cost increases.

Research Question 9. What is the supplier’s perspectiveon the organization’s cost management efforts?

Each of the participating core companies identified asupplier with which it believed it had worked effectivelyin managing costs and would also be willing toparticipate in this research. The perspectives of thesuppliers are presented in response to this question. Oneof the factors that made the conversations with suppliersparticularly interesting was the timing of the study, whichoccurred during difficult financial times for all of thecompanies involved.

1. Customer cost management pressure has a directand indirect effect on the suppliers. All of thesuppliers acknowledged the importance of cost/pricemanagement, and the need to continuously performin terms of price and value to maintain the businesswith this customer. With the downturn in theeconomy, the supplier to Chip and the supplier toLCP stated that they had felt a great deal of directpressure to cut prices, without much support interms of supplier development. This had causedstrain on the buyer-supplier relationship.

2. It is not the fact of asking for year-over-year pricereductions that creates strain in itself. Rather, it is thesupplier’s perception that the customer will notsupport it in achieving these price reductions, and ismore concerned about getting a low price thanreducing the underlying costs that support thatprice.

3. The degree of direct customer influence on thesupplier’s cost management effort varied. The


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suppliers to Deere and Chip both indicated that theywere emulating this customer’s cost management andanalysis approach. In both cases, the customerencouraged them to do so as a way of bettermanaging their suppliers, who are second tiersuppliers to Deere and Chip. Both Deere and Chiphave sophisticated cost management approacheswith a high level of resources dedicated to suppliercost management.

4. All of the suppliers studied also work with theirsuppliers in various ways on managing theirsupplier’s costs. In general, all of the customersstudied had more sophisticated cost managementsystems than did their suppliers. Each supplierindicated that supplier management is becomingmore important to it, and that its organization isincreasing the effort it expends on supplier cost andrelationship management.

Research Question 10. What impact do customers haveon the organization’s cost management approaches?

1. In general, the PSM organizations studied did nothave direct customer contact. As a result, PSM didnot directly feel the influence of customer costpressure. However, the indirect pressure issignificant. In general, the customer viewpoint iscommunicated to PSM in PSM’s role as a member ofa cross-functional team.

2. In the cases of LCP and Chip, which both deal withvery large and powerful customers that interactdirectly with consumers, standing customer serviceteams are in place to work with key customers tohelp manage and improve cost and performance.These customer service teams within Chip and LCPalso develop deep understandings of their customers’cost structures. Chip uses this understanding tosupport negotiations and anticipate customerdemands. LCP uses the data in this way, but also tohelp the customer manage its costs.

3. In the case of the only customer with whom theresearcher had direct contact, a large retail customerof LCP, the customer indicated that LCP had beeninstrumental in shaping its cost managementapproaches, adding value, and demonstrating truepartnership characteristics. This customer alsoindicated that it is rationalizing its supply base andworking to form closer relationships with itsremaining suppliers.

Research Question 11. Does the organization take a truesupply chain management perspective of strategic costmanagement?

1. All of the organizations studied agreed that whilethey aspire to a true supply chain/supply networkview of strategic cost management, they still haveopportunity for improvement. They all had differentapproaches for improving their supply chainperspectives. Common themes were the need forearly involvement in projects, and a more holisticview of the supply chain. Currently, issues directlyrelated to the customer are communicated indirectlyto PSM. As a result, critical customer issues may bemissed.

2. Not surprisingly, PSM focuses on the upstream costmanagement aspects of the supply chain, related tothe suppliers. It does a good job of understandingand managing the costs associated with the first tiersuppliers. None of the organizations studied focuson suppliers beyond the first tier as a matter ofcourse. Rather, second tier suppliers and beyond aredealt with on an exception basis, as problems andissues arise. The stated policy in all of the companiesstudied was to rely on the first tier suppliers tomanage their own suppliers, the second tiersuppliers to the core organization studied. However,it was acknowledged that there is great potential forimprovement in the second tier suppliers, and thatinvolvement with key second tier suppliers willlikely increase in the future.

Research Question 12. What are the key success factorsand barriers to strategic cost management?

Because overcoming the barriers to successful strategiccost management in the supply chain is closely related tosuccess factors, these issues are discussed together.

1. High-level visibility and reporting relationships forPSM are important for PSM’s initiatives to receivevisibility and attention to support their success.Several of the organizations noted that they hadundergone reorganizations that increased thevisibility and reporting level of PSM at about thesame time that they accelerated their strategic costmanagement efforts. They believed that the topmanagement attention and support were importantto their successful contributions to costmanagement.

2. The availability of trained, dedicated personnel tosupport supplier cost analysis is also important.Dedicating resources to supplier cost managementnot only shows management support, it also allowsPSM to identify opportunities and deliver results.

3. Credibility in the numbers reported is also importantto the success of strategic cost management. This


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means that all key players agree on how the numbersare calculated. The numbers must also bedetermined and computed by a trustworthy source,with the emphasis on reporting numbers that can betraced to bottom line cost improvement.

4. Cost management must be viewed as an importantpriority throughout the organization. This should bereflected in performance expectations and the rewardand measurement systems in the organization.

5. Strategic cost management is not one process, butrather a series of processes and tools that arecoordinated to support organizational objectives. Tobe effective in strategic cost management,organizations need to have good sourcing and costmanagement tools and processes, such as cross-functional sourcing and new product developmentteams, strategic sourcing, target costing, should-costanalysis, and total cost of ownership analysis inplace.

6. Organizations must have good information systemsto gather the data needed to analyze spend patternsand monitor price and cost trends for strategic costmanagement.

7. PSM must deliver bottom line cost improvements inorder to earn and retain its credibility and respectfrom top management.

Research Question 13. What is the future of strategiccost management in your organization?

1. Strategic cost management will continue to beemphasized, and even grow in its importance for theorganizations studied.

2. Suppliers and supplier relationship management willgrow in importance as sources of cost savings andimprovement. There is a limit to the amount of year-over-year cost savings attainable from on-line reverseauctions. The long-term opportunities lie in workingmore closely with suppliers.

3. The emphasis on early PSM and supplierinvolvement will continue to grow as a source of costsavings and product improvement. The emphasis oncustomer value in cost management will grow andgain more visibility within PSM.

Implications of the Study

This study has several implications related to PSM’sinvolvement in strategic cost management in theorganization. They are closely related to the results of theresearch questions presented above.

Organizational Support at all LevelsWhile PSM is held to a high level of accountability forstrategic cost management and delivering bottom-linesavings, PSM cannot be successful without extensivesupport from others throughout the organization. Firstand foremost, top management support is critical. It setsthe tone for the attitude that everyone in the organizationhas toward strategic cost management. Through thebusiness unit and functional metrics, top managementdetermines the nature and extent of cost managementfocus as an organizational priority. Based on this, PSMneeds the support of other functional areas cooperatingteams that have a primary or second goal of managingsupplier costs. The participants on cross-functional teamsneed to be held accountable for the identification ofopportunities and delivery of results.

PSM also needs specific support from cost managementspecialists, who are assigned to support PSM and cross-functional teams in supplier cost analysis. Theseindividuals may be part of PSM or part of finance. Thecritical requirement is that they have the charter and thequalifications to effectively support supplier cost analysisand management. Supplier cost management must beviewed as one of, if not the most important aspect oftheir jobs. This focus is critical because supplier costanalysis is often specialized and time consuming. PSMand cross-functional teams need to know that there areinternal experts upon whom they can call to supporttheir supplier cost management efforts. Without suchsupport, the analysis may be too complex and timeconsuming to be done as part of PSM’s or the cross-functional team’s regular activities.

Supplier Cost Management is a Good InvestmentThe suggested approach for dedicating resources tosupplier cost management may seem cost prohibitive.However, the organizations studied unanimously agreethat they receive extremely high returns on theirinvestments in supplier cost management efforts. Themoney spent on supplier should-cost analysis, supplierdevelopment, and other tools and approaches pays foritself many times over in terms of reducing costs andbottom-line prices paid to suppliers. For large Fortune500 companies, successful strategic cost managementmay mean the addition of dedicated personnel to focuson supplier cost management. For smaller organizationswhich might not have as great an on-going need, or asgreat an asset base, successful strategic cost management


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may mean diverting resources from PSM and/or finance,and retraining one or more people to become internalexperts on some of the cost management and analysistools mentioned in this study.

Strategic Cost Management in the Supply Chainis a Process and a PhilosophyThe organizations studied indicate that they live andbreathe cost management. It is integrated into all aspectsof their jobs and all dealings with suppliers. Topmanagement and functional support is not enough toensure the success of strategic cost management. Keyinternal processes, such as new product development andstrategic sourcing, must also be designed in a mannerthat integrates an understanding of customer needs, andthe creation of specific cost and profitability goals.

Credibility in Reporting ResultsThe savings that are attributed to supplier costmanagement must be believable, and traceable to thebottom line. It is important that there is consensus acrossthe organization regarding how the numbers arecalculated and reported. In general, finance reports thesenumbers to increase the credibility of the results. Thefocus is on reporting cost savings that can be traced toreduced spending within the organization.

Supply Chain PerspectiveTaking a seamless view of strategic cost managementacross the supply chain is not yet a reality. In most cases,the inbound view of the supplier is handled by a differentteam/organization than the outbound supply chain viewto the customer. It is critical that somewhere in themiddle, the organizations dealing with the customersmake sure that the customer value proposition is clearlycommunicated to the organization dealing with thesupplier. It is essential that internal organization goalsand objectives be aligned in order to align the goals andobjectives of the supply chain.

Customer-Facing Supply Chain Perspective – In general, thesupply chain managed by the organizations studiedincluded only the first tier of suppliers and the immediatecustomer. A notable exception was two of the companieswhose products are sold to consumers, either through aretail channel or after the product is used to produceanother product. Both of these organizations had a veryclose watch on demands and vagaries of the endconsumer, and aimed to anticipate shifts in consumerdemand patterns in order to better serve their immediatecustomers. Who ultimately determines the demand for aproduct, the end customers or the immediate customersis an important determinant of where the producingorganization should focus its attention.

Supplier-Facing Supply Chain Perspective – All of the studiedorganizations segment their supply bases and use differenttools and approaches for managing different suppliers andpurchases. It is critical to use a cost/benefit approach tosupplier cost management to use the organization’s limitedresources wisely. In addition, all of the organizationsstudied focus their supplier management attention ontheir first tier suppliers. They also recognize that there ismuch possibility for improvement in the supply chain inthe second tier, yet do not plan to focus on the secondtier. There could be significant opportunity for supplychain improvement by working directly with criticalsuppliers in the second tier and beyond.

Supplier Perspective on Strategic CostManagement in the Supply ChainThe suppliers to the core organizations studied werequite aware of the importance of cost management andcontinuous improvement in retaining their business withthe buying organizations. While all felt continual pressureto perform, some suppliers felt that the pressure was fair,and other suppliers felt that the pressure had becomeunreasonable. In order for buying organizations to retaingood supplier relationships and the image of fairness inthe face of continued cost pressure, they should:

1. Be concerned with the supplier’s underlying coststructure and how they can support pricereductions, instead of being concerned only withprice.

2. Provide resources and ideas to support supplier’s costreduction efforts when requested by the supplier andit is reasonable to do so. If an organization is unableto support the supplier’s cost reduction efforts, itshould explain why.

Suppliers’ Management of Their SuppliersWhile all of the supplier organizations studied wereworking on managing the costs of their suppliers, nonehad a supplier cost management system as sophisticatedand well-developed as did the core organizations whichthey supply. As a result, it might be a good investment forbuying organizations to provide thorough costmanagement training to their suppliers, and help theirfirst tier suppliers develop excellent cost managementapproaches, so that they, in turn, can do a better job ofmanaging their suppliers. This is particularly critical sincethe core organizations do not want to get involved in theinbound supply chain beyond first tier suppliers.

Support for Strategic Cost Management TheoryAs mentioned in the brief review of the literature below,strategic cost management theory embodiesunderstanding and managing the organization’s supplychain, the cost drivers and the customer value


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proposition. It is a matter of simultaneouslyunderstanding and managing these elements in relationto each other. The organizations investigated do anexcellent job of understanding and managing theirinternal cost drivers and supplier-facing cost drivers. Twoof the organizations that have a strong management focuson customer relationships also do an excellent job ofmanaging the customer-facing cost drivers.

It is not clear from the study how well theseorganizations understand the customers’ valueproposition and translate that across internal functionsand to their suppliers. Except in the case of LCP, and tosome extent Deere, the translation mechanism is indirect,through one or more functions that may have directcustomer contact. This represents an opportunity forpotential improvement.

Related to this, as mentioned in the section on supplychain perspective, most of the organizations studied donot generally have a seamless view of the supply chainfrom customer to supplier; the customer view andsupplier view are still managed separately in differentorganizations, with some interface in the middle. Suchcoordination would be a complex undertaking, andmight require a change in team structure. Theorganization that comes closest to embodying a truesupply chain perspective is LCP, with its product supplystructure. While the argument could be made that it is

more important for LCP to be close to its customersbecause it is a consumer products firm, all types ofcustomers are becoming more demanding (Fawcett andMagnan, 2001). LCP’s product supply structure has aProduct Supply Vice President who reports into theBusiness Unit President. Also reporting to the VP ofProduct Supply are PSM, engineering, manufacturing,customer service/logistics, and finance. Deere has asimilar structure, although there is a mix of direct andindirect reporting relationships.

Characteristics of Companies with EffectiveSupply Chain Strategic Cost ManagementApproachesThe key characteristics that organizations with effectivestrategic cost management systems should display areshown in Table 3. Table 3 was developed as a compositeideal of the best characteristics of the core supply chainorganizations studied. It is not representative of any oneorganization. There are specific attributes related to waythe organization understands and manages therelationship with the customer, its supplier, and related totheir own internal organization. The key organizationalcharacteristics have been divided intocultural/organizational issues, measurement issues, andinformation/communication issues.

Internal requirements/characteristics – Both the customer-facing and supplier-facing characteristics stem from inside


Table 3Ideal Organizational Characteristics for Strategic Cost Management

Customer-Facing Internal Supplier-Facing Knowledge Requirement/Characteristics Knowledge/Characteristics

Culture/Organization Culture/Organization Culture/Organization• Work closely with immediate • Top management support • Continuous improvement focus

customer on supply chain design, • Cross-function teams • Support key suppliers with resourcescost and customer issues • Dedicated supplier cost to facilitate continuous improvement

management/analysis specialists • Early involvement of key suppliers• Cost management integral to all • Train suppliers in supply chain cost

supplier-facing processes management

Measurement Measurement Measurement• Understand end customer’s • Metrics aligned with cost • Reward key suppliers with more

wants/needs management/other goals business and/or sharing savings• Understand market trends • High level visibility/reporting of • Segment supply base to vary

cost management results relationships and cost management techniques

Information/Communication Information/Communication Information/Communication• Recognize the importance of • Excellent information systems • Clear communication of

communicating customer needs • Seamless understanding and expectations to suppliersthroughout the organization communication of customer needs

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the organization. The internal culture and organizationalstructure create the framework for effective supply chaincost management. Internally, an effective cost-management culture is characterized by top managementsupport for cost management and a high level of cost andvalue consciousness throughout the company. In additionto dedicated resources to support supply chain costmanagement, cross-functional teams are used to identifyand implement cost management approaches. Ratherthan an afterthought, cost management is an integral partof all key supplier processes.

The right type of reward and measurement systems isalso critical to reinforce the cost management culture. Itis critical that the organizations measure what they wantto achieve, and the metrics are aligned throughout theorganization, reflecting cost goals as well as customervalue and supplier performance goals. Supply chainperformance metrics and results must be published andreceive high visibility throughout the organization. Thisrequires excellent information systems andcommunication. Part of this communication includesawareness throughout the organization of customer needsand the organization’s value proposition in serving thecustomer.

Customer-facing knowledge – Supply chain management isall about meeting the needs of customers better than thecompetition does. In terms of the organization’s culture,the company needs to be customer centric, valuing itscustomers and working with them to meet their needswhile improving the efficiency and effectiveness of thesupply chain. From a measurement standpoint, theorganization needs to understand the needs of the endcustomer as well as market trends, and respond to theseproactively. From an information and communicationperspective, it is critical that the customers’ needs and theorganization’s plans for meeting those needs becommunicated throughout the organization. This allowseveryone in the organization to align his or her effortsaround the customer.

Supplier facing knowledge/characteristics — Effective supplychain strategic cost management relies heavily onsuppliers. Culturally, this means a continuousimprovement focus on working with suppliers, includingearly supplier involvement. It also means supportingsupplier’s continuous improvement with resources andtraining. From a measurement and reward standpoint,the organization must properly segment its supply base touse the appropriate types of supplier relationships andcost management techniques. It also needs to measuresupplier performance, and reward the suppliers whoperform well. Clearly communicating expectations andneeds to suppliers is essential.

The organizations studied in this research excel in thethird column of Table 3: supplier-facing knowledge. Theysegment their supply bases, have dedicated supplier costmanagement resources, emphasize continuousimprovement, and in many cases develop the suppliersby providing resources to support continuousimprovement. They reward their top suppliers by sharingcost savings or giving them more business. They areworking on improving communications and earlysupplier involvement. One strong recommendation isthat they invest more resources in supplier training. Ingeneral, their first tier suppliers do not have as well-developed approaches to supplier cost management.Since these core organizations would prefer not to workon supplier cost management beyond their first tiersuppliers, the first tier suppliers would likely be muchmore effective if they improved their cost managementsystems, and worked more closely with their suppliers.


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Much of the impetus for this study is driven by thetimeliness of the topic and the lack or relevant researchand literature in strategic cost management in the supplychange from the PSM perspective, as presented inAppendix B: Research Proposal. This section presents abrief overview of the research design. A literature reviewthat provides more insight into strategic cost managementis included in Appendix F. A more comprehensivepresentation of the research design is provided inAppendix G.

Design

This study was conducted using an in-depth case studyresearch method. This method was chosen to support thebroad and exploratory nature of the research questions ofinterest (Yin, 1994; Meredith, 1998). The input of PSMprofessionals was used to shape and modify the researchdesign.

Sample SelectionThe criteria for selecting companies to participate in theresearch study were as follows:

1. Active involvement in cost management effortsworking with suppliers and/or customers to reducesupply chain costs.

2. Belief that some of your organization’s costmanagement practices are leading edge/innovative.

3. Significant bottom line savings to the organizationthrough supply chain cost management efforts.

4. Willingness to openly share thoughts and processesinvolved in supply chain cost management.

5. Willingness and ability of the initial contact to act asa liaison to provide the researcher with entrée toother members of the organization, the supply base,and customers.

Appendix C contains the interview protocols, cover letterand abbreviated research proposal used to engage thecase study participants.

The number of people interviewed and their functionsvaried among the organizations. A summary of therepresentation of case study participants is shown in

Design of the Study


Table 4Case Study Participants

CASE PSM OTHER INTERNAL* SUPPLIERS CUSTOMERS TOTALDeere 6 3 1 - 10Chip 5 7 3 - 15LCP 4 4 2 1 11Tele 8 3 1 - 12

Praxair 4 1 2 - 7Total 27 18 9 1 55

*Titles/positions of each participant are available in the appendices to this report at the end of each case study

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Table 4. In all core cases, representatives from PSM andfinance/accounting participated in the case studies.Individual cases summarizing the respondents’ commentswere prepared and e-mailed to the individualrespondents for comments. These were very detailed,beyond the summary cases included in Appendix A.Participant feedback was incorporated and the case

modified. This increased the validity of the results. Othermethods used to increase validity are shown in Table 5,and explained in more detail in Appendix G.


Table 5Tactics Used to Increase Validity

Construct Validity -External business executives review interview protocol research proposal-Use multiple sources of evidence as included in the case study database:

• Multiple informants• Internal and external informants• Multiple sources of evidence including presentations, web-sites, published articles

-Have key informants review case study draft report

Face Validity -External business executives review

Internal Validity -Pattern matching-Multiple informants from within the same company review study-Multiple informants from within the same company report on same phenomenon

External Validity -Replication with five core companies and five suppliers

Reliability -Use case study protocol-Develop case study database-Triangulation

Adapted from Yin, 1994; Ellram, and Siferd, 1998.

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Introduction and Background

Strategic cost management in the supply chain ischaracterized as follows:

• It is purposeful: It supports the organization’sstrategy.

• It is boundary spanning: goes beyond supplymanagement both within the organization andoutside the organization (suppliers, customers).

This broad definition allows the researcher a great deal oflatitude in identifying strategic cost management withinand among organizations. This is consistent with the casestudy research method, which endeavors to providediscovery and new insights. The distinguishing feature ofstrategic cost management is that it considers costmanagement not as an end in itself, but as a means tosupport the goals of the larger corporation. Thus, it has abroader view and broader implications than simplygetting a price that is a few pennies less.

The supply chain is defined here as a minimum of threelinks that work together to fulfill the needs of a commoncustomer. While only one of the case studies includecases from people in three links of the supply chain, theyall include the indirect perspective of three links byasking people within various organizations how theyinterface with other links in their supply chain. Theoverall objective of this study is to gain a perspective onPSM’s participation in strategic cost management in thesupply chain.

Discussion of the findings

Research Question 1. How Important is Strategic CostManagement in the Organizations Studied, and Why?To set the stage for this research, the researcher began theinterviewing process by asking the above question. Notsurprisingly, all of the organizations studied identifiedcost management as extremely important and growing inimportance within their organizations. The rationale forthe growing importance of cost management varied

The Role of Purchasing and Supplyin Strategic Cost Management

in the Supply Chain


Table 6Reasons for the Increasing Importance of Strategic Cost Management in the Organization

- Declining sales- Declining margins- Declining prices- Decreased global competition- Stated objective of mergers/acquisitions that must be monitored and realized- Customer pressures to lower prices (mentioned both in the context of consumers and industrial customers)- Market is price-oriented- Increasing amount of total spend of company is spent on purchases from suppliers- Capacity constraints/industry allocations create cost pressures elsewhere- Need to improve profit margins- Increased commoditization of products

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among the firms studied. A list of some of the reasonsthat cost management is increasingly important today isshown in Table 6. For example, Deere noted that it hasbeen subject to the economic swings, like the 1998 and2000 downturns, and growing global competition.Simultaneously, it has been expanding to serve highlycompetitive world markets, which also creates a challengein terms of cost efficiency. As a result of a combination ofdeclining sales and the market’s inability to support priceincreases, it has been under increasing pressure to reducecosts to help contribute to the corporation’s bottom line.

Chip mentioned that it has always been in a cost-competitive and cost-focused environment, but recently,it has been feeling increased pressure from the marketplace, and the demands of the end consumer. The focusand attention on costs has increased substantially in thepast five years or so, due to increased competition andthe declining prices of PCs. As a result, the materialsgroup, including purchasing, receives many top-downmandates for achieving cost goals. It is expected thatthere will continue to be a greater cost managementemphasis due to where Chip is in the life cycle of its ownproduct.

LCP also mentioned the increased commoditization of itsproducts, and the growing size and power of itscustomers as factors contributing to increased pressure tomanage cost. More effective purchasing and improvedmanufacturing reliability have been the primary sourcesof improved profits for LCP over the past 10 years. Thesepositive results have added to the pressure to bettermanage costs. LCP tends to pass along the majority of itscost improvements to its customers in the form of lowerpricing. This is important in keeping strong sales andconsumer demand.

Tele has similar pressures, with the added complicationof a large number of recent mergers and acquisitions.Everyone interviewed agreed that cost management isvery important at Tele. One person mentioned, “The factthat an internal consulting group to support costmanagement and analysis even exists is an good indicatorof the importance of cost management.” All of thoseinterviewed agreed that cost management is so importantat both an enterprise-wide level and a purchasing level inparticular that it would be difficult to further increase itsimportance. The recent mergers have heightened thevisibility of cost issues. One of the goals of the mergerswas to significantly increase procurement savings. Thatgoal has been achieved and exceeded, as savings havebeen greater than planned.

Praxair’s product has always been a commodity. Itattributes the increased cost pressure that it is feeling tothe weaker economy that is affecting some of the

industries that it supports, as well as to a growinginternal recognition of the major impact supply has onthe organization’s bottom line.

During the interviewing process, it became clear that allof the organizations studied had cultures of costconsciousness, permeating from the top of theorganization through all levels and functions of theorganization, and touching their suppliers as well. Thiswas seen in comments like that from Tele, “We spend thecompany’s money like it is our own.” As one personinterviewed at Chip explained, “We have a frugalitymentality.” Thus, the emphasis on cost consciousnessdemonstrated by the organizations studied is aphilosophy or way of doing business, rather than anisolated initiative.

Research Question 2. How Are Firms OrganizedEffectively to Achieve Strategic Cost Management?To answer this question, we look first at how thepurchasing functions are organized within each firm,then more specifically at where the cost analysis andmanagement activities occur. As shown in Table 7, all fiveof the primary companies studied had centralized, or amix of centralized and decentralized purchasingorganizations. There was widespread agreement amongthe firms studied that at least some degree ofcentralization was required to get visibility of purchasesin order to gain leverage and properly manage thesupplier relationships and cost issues. For example, inthe past several years, Deere changed from a highlydecentralized purchasing structure to one that waspurchasing about 50 percent of the corporation’s totalspend at the corporate level. This includes virtually allindirect spending, and about 20 percent to 30 percent ofthe total direct materials. Most of the rest is nowpurchased at a more centralized divisional level, whileonly about 10 percent of the total spend now occurs atthe factories. This represents a significant change forDeere, which always has operated as a highlydecentralized organization.

Chip always has operated as a highly centralizedpurchasing organization with a direct reportingrelationship to the manufacturing group. In this high-technology arena, there is realization that effective

Table 7PSM Function Organization Structure

Centralized Decentralized MixedChip XTele XDeere XLCP XPraxair X


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purchasing and supplier relationship management areessential to manufacturing and new product support.Similarly, Tele recognizes the value of a centralized supplyorganization to support its business units and its newservice development.

Likewise, Praxair moved from a more decentralized, adhoc approach to purchasing in the late ’90s to a highlycentralized approach. Just like the change that wasinstituted by Deere, this change came about with topmanagement support and the recognition that there wascommonality across business units, and that leveragingthat commonality in purchasing was critical forpurchasing to support effective cost management andsupplier relationship management.

LCP’s purchasing has been a mix of a centralized anddecentralized structure. It has recently shifted moreresponsibility away from the central corporate purchasinggroup back to the business units. It continues to have acentralized “service” organization that leverages thecommon indirect purchases. In downsizing the corporategroup, it eliminated non-value activity. Today, there isalso a centralized purchasing/supply chain group that actsas a global think tank, looking for innovative ideas andopportunities for supply chain improvement and feedingthese ideas back to the business units. With the overallorganizational structure in mind, it is helpful to thinkabout how the case study firms are organized for strategiccost management.

Research Question 3. Who is Responsible forConducting Cost Management in the Organization,and Who is Accountable for Delivering Results?

This question is answered by considering the role of PSMas well as others within the organization.

Supply Management’s Responsibility for Delivering SupplyChain Cost Savings – At Deere, cost management andstrategic sourcing share the goal of bringing savings to theorganization through supporting the business units. Costmanagement helps evaluate supplier quotes, andsupports and reports on the progress of strategic sourcingfrom a cost management perspective. The strategicsourcing manager at the business unit level drives thecost savings initiatives down to the strategic sourcing andcommodity managers. Ultimately, strategic sourcing iscompletely responsible for executing and delivering costsavings. Cost management is part of the personal goalsheet for each person in supply management.

At Chip, purchasing has a very high level ofaccountability for cost management through thepurchasing expenditure plan. PEP is a cost performancemanagement program used within the materials group

and Chip to monitor and manage cost performance. Thefocus of PEP is on the current year’s performance.Bonuses and pay are strongly influenced by individualand functional contribution to cost savings.

At LCP, the Purchasing Director for the business unit isresponsible for the cost of materials and cost savingsprograms. These objectives, in turn, roll up to supportthe objectives of the Business Unit Vice President, anddown to influence the goals of the Purchasing Director’sreports.

Within procurement at Tele, cost management efforts fornew or existing products or services are driven byStrategic Sourcing organization, which creates suppliercontracts. Savings are monitored by evaluating the totalcost of ownership for those goods/services, as well assuppliers’ performances in the areas of on time deliveryand cost of product or delivery non-conformance. This isa key part of how supply management is evaluated atTele. The ICG, described above, is responsible for helpingto identify savings opportunities, but has noresponsibility for execution. In addition, supplymanagement is responsible for achieving savings andsupply chain process efficiency targets agreed to inmerger contracts.

At Praxair, the specific accountability for cost savings inthe PSM area includes operating profit impact, savings oncapital expenditures, and contribution to cash flow viasavings in cash and inventory. Each individual withinsupply management has specific accountability forachieving certain cost savings objectives.

Responsibility for conducting cost management in theorganization – In general, the responsibility forconducting cost analysis and management activities iswidespread throughout the organizations studied, as wellas in purchasing specifically. Table 8 summarizes howresponsibility for conducting cost management is spreadwithin the core organizations studied. Each of theorganizations has taken unique approaches to ensure thatit has the cost analysis and cost modeling skills in placewithin its organization to support strategic decision

Table 8Responsibility for Conducting

Cost Management/Cost Analysis

PSM Finance- Internal SpecialController Consulting Team

Chip X XTele X X XDeere X XLCP X XPraxair X X X


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making in purchasing decisions. The two generalapproaches are the use of experts who specifically focuson supplier/supply chain cost management, and the useof finance/accounting personnel to support/conductvarious types of supplier cost management. Beyondrelatively routine cost management within theorganizations studied, PSM was not expected to conductsupplier cost management/cost analysis on its own. Theunderlying philosophy in the cost management processesused at all of these organizations was to develop andleverage cost management/cost analysis expertise. Someorganization’s also designated special teams, such asDeere’s “compare and share” team, to specifically conductsupplier/supply chain cost analysis over a given timeframe. The special approaches are discussed in a separatesection under Research Question 7.

Deere’s overall approach is to have in place in eachbusiness unit cost managers who can support all of thecost management/analysis needs of that unit. In the pastseveral years, five cost managers have been put in placewithin the PSM organization, one for each division andone for corporate purchasing. These cost managers arehighly trained and skilled specialists, many of whomhave years of cost management/analysis experience withother companies. These cost managers all have smallstaffs that support them in providing cost analysis to theirrespective divisions. The cost managers also meetregularly as a team. The support that cost managersprovide can take the form of conducting various types ofcost analysis as well as supporting the efforts of otherindividuals in the business unit in conducting costanalysis.

At Chip, the finance organization views optimizingshareholder value as its mission. Finance is disbursedentirely throughout the organization, becoming involvedin all key decisions. Finance has a big picture perspective,supported by the organization structure. Finance reportsdirectly to corporate finance and has a dotted line to thebusiness unit or functional area it supports. Financesupports cost management by working very closely withthe PSM function, creating cost models, validating costmodels, including visiting suppliers to gather data andget feedback on models created. Finance also facilitatesthe use of cost models, and supports model credibility.Thus, finance is key in supporting supplier costmanagement. Part of finance’s charter is to help identifycost savings opportunities.

At LCP, the finance and accounting manager of therespective business unit leads cost savings efforts. This issupported by Product Supply and Marketing. The idea isto work as a cross-functional team and leverage theexpertise of each area.

Tele also has a variation on supplier cost management. Allthe groups within supply management are more or lessinvolved in strategic cost management. However, becauseof the diversity of participants, an internal costmanagement consulting group was formed to collect andanalyze cost data for the entire procurement organizationin a centralized manner, and then provide consultingservice to the internal clients within procurement as wellas clients throughout the enterprise. This InternalConsulting Group (ICG) was formed within procurementabout five years ago when one of the purchasing managersapproached the Vice President of Procurement with theidea that total cost of ownership analysis and doing amore thorough, complete analysis of purchases couldreduce the company’s costs significantly and improvedecision-making. The Internal Consulting Group focuseson cost, process, and planning issues for internal clients.This group gets involved in a variety of projects, solely atthe bidding of internal clients. There is no obligation touse their services, nor is there a direct charge for theirservices. ICG mainly serves internal clients withinprocurement. More detailed information about ICG isavailable in the Tele case study in Appendix A.

Praxair has a similar approach to Chip in leveraging theexpertise of finance. However, at Praxair there is adirector-level controllership function in the globalprocurement group that reports to the Vice President ofProcurement, along with the three other procurementdirectors. This function was added for a number ofreasons when the procurement organization was re-engineered in the late 1990s. The reasons for adding thecontrollership function include:

· Helping to determine the savings potential ofprojects.

· Developing appropriate mechanisms for trackingcost savings.

· Tracking the actual savings potential of projects.· Obtaining business unit buy-in to the actual project

savings.

Thus, the controllership function at Praxair also plays akey role in supporting supplier cost management andsupporting the analysis.

Given the predominance of finance and cost analysisspecialists to support cost management and analysis, thequestion must be this: Who is held accountable fordelivering cost savings results to the organization? Theanswer to this question is previewed in Table 9, andsummarized below.

Accountability for strategic cost management through theorganization – As mentioned previously, the accountabilityfor cost savings and cost management is widespread


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through all of the core organizations studied. Forexample, functions outside of cost management withinDeere have felt some accountability for cost management.This has been spread to engineering, operations,accounting, and marketing so they will feel greateraccountability for cost. Buy-in is improving. Twentypercent of each employee’s bonus calculation is based oncost reduction, and there is no cap on the bonus. Returnon investment is also a major factor, along with divisionspecific objectives.

In the new product arena at Deere, the supply chainintegration (SCI) manager is responsible for all newproduct programs. The SCI manager integrates strategicsourcing early into new product programs. Throughstrategic sourcing, suppliers may be co-located during thedesign phase of new product programs. Critical areas ofdesign focus are large cost areas and those areas wherethere is a major design change. SCI managers ask costmanagement experts to evaluate the cost structure of thenew designs. If there is a problem, strategic sourcing andsupplier development may get involved. There may alsobe engineer swaps with the supplier in order to get moreintegration.

At Chip, a centralized organization carries out theoperational aspects of purchasing, production, testing, andlogistics. Purchasing/materials is part of that group andincludes all aspects of material acquisition, purchasing,supply chain management, materials technology and aspecial projects/collaboration group. Cost management isco-owned by all functions. Engineering focuses on costtake out through design and development. Operationsdoes the project schedules and implementation. Financehelps understand trade-offs, pulls data together, developsanalysis tools, quantifies options, calculates savings andprofitability, and folds these into overall strategy.Purchasing/commodity management focuses on ongoingcost reduction and performance issues. Logistics managesinventory and transportation. All are ultimately

responsible. They need cooperation, a team effort. Financeand operational owners/business units have to sign off onall key materials decisions. While all participants are heldresponsible for achieving the goals to which they commit,ultimately business units are accountable for achievingcost targets.

At LCP, the VP of Product Supply organizational structureprovides one-person visibility of all key product supplycosts and issues. This position ultimately hasresponsibility and accountability for processes andresults. In addition, this role is designed to break downfunctional barriers and create a process focus with jointgoals and responsibilities. The Vice President of ProductSupply of the business unit is responsible for meeting thebusiness unit cost target for the total delivered cost of theproduct. The accountability and total delivered costbreakdown averages as follows:

Category % Primary Owner of CostsMaterials 60% BU Purchasing DirectorManufacturing Expense 20% BU Manufacturing SitesLogistics 10% BU SitesProduct Supply Overhead 10% BU and Corporate Overhead

100%

At Tele, the responsibility for managing costs is welldistributed throughout functions and levels in theenterprise. Those with budget and/or revenue objectives,as well as the entire procurement organization feel costpressure keenly. Cross-functional sourcing teams,comprised or purchasing, business unit representatives,and key stakeholders are held jointly and individuallyresponsible for achieving cost objectives.

At Praxair, the focus is both internal, on operatingspending, and external, on money spent with suppliers.Yearly financial objectives drive processes. The objectivesare set based on savings translated in terms of earningsper share.


Table 9Functions that are Primarily Responsible for Delivering Supplier Cost Savings*

PSM Finance/Cost Product** Distribution Production/ Quality/ Engineering/Specialist Supply Operations Productivity Design

Chip X X X X XTele X XDeere X X X X XLCP X XPraxair X X X X

*The organizations studied may use different names for the similar functions.**Product supply is a unique function that includes PSM, operations, finance, and customer service.

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Each business is accountable for its own costmanagement. This includes:

• Business Units – each is responsible for the cost ofindustrial gas that it sells.

• Distribution group – is responsible for the cost ofdistribution of gas.

• Production/Operations – is responsible for the costto run/maintain facilities.

No group can manage costs effectively without the helpand support of procurement, because purchasing doesthe buying. Throughout Praxair, there is a strongaccountability for both costs and budgets. This very highlevel of accountability for all spend raises awareness ofbudgetary issues and controls. In sales and marketing,the focus is on revenue growth and cost in terms of thebudget. Seventy percent of internal costs aresalaries/benefits.

There are also certain service groups in addition to globalprocurement, that have overall responsibility for costmanagement within the company:

• Productivity team looks at productivity initiativesthroughout the organization, with a primaryemphasis at the plant level productivity.

• Six sigma team/initiative looks at many projects andanalyzes/creates solutions, to save the company

money. Many of the issues this team deals with arerelated to Praxair customer satisfaction, such as on-time delivery.

• Energy management group is a dedicated energymanagement team that has existed for more than 10years. Because electricity is one of Praxair’s largestcosts of doing business, this focused team looks forcontinuous improvement opportunities.

All of the teams have the overarching goal of generatingmeasurable cost improvements, efficiency, and value aswell as focusing on customer satisfaction. Each isaccountable for delivering major, traceable savings eachyear.

Cross-functional teams in cost management – As has beenalluded to throughout this study, and is illustrated inTable 10, cross-functional teams prevail in organizationalcost management. The membership on these teams variesdepending upon the nature of the commodity studiedand the breadth and depth of organizational impact. Thetable is not meant to provide an exhaustive list of allthose who might participate in a team to support costmanagement, but rather presents examples of membersmentioned in specific instances provided by theorganizations studied. Common members include PSM,finance or some cost management representative and keystakeholders from various functions and at various levelswithin the organization.


Table 10Cross-Functional Team Membership In Supplier Cost Management*

Chip Tele Deere LCP PraxairPurchasing X X X X XFinance/Accounting X X X XCost Management X XR&D X XEngineering X X X X XSales X XMarketing X X XManufacturing X XOperations X XDesign XTechnology XLogistics X XTransport XWarehouse/Inventory XGeneral Management XContracting XProject Management XBusiness Unit XCommodity Management X XIT X

*The organizations studied may use different names for similar functions.

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Tele provided an in-depth explanation of how its cross-functional sourcing teams support its commoditystrategy/cost management process, as presented below.Tele calls its commodity strategy process a “clientprocurement plan.” The Client Procurement Plan (CPP)supports PSM’s internal clients, and achieves thefollowing objectives:

· Clearly links the supply chain process to the client’ssuccess.

· Provides an opportunity to dialogue with client andcalibrate on its key objectives, creating buy-in at theofficer team level.

· Proactively focuses supply line issues to create asignificant competitive advantage and increase clientsatisfaction.

· Develops and prioritizes client list, reviews clientpriorities periodically.

· Schedules attendance at client staff meetingswhenever possible to facilitate participation of keydirect reports and ease scheduling difficulties.

· Schedules one formal meeting per year and usesfollow-up appropriate to each client (e-mail,conference call).

· Integrates client procurement plan into CrossFunctional Sourcing Team (CFST) process, takingadvantage of established lines of communication andeliminating duplication of effort.

· Assesses program effectiveness from both client andprocurement viewpoint.

The Cross Functional Sourcing Teams (CFST) consist ofemployees and suppliers, having diverse skills,functionality, and expertise, from multiple organizationsworking to achieve a common strategic sourcing purposeand specific goals including total cost of qwnership(TCO) Savings.

The overall purpose of a CFST at Tele is to consolidateand streamline the purchasing activities of theorganization — creating savings, efficiencies, quality, andultimately, shareowner value.

This team of skilled professionals represents a variety ofstakeholder organizations across Tele. It carefullyconsiders specific procurement needs and financialconcerns and then recommends a unified program thataligns with the organization’s supply-chain managementgoals. CFSTs actively collaborate with business units,exchanging ideas, sharing knowledge, and capturingissues that may impact the procurement process. Teleprocurement is focused on delivering the value of best-in-class supply chain management throughout all Telebusiness units. CFSTs perform a critical role in ensuringthat mission is successfully executed.

Fostering a healthy team environment is the key tosuccess. A successful team exhibits:

• Effective team leadership and member participation.• Optimum team size.• Team cohesiveness.• Effective use of organizational resources.• Commitment to meeting or exceeding goals.• Willingness to evaluate performance and recognize

contributions.

Demonstrating these attributes will help ensure CFSTmeets or exceeds its financial targets.

CFSTs are empowered through the decision-makingprocess to design high-quality, supply-line initiatives(within short cycle times) that conform to Tele’s CoreProcurement Processes and Operating Practice 6 (OP-6)guidelines. Each team is dedicated toward:

• Ensuring cycle time reductions, especially with newproducts.

• Developing cross-boundary ownership.• Promoting innovation and synergy.• Reducing costs and total cost of ownership.• Promoting the development and growth of

individual team members.

Every CFST has an Executive Advocate who supportsand empowers the team’s efforts, troubleshoots problemareas, and removes any roadblocks to success. A TeamLead (typically a procurement director or senior contractmanager) guides and directs the team. This includesensuring the team’s charter is developed and executedand member roles and responsibilities are effectivelycommunicated. Team members participate in a variety ofteam activities, such as gathering appropriateinformation, sharing knowledge, and making decisions.The team also includes representatives from businessunits and, when applicable, supplier organizations.

Research Question 4. How Do OrganizationsDetermine the Focus of Their Cost ManagementEfforts?In analyzing the data from all the organizations thatparticipated in this study, it is clear that the organizationsall stratify their purchases for cost management. They usedifferent tools and different levels of attention based ontheir perceived importance and ability to influence thecosts of the item being purchased. The level and natureof attention also varies for new products versus existingproducts. None of these organizations had a formalizedclassification matching the type of purchase to the type ofcost management tool. Rather, supplier classificationseems to be part of the corporate culture. For example,everyone at Chip knows that total cost of ownership


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analysis is used for capital acquisitions, and that the priceof high technology raw materials and components mustbe constantly monitored, and renegotiated every one tosix months, depending on market conditions. Thereappears to be some judgment and learning that occur inselecting the right approach to cost management. Whenselecting the right approach, all of the organizationsstudied had several key caveats:

1. Always consider the potential cost versus thepotential benefit of the cost/price analysis approachemployed.

2. Stay in touch with the market and use pertinentmarket information in analyzing and negotiatingcosts and prices.

3. Make sure to involve people with the right expertisein any sort of complex analysis. This generally meansfinance people or cost management specialists.

4. Cost management is an integral part of commoditymanagement

Each of the core case studies’ overall approaches to costmanagement is briefly presented below. More informationis provided in the case studies.

At Deere, cost management is clearly just one integralpart of the many initiatives that Deere is pursuing toachieve excellence in supply chain management. Itsoverall approach is to have in place in each business unitcost managers who can support all of the costmanagement/analysis needs of that unit either directly orin a support role. Some of the specific cost managementinitiatives that Deere has undertaken include:

• Benchmarking• Deployment of Cost Managers in each division and

at the corporate level.• Development of cost models/should-cost.• Target costing for new and existing products.• Standardization through compare and share.• Supplier Involvement in Value Improvement.• JDCrop

Cost planning and management are part of thecommodity management process at Deere, andareintegrated in PSM’s strategic plan. There are six peoplein cost management at the corporate level, supportingapproximately 30 teams that cover common parts and allindirect spend. Thus, cost management is a teamapproach that occurs as the commodity strategy is set forcommon buys across the organization. In all, there aremore than 60 people in cost management at Deere.About one-third of the 29 teams are covered by costmodels. The remaining two-thirds use market-basedpricing. The market-based pricing primarily involvescommodities, so the team forecasts prices to decide

tactics. Team membership includes strategic supply, costmanagement, representatives from each of the businessunits and technical/engineering. On the indirect side, theteams try to look creatively at buys/costs, not usingtraditional cost models. Cost management helps teamsunderstand cash flow issues, and try to get a better feelfor total cost. They also try to get teams thinking longterm on going from a “per piece” mentality to totalspend/total cost of ownership perspective. Divisional levelpurchases are supported by the divisional costmanagement staff that has been deployed in eachbusiness unit. Suppliers also help provide direction forDeere’s cost management efforts through suggestionsmade for cost improvement via Deere’s JD Crop system.See the Deere case in Appendix A for more information.

Chip has a formal strategic long range planning (LRP)process. Each major organization within Chip prepares astrategic LRP. For PSM, the Purchasing Expenditure Plan(PEP) is part of the strategic LRP. The PEP is preparedannually and undergoes much scrutiny. The PEPexamines where Chip plans to spend money, based onbusiness unit forecasts. It compares the “do nothing” orstatus quo alternative to active approaches to managecosts. Both direct savings and indirect savings areconsidered.

The PEP is prepared by commodity, by buyer,considering volume and mix changes. The plans arerolled up as needed to provide high-level summaries. ThePEP is precisely detailed in terms of cost-saving and valuemanagement approaches that the buyer will take witheach of his or her commodities for the year, and issupported by a detailed commodity plan. Thecommodity plan includes:

• Key cost drivers.• Detailed supplier information.• Flagship products, with an emphasis on specific

steps to achieve targets for flagship products.• Benchmarking data related to costs (history, market,

trends).• Specific cost savings projects planned and under

way.• Shipment mode.• Value enhancement projects.• Contracts in place to limit downside liability

(consider lowest possible lead time).• Enhanced terms and conditions that are used for this

commodity.

At LCP, managing supplier relations is a key role ofpurchasing throughout the whole life cycle, from findingsuppliers, setting up the relationship, aligning LCP andsupplier goals, and transitioning the relationship to phaseout at the end of the product life. In the past, purchasing


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was price oriented, and delivered price was viewed as theprimary yardstick. However, price has been driven downin the past five years or so. Today, there is a shift tolooking at costs holistically, from a total cost of ownershipperspective (TCO), considering issues such as how amaterial actually runs and inventory requirements. Thistrend toward TCO will continue. Now, LCP is working toimprove suppliers’ manufacturing processes, and createsynchronous manufacturing. This involves working moreclosely with suppliers on cost (e.g. target costing and costmodeling), sharing proprietary manufacturingtechnologies, and bringing in the supplier early in thedevelopment stage (not the black box syndrome). Thegoal is to streamline the whole supply chain. This is agradual shift towards improvement/streamlining ratherthan just focusing on price. This is a more difficultprocess with commodity type items, where marketpricing prevails.

At Praxair, the commodity management/strategic sourcingprocess is the heart of the approach to cost management.Commodity managers lead the cross-functional teams.The commodities under focus vary from year to year. Ingeneral, Praxair performs a complete commodity analysison one to two major commodity categories per month.This involves understanding all aspects of the cost andvalue contribution of the commodity.

Supplier interaction on cost management occurs as partof the strategic sourcing process. After the sourcing teamhas internally developed a strategy for TCOimprovement, and a formal sourcing strategy document,it involves the suppliers. It conducts individual supplierworkshops with suppliers that it intends to invite toparticipate in the RFQ. Praxair shares with the suppliersone on one what the initiative is about, the goals, howthey view the TCO elements and their magnitude. Thesupplier is then asked to answer questions about its bestpractices for cost management, delivery, and relatedissues so that it can build its case as a viable supplier. Thesuppliers receive the questions in advance, so they can beprepared. This meeting validates and enhances thesourcing process. Based on the workshops, there may bea reduced pool of suppliers invited to participate in theRFQ processes.

The cross-functional team assesses the suppliers’ bids andselects the winner based on what it rated as important inthe TCO model. Praxair asks suppliers for costbreakdowns, and creates its own as well. It presents itscost breakdowns to suppliers, and asks suppliers to tellthem where Praxair is wrong. The more open suppliersare the ones Praxair wants to work with. This approachworked well on PCs, services, and with someconstruction contractors. They agree on profit margin,and share in the risk on costs. Travel is also managed in a

detailed way, in which the cost management processincludes management of the entire overhead. Afterselection, Praxair negotiates with the supplier anddevelops/executes the contract and its terms andconditions, including performance commitments andyear-over-year price reductions. To facilitate supplierprocess improvements, Praxair encourages suppliers touse Praxair’s commodity management approaches withtheir suppliers (Praxair’s second tier).

At Tele, cost management efforts for new or existingproducts or services are driven by the Strategic Sourcingorganization (contracting) within PSM, and monitored byevaluating the total cost of ownership for thosegoods/services, as well as supplier performance in theareas of on-time delivery and cost of product or deliverynon-conformance. As with the other organizationsstudied, cost management is built into the strategicsourcing process at Tele. It follows a guideline called“Procurement Operating Practice No. 6” (“OP6”). OP6contains corporate policy and operating guidelines forcontracting with suppliers. It describes how Tele’sprocurement process operates within the scope of theapproved Tele Corporate Procurement Principles and isdesigned to support implementation of these principlesfor effective supplier management. It also provides asingle “One Tele” contracting process that allows thesepurchasing requirements to be aggregated andcoordinated across Tele for full leverage of the company’sbuying power.

First cost of product is still the major consideration. Forexample, PSM documents approximately 200 projects peryear and only around 20 percent look at more that justthe first cost of the product. Contract managers leveragehigh volume material purchases to obtain the lowestpurchase price through a request for quote process(RFQ). Value added resellers (VARs) are used to reducecosts and improve efficiencies in non-core businessactivities (e.g. assembly, packaging, installation, etc). Telehas material planners who work with suppliers tocommunicate Tele’s business requirements and materialforecasts. The suppliers are required to reduce theirprices year over year via their cost saving and qualityimprovement practices.

With all the Tele mergers, the primary emphasis has beento reduce first cost. Now that Tele is settling into a morestable environment and first costs associated witheconomies of scale have been achieved, it is expected thatthe total supply chain will be emphasized. Consequently,more research has been initiated to investigate the supplychain impact of alternatives, i.e., transportation elementsembedded in a supply chain. Tele takes a total view ofstrategic cost management by focusing on a Total Cost ofOwnership model. TCO is a specified methodology for


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analyzing and reporting the value of first cost savings andother in process costs.

Thus, cost management must be an integral part ofsupplier selection, commodity management and ongoingplanning in order to be effective. It should not be a one-off approach that the company takes when it really needsto reduce its costs, but an ongoing expectation that isbuilt into the relationship with the supplier and theorganization’s reward and measurement system.

Research Question 5. What Specific CostManagement Tools Do Organizations Use to SupportStrategic Cost Management?Table 11 shows some of the specific cost managementtools/approaches cited by the organizations studied. Theorganizations were not provided with a list of tools fromwhich to choose. Thus, the fact that an organization isnot listed as using a specific cost tool does not mean thatit does not use it. Rather, it was not brought out indiscussion. Some of the specific categories of costmanagement tools and their applications are presented inmore detail below. As mentioned above, all of thesecompanies have integrated their approaches to costmanagement into their sourcing strategy/commodityplanning processes, so that cost analysis is not a stand-alone approach, but part of the organization’s operatingprocedures. In addition, all of the companies studied varythe approaches to cost analysis based on the relativeimportance of the purchase to the organization, whilealso considering the market conditions and the supplier

relationship. There is a rank ordering of priorities, notedamong the case studies as applying Pareto’s law,cost/benefit analysis, or an ABC approach, to determinewhich purchases to analyze and the depth/nature of costmanagement approaches applied. Chip also specificallynoted that the nature of its approaches to costmanagement, even for the same commodity, varysignificantly over the short duration of its product lifecycle. For example, Chip uses target costing duringproduct development, supplemented by should-costanalysis. As the product matures, it focuses its costmanagement more on price analysis and supplier costanalysis by relying heavily on the negotiations process.Some of the reasons companies gave for using differentcost management and analysis tools in different situationsare listed in Table 12.

BenchmarkingBenchmarking was cited as a common cost-managementmethod used among the organizations studied. Ininvestigating the use of benchmarking in costmanagement, two general types of benchmarking areused, as shown in Table 13.

The first type of benchmarking is used to support priceanalysis and evaluation of supplier pricing. All of thefirms studied do engage in supplier price analysis whenthe availability of data permits. This direct pricebenchmarking allows organizations to assessreasonableness of prices, assess price increase requests,and understand trends. The other type of benchmarking


Table 11Types of Cost Management Tools Mentioned

Chip Tele Deere LCP PraxairTarget costing X X X X XTCO X X X X XBenchmark X X X X XShould-cost X X X X XSupplier cost breakdown X X X X XCost driver analysis X X X XDesign for cost XCompetitive bidding X X X X XStandardization X X X XStandardized contracts X XPrice analysis X X X X XCost benefit analysis/ X X XContract Decision Matrix XOperating Procedure 6 XValue improvement/Value Engineering X XNet present value analysis X XOnline-reverse auction X X X X XE-biz/procurement X X X X XData warehouse X

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Table 12Factors Influencing the Type of

Cost Management Approach Used

• Time available• Cost of the purchase• Stage in life cycle• Future impact of item purchased• Relationship with supplier• Market conditions/availability/competition• Number of sources available• Nature of the buy: capital, indirect, etc.• Unique versus standard item

Table 13Cost-Related Issues Firms Benchmark

Price-related• Market price of similar/substitute products to gauge

price reasonableness.• Market prices.• Historic price trends.• Equipment prices/capabilities.• Benchmark industry for commodity price.

Cost/Process related• Outsourcing processes.• Strategic sourcing process.• Supplier improvement.• Manufacturing processes.• Terms and conditions.• Adopt experience from other industries.

has more to do with understanding cost structures andprocesses rather than prices. This type focuses onexamining effective processes across the supply chain toidentify opportunities for cost and process improvementboth internally and externally. This may involve lookingat processes and best practices of non-competitors,customers, suppliers, acquired companies, and otherbusiness units.

In recognizing how important benchmarking is to theircompetitiveness, Tele recently developed a new positiondedicated to gathering/coordinating all competitiveintelligence on benchmarking. This represents a departurefrom the typical approach to random and non-standardindustry benchmarking. The goal is to get Tele to the nextlevel: institutionalization of routine industrybenchmarking on a set of key metrics, since it is notpossible (due to extreme resource constraints) to coverevery aspect Tele tracks on its business plan. The objectiveis to develop consensus on its benchmarking strategy as itrelates to industry performance and best practices.

The price and the cost/process benchmarking are used tosupport virtually all of the other approaches to costmanagement included in Table 11. For example,benchmark data are used to support target costing,should-cost analysis, supplier cost breakdown analysis,and total cost of ownership analysis.

Target CostingAll of the core organizations studied state that they usetarget costing as an important tool in managing theircosts. While the definition of target costing varies inpractice, in general, target costing is an approach wherebythe organization gathers internally and from the marketdata regarding what a customer will reasonably pay for aproduct or service offering including specific featuresand/or functions. The producing organization then backsout its profit requirements, and the remaining amountbecomes the total allowable cost. In order for this numberto be meaningful, the allowable cost is apportionedamong all of the organization’s cost centers, includingadministrative costs, marketing, direct labor, and materialscosts. From there, the allowable or target costs for specificmaterials and components are determined.

The companies studied all agree that target costing is acritical tool for linking all the functions within anorganization to support a common goal for new productdevelopment. Target costing is a way to ensure that all ofthe functions involved in new product developmentunderstand the customer’s needs as well as the cost goals,and are all aiming for the same target. In addition to usingtarget costing for new product development, these firmsalso use target costing in a slightly different way foracquiring capital equipment. The purchasing, finance, andoften engineering organizations work together todetermine what the machine should cost based on itscapabilities and the parts that go into the equipment. Thetargets for spend levels on capital are derived byconsidering the should-cost analysis as well as therequired return on investment and project net presentvalue based on the revenue streams and product costsassociated with the purchase of that capital. The overallmanner in which the companies studied indicate that theyuse target costing is summarized in the Table 14 below.

The use of target costing at Chip is highlighted here,because Chip has used the target costing process for anumber of years, and identified target costing as acornerstone to its strategic cost management efforts. Asone person interviewed at Chip said, “The target costingprocess drives the direct materials cost managementprocess at Chip.” Historically, Chip’s business unitsdetermine what something should cost to make thebusiness’ required profit for that item. Sales andmarketing consider the total cost of Chip solution vs. acompetitive solution. They push back on design to


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control costs. At the business unit level, target costing isused to help the design group focus on costs. ThePSM/manufacturing group at Chip has moved targetcosting to a higher level, to understanding the driversand what aspects of cost can be affected commerciallyand what aspects can be affected by design. Thus, there isdual ownership for cost by procurement and design. ThePSM and manufacturing group support the target profitmodel by achieving the target cost. Finance tries toensure that the target cost approach works to achieve thedesired goals and doesn’t cause the wrong behavior, suchas sacrificing customer value. Thus, target costing is trulyan integrated, company-wide effort.

At times, the target cost is based primarily on theunderlying technology and design. However, other timesthe target cost is based upon the target price required tobe viable in today’s extremely competitive market, even ifit does not seem technically feasible to achieve that costtoday. Having a firm goal/direction causes Chip toquestion design, technology, and related assumptions.There is immense cost pressure and challenge, and thegoals are getting more rigorous. A key objective of targetcosting is to achieve the target cost in the design stage. Ifthis can’t be accomplished, there is even more pressurewhen the item is in production, where ongoing and rapidcost reduction is an expectation of the market place. Thatis why it is critical to continuously keep the target costright in front of everyone involved in the new productdevelopment process as well as in the ongoing purchasingof materials and components used in production.

As mentioned above, target costing is used in newproduct development, as well as early in the product lifecycle. Company wide, Chip identifies four or five flagshipproducts at any given time. Every part on the flagshipproducts is targeted for cost improvement. These flagshipitems get frequent review and high visibility to hit targetsboth in materials and at the business unit level. Once aproduct is in the sustaining mode, target costing andshould-cost modeling are less relevant. Chip focusesmore on negotiations.

Commodity managers have cost targets. They are giventarget costs for new products, and can agree or disagreewith the target cost, and can challenge the targets. Thetargets come from business unit finance. Each businessunit has its own should-cost model that it uses todevelop the targets for specific commodities. Thesetargets must sum up to support the overall target cost forthe organization.

Should-Cost AnalysisShould-cost analysis is a cost management approach inwhich the buying organization determines what aproduct, service, or piece of equipment should cost. Thisis determined by looking at the elements that make upthe cost of that purchase, and adding a reasonable marginfor profit, administrative expenses, and reinvestment intothe business. This becomes a benchmark for whether asupplier quotation/bid is reasonable. The should-costfigure is also frequently used, in conjunction with targetcost, to determine a range for the target cost. In some


Table 14For Which Purchases and in Which Situations Do Companies Use Target Costing?

Chip Tele Deere LCP PraxairNew product development X X X X XEarly stages of PLC X XAssess price ranges for components X X XTarget cost by tool, total cost, cost per unit XCapital equipment X X X XNew products X XExisting products X X XCost targets are always used by purchasing XSupport supply chain cost analysis X X XIntegrate internal cost management issues XDrive direct material cost management X XHelp design focus on cost XCost driver analysis X X XTotal delivered cost of the product XUnderstand supplier’s cost XUnderstand consumer X XSupplier improvement X XUsed by customer XCost reduction in commodity area X

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situations, the target cost allowable may be higher thanthe should-cost analysis indicates, in which case thecompany would use the lower should-cost figure. Thetypes of purchase situations for which the companiesstudied use should-cost are listed below in Table 15. Thereasons indicated for conducting a should-cost analysisare shown in Table 16.

Table 15Purchases Supported by Should-Cost Analysis

• New Product Development (NPD).• Sustaining products.• Equipment.• Commodities.• Outsourcing.

Table 16Why Organizations Perform Should-Cost Analysis

To Facilitate Improvement:• Share design and improvement.• Identify cost reduction area.• Support SC cost management.• Professionalize purchasing.

To Increase Understanding:• Understand impact of design changes.• Understand supplier costs.• Manage supplier’s profit (together with target

margin).• Applied to international suppliers.• Part of target costing.• Better understand cost issues.

To Involve Suppliers:• Supplier involvement.• Supplier cooperation.

To Support Evaluation:• Help validate cost savings.• Evaluate PSM’s performance.• Support NPV analysis.• Evaluate submitted bids.• Support competitive bidding.• Support operations to realize cost savings.• Determine the business model’s required profit.

In addition, the organizations studied indicated thatshould-cost models are generally not used alone, butused to corroborate bids, e-auctions, and target costing,as mentioned above. Chip’s and Deere’s approaches toshould-cost analysis are highlighted here to illustrate therichness and diversity of applying should-cost methods inpractice.

At Chip, commodity managers are responsible for thedevelopment of should-cost models for the commoditiesthey purchase. These are generally developed with thesupport of finance and other commodity team members.Should-cost models are based on key processes (asidentified by the commodity manager and finance), andconsider material, equipment, labor, and facility costs.Suppliers and Chip both develop should-cost models andwork together to understand and recognize differences inapproaches and assumptions.

In developing should-cost models for key commoditypurchases, finance has visited suppliers and developed anunderstanding of all the suppliers’ costs, such asmaterials, labor, capital, and depreciation. Some suppliersshare this information in detail. Finance owns should-cost model development, and supports its use. OneCommodity Manager noted that if Chip is fair with asupplier, and guarantees it volume and communicateswell, the supplier is honest with Chip.

Should-cost models are very effective in new productdevelopment, early stages of product life for target costs,ensuring qualified suppliers are prepared at productlaunch, and in sharing design ideas and improvements.The goal is to drive most of the cost reduction activitiesearly in the product development cycle, to challengespecifications and assumptions. Some specific examplesinclude:

· Reducing the amount of precious metal used in aproduct.

· Relaxing product tolerances.· Asking the supplier for ideas to improve

manufacturability.

The use of should-cost models is a common practice atChip. The development of the model helps in gaining abetter understanding of costs while the results of theshould-cost model provide a source of validation forevaluating submitted bids. Additionally, actual costs thatdeviate from the should-cost model help identify areas offocus for cost reduction efforts. As an example, thelogistics group maintains should-cost models for groundtransportation services.

Historically, should-cost models have been valuable atChip, but they do have limitations. To better enabledecision making, finance incorporates target marginsinto should-cost models. It uses these margins tomanage total supplier profit over time. Chip createssupplier portfolios with target margins set for eachproduct based on where the product/platform is in thelife cycle. It uses these targets to negotiate andunderstand supplier’s total margin and profitability. Itprovides a higher level check. It focuses on the big


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picture over the product’s life cycle, not onmicromanaging pennies here and there.

Chip develops a should-cost for its capital equipmentpurchases. It actually creates a bill of materialsexplosion for equipment, using Pareto analysis to focuson the big items. It also considers margin, usingsupplier financials and looking at what is reasonable.For capital equipment purchases, the focus is on theimpact of equipment cost and efficiency on the per unitTCO of product. This target is set by manufacturing,using inputs (cost targets) from the business unit.Working with marketing, finance develops a “mustcost,” what it takes to meet cost targets in terms ofequipment depreciation to allow Chip to sell productaffordably, and earn a reasonable margin. Chip may aska supplier to reduce its price, and has a competitive bidprocess. Thus, should-cost analysis is a key element tosupport target costing, competitive bidding, and fact-based negotiations.

Chip views should-cost modeling as an evolution ofTCO. It goes beyond TCO; to break out overheadelements in should-cost modeling, and to better breakdown the costs of supplier processes. Costs such asfreight, pass through costs, and local support areincluded in should-cost models.

At Deere, the should-cost process is supported by costmanagement specialists housed within the purchasingarea. Deere has also purchased cost modeling software toallow it to determine the process cost elements of ashould-cost analysis, such as how much should a certaintype of process should cost, and what yields are to beexpected. Deere has also developed cost tables, which aremodels that can be used either to determine whether asupplier’s quoted cost for a particular process isreasonable or to develop a should-cost estimate for newor existing products.

Deere develops two primary types of should-cost models:historical and theoretical.

Historical based cost models are derived from:

· Market-based information.· Cost detail provided by supplier on quote form.· Inputs from multiple suppliers.

Theoretical cost models build up the costs for a processfrom the ground up. They consider issues such as:

· Space a machine takes up (building, depreciation).· Number of people on machine.· Initial cost of the machine.· Financing for the machine.

· Tooling.· Maintenance.· Efficiency for the machine.· Other relevant costs and performance issues.

It is possible that the cost modeling software mentionedabove could support either type of should-cost analysis.For existing products, historical based cost modeling ismore common, and focuses heavily on comparing andunderstanding the differences among supplier-providedcost breakdowns.

Deere has developed a structured process for new productdesign. Underlying this approach is the philosophy thatearly involvement of critical suppliers and functions is key,and that target costs must be set up front. Should-costanalysis supports the target costing process and is oftenthe first step of cost analysis in target costing. The should-cost and target costing processes are a team effort. Forexample, the design engineer checks the design cost basedon the should-cost analysis developed by supplymanagement and/or through a purchased cost modelingsoftware or software developed/supported by the costspecialist. This result is compared to the supplier quote. Ifthe supplier quote does not meet the design costrequirements, Deere uses the should-cost data to helpidentify whether the gap is due to design issues or supplycost issues. This process iterates with design changes andmaterial modifications until agreement is achieved and thetarget cost can be met.

Total Cost of Ownership (TCO) AnalysisTotal cost of ownership was used in some fashion by allthe companies studied, by some more than others. Totalcost of ownership analysis is defined as an approach forunderstanding and managing the true costs of doingbusiness with a particular supplier, of a particularprocess, or an outsourcing decision. TCO includes price,administration, usage, training, and disposal costs thatare often hidden at the time a purchase or processdecision is made. Chip, Tele, and Praxair all emphasizedthat they use TCO extensively in certain types ofsituations. How these companies use TCO will beexplained in more depth below. Deere and LCPindicated a lesser, but growing, extent of TCO analysis.Table 17 provides a list of the types of purchases forwhich the participants indicated they use TCO analysis.It covers a whole gamut of situations, from strategicpurchases such as outsourcing and capital equipment totactical purchases such as indirect materials. Oneconsistency among the organizations studied is that TCOanalysis must be done as a team in order to be effective.Team membership varies, but it needs to include acredible representative with a finance/cost analysisbackground.


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Table 17Type of Purchases Supported by Total Cost of Ownership

• Capital equipment acquisition.• New product development.• Indirect expenditure.• Outsourcing.• Commodity sourcing.• External goods/services.• Sustaining product cost management.• Existing product/services.

Total cost of ownership analysis also is used to explore anumber of different issues within an organization, asillustrated in Table 18.

Table 18How TCO is Used in the Organization

• To understand process costs.• Part of target costing.• Analyze/report cost savings.• To assess and manage risk.• Support a supply chain focus.• Supply chain cost management.• Strategic sourcing decisions.• Supplier selection.• To focus key supplier continuous improvement.• Understand customer decisions.• Understand supplier costs.

A recurring theme of TCO analysis is that it is animportant tool to help get a true supply chain cost perspective. This comment came up in conjunction withTCO analysis more than with any other cost managementapproach mentioned. The reasoning behind this is thatTCO takes a broad look at costs, both internally andexternally, both specific to a situation as well as supplychain wide. This view of TCO is shown in the matrix inTable 19. Thus, while target costing is an excellent toolfor understanding what the customer wants andproducing at an internal cost that will support both thecustomer’s desired price and the organization’s desiredprofits, it does not inherently consider the process andother cost implications on the rest of the supply chain.Understanding the tertiary and hidden costs is thefoundation of TCO analysis.

To illustrate the importance of TCO analysis to Tele, aninternal consulting group (ICG) was formed withinprocurement about four years ago when one of thepurchasing managers approached the Vice President of

Table 19Total Cost of Ownership Decision Focus

•Supplier selection • Supply chain cost•Focus on key supplier management

continuous improvement • Understand customer •Understand supplier costs decisions•Understand process costs • Support a supply chain •Analyze/report cost focus

savings • Part of target costing• Assess/manage risk• Strategic sourcing

decisions

Procurement with the idea that total cost of ownershipanalysis and a more thorough, complete analysis ofpurchases could reduce the company’s costs significantly,and improve decision-making. The internal consultinggroup focuses on cost, process and planning issues forinternal clients.

Total cost of ownership analysis is one of the principalanalysis approaches used by ICG. The goal of Tele is totake a supply chain focus in its analysis. ICG believes thatusing TCO analysis allows it to understand and factor inthe impact of different alternatives on its suppliers andcustomers, as well as on its own performance. ICG triesto identify all direct effects, and many of the indirecteffects associated with the situations it analyzes. This toolcuts across many of its projects. It is a primary tool usedin analysis of process costs and make/buy orinsource/outsource alternatives. Where long-terminvestments or multi-year projects are involved, ICG alsouses net present value analysis. Some of the areas inwhich ICG conducts TCO include:

- Capital expenditure analysis.· Outsourcing/make-buy analysis.· Warehouse location decisions.· Warehouse layout decisions.· Information technology recommendations.· Logistics network decisions, such as trans-shipment

options, material visibility, equipment choice.· Support of supplier selection.

TCO is viewed as so important at Tele that oneparticipant responded, “Tele takes a total view of strategiccost management by focusing on a Total Cost ofOwnership model.” He further went on to elaborate thatTCO is a specified methodology for analyzing andreporting the value of first cost savings and other inprocess costs, rather than focusing only on price.

Since Praxair reorganized, TCO has become a moreimportant approach for managing cost over the past


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several years. To Praxair, TCO is a primary approach forassessing spending on particular goods or service area.The use of procurement-led cross-functional sourcingteams is important in improving analysis and facilitatingchange in sourcing practices and execution. Theprimary purpose for creating a strategic sourcing team isto lower the TCO for the commodity studied whilemaintaining the level of service. Praxair also wants toincrease the level of support and attention it gets fromthe suppliers, to get a higher allocation of the suppliers’resources. The sourcing teams stay together through theimplementation and management of the chosensupplier.

All Praxair procurement members are taught to lookbeyond purchase price in assessing opportunities. Asmentioned in the section related to overall costmanagement practices, supplier interaction on costmanagement occurs as part of the strategic sourcingprocess. Praxair tries to quantify all the key elements inthe TCO model it develops for a commodity. Forexample, if it is sourcing cranes, Praxair will consider thecost for equipment and the operator, as well as thecapability of the crane, and how long it will take thecrane to get the required job done. In many cases, afundamental strategy is to first standardize, then go tomarket. As part of the individual supplier workshopsheld prior to the RFQ process, Praxair asks the suppliershow they view the TCO elements and their magnitude,and how they could affect them.

The cross-functional team assesses the suppliers’ bidsbased on what they rated as important in the TCO model.After selection, they negotiate with the supplier anddevelop/execute the contract and its terms and conditions.

There are situations where there is a conflict betweenTCO and price. Price is easy to track, so it may receivemore weight than it should. Praxair is developing goodmethods for tracking TCO to overcome this potentialconflict. Now, the best way to get people internally andexternally to understand TCO principles is througheducation. Praxair conducts training with key suppliers,business unit contacts, and sourcing people on TCOprinciples. Because of this training, Praxair has set uppilot programs with teams to use TCO. This helps theunderstanding and use of TCO.

Praxair’s concept of TCO is to look at all cost elementsfrom design, supply chain, and usage perspectives, anddrive costs out by coming up with better solutions. Onesuccess that Praxair could share was the use of TCO tosignificantly lower the cost of an imported product that itformerly brought in to a central location and distributed.Praxair has redesigned the supply chain, improvingfreight and using a third party to distribute. This was a

great TCO example of working with a supplier andconsidering the whole supply chain/processes.

At Chip, TCO has been institutionalized as a process forover 10 years, so that it is now second nature at Chip.Chip does not even call TCO analysis by that name inmany cases. Should-cost modeling is an evolution ofTCO, going beyond TCO, to break out overheadelements and the costs of supplier processes. Rather thanperforming detailed TCO analysis on all materialspurchases, Chip’s objective is to have qualityrequirements that all suppliers must meet, therebyreducing the need for TCO. One goal of TCO analysis isto explore and develop different alternatives/models tobetter understand how to manage the risk between Chipand its suppliers. Risk management involves analyzingalternative processes, and must be viewed from a TCOperspective. Examples of models for inventorymanagement are Vendor Managed Inventory andConsignment. In exploring the alternatives and the costfrom a TCO perspective, finance works with PSM to:

· Identify opportunities.· Build financial models.· Develop tradeoffs.· Make recommendations.

The following is an example of the TCO process in actionat Chip: The business unit brings a new product idea andtarget cost objectives (Internet terminal, for example) tothe PSM/Manufacturing group. Information on costs formanufacturing, logistics, planning, and componentmaterials are collected to create a cost profile for theproduct. In the past, this collection of cost informationhas been executed in a linear fashion (idea, materials,manufacturing, distribution, and planning) with eachcost component optimized before moving to the nextcomponent. PSM/Manufacturing group is working tobring these elements together for simultaneous discussionand consideration to achieve the desired result ofoptimization in the cost structure as a whole rather thanas optimization of independent components. The lattercan result in sub-optimization of the final total costprofile or a lengthy iterative cost development process.Chip is looking at long-term supply chain design from aTCO standpoint, with more focus on design for highcapacity and for low cost. Chip views the supply chain asa capacity problem. In designing the supply chain,depreciation on equipment is a big cost factor for Chip.Capital acquisition relies heavily on TCO analysis. Innegotiation for capital, Chip focuses on an affordabilitygoal. It has a target for TCO by tool, TCO for all of thecapital combined, and TCO per unit.

There is a strong focus on revenue generation for thecompany as a whole. PSM/Manufacturing is starting to


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ask more questions about business plan product goals,competitive strengths, etc., starting to shift its focus todelivering an efficient supply chain. In the past, therewere more PSM TCO solutions than true supply chainTCO solutions. Today, supply chain TCO solutions mustconsider revenue generation.

The Impact of Information Technology on CostManagementAn entire study could be conducted to explore theimpact of information technology on PSM. While theimpact of information technology on PSM managementwas not the focus of this study, several recurring findingsare worth mentioning.

The ability to access and understand spend data is critical – Itis essential to be able to aggregate spend data in order tounderstand opportunities and achieve leverage. Inaddition, it is critical to be able to monitor actual spendpatterns for compliance as well as trends in spend andpricing in order to provide feedback and encouragecontinuous improvement. This is also vital in order toreport credible savings results.

E-Auctions are effective bidding tools – All of theorganizations studied have used reverse on-line auctionsin various ways. The consensus is that they apply tosituations in which there is adequate competition andparticipation, where you might otherwise use a requestfor quotation or request for bid. Reverse e-auctions areessentially tools to create greater competition andtransparency of competition, not a way to cut corners ordo things more quickly. They require all of the duediligence of any effective RFQ/RFB process. There wasalso some questioning on the part of several of theorganizations, particularly Praxair, regarding whether on-line auctions could continue to bring savings year-over-year. In some cases, Praxair uses/intends to use on-lineauctions as a way to select and identify a supplier that itwants to work with in the long run, rather thanreauctioning every year or two.

Information technology can help analyze/build cost models –All of the organizations studied rely heavily on

information technology of various types to help supporttheir cost modeling and cost management efforts. Thereis a heavy reliance on the development of home grownmodels such as Deere’s cost tables and Chip’s TCOmodels for capital acquisition. Many of these models arereused in whole or in part from one cost analysissituation to another.

Approaches to Support Specific Types ofPurchasesMuch of the presentation related to cost tools focuses onraw material and component purchases, items thatbecome part of the cost of good sold. However, theorganizations studied all have specific approaches formanaging indirect purchases, services and capitalacquisitions as well. The approaches are summarized inTable 20. In the PSM organizations that are a mix ofcentralized and decentralized purchasing, indirect itemsand common services are likely to be purchased centrally.

Indirect purchases – The overall philosophy followed bythese organizations is to standardize and reduce thenumber of transactions. For Deere, this means thatcorporate purchasing leads commodity teams to reducethe number of variations on a given item and standardizethe remaining items across the corporation. For example,Deere was purchasing 220 styles of gloves. A team wasable to reduce this to 25 styles/types, which resulting insavings of 20 percent to 30 percent. LCP has essentiallyoutsourced all indirect purchases to a corporate buyinggroup that acts as a service center. Chip’s focus in theindirect arena is on TCO: reducing the total transactioncost of procuring, receiving, stocking, using, andmanaging spares and other high volume, high valueindirect. It focuses on the cost of processes, and usespurchasing cards or on-line catalogues when it makessense to do so, and supplier managed inventory in othercases. Praxair takes a similar approach in managing thecost of indirect purchases.

Service purchases – In addition to reducing the costs inthe associated transaction costs, PSM also focuses onreducing consumption. Thus, instead of trying to find acheaper airfare for a trip, the question becomes: Is the


Table 20Approaches for Managing Specific Types of Purchases

Indirect Services Capital- Standardize - Reduce transaction costs - TCO- Centralize/leverage at corporate level - Reduce consumption - Net present value- Reduce transactions costs/ automate - Understand cost/value drivers- TCO - TCO- Supplier managed inventory

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trip even necessary? In service purchases, it is importantto understand the key drivers of cost, value, and thenecessary timing. A TCO approach is also likely here. Inservices, it is likely that PSM adds value by setting up thedeal, and then getting out of the way so that the internalcustomer can directly manage the transaction.

Capital acquisition – TCO analysis is the key approachused for capital purchases: understanding the net presentvalue of all the costs associated with acquisition, start-up,use, maintenance, and ultimate disposal of a piece ofequipment, including yield issues, volume capability, anddown time. Companies with more sophisticatedapproaches such as Chip and Praxair, where capital is ahuge proportion of operating costs, also focus heavily onhow the equipment interacts with other pieces ofequipment. The level of sophistication and effort ofanalysis varies directly with the impact of the purchaseon the organization.

Sources of Cost InformationOrganizations use a wide range of sources to gather datato support strategic cost management. This is notsurprising, given that all sources of data have relativestrengths and weaknesses. The key to gathering cost datais that multiple sources are used to corroborate theresults. The following table shows some of the sources ofcost information identified by the case study firms. Theyhave been organized into internal data sources and twotypes of external data sources. One type of external datais data that is publicly available and/or purchased, and istherefore more likely to be independent rather thanpositioned to win the bid. The other external source,external data that is potentially biased to favor the dataprovider, is an important and growing source ofinformation. For example, companies like Deere andPraxair increasingly make full supplier cost disclosure acondition for consideration as a potential supplier. Inthese cases, the buying firms relied on corroboration frommultiple suppliers as well as unbiased external data andtheir internal cost knowledge. All of the firms indicatethat they use market data and external price/costbenchmarks whenever such data are available.

The firms studied were not prompted with specificexamples, but rather volunteered their key data sources.Not surprisingly, several of the data sources, such asvarious forms of benchmarking, obtaining supplierquotes, and market price analysis were cited by all theorganizations studied. Some of the specific means ofgathering data are simultaneously data analysisapproaches. These methods, such as should-cost analysisare presented in more depth in the section on specificcost tools used.

Table 21Sources of Cost information

Internal data:• Internal functions.*• Internal consulting group.• Information system/technology.• Private data warehouse.• Theoretical modeling.• Should-cost model of suppliers.• Benchmark data from acquired/merged companies.

External Data from Independent Source• Benchmark data.• Market price analysis.• Competitive assessment by third party.

External Data from Potentially Biased Source• Supplier site visit.• Cooperative supplier of like items (should-cost).• Inputs from multiple suppliers.• Bill of Material from supplier.• Bid/Quote from suppliers.• Customer.• Bill of Material from customers.

*Internal functions include operations, purchasing,logistics, finance, and many others.

Research Question 6. How are the Results OfCost Management Efforts Reported?A continuing question that comes up for those in PSM is,“What should we report and how should we reportregarding PSM’s contribution to cost savings, so thatPSM’s contribution is credible to those throughout theorganization?” The way case study participants respondedto that question is summarized below. There is a greatdeal of variance in the way that the numbers are trackedand reported. The key issues were that the reportingmust be done by someone who has credibility, and thatthose outside of supply management must agree to thereporting method. In addition, cost or price savings isnever the singular goal of purchasing. Cost/price savingsis always balanced by other important metrics such asquality, reliability, and so on.

Deere approaches reporting its cost management resultsin several ways. First, it reports the savings that itachieves in terms of cost reduction on a price-to-pricebasis for individual commodities. This approach hascredibility since cross-functional teams work on most ofthe cost savings projects, with the savings reported by thecost manager. In addition, at a very high level, Deerecompares its performance to the market place using arepresentative, weighted market basket of goods that it


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purchases. Based on the Producer’s Price Index, Deerereports what it spends on those items versus a baselineyear. It also has a line showing how the PPI for thatbasket of goods has changed during that time frame, asshown in Figure 3. This allows the purchasing group atDeere to get credit for doing better than the market if thatis occurring, or to take the heat for not achieving thesame level of savings as experienced by the market place.This translates the savings achieved into both a micro anda macro level.

However, it is not savings alone that Deere’s supplymanagement group measures and reports. Its other goalsinclude:

1. Number 1 overall rank in A.T. Kearney SupplyManagement Benchmark Study.

2. 5 percent annual cost improvement.3. 20 percent improvement in supply management

productivity.4. 50 percent annual improvement in cost of quality.

5. 90 percent of purchases covered by commoditystrategies.

6. 100 percent on-time delivery of finished goodsavailable to promise.

Thus, it cannot be accused of focusing on cost reductionat the expense of other critical goals. The goal is to bringvalue, not just price reductions, to the customers and theorganization.

At Chip, Finance plays the major role in measuring andreporting cost savings. Company-wide, Chip identifiesfour to five flagship products at any given time. Everypart on the flagship products is targeted for costimprovement. These flagship items get frequent reviewand high visibility to hit cost targets both in materials andat the business unit level. A product is typically identifiedas flagship when it is in the development phase. Once ithas been in production six to 18 months, it is no longerconsidered a flagship product. Many of the objectives forflagship products are cross-functional. PSM’s ability to


Figure 3Reporting Cost Savings: A Deere Example

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contribute to design for cost and cycle time reduction isviewed as critical by top management.

Metrics for cost management of sustaining productsinclude:

• Direct cost savings: yield improvement, reducedpiece part price, negotiations results.

• Indirect cost savings: total cost of ownership (TCO),freight, tooling.

• Design for cost: reduction over previous generationsof products due to improvements incost/functionality/yield of materials that are designedinto a product.

• Cost avoidance: receives less weight than direct costsavings, but is considered primarily within thematerials group.

The purchasing expenditure plan (PEP process) is theoverall approach PSM uses to ensure it is purchasing inthe most competitive manner. Savings plans areincorporated into PEP, and affect the employee’s bonus.Finance measures and tracks savings, and owns thesavings calculations to ensure they make sense. Financetries to track true savings to the bottom line. Finance alsoconsiders PSM’s impact on inventory and other balancesheet related items, and gives them credit for thesesavings. The savings are reported to top management,generally on a quarterly basis.

The specific initiatives in PEP vary from year to year.Examples of recent initiatives include:

• How much cost supply management can take out ofthe Bill of Materials versus the initial plan (everyyear).

• The number of Design for Cost projects.• How much business is conducted through e-

business.• Percentage of dollars spend covered by favorable

contract terms and conditions.• Percentage of dollars spend covered by should-cost

modeling.• Percentage of dollars spend covered by most

favorable customer pricing.• Percentage of dollars spend covered by payment

terms.• Percentage of dollars spend covered by up/downside

liability.• Percentage of dollars spend covered by who pays

freight.

Thus, there are a number of non-cost factors thatindirectly affect costs for which PSM is held accountable.Top management receives a report on progress in the keyPEP initiatives quarterly. Particular attention is paid to

new products, particularly PSM’s progress on thedesignated flagship products.

Every Chip employee is eligible for bonuses. Part of thebonus of every employee is based on PSM performanceand cost savings, as well as overall company performanceand performance of the other key functions. Thus, eachemployee is encouraged to consider the impact of his orher activities on other functions and the organization as awhole.

Virtually all functions at LCP are heavily trained in costmanagement. The General Manager has responsibility forall sales, costs, and profits; in short, everything. TheGeneral Manager then delegates responsibility for totaldelivered cost and volume. The finance and accountingmanager leads cost savings efforts at LCP, supported byproduct supply and marketing. Total delivered cost is keyto the product supply manager.

LCP is trying to move away from rewarding behavior thatdoesn’t make sense and looking more at the big picture.This is one of the reasons that the direct purchasingaccountability has been returned to the business unit. Atthis level, purchasing can gain a much betterunderstanding of specific business unit goals andobjectives that may be sacrificed if the price focus is toohigh. In general, purchasing is measured and rewardedbased on getting the best value, including price, supplierinnovation, capital investment, and related factors.Finance helps provide measurement of savings. A multi-functional team runs each business. Performance of theBU and team members is rolled up into each member’sperformance appraisal. Finance supports creation andreporting of credible performance metrics for eachmember of the organization. In addition, because a cross-functional team runs the business, there is generalunderstanding of agreement on both what is measuredand how it is measured.

LCP gave a less detailed account of its measurementprocesses. Its reward system has recently been changedand broadened to look beyond profit, including suchmeasures as:

· Total shareholder return, including cash, profit, stockprice.

· Profit and loss, working capital, capital investment.· Forecast accuracy.· Working capital in terms of operating cash flow.

PSM’s contribution to the organization is translated to theabove metrics.

At Tele, cost management is one of the procurementgroup’s four primary objectives, along with client


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satisfaction, process improvement, and a winning team.Purchasing savings are given significant weight as part ofindividual performance appraisals in procurement. Teamawards and recognition also are based on cost savings.

At Tele, goals and expectations for savings are specificand clearly laid out. There are specific rules as to whatcan and cannot be recognized as savings, and whichsavings need to be counted as hard or soft savings, andcost savings versus cost avoidance. In general, savings arecalculated based on current year spend versus priorspend, adjusted for volume. However, Tele is constantlypurchasing new items, and using new technology thathas not been used before, with no prior spend history. Inthese cases, savings are tracked based on reduction inactual price paid versus the lowest bid received. Thismethod is accepted by the organization because it isrelatively objective. The overall value proposition of theprocurement organization is measured by the bottom linesavings the organization achieves when sourcingproducts. It has recently received much positive attentionfor the purchasing cost savings generated by the mergers.

Much of Tele’s current internal reporting is aggregatedinformation aimed at top management. For example, at avery high level, procurement performance is alsomeasured by looking at cost of goods sold, less spend asa percentage of revenue. It is expected that thispercentage figure should go down each year ifprocurement is doing a good job. The percentage hasbeen going down in recent years.

At Praxair, the specific accountability for cost savings inthe purchasing area and how the savings are tracked issummarized below. Measurement includes:

• Operating Profit impact: Purchasing has saved over$100 million in the last three years. Praxair has asophisticated database and tracking system tomeasure the impact of each initiative, comparingactual vs. planned savings. To date, most of the $100million savings is in expense items rather than costof goods.

• Capital Goods: There is separate measure forvariance on capital expenditures over previous buys.It is harder to identify savings on capital becausePraxair buys different capital each year. One measureof savings is whether purchasing spends less thanbudgeted to achieve the business unit goals.

• Materials Management: This group concentrates onhow to manage cash/inventory. The focus here is onreducing inventory without decreasing service.Consignment and/or supplier inventory are twofavorite approaches for improving inventorymanagement.

Praxair revealed a sophisticated and credible system fortracking purchasing savings, as calculated by thepurchasing controller. To determine the amount ofsavings realized, Praxair compares past spend to currentspend, adjusted for volume. It reports savings over a 12-month period. The initiative drops out of the savingscalculation after a 12-month period. This providesconsistent reporting of savings. While most contracts aretwo to three years in length, purchasing gets credit onlyfor the first 12 months of savings.

When initiatives are identified, the purchasingcontrollership function presents the ideas to thebusinesses. If accepted, the business units build thesavings into their business plans. Praxair capturesspecific, separate line items in reporting that showprocurement related savings. These appear right next tosales in the internal reports. Purchasing savings arereported monthly, and must be consistent with what thebusiness units report as purchasing savings.

Praxair PSM saves $30 million to $35 million per year on$1.5 billion spend. To achieve this, purchasing focuses onspecifics; they don’t look at every spend category eachyear. The purchasing initiatives are managed like projects.They separate initiatives that generate profit fromcapitalized savings in property, plant, and equipment(P, P, & E).

The P, P, & E savings don’t drop to income statementsavings directly; they appear over time as lowerdepreciation. Praxair hasn’t started to track these savings,in part because it would be a challenge to arrive at thecorrect and believable number. Each capital acquisition isdifferent. Today, capital savings are tracked separately ascost avoidance, which is not explicitly part of PSM’sbottom line contribution. In the future, Praxair willconsider cost avoidance and segregate these costs. Thereis a significant contribution made here.

Individuals within PSM have specific goals, such as goalsfor country, by commodity, and by commodity manager.These focus on bottom line savings. Praxair uses adashboard system that captures 27 measures. Differentpeople and functions have responsibility for differentmeasures.

How Can Compliance With Contracts Be Achieved? –Renegade buying is a problem that was mentioned by allof the companies interviewed. It is particularly commonwith indirect purchases. Deere mentioned that it is tryingto stop “buying outside of contracts” by implementing anAriba system that makes buying so much easier thatpeople want to use it rather than purchase on their own.Chip identified this as a problem that is growing due toacquisitions, and acquired companies coming on board


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with their own systems and approaches. Like Tele, Chipis trying to stop this by demonstrating that PSM can get abetter deal. LCP does not really worry about this at thecorporate level since ownership for cost of purchasesrests in the business units. At the business unit level,there is such strong cost accountability that buyingoutside of contracts is discouraged at the top level withinthe business unit.

Praxair has a particularly interesting model. Asmentioned above, purchasing savings are reportedmonthly, and must be consistent with what the businessunits report as purchasing savings. The focus is onincome statement impact: Only savings that go to thebottom line, i.e. result in a lower level ofexpenditure/budget, are reported as savings. However,PSM also reports to the business unit spending that is notin compliance with contracts based on information fromits data mart, and lets the business know how muchsavings were forfeited by not using corporate contracts.Praxair does not have a mandating corporate culture;people can choose whether or not to use negotiatedagreements. When business unit management sees howmuch savings are forfeited, it generally questions whythose within the business are not using corporatecontracts, and encourages them to do so.

Likewise, Praxair was the only company that took savingsin indirect or budgeted items out of the business unit’sbudget and directly to the bottom line. This is anacceptable part of the culture, because each business unitis directed by top management to reduce its expenses.Rather than viewing purchasing cost reductions as anegative because they result in budget cuts, business unitgeneral managers welcome them as a way to achieve theirobjectives of lower operating costs. Improving andlowering the cost of internal operations is a strong focusacross all disciplines at Praxair.

Praxair’s PSM controller is accountable for reviewingsavings calculations with businesses; PSM doesn’t get toreport savings unless business unit finance buys into thesavings. The controller works with business unit financeto achieve buy-in to the savings calculations in advance.No savings are claimed until a new contract is in placeand goods/services have been received, where savings areactually recognized on the books. The goals of the PSMgroup are to be world class in sourcing material andservices and to generate business growth. As part of this,PSM must leverage what it spends with suppliers.

Tools are critical to help support reporting and determinesavings, as well as to monitor compliance. A key tool isthe spend data warehouse. This has given Praxair theability to sort spending throughout the world, by region,by commodity, by supplier, and so on. There are also

systems to track progress on various initiatives. Thesesystems are key to forecasting and planning current andfuture savings potential. To further improve thecompliance and visibility of cost savings, PSMparticipates fully in monthly reviews with the office of thechairman, and presents its progress and plans like anyother business unit. It has the opportunity to present costsavings initiatives and performance at the highest levelwithin the organization. This further enhances theimportance with which PSM contribution is viewed atPraxair.

Research Question 7: What Other FactorsContribute to the Success of Strategic CostManagement Efforts in the Organization?This section presents some of the unique ways, notcovered in other sections of this report, that organizationsmake strategic cost management a success.

The Potential Contribution of Finance or CostManagement Experts to Strategic CostManagementIn all of the organizations studied, it was important thatPSM’s contribution to savings was viewed as credible.Finance and cost management play the important role ofmeasuring and reporting PSM’s results. However, inseveral organizations, these groups do much more thansimply report results. Finance and/or cost managementare actively engaged in supporting the analysis, andsometimes identifying the potential opportunities forgenerating cost savings. The roles of finance or costmanagement at Deere, Chip, and Praxair are detailedbelow.

Deployment of Cost Managers – Deere followed a modelfrom Honda of America Manufacturing in deployingspecially trained cost managers in each business unit aswell as at the corporate level. In the past two years, fivecost managers have been put in place, one for eachdivision and one for corporate purchasing. These costmanagers are highly trained and skilled specialists, manyof whom have years of cost management/analysisexperience with other companies. Each of these costmanagers has a small staff that supports providing costanalysis to their respective divisions. The cost managersalso meet regularly as a team. They have agreed to:

• A process for cost model creation.• A process for evaluating cost models.• Where/how to post cost model information on their

internal web site.

The cost managers put together cross-functional teamsthat work on the cost models. The teams includerepresentatives from each division that uses the item in asignificant way. There is a lead for each team. The overall


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direction for the team comes from the cost manager withinput from the lead. The team includes cost management,a supply management specialist, manufacturing,engineers, and representatives from the supplier’s costmanagement and manufacturing areas. Cost managementefforts often complement supplier development and valueimprovement initiatives. Deere has also purchased costmodeling software for theoretical costing on some of thebasic processes that are common across a number ofindustries. This provides them with information on whatit costs to run certain equipment. They relate these datato historical information. There is a trade-off betweenkeeping the analysis simple and developing a goodunderstanding of the process.

Cost management’s focus is to be a resource to strategicsourcing for current and new products in terms of gettingthe right price. Saving money is the ultimate goal of costmanagement, and building the cost models is part ofthat. The cost management group is currently working ona number of cost models, including decals, injectionmolding, stamping, and casting. Cost management has toidentify the market opportunities. Another goal of costmanagement is to avoid any unnecessary price increases.When increases are necessary and valid, Deere uses valueimprovement and supplier development approaches tofind ways to reduce costs to offset the increase. Theseprocesses are presented in more detail in the Deere casein Appendix A.

To analyze cost increases for existing buys, cost managersuse a cost table if available. These cost tables aredeveloped by Deere cost management to show theexpected relationship among various performanceparameters and features and materials prices. Deere mayperform a site visit to analyze supplier processes. It mayalso do an incremental look to see if the cost change isjustified based on the functionality change. For example,one supplier of a $17 part asked for increased price of$25 for that part. After the analysis was complete, Deereended up getting a 15 percent across-the-board decreaseon all items from this supplier. Deere follows a systematicapproach to cost management, and truly has a center ofexcellence in terms of cost management.

Use of Finance Personnel – Chip relies heavily on itsfinance/controllership organization to support purchasingin all aspects of PSM’s cost saving efforts. Finance andoperational owners have to sign off on all keyPSM/materials decisions.

The controllership function supports PSM and otherfunctions at both the functional and business unit levels.The finance/controllership function views optimizingshareholder value as its mission and finance is disbursedentirely throughout the organization, becoming involved

in all key decisions. Finance drives the accumulation ofinformation across organizational boundaries and pullsoperational partners onto the team as needed toappropriately assess proposed projects and drive databased decisions. Part of finance’s charter is to help identifycost savings opportunities. Finance drives costmanagement at Chip by helping to structure problems.Finance helps understand trade-offs, gathers data,quantifies options, determines savings, and evaluates howvarious approaches support overall strategy. However, costmanagement is co-owned by all functions. Business unitsare ultimately accountable for cost management results.

The finance structure is such that cooperation acrossorganizational boundaries is generally easier than in theoperational structure of its business partners. Targetcosting, should-cost, and design for cost initiatives aredriven by finance. Finance develops these models andenables the organization to use the models. Financeenables this through model creation, validation, andcredibility. Finance helps with cost modeling byidentifying key drivers in advance. For example, financewill create a pro forma bill of materials, showingproposed changes, and indicating on which areas to focusfor the greatest opportunity. Finance also identifiesdifferent operating models/approaches that exist forperforming a process, and determines which issues itwants to tackle for maximizing results, such as inventory,price, warranty, and obsolescence. Finance, working withmarketing develops a must-cost, what it takes to meetcost targets per unit, per tool, depreciation as it is, and asit should be to allow Chip to sell product affordably andearn a reasonable margin. For example, finance hasproliferated a tool to help determine how much inventoryis needed for an item in various stages of its life cycle.

In addition, finance often plays a strong coordination rolein getting a complete cost analysis done. The data for theanalysis usually is owned by the operations partners, butis centralized and analyzed through financial modeling.Finance supports material cost analysis and understandingof supplier cost drivers. PSM often comes to finance tohelp quantify savings opportunities. For example, in onesituation, design-for-cost models were developed byworking with two key suppliers. Chip sent both financeand technical people to these manufacturers tocorroborate the models. Capital procurement collaborateswith suppliers on cost and capacity issues. Finance plays akey role in capital expenditure analysis as well.

At Praxair, the controller of the global PSM group is adirector-level position, reporting to the Vice President ofPSM, along with the three other PSM directors. One ofthe primary duties of the controller is to coordinate andensure consistency in PSM’s operating profit impact interms of forecasts, actual reporting, and estimates.


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As presented above in the section How Can ComplianceWith Contracts Be Achieved?, the controller plays acoordination role among global PSM, the global businessunits, and the financial services group. There is no real orperceived conflict regarding the controllership function’sreporting relationship to PSM. The controllership area isdata driven, provides credible numbers, and shares thebasis of its calculations.

The controller works with everyone in the PSMorganization. When PSM claims to have an operatingprofit impact, there is substance to it, as verified by thecontroller function. Savings are not counted fornegotiated savings. The focus is on income statementimpact: savings that drop to bottom line.

Praxair views purchasing like it views sales, as a way togrow the business, but with an emphasis on savingsrather than sales. The reporting by the controller lendscredibility to the savings calculations. The controller andhis team report savings, provide direction, educate staff tohelp reduce operating costs within procurement, andmonitor the budget. The controller function meets withanalysts within business units to identify monthly spendpatterns. It also works with purchasing to understandspend at the supplier and commodity levels. Thecontroller function then goes back to internal clients atthe business units to make sure that they are realizing thesavings anticipated. The biggest reason for not achievingsavings is spending that is out of compliance withnegotiated agreements. Thus, the controller function hasalso educated business partners on lost opportunitiesbecause of using suppliers outside of procurement’scontracts.

Special Approaches to Cost ManagementEach of the organizations studied noted specific practicesor approaches that are very effective in managing costsand delivering cost savings in their organizations. Someof the approaches are highlighted here. These approachesare not presented as a prescription for success in all cases.Rather, they are meant to be illustrative of some of themany creative ways that organizations have been able toimprove upon their delivery of measurable, crediblebottom-line purchasing cost savings. The creative waysthat three of the companies rely upon finance/costspecialists to support and validate cost savings arepresented above, so will not be discussed again here.

Internal Consulting Group at Tele – As already mentioned,an internal consulting group (ICG) was formed withinPSM at Tele about four years ago when one of thepurchasing managers approached the President ofProcurement with the idea that total cost of ownershipanalysis and doing a more thorough, complete analysis ofpurchases could reduce the company’s costs significantly,

and improve decision-making. The internal consultinggroup focuses on cost, process and planning issues forinternal clients. This group gets involved in a variety ofprojects, solely at the bidding of internal clients. There isno obligation to use their services, nor is there a directcharge for their services. The procurement group at Tele,members of which are also the primary clients of ICG,includes sourcing/contracting, purchasing strategy andplanning, systems and services, supplier diversity, andsupply logistics. However, the group may service otherswithin the enterprise, including engineering andmarketing, either directly or indirectly.

The ICG is a service organization with a mission tosupport important decisions of all types withinprocurement, or somehow related to procurement.Virtually all of the decisions/analysis in which the ICGgets involved include some type of financial analysis/costassessment. The members of this group have a variety ofbackgrounds, including many years of experience infinance, internal consulting in other areas in Tele, as wellas purchasing and logistics experience. This broad baselends to the credibility of the group and ensures that theyhave the right expertise available for the job at hand. ICGalso includes others on teams who are not directly part ofthe ICG as needed. For example, many of their projectslook at various software options; ICG frequently worksclosely with the IT group.

Examples of projects – ICG is apt to get involved inanalysis of projects of significant size and scope. It tendsto participate in analysis of high visibility projects that areimportant to its clients. Many of the projects ICG hasbeen involved in recently are logistics oriented and/orinformation technology (IT) focused. For example, on thelogistics side, ICG has been looking at various software torun warehouse and inventory management systems. Thetype of projects that the internal consulting group (ICG)gets involved in vary greatly, but includes issues such as:

• Capital expenditure analysis.• Outsourcing/make-buy analysis.• Warehouse location decisions.• Warehouse layout decisions.• Information technology recommendations.• Logistics network decisions, such as trans-shipment

options, material visibility, equipment choice.• Total Cost of Ownership (TCO) analysis to support

supplier selection.• Spend analysis.• Benchmarking best practices.• Assessment of recommendations/decisions made by

external consultants.• General decision support within procurement, much

as an external consultant would provide.


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Like an external consultant, ICG presents its clients witha thorough analysis and recommendations. It does notimplement the project.

Deere’s Compare and Share Initiative – Compare and shareis an initiative specifically aimed at reducing partsproliferation and increasing standardization by comparingparts with similar features/functions among and withindivisions to determine what provides the best value. Twosupply management professionals are dedicated to thistask for two years, and work with supply managementspecialists and engineers to identify, prioritize, andexecute cost savings. Compare and share was initiallyanother cost management initiative to create informationto build cost models. Today, it is strategic. It explores:

• Supply base reduction• Overall issues related to European vs. U.S. sourcing• Who will be major suppliers in future?• How to get engineering involved, engaged, and how

to incorporate in design.

Compare and share is helping overcome some of theinefficiencies associated with decentralization. While eachfactory has its own design group, compare and share triesto coordinate and standardize design and components.Compare and share has yielded significant savings forDeere. For more detailed information, see Ellram, 2001a.

Research Question 8. What Impact Do SupplierRelationships Have on the Organization’s CostManagement Approaches?As the focus of this study is on cost management betweenorganizations and their suppliers, this section exploresthe buyer-supplier relationships from the perspective ofthe buyer. All of the core organizations studied agree thattheir suppliers, and the relationship with their suppliers,are becoming more important in general. How this isdemonstrated and executed varies among theorganizations studied. This section looks primarily atrelationship perceptions and overall approaches; the nextexamines supplier development and continuousimprovement mechanisms.

General Approach to Supplier RelationshipsDeere worked extensively throughout the 1990s toimprove its relationships and trust levels with suppliers.One of the specific things that it has done is consolidateits supply base, which allows it to work more closelywith the remaining suppliers. It also has emphasized toits suppliers that its cost reduction efforts are aimed attaking costs out of the supply chain, not squeezingsupplier profits.

Chip has long-term, ongoing relationships with a largenumber of its suppliers. Its systems, processes, and

expectations are complex and stringent, so it tries toreuse current suppliers if possible. In addition, it can costChip $250,000 to $1 million to qualify new suppliers insome cases. Chip’s relationship with its suppliers andcontract manufacturers has been traditional, based on theexistence of well-documented contractual relationships.There was a general agreement among those interviewedat Chip that while it says the right things about thesupplier relationships, there is not enough concern aboutsuppliers in general. Chip has developed an allianceprogram with its big suppliers, including guaranteedvolume and guaranteed profit. However, when times gettough, relationship building is pushed aside. Chip looksto suppliers for big price cuts. Supplier relationships are aperpetual dilemma, going from good to bad to good; it isan ongoing cycle. Chip acknowledges the need for morelong-term relationships with suppliers. There will be evenmore reliance on suppliers in the future. One challenge isChip’s huge volume requirements. It needs betterrelationships, to work closely with suppliers as realpartners to meet huge capacity demands. Chip has triedto be market neutral rather than being opportunistic. Ithas tried to share the risks of price and volumefluctuations with suppliers. But everyone in this industryis opportunistic. When the market turns, whoever is in aposition to do so will be opportunistic. It is difficult tonegotiate and enforce a price volume contract withsuppliers.

At LCP, managing supplier relations is a key role ofpurchasing throughout the whole life cycle, from findingsuppliers, setting up the relationship, aligning LCP andsupplier goals, and transitioning the relationship to phaseout at the end of the product. This includes buildingtrust, personal relationships, good communication, andsharing of benefits. All are seen as key elements to long-term supply/cost management success. LCP has not beenfocused on being a business partner with its suppliers. Ithas been internally focused, in line with its philosophy ofcompetition. Its external focus has been on getting thebest price from suppliers. About 10 years ago, it began towork more strategically with suppliers, includingbuilding relationships. In some cases, it has collaborativerelationships with its key suppliers where there is value-added potential. In other cases, it uses competitiverelationships, where the purchase is commoditized andthere are good competitive sources. It also is aware of theneed to transition from one relationship type to the otheras the market and technologies change.

Tele recognizes that with industry restructuring andtechnology change, the competitive advantage lies in thesupply chain. As a result, more emphasis is being placedon supplier base consolidation, and working more closelywith suppliers. Tele is growing in the area of partneringwith its first, second, and third tier suppliers helping


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them identify where they can drive costs out of theiroperations and pass the savings to Tele.

Praxair considers supplier relationships as part of itsstrategic sourcing process. As a first step of the suppliersegmentation process, Praxair segments its supply basebased upon the criticality of the purchase and thesupplier to Praxair. This is how Praxair determinessuppliers with whom to collaborate, versus those wherethe focus can be more price-oriented. Praxair limits thenumber of suppliers with whom it will align to 65 to100. Praxair also wants to increase the level of supportand attention it gets from these suppliers, to get a higherallocation of these suppliers’ resources. With this selectgroup of suppliers, Praxair works very closely tocollaborate on joint efforts for mutual benefit. Bothparties can make changes to processes to save money. Inturn, Praxair will be loyal to suppliers who perform welland add value.

Supplier DevelopmentSupplier development is a process whereby anorganization works with its supplier base to help selectedsuppliers improve their performances. This approach cantake on a whole range of activities, from simply givingsuppliers feedback about their performance so that theycan improve, to providing the supplier with technicalassistance, training, and process improvement support.Each of the core company’s overall approaches to supplierdevelopment is presented below.

At Deere, the cost management group has done a goodjob of reducing internal cost. It has now shifted its focusexternally, to work on supplier development and othervalue enhancement opportunities. Deere’s valueimprovement program is designed to improve productquality and reduce product cost. The value improvementprocess is “a tool used to facilitate identification,implementation, and completion of projects that willmaintain or increase quality while decreasing costs ofspecific parts, part families, and/or assemblies.” It is aprocess whereby a Deere team and a supplier team gettogether for a day or more to brainstorm and quicklydevelop a number of ideas they can implement to takeout costs and improve processes. Some of these ideas areselected for implementation, then monitored andsupported to implementation. They might complementthe supplier development process detailed below.

Deere has an extensive, dedicated supplier developmentstaff made up of more than 70 engineers and PSMspecialists, housed in each business unit, reporting to thedirector of supply chain management for that businessunit. Deere defines supplier development as, “aDeere/Supplier process of shared resources andtechnology resulting in improved business and

manufacturing process efficiencies, reduced total costs,shared savings, and satisfied customers.” One goal is tocontribute to the differentiation that creates sustainablecompetitive advantage for Deere.

Deere’s focus is on its first tier suppliers, and in somecases even critical second tier suppliers, in order to get afeel for the value improvement opportunity down thesupply chain. Many second tier suppliers are smaller andneed help. With the top suppliers, Deere does a valueimprovement and supply development process if itdoesn’t have the opportunity to bring in competition.Deere approaches supplier development in six steps:

1. Initiate a project with supplier, including definitionof processes, assessment of needs, and gainingsupplier support.

2. Map and measure the supplier processes, includingbaseline performance and process metrics.

3. Process development via creating and selectingsolutions and implementation plans.

4. Achieve results by means of implementing the newprocess.

5. Control by establishing the control and feedbackmechanisms.

6. Recognize teams through sharing bestpractices/lessons learned, and providing recognition.

These steps may involve a team of Deere supplierdevelopment specialists co-located with the supplier tohelp the supplier implement the changes to improve itsresults. Deere has countless supplier development successstories. With the permission of the cooperating supplier,Deere publishes and makes available these successstories. Between compare and share, supplierdevelopment, and value improvement processes, Deeresaves about $7 million to 8 million a year.

Chip also sees the value of selective supplierdevelopment. Chip may send a team to a supplier site towork through a yield improvement process, or otherprocess that will reduce costs and otherwise improvesupplier performance. One issue that Chip struggles withis how far back in the supply chain it should go to a tryto manage its supplier’s suppliers. For example, Chip hada tool that was made of aluminum. The higher thequality of aluminum used in the manufacturing of thattool, the better the performance and longer the life of thattool. The aluminum supplier actually became a constraintto Chip’s quality and productivity. Even though thealuminum supplier was not a direct supplier to Chip,Chip worked with that supplier to deal with thisconstraint. The focus was on quality, cost, and gainingleverage with this supplier. Chip will only focus on thecritical suppliers beyond the first tier of its supply chain.It is rare to work directly with a second tier supplier.


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With second tier suppliers, the nature of involvementwould more likely be to direct them to other good,cheaper supply sources.

LCP also works with key suppliers to improve suppliers’manufacturing processes, and create synchronousmanufacturing. This involves working more closely withsuppliers on cost (e.g. target costing and cost modeling),sharing proprietary manufacturing technologies, andbringing the supplier in early in the development stage(not the black box syndrome). The goal is to streamlinethe whole supply chain. For example, it recently had anexcellent supplier development success by workingcollaboratively with the supplier of a specializedcontainer on a new product development. LCP calls itssupplier development process “Supplier BusinessDevelopment.” It uses this approach for new productsand product innovations as well as for continuousimprovement with a supplier. It involves sending in anLCP team of technical people, manufacturing people, andengineers to set up the process and work with thesupplier to understand and improve upon cost elements,buffers, cycle time, quality, and communication.

Tele develops some of its key suppliers by involving themin cost management via training and quality programs.Suppliers are also trained on internet-based measurementtools to ensure the integrity of their performance metrics.Tele conducts ad hoc training in order to implementsupplier performance metrics, relying heavily ondocumented, industry-standard quality methods. Keysuppliers are invited to participate in cross-functionalcontinuous improvement teams. Tele currently does nothave a formal supplier training program for strategic costmanagement, but is considering developing such aprogram.

Praxair PSM works with some suppliers on development.Once the relationship is under way, Praxair has aprogram for supplier management that it uses with keysuppliers. The process involves meeting with criticalsuppliers to identify key performance indicators such asprice, technology, and service. Based on the indicators, itestablishes a report card and works with cross-functionalteams to get feedback from the various businesses onhow the supplier is doing. In addition to doing a formalreport card rating for each critical supplier, Praxair getsinput from suppliers on Praxair’s performance and howPraxair can improve as a customer. Praxair calls this theTARGET process, because the focus of continuousimprovement revolves around a combination of thefollowing elements:

• TCO.• Assurance of Supply.• Responsiveness.

• Global reach.• Environment and safety issues (big for some

suppliers).• Technology.

Sharing Cost SavingsThe idea of sharing cost savings is popular in somecircles. It was made very popular by Chryslers’ SCOREsystem in the 1990s, in which suppliers madeimprovement suggestions and shared in the savings thatoccurred if those improvements were successfullyimplemented. Sharing cost savings was not a universalpolicy among those organizations studied. While theorganizations could also see the value of sharing costsavings, the reasons given for not sharing cost savingscould be summed up as, “It was our idea and we did allthe work, and the competition is so tough that we haveto pass along all the savings to our customers in the formof lower prices.”

At Deere, cost savings are shared based upon whoinitiates the idea and the level of effort/investment fromboth parties. Deere has a formal supplier suggestionprogram called JDCrop, modeled after Chrysler’s SCOREsystem. Cost savings generated from this program aregenerally shared with the supplier, often evenly dividedbetween Deere and the supplier. Cost savings may also beshared when the supplier initiates the idea. In othercases, the supplier is permitted to use the idea with othercustomers, and keep the benefit it gains in extra profitfrom those customers.

At Chip, sharing of cost savings with suppliers dependson the source of the savings.

• If supplier develops independently, there is nosharing with Chip.

• If supplier shares development, they share savings.• If it is totally a Chip idea and process, with no

supplier work involved, all savings go to Chip.

Cost savings are not shared with suppliers in the designphase, because all design changes are part of product cost.With value engineering, if Chip spends most of the time,and provides the idea, and the supplier evaluates, like aspecification relaxation, Chip takes 100 percent of thesavings. For supplier driven changes, optimization, theyshare, case-by-case, generally evenly. The impact of Yenvaluation changes is shared. Traditionally, Chip tried totake advantage of the Yen change. Recently, they share it.

LCP noted that sharing cost savings with suppliers varieswith the situation. In general, cost savings and otherbenefits are shared, based on various criteria. The key isthat both parties will benefit as appropriate.


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Sharing cost savings with suppliers is not a commonpractice at Tele. None of those interviewed had beeninvolved in any projects where Tele shared cost savingswith its suppliers. Tele is in a highly competitiveindustry; all cost take-outs are passed on to the endcustomer.

At Praxair, sharing of savings varies with the situation. Inan ideal world, Praxair would like to make suchimprovements a win-win scenario and provide incentivesto suppliers to improve performance. However, theystated that this not always possible due to cost reductionpressures. Praxair shared an example where it created asystem to get a better load ratio on its trucks, thenworked with the outsourced supplier of drivers andtrained the drivers to use this improved system. Thesavings from carrying full loads have been shared withthe supplier.

Research Question 9. What Is the Supplier’sPerspective on the Organization’s CostManagement Efforts?All of the participating core companies identified asupplier that they believed they had worked witheffectively in managing costs and which would be willingto participate in this research. The supplier cases forMetal, SC, Network, and McJunkin are summarized inAppendix E, and identified with the matching corecompany. Some top-line information on each of the fiveof the supplier cases is provided in Table 22 below. Theresponses from the suppliers varied in terms of theimpact of the customer’s cost management efforts on theirrelationship with the customer. The suppliers had thesethings in common:

• The supplier viewed the customer as an importantcustomer.

• The supplier believed that they had to constantlywin the customer’s business by proving that theywere the best supplier.

• The supplier believed that the customer was willingto help the supplier work on improvement efforts ifthe customer believed it was in its best interest todo so.

• Each of the suppliers viewed themselves ascompeting on value or a “total cost of ownershipperspective.” Although price was viewed asimportant, in all of the cases, each supplier believedthat it really wins the business because of the uniquevalue it provides above price.

One of the factors that made the discussions withsuppliers particularly interesting was the timing of thestudy, which occurred during difficult financial times forall of the companies involved. This section explores howthe suppliers’ cost management efforts are influenced bythese customers’ cost management pressure, the nature ofthe relationships with the customer, and how thecustomer influences its cost management efforts with itsown customers.

Impact of Customer Cost Management Pressureon SuppliersThis pressure had a direct and indirect effect on thesuppliers. Metal, SC, and Packaging felt the most directcost pressure. Deere develops cost targets and sharesthem with Metal most of the time. Sometimes Metal andDeere work together to actually establish cost targets (inthe minority of situations). During the iterations ofDeere’s design, Metal provides multiple quotes for


Customer Industry Supplier Industry Items sold to customerDeere Heavy equipment Metal Precision plastic and Precision metal parts

manufacturing metal partsChip Semiconductors SC Subcontractor of Custom integrated

custom integrated circuits and chipscircuits and chips

LCP Consumer products Packaging High technology High technology containers and custom containerspackaging

Tele Telecommunications Network Manufacturer of Network equipmentnetwork equipment and software

Praxair Industrial air products McJunkin Pipe, valve, and Integrated supplier of and chemicals fittings distributor pipes, valves, and fittings

Table 22Buyer-Supplier Dyads

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different designs for a certain product. Metal knows whatcost it needs to achieve to satisfy Deere, based on Deere’starget costing process.

SC noted that in the past 18 to 36 months, a shift inindustry forces has created and supported a change in thecost management emphasis in this industry. Recently, theend consumers have gained much influence. They aredemanding higher performance, more variety, and lowerprices in high technology electronics. This is no longer ahigh volume, low product variety business. This newbusiness model has created greater complexity and higherproduction cost. As a result, SC’s customers, like Chip,are putting more cost/price pressure on SC. Much of itsrecent cost management effort has been influenced by thehigh degree of price pressure SC receives from itscustomers, such as Chip. Some of its customers,including Chip, have the same suppliers as SC. Thus,SC’s suppliers were being pressured from multiplecustomers simultaneously.

Packaging has also noted a shift due to the economicdownturn. Several years ago, Packaging and LCP had aformalized program to look at long-term issues inimprovement. The focus was on quality, development,inventory reduction, and cost reduction. The goals werelong-term, aimed at improving processes and taking costsout of both the supply chain and the products LCPpurchases from Packaging. LCP and Packaging had anexcellent alliance relationship three to five years ago.Packaging feels that LCP was well ahead of its othercustomers in its progressive thinking at that time. Thefocus of the relationship between Packaging and LCP hasshifted.

Today, most of the discussions between LCP andPackaging have a strong cost/price focus, aimed atimmediate results rather than long-term improvement.Packaging notes that LCP has been under greaterprice/cost pressure than in the past, and is in turnpressuring Packaging. Rather than helping Packagingseek long-term solutions, it is asking Packaging to reducecosts on its own, explaining that it does not have theresources to dedicate to support Packaging’s efforts. It isapplying this approach not only to Packaging, but also toits other suppliers.

Tele’s influence on Network is more indirect. Network isextremely cost conscious, and has a whole teamdedicated to cost management/continuous improvements.

The situation between McJunkin and Praxair is similar.McJunkin has brought many ideas to Praxair and learnedmuch from Praxair as well in terms of identifying andimplementing cost savings. Cost management is anintegral part of the long-term relationship between

Praxair and McJunkin. McJunkin must continue to proveitself and earn its business. Praxair is tough but fair withMcJunkin.

Customer RelationshipIn general, all of the suppliers recognize that theprice/cost pressure that they experience from theircustomers is a genuine reflection of the businessenvironment. As SC explained, “As in any industry, theplayers here are all profit maximizers. There is a hesitancyto get too close and share too much. This creates a barrierto true collaboration.” It was clear from talking to thesuppliers that there was a fine line between what theyperceived as reasonable and unreasonable cost pressure.Some of the key factors that distinguish whether the costpressure was seen as reasonable or unreasonable by thesuppliers include:

• The customer’s willingness to work with the supplieron cost improvement initiatives. The more that thecustomer supported the efforts through resourcesand idea sharing, the more it was perceived as fair.

• The perceived attitude with which the cost reductionmandate was given also had an impact. This issomething that truly is in the eye of the beholder.Did the supplier perceive that the customer wassharing its pain and had empathy, or that thecustomer really did not care about the supplier’ssituation and the supplier was expected to just do it.

• If the supplier expects the lowest price in themarketplace, but still wants value-added services,that is seen as unreasonable.

• Whether or not the relationship is a goodrelationship in other ways, in that the customershares information and communicates key issues andchanges, and treats the supplier with respect.

• Whether or not the supplier perceives that it receivesa fair return on its investment in this relationship

Again, these are subjective factors, but important issuesin order for the supplier to feel valued and dedicated tothe relationship. There seems to be the greatest negativeimpact on supplier relationships when the supplierbelieves that the customer had acted in a supportive wayin the past, and has withdrawn this support.

As mentioned above, all of the suppliers in this studywanted to have long-term, collaborative relationshipswith the customers in this study. Metal specifically noted,“The objective of Metal is to have a long-termrelationship with Deere, to understand each other’sbusiness objectives. This is a competitive industry, andwhoever excels benefits. Delivery and quality aremandates. Whoever has the low cost gets the business.Metal must perform. There is a healthy tension, and thefailure to meet objectives in NOT acceptable; Metal must


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be a low cost provider or it is out.” Deere’s understandingof Metal’s cost structures and associated issues is high. Itasks many questions. It helps them better understandissues and where costs are coming from. They stillstruggle over price/cost, but there is more focus on cost,and reducing cost not just price. Metal stated that itsrelationship with Deere is characterized by a commitmenton both sides to act as partners.

On the other hand, SC sticks with some of its powerfulcustomers like Chip due to their large volumes andmarket presences. However, the customers’ relentlesssearch for deep price cuts limits real alliancedevelopment. SC believes that it could actuallyaccomplish more with Chip if Chip was morecollaborative. Likewise, Packaging expressed itsdisappointment in LCP’s shift away from collaborating forimprovement.

Network also noted that Tele’s approach to costmanagement affects its relationship. Cost is a constantissue. Network’s sales model is not to be the low priceprovider, but rather to sell based on value. It must makesure that customers get the service they expect. On astrict bidding war, Network loses. However, Networkconsiders things like administrative costs and it bringsthe customers new ideas. Tele is willing to consider valueversus merely price, because Tele sees the value. In theend, Network believes that Tele has gained a great dealfrom looking at the total cost perspective. Network andTele have worked together for eight to 10 years. Duringthat time, their relationship has strengthenedconsiderably, and is now a close working relationship.

McJunkin is working very closely with Praxair onPraxair’s Six-Sigma teams. Some major goals of theseteams are to reduce rework and increase contractcompliance. Representatives from McJunkin have beenaccompanying Praxair purchasing people and others tosite locations to educate users on the benefits of usingMcJunkin’s automated ordering system in terms ofrework, order accuracy, quality, and cost. Thisimprovement effort is viewed as a partnership. McJunkinbelieves that Praxair very much understands andembraces the total cost of ownership/value concept.McJunkin tries to establish relationships based onproviding the best TCO/value to its customers. Thisapproach is much more sustainable and mutuallybeneficial than only a first-price approach.

Each of these suppliers indicated that it is not the low-cost supplier, but focuses on value, providing a fair priceand excellent service. They noted that, in general, thecustomers with whom they have the biggest problems arethe ones that want considerable extra services/dedicatedpersonnel, but don’t want to pay for them.

Customer Influences on its Cost ManagementEffortsMetal and SC noted the most direct effects on their owncost management processes because of working with thecustomers identified in this study. Cost targets from Deerehave encouraged Metal to look for more informationfrom its suppliers than in past (it has learned from bothDeere and another major customer). Metal is not assophisticated at this process as are its key customers.Metal’s PSM group interacts directly with Deere, andunderstands Deere’s supplier management processes. As aresult, Metal is now working on developing its ownmethod for supply chain management, and consolidatingits supply base to gain leverage.

SC also commented that much of its efforts in suppliercost management and its own internal cost managementsystem have been influenced by the high degree of pricepressure SC was receiving from its customers, such asChip. Some of SC’s cost management processesinfluenced by Chip, include:

• Mapping processes.• Breaking down and analyzing all that it knows about

the supplier processes in terms of cost.• Considering what the market will bear based on

market research (target development).• Developing detailed should-cost models.• Estimating supplier’s cost structures.

One output of the should-cost effort was the developmentof generalized models for major cost categories. Anotherresult was an understanding of the key cost drivers ofvarious inputs. This helped SC develop price targets forsuppliers and get a better understanding of cost issuesover a product’s life cycle. In addition, SC has negotiatedagreements with its customers such as Chip, making thecustomers responsible for a certain amount of inventorybased on the customer’s demand forecasts, moving thewhole supply chain closer to a make-to-orderenvironment. SC has been able to reduce its inventory byabout 80 percent since this approach was implemented.Its suppliers have had similar reductions, and are veryenthusiastic about VMI.

While the other suppliers were certainly influenced todeliver savings to the suppliers identified, they did notnecessarily emulate their customer’s processes.

Supplier Relationships with Their SuppliersAll of these suppliers also work with their own suppliersin various ways on cost management. SC is perhaps thefurthest along in its supplier cost management efforts, asits suppliers have also been influenced by customers suchas Chip. Metal is developing a very Deere-like process inmanaging its suppliers’ costs. It was more tactical in


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dealing with suppliers in the past. It is moving towardstrategic processes, benchmarking, and related processes.It is moving from many to few suppliers and developingcost models. Metal has established a core team toimplement the process.

In addition to the cost management approachesmentioned in the previous section, SC has also workedwith its suppliers on increased electronic informationsharing. SC believes that its suppliers have been quickerto embrace the supply chain cost management effortsthan have its customers. As mentioned earlier, thismarket is extremely price oriented. SC believes that mostof its customers still have a price focus. Some customers,like Chip, have developed excellent tools forunderstanding the costs that drive price, which havehelped SC’s understanding of costs immensely. Whileprice will always be important, SC believes it is not asufficient focus for them if they hope to achievesignificant improvements. Thus, SC has approached itscustomers on improving collaborative efforts.

SC is continuing to increase its focus on collaboratingwith suppliers, and moving into collaborating with andunderstanding the markets of second tier suppliers.Education has proved to be one of the most valuabletools in improving supply chain performance and costmanagement. SC has a goal of being a preferred customerto its suppliers. Relations with suppliers have not alwaysbeen good, due at least in part to the continual pricesqueezes. While the price emphasis will never go away,SC is now working closely with its suppliers to facilitateimprovement. SC is co-locating engineers at supplierlocations, emphasizing process and technologyinnovations and improvements, and sharing the savings.SC is also benefiting from the efforts of competitors, whoare working to improve the same supply base.

Packaging also looks at its external supply chain andinternal operations regularly as a source of potential costimprovement. It would do this with or without thepressure from LCP. On the operations side, Packagingfocuses on operating improvements, site location,changeover costs, and utilization. Due to of the strongpressure from LCP, Packaging goes back to its suppliersmore often, and probably fights a bit harder for savingsthan it otherwise would. Marketing goes to purchasingand asks for help in maintaining margins, which in turnaffects the suppliers. Purchasing is very aware of the pricepressure from customers, and might use this as abargaining chip with suppliers, pointing out that if itcan’t get price reductions, it might lose business, and thesuppliers, in turn, might lose business.

Packaging has also reorganized its purchasing departmentto purchase globally from a smaller set of suppliers,

gaining leverage, price protection, and supply guaranteesfrom global contracts. The goal is to drive costs out of thesystem. Purchasing, manufacturing, and R&D haveongoing programs with key suppliers.

Network has not had as great a focus on supplierrelationships because it is very vertically integrated. Manyof the raw materials that it purchases are commodities.However, the focus on suppliers, supplier relationships,and supplier cost management is growing as Networkoutsources more. It does work with some suppliers onhelping the suppliers reduce costs. Network has aprogram for its top 20 to 25 preferred suppliers in whichit works with some key suppliers as long-term partners.

McJunkin tends to have long-term supplier relationships,and relies a great deal on leverage over both time andquantity with these suppliers wherever possible. In muchof the industry, pricing is based strictly on volume level.McJunkin is beginning to implement some strategicsupplier initiatives, and supply base reduction to furtherfocus its volume. It just re-examined its supply base for acertain type of valve, committing to the suppliers, askingfor advantages in price and field support, to really form apartnership. If this is successful and provides advantage,McJunkin will spread this idea to other areas where it isbeneficial. In general, the suppliers and McJunkin’sinterests are very well aligned.

In the main, the customers, or core cases, studied appearto have more sophisticated cost management approachesfor dealing with suppliers than do these suppliers fordealing with their own suppliers. Each supplier indicatedthat it is doing more in the way of supplier cost andrelationship management.

Research Question 10. What Impact DoCustomers Have on the Organization’s CostManagement Approaches?This section focuses on how the customer affects PSM’scost and value management efforts. In general, PSM doesnot have direct interaction with its end customers.Instead, The value proposition and needs of the customerare communicated to PSM indirectly, through interactingwith marketing, sales, customer service, or other similarfunctions that do have direct interaction with thecustomers. The exceptions to this scenario cases arepresented below.

In general, the customer viewpoint is communicated toPSM in PSM’s role as a member of a cross-functionalteam. This could be a team focused on target costing/newproduct development, on sourcing, or a similar issue. Anexample of the specific nature of a cross-functionalsourcing team was provided above in the section on theuse of teams in cost management. In this example, Tele


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aims to serve its internal client and meet the internalclient’s needs, and in doing so, meet the needs of the endcustomer. In the organizations studied, this is a typicalway in which purchasing develops an understanding ofthe external customer’s needs. Many of Tele’s endcustomers are consumers, rather than industrialcustomers, so the pressure to manage costs and reduceprices tends to come more from the market andcompetition than directly from the final customer. Priceand service competition are high in this industry. PSMfeels this pressure through internal clients, and respondsaccordingly.

The mission of Deere PSM is to establish a case for actionand drive key cultural changes to create a fullyintegrated, worldwide, customer driven supply chainmanagement process. The cost management specialists atDeere are involved with a team that interacts withmanufacturing engineering, design engineering,marketing, suppliers, and the customers to understandthe dealer and end user to understand feature/cost trade-offs. They do get some direct customer feedback throughinteraction with dealers. Again, it feels price and valuepressure keenly.

Chip PSM/manufacturing receives its information oncustomer needs and expectations much the same way assupply management at Tele. It has customer servicesupport staff that deals directly with and supports each ofits key customers. Within the PSM/manufacturing group,there is a planning group that provides customerinformation to be used in engineering, design, andPSM/manufacturing decisions.

From the customer side, Chip gathers much data on howthe customer makes its purchase decisions. Some endcustomers really look more at the TCO of Chip’s productsthan at price. Chip develops an understanding of thecustomer/OEM’s bill of materials (BOM) as well as howthat customer prioritizes its costs. Chip also strives tounderstand how the OEMs it supplies make theirdecisions. It also develops an understanding of thedecision making process of the OEM’s customers. Chip’slarge OEM customers provide Chip their BOM to provewhat they can afford to pay Chip for components. Thus,the negotiation begins with facts, based on what themarket will support, the OEM’s own targets, competitivepressure, and geography. However, Chip aims to stayenough ahead of the market and in tune with the finalcustomer of the OEM’s product so that it is prepared forprice decreases by continually improving its own coststructure.

At LCP, PSM resides in the product supply group, whichdirectly focuses on LCP’s relationship with retailers, andattempts to take a supply chain perspective. The big

retailers consume most of the resources. These arestrategic customers, tier one retailers like Wal-Mart,Target, K-Mart, etc. The LCP team develops anunderstanding of customers’ cost drivers/operations,sometimes even beyond a customer’s understanding. Atsome customers, LCP personnel are treated almost asemployees of the customer. They have a great deal ofinfluence. LCP personnel are frequently asked for adviceand are included on project teams. While these teamsgenerally do not include PSM as regular members, PSMmay be called in to participate if there is a specific issuerelated to supply.

The customer teams help customers understand/managecategory profitability as a whole, by category, and bystore. They research how profitable LCP brands are to thecustomer and how purchases of LCP products influenceother consumer purchases. The teams also understandhow profitable the customer is for LCP, and how it drivesLCP costs in areas such as:

• Backhaul performance.• Unloading time.• Cost of the operating team.

Thus, PSM is closer to the customer at LCP than mostorganizations simply because it is part of the businessunit, and reports in to the Vice President of productsupply. The Vice President of product supply is very closeto the customer.

At Praxair, PSM focuses mainly on internal Praxair clientsand plays a predominant role with suppliers. However,PSM does have an understanding of the externalcustomer. Within purchasing, specific sourcing managersare aligned with specific businesses. They becomeintegrated with the business team, which is where theydevelop their understanding of the needs of customers.This varies considerably by business. In the businessesthat support the electronics industry, Praxair becomesvery involved with some of its key customers. PSMalways strives to understand the importance of the endcustomer. Some customers, especially in the electronicssector, are very concerned with Praxair quality, and lookclosely at Praxair systems and Praxair’s interfaces with itssuppliers. However, most of the customers’ influence onPraxair’s supplier relations and supplier cost/pricereduction is indirect.

An exception to PSM’s direct interaction with customersdeveloped at the request of Praxair sales. Praxair PSM hasmet with a number of customers to explain some of theapproaches that it takes to achieve improved savings andvalue in procurement and to help the customer developsavings ideas.


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Thus, PSM gets most of its information on customerneeds and value propositions indirectly, from those whointerface directly with the customer. Nonetheless;through interaction with internal clients and participationon cross-functional teams, PSM is aware of andresponsive to the cost and value demands that customersplace upon it.

Impact of Customer on Cost ManagementIn four of the five case studies, PSM was unable forvarious reasons to provide access to a customer to discusscost management. In Chip’s case, the researcher was ableto speak with one of Chip’s customer relationshipmanagers, who leads a team of seven in managing therelationship with one of Chip’s key customers. Thismanager deals with all shipping, order management,invoicing, and relationship management issues. Heinterfaces directly with this customer’s supplymanagement people on cost and price issues. The fieldsales people conduct the price negotiations, with therelationship manager sitting in. This customer has a veryefficient supply chain, so Chip can’t provide it muchsupport in improvement ideas. The customer also doesnot tell Chip how to run its business. Three to four yearsago, Chip implemented a total cost of ownershipinitiative on the sales side. Chip started to work with itscustomers to understand how people make decisions forpurchasing OEM technology. It tries to use a TCO/valueapproach rather than a price focus in selling to itscustomers.

A major discount retailer, MDR, provided informationabout its relationship with LCP. MDR feels that it hastreated all but a few of its key suppliers as commoditiesin the past. It recognizes that true collaboration isrequired for both it and its suppliers to be successful. It ismoving in that direction. It has also responded tosuppliers’ complaints that it was unresponsive to theirquestions and comments. MDR has recently instituted asupplier tracking system to ensure that 100 percent ofthe suppliers’ issues are resolved.

Its overall supply chain direction related to suppliersincludes:

1. Getting the basics of good supply chain managementin place.

2. Rationalizing the supply base.3. Increasing supplier partnerships.

It is working on several key initiatives aimed at takingcosts out of the supply chain. Before MDR begins toproactively work directly with suppliers to reduce theircosts, it is developing an understanding of the poorpractices that it employs, and how these practices affectthe supply chain and the costs of its suppliers. It is

moving more in the direction of supplier-managedinventory, and on improving its logistics operations,including quick unloading of trailers rather than usingsuppliers’ trailers as temporary warehouses. It realizesthat its own practices represent a large part of the supplychain cost savings opportunity.

MDR has had a very close working relationship with LCP,so much so that MDR has not historically beaten up LCPas it has many of its other suppliers. MDR credits LCPwith taking the initiative to maintain that relationship.MDR notes that it is difficult to quantify all of the savingsthat LCP has generated for MDR. However, LCP has beeninstrumental in helping MDR think about and evaluate itssupply chain philosophy, and recognize some of theopportunities to improve its supply chain. For example,LCP worked with MDR to set up a project to track causesfor out-of-stock and overstock items, and help MDRreally see the opportunities for supply chainimprovement in its own behaviors. MDR sees LCP as amodel supplier, and would like to replicate the type ofrelationship it has with LCP with other suppliers. This isa positive example of how a significant supplier canpositively educate and influence a major customer’ssupply chain and cost management strategy.

Research Question 11. Does the OrganizationTake a True Supply Chain ManagementPerspective of Strategic Cost Management?All of the organizations studied agreed that while theyaspire to a true supply chain/supply network view ofstrategic cost management, they still had opportunity forimprovement.

For example, at Deere, supply chain design and supplychain integration are two of PSM’s top five initiatives,with the goal of making Deere’s supply chain one of itssources of competitive advantage. Deere’s supply chaindefinition includes production, supply and supplierrelationships, logistics/order fulfillment, and customerservice. It has made excellent progress in many of theseareas, but has many additional goals for improvement.

Chip also does not take as strong a supply chain view asit would like to, but is moving in that direction.Improving cost management with design for cost is a keyprogram to support this effort. Chip has learned that it isnot fair to expect the supplier to improve/lower costs onsub-optimal parts. Thus, Chip needs to design the partsproperly in the first place. In addition, Chip is also fine-tuning its supply chain perspective. Historically, Chip wasso powerful in the market and with its suppliers that itcould dictate policy. This is changing, and Chip isdiscovering that it can often learn from its suppliers’ andcustomers’ perspectives and practices.


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LCP is working on its supply chain perspective explicitlyusing the Vice President of Supply organization structure,where all of the functions that affect the supplier reportto the same organization. In addition, the CorporateSupply Group has provided training and support topurchasing and others in each division regarding supplychain improvements and cost management. Today, truesupply chain analyses are performed on an ad hoc orproject basis rather than as a matter of routine. Forexample, LCP looked at the entire supply chain for oneproduct. It looked at all losses and spent four weeks on aregimented, computerized, and intense analysis. Usinginformation gathered on all losses in that supply chain, itwas able to decide which losses to pursue in order toeliminate the largest cost drivers/areas of loss. Suchanalysis involves 1) plant operational analysis,understanding what happens within the walls of plant;and 2) comprehensive category/product level analysisacross the entire supply chain. LCP found that one of thegreatest areas of loss it had was lost time/lack of flexibilityin the manufacturing of retail display units. It workedwith the supplier of these retail display units, and withinthree months cut the process time in half, whileincreasing flexibility in the type of retail displaysavailable.

The goal of Tele is to take a supply chain focus in itsanalysis. That is one of the reasons that the internalconsulting group, ICG, tries to use a total cost ofownership perspective in its analysis whenever it isapplicable. It tries to understand and factor in the impactof different alternatives on its suppliers and customers, aswell as on its own performance. The reality of thesituation is that many projects are complex and far-reaching, and may be analyzed in part by a number ofdifferent groups. Whereas ICG might look at the cost andoperational issues associated with distribution centerlocations, marketing might look at customer serviceissues associated with the same decision. Thus, whileICG might focus more on supply side issues, othergroups are investigating additional factors that affect thesupply chain view.

The aspiration of Praxair PSM is to develop a supplychain view of cost management. This is seen in itsextensive use of total cost of ownership. Praxair considersmore than price. It also looks at supplier performance inareas such as quality and electronic capability. Total costof ownership is also a key tool for capital acquisition.TCO also comes into play in managing internalcost/budgets. Today, Praxair doesn’t see the entire supplychain within PSM. The Business Development functionfocuses more on the buy side, up to product delivery. ThePSM group is not yet dealing directly with customers ona regular basis. The sales/marketing organization isprotective of customer relationships, and PSM now has

plenty to do without direct customer involvement. Thesourcing process is very integrated with the businessunits, so purchasing gets much front-end involvement.Today, PSM looks at all aspects that touch the supplychain from design to purchasing to strategy to payment,transport, and storage. PSM is really looking at all the keyelements of the supply chain. The perspective is gettingbroader.

Thus, strategic cost management in the supply chain isstill a vision rather than a reality in all of the companiesstudied. Each has made progress, but each sees the roadto strategic cost management in the supply chain as acontinuous improvement process rather than a static stateto achieve.

Second Tier SuppliersNone of the organizations studied focus on suppliersbeyond the first tier as a matter of course. Rather, secondtier suppliers and beyond are dealt with on an exceptionbasis, as problems and issues arise. This is not becausethe second tier is not viewed as important. It is becauseof resource limitations, and in general, the buyingorganizations would like their suppliers to manage theirown suppliers effectively. It is likely that there will begreater involvement with second tier suppliers in thefuture. Deere commented, “Many second tier suppliersare smaller and need help.”

Chip stated that it tries to stay out of supplier-supplierrelationships wherever possible. It wants suppliers toown/drive/be responsible for their own supply chains. Itmay get involved for critical issues, such as to influenceallocation and pricing from second tier suppliers by usingChip’s volume. Chip recognizes that much of the supplychain risk is coming from second tier suppliers andbeyond, and encourages first tier suppliers to train theirown suppliers, but this is not yet a common practice.

Tele is increasingly looking at the cost structure for first,second and often third tier suppliers in order to examineways to improve processes which may affect downstreamcosts. Many of their first tier suppliers use the samesecond tier suppliers, so the issues are transferable amongsupplier relationships. Tele is growing in the area ofpartnering with its first, second, and third tier suppliersto help them identify where they can drive costs out oftheir operations and pass them along to Tele.

Research Question 12. What Are the KeySuccess Factors and Barriers to Strategic CostManagement?All of the organizations were asked about what difficultiesthey had to overcome on their roads to improvingstrategic cost management in the PSM organization.


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BarriersA number of barriers that organizations had to overcome,to be successful in strategic cost management, or are stillworking to overcome are listed in Table 23. The list ofinternal barriers outweighs the list of external barriers.Some of the barriers are presented in more detail below.

Deere noted several barriers to success in cost manage-ment. One was simply the economic swings. It is hard togain leverage when the demand is constantly changing. Inaddition, Deere had many good ideas for years, but reallydid not get a chance to implement them because PSMreported in at too low a level in the organization.

Chip also commented that PSM is viewed by the businessunits as an executing arm rather than a strategic function.One barrier to better managing cost at Chip is that itintentionally over-designs its products virtually all thetime. There is somewhat of a “not invented here”mentality for some specifications and requirements thatare actually transparent to the customer. Likewise, wherethings give Chip a competitive advantage versus acommodity is not always clear.

LCP noted a number of barriers, including the idea offragmentation or functional silos: individuals/functionsare aware of their own issues and responsibilities but not

as aware and accountable for those of others. LCP tendsto focus on how to win in LCP’s part of the supply chainwithout hurting the supply chain as a whole. Trying tofind win-wins is a challenge. It is still difficult to get thecustomer/supplier to see a bigger picture. Also, LCP maynot see direct and immediate benefits in price changefrom improved supplier information.

At Tele, PSM often simply did not have the time orexpertise to get involved in the projects to the level that itwould like to. Alternatively, like Praxair, it was notinvited to be part of the internal customer’s decision-making process in the past. Prior to its reorganization,Praxair’s PSM group was viewed as the least favorableplace to work in the organization. The focus on price tothe exclusion of other factors, and non-involvement inmany key purchases blocked PSM’s potential for success.In addition, it did not have information systems toconsolidate, manage, and track spending.

Success FactorsThe organizations studied made many changes, or are inthe process of making changes, to support increasedfocus on and involvement in strategic cost managementin the supply chain. Some of the key success factors andchanges that have been made to overcome the barriersare shown in Table 24.


Table 23Barriers to Successful Strategic Cost Management

in the Supply Chain

InternalReporting level of PSMPSM viewed as a support group by other functionsOver-design of productLack of immediate benefitsLack of compliance with contractsLack of credible savings numbersPrice only or first cost focusRapid growthLarge size of companyLack of understanding of the conceptFocus on internal costs onlyLack of relevant measuresLack of accountabilityLack of immediate benefitsLack of information systems to support analysis and trackingLack of timeLack of skills

ExternalEconomic downturnInconsistency in treatment of suppliers; swing from alliances to adversariesCustomers unwilling to share informationSuppliers unwilling to share information

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Deere made several key changes to better supportstrategic cost management and raise the status of PSM.Deere benchmarked with leading organizations and builta business case that convinced senior management thatPSM could make a significant contribution if only itslevel was elevated. In late 1997, it hired a Senior SupplyManagement officer at the VP level, the highest level everin Deere. Throughout 1998, it created SupplyManagement leadership teams, defined its strategicprocesses with business process excellence teams, anddeveloped hiring and training plans. PSM developed itsfirst-ever strategic plan, and began to put new processesin place, saving the organization money, improvingsupplier performance and relationships. These newprocesses included supplier development, the use of costmanagement experts, target costing and on-line auctions,to name a few. To support these processes, it also hiredexperts in cost management, PSM engineering and otherplaces that they were needed within PSM. For moredetailed insight into Praxair’s reorganization, see Leendersand Johnson, 2000 and 2002.

At Chip, PSM is viewed as important because materialsare a bigger cost today. There is a focus and pressure oncost reduction. The reward and measurement processhelps both within PSM and throughout the organization.As mentioned earlier, everyone in PSM has specific costsavings goals for which he/she is held accountable interms of his/her performance appraisal, raises, andbonuses. In addition, part of the bonus for everyone inthe organization, regardless of function, is based on PSMperformance. However, probably the biggest evolution inthe past several years is that PSM is getting involved

earlier in the new product development process, where itreally can have an impact on taking cost out of theproduct before the first item is produced.

LCP noted many success factors supporting its approach.First, as mentioned earlier, the Vice President of ProductSupply Structure provides one-person visibility of all keyproduct supply costs and issues. This individualultimately has responsibility and accountability forprocesses and results. This role was designed to breakdown functional barriers and create a process focus withjoint goals and responsibilities. It has improved manyprocesses to support strategic cost management,including training to support purchasing and others ineach division regarding supply chain improvements andcost management. It has implemented target costing,supplier cost breakdowns/should-cost analysis, and isfocusing more on value, not just price.

PSM is viewed as a key strategic function and is highlyregarded at Tele. Over the last few years, PSM has beenelevated and established as part of the core business ofTele. As such, its expenses are watched closely at thecorporate level. The organization is involved in theplanning and implementation of key company growthinitiatives, and participates in high-level decisions onSCM direction and value propositions for thecorporation. The overall value proposition of the PSMorganization is measured by the total savings theorganization achieves when sourcing products, and itscontribution to bottom line business results. As presentedat length in the Tele case, it formed an internal consultinggroup to help support its efforts.


Table 24Key Success Factors in Strategic Cost Management

PSM reports in at a level equal to other key functionsParticipates in top management strategy setting and other meetingsAttends key management meetings with business unitsHas new PSM leadershipHired trained professionals where neededImplemented new processes, including:

- Total cost of ownership- Target costing- Should-cost analysis- Cross-functional teaming- Supplier development

Top management supportEarlier involvement in new product development and other key decisionsHas been successful in achieving savingsHas support from outside financial experts in reporting credible savings numbersMade changes to the reward and measurement system to better support cost managementEducates its suppliers and customers

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Tele’s PSM group must constantly prove that it adds valueto processes and purchases. There is no requirementwithin the organization that other areas use purchasing.Those areas may circumvent the procurementorganization if they feel it does not add value. However,given that PSM does handle a great deal of Tele’sbusiness, it is clear that some feel it is a value-addedoperation. It has recently received much positiveattention for the purchasing cost savings generated by themergers.

The changes in PSM at Praxair were made under thedirective of and with the full support of the CEO andCFO, based upon recommendations from an outsideconsultant. Praxair brought a number of key people fromsales into PSM; these people understood negotiationsissues, sales, and market pressure from a different, butcomplementary, perspective. Personnel from R&D andfinance were also mixed in with PSM professionals tocreate a stronger organization.

To rectify the lack of information available, Praxairimplemented a data warehouse. PSM can now thoroughlyanalyze spending, transforming data to information inorder to make decisions. The data warehouse alsoprovides data to report contract compliance and savingsresults. Praxair learned the process of strategic sourcingfrom its outside consultant, and developed its owninternal training programs so that everyone understandsthe strategic sourcing process. PSM continues to havevery strong support and visibility from seniormanagement leadership, especially the CEO and the VicePresident of Finance at Praxair. PSM participates fully inmonthly reviews with the office of the chairman, andpresents its progress and plans like any other businessunit.

Research Question 13. What Is the Future ofStrategic Cost Management in YourOrganization?All of those interviewed concurred that the emphasis onstrategic cost management would stay the same or grow,if possible. There was also a consensus that the impact ofthe supplier and having alliances with key supplierswould become more important as organizationsincreasingly rely on their suppliers for quality, technology,and new ideas, and as more is outsourced.

Other areas of emphasis in cost management included acontinued emphasis on design for cost. Chip noted thatthe focus would shift to technologies, and how to achievecost parity from one generation of technology to the next,rather than emphasizing the cost of an individualproduct. Chip also believes that the future costmanagement focus will incorporate customer value, aswell as supply chain issues. Several of the cases also

noted that there must be a greater emphasis onrelationships and collaboration with key suppliers inorder to make significant cost progress in the future.There is also greater recognition of the importance oftaking a supply chain perspective in cost management.

One concern expressed by one of the financial peopleinterviewed was “the belief by senior leadership thatprocurement can deliver the same magnitude of resultsyear after year. It can’t be done. There is a limit. PSMmust work to educate them on additional contributionsthat can be made beyond bottom line cost reduction.”


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Table 25, also shown as Table 3 above, illustrates the keycharacteristics and knowledge recommended for effectivestrategic cost management in the supply chain. Strategiccost management in the supply chain has both strategicelements and tactical elements, as shown in Figure 4. Thestrategic elements related to understanding the biggerpicture or organizational goals, customer needs, supplybase segmentation, and market trends. The tacticalelements relate to some of the execution and analysis,such as having cross-functional teams and reporting andrewarding cost management. The tactical and strategicelements, in turn, support major organizational processesand philosophies, such as continuous improvement, newproduct development, and strategic sourcing. Theseprocesses are supported by external and internal data.For PSM, this process results in greater understandingand integration of supply base issues throughout theorganization, earlier involvement, greater visibility, andimproved bottom-line contribution.

The following paragraphs rehash the sections, “ResearchQuestions and Major Findings” and “Implications of theStudy” presented in the Executive Summary at thebeginning of this study.

Research Question 1. How important is strategic costmanagement in the organizations studied, and why?

1. All of the core and supplier organizations thatparticipated in this study indicated that costconsciousness is a way of life in their organizations.This philosophy is felt and lived from the chairmanof the board to the administrative staff to theworkers on the manufacturing floor.

2. Cost management is not a passing fad; it is a way oflife that will continue, and perhaps grow even moreimportant.

3. All of the core organizations studied believe that theyhave been very successful in supplier costmanagement, as shown by the significant,documented savings supplier cost management hascontributed to the bottom line of the organization.All reported savings ranging from millions of dollars,to tens of millions of dollars per year, and savingsranging from about 5 percent to over 10 percent inannual expenditures.

Research Question 2. How are firms organized toeffectively achieve strategic cost management?

1. All five of the core companies studied hadcentralized, or a mix of centralized anddecentralized, purchasing organizations. There waswidespread agreement among the firms studied thatat least some degree of centralization was required toget visibility of purchases in order to gain leverageand properly manage the supplier relationships andcost issues.

2. Purchases that were unique to particular businessunits were managed at a business unit level in two ofthe five organizations studied.

Research Question 3. Who is responsible for conductingcost management in the organization, and who isaccountable for delivering results?

This question has several, related answers.

1. PSM is held highly accountable for the delivery ofcost savings in all of the organizations. It has specificgoals for bottom line savings at functional,commodity and individual levels. There may also bespecific commitments made to support specificbusiness units, certain product lines, or newproducts.

Summary and Conclusions


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2. Cost management specialists, either from within thePSM organization or from the finance organization,are the focal point for supporting supplier costanalysis, building cost models and should-costanalysis, and validating results.

3. Everyone in the organization appears to have somelevel of accountability for, and commitment to,supporting strategic cost management and reducingthe organization’s cost. It is part of individual andfunctional performance appraisals and bonuscalculations.

4. Strategic cost management is generally not conductedby a single individual. Depending on the magnitudeof the analysis required, cost analysis may beperformed by an individual in PSM and supported bya cost management specialist, or conducted by across-disciplinary team. When a team is involved, itgenerally becomes involved with strategic costmanagement in conjunction with other activities, suchas developing a sourcing strategy, working on newproduct development, or continuous improvementinitiatives. The cost models used by individuals withinPSM or teams are developed and supported by costmanagement specialists, who may reside withinpurchasing or be part of the finance organization.

Research Question 4. How do organizations determinethe focus of their cost management efforts?

1. All of the organizations studied stratify theirpurchases, considering factors such as the magnitudeof the spend, market conditions, stage in product lifecycle, and the importance of the supplier in selectingtheir approaches to strategic cost management. Theapproaches used vary among the organizationsstudied based on their product life cycles, the currentmarket conditions, and internal resources available.

2. In considering the overall approach to strategic costmanagement, the organizations studied apply thefollowing rules of thumb:

e. Always consider the potential cost versus thepotential benefit of the cost/price analysisapproach employed.

f. Stay in touch with the market and use pertinentmarket information in analyzing and negotiatingcosts and prices.

g. Make sure that you have people with the rightexpertise involved in any sort of complexanalysis. This generally means finance people orcost management specialists.

h. Cost management is an integral part ofcommodity management.


Table 25Ideal Organizational Characteristics for Strategic Cost Management

Customer-Facing Internal Supplier-Facing Knowledge Requirement/Characteristics Knowledge/Characteristics

Culture/Organization Culture/Organization Culture/Organization• Work closely with immediate • Top management support • Continuous improvement focus

customer on supply chain design, • Cross-function teams • Support key suppliers with resourcescost and customer issues • Dedicated supplier cost to facilitate continuous improvement

management/analysis specialists • Early involvement of key suppliers• Cost management integral to all • Train suppliers in supply chain cost

supplier-facing processes management

Measurement Measurement Measurement• Understand end customer’s • Metrics aligned with cost • Reward key suppliers with more

wants/needs management/other goals business and/or sharing savings• Understand market trends • High level visibility/reporting • Segment supply base to vary

of cost management results relationships and cost management techniques

Information/Communication Information/Communication Information/Communication• Recognize the importance of • Excellent information systems • Clear communication of

communicating customer needs • Seamless understanding and expectations to suppliersthroughout the organization communication of customer needs

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3. Cost management must be an integral part ofsupplier selection, commodity management, andongoing planning in order for it to be effective. Theorganizations studied link strategic cost managementefforts closely with their other supply managementand new product development processes, to ensurethat cost management is always in the forefront ofsupply decisions. Effective cost management is not aone-off approach that the company takes when itreally needs to reduce its costs, but an ongoingexpectation that is built into supplier relationshipsand the organization’s reward and measurementsystem.

Research Question 5. What specific cost managementtools do organizations use to support strategic costmanagement?

This question explored the major cost analysis tools thatorganizations use to support their strategic costmanagement efforts.

1. Benchmarking is used extensively for costmanagement purposes by all of the organizationsstudied. There organizations use two types ofbenchmarking: benchmarking prices andbenchmarking processes. Benchmarking pricesinvolves looking for sources of information availableto corroborate pricing information. The other type ofbenchmarking centers on understanding coststructures and processes rather than prices. Thisprocess-centered benchmarking focuses onexamining effective methods across the supply chainand in unrelated or competitive companies andindustries to understand best practices. Thisknowledge is used to identify and implementopportunities for cost and process improvement,both internally and externally. Data frombenchmarking supports virtually all the other costanalysis and management approaches that theseorganizations employ.

2. All of the companies studies use target costing toensure that all of the functions involved in newproduct development understand the customer’sneeds as well as the cost and profitability goals, andare all aiming for the same objective. This is astrategic as well as a tactical approach. It is strategicin that it links all the functions within anorganization to support a common goal for newproduct development or for capital acquisition.Target costing is also tactical in that it provides aspecific framework for action and procedures forachieving goals and tracking progress towards thosegoals throughout the target costing cycle.

3. Should-cost analysis is a cost managementmethodology whereby the buying organizationdetermines what a product, service, or piece ofequipment should cost. This type of analysis is usedfor purchases of all types, from commodities tocapital equipment and new products. The should-cost figure becomes a benchmark for whether asupplier quotation or bid is reasonable as well as forunderstanding potential improvement opportunities.Should-cost analysis is used in many ways within theorganizations studied, such as to facilitateimprovement both within the organization and withsuppliers, to increase the organization’sunderstanding of costs, as a tool to work moreclosely with suppliers, and to help supportevaluation of other cost analysis approaches, externaldata, bids, and other items. It is a very richapproach, and one that the case study organizationsare using more frequently today than in the past.

4. Total cost of ownership (TCO) is used by all thecompanies studied in some fashion in varyingdegrees. Total cost of ownership analysis is definedas an approach for understanding and managing thetrue costs of doing business with a particularsupplier, of a particular process, or an outsourcingdecision. It covers a whole gamut of situations, fromstrategic purchases such as outsourcing and capitalequipment to tactical purchases such as indirectmaterials. TCO analysis is used to understand andimprove upon both internal and external costdrivers. It is also used to look at the costimplications in very specific, isolated situations aswell as cost implications across the supply chain.

5. The impact of information technology on costmanagement is also critical. The organizationsparticipating in this study noted two informationtechnology issues in particular that had significantimpacts on their cost management and analysisapproaches: The ability to access and understandspend data is a critical success factor, andinformation technology can be very helpful inanalyzing/building cost models. Thus, information isdefinitely a facilitator of effective cost management.In addition, the organizations found that one e-technology in particular, the use of reverse, on-lineauctions, was very helpful in reducing the pricespaid on certain competitive commodities where theywould otherwise employ a bidding process. Savingsoccurred both due to process transparency andintroduction of new players into the bidding process.

6. Organizations do use specific approaches to supportspecific types of purchases. Most of the discussionwith the organizations studied focused on cost


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management and analysis of raw materials, becausethey are often the largest spend category and havethe most mature cost management models. However,there was also extensive discussion on themanagement of capital, indirectmaterials/maintenance, repair and operatingsuppliers (MRO), and to a lesser extent on services.In the area of indirect purchases, the overallphilosophy followed by these organizations is tostandardize and reduce the number of transactions,focusing on TCO issues as much as on price.Services follow a similar approach in terms ofunderstanding the value and taking a TCOperspective. For capital acquisition, TCO analysis isthe key approach used. This includes understandingthe net present value of all the costs associated withacquisition, start-up, use, maintenance, and ultimatedisposal of a piece of equipment, including yieldissues, volume capability, and down time. The levelsof complexity and sophistication of these modelsvary in direct proportion to the levels of spend andcomplexity of the equipment purchased.

7. The organizations studied use a wide variety ofinternal and external data sources to support theiranalysis. The key to using data effectively is totriangulate, using multiple data sources to supportthe analysis.

Research Question 6. How are the results of costmanagement efforts reported?

1. The key issues related to reporting of cost savingswere that the reporting must be done by someonewho has credibility, and that those outside of supplymanagement must agree to the reporting method. Inaddition, cost or price savings is never the singulargoal of purchasing. Cost/price savings is alwaysbalanced by other important metrics such as quality,reliability, and so on.

2. All the organizations studied were very careful toseparate hard cost savings that could be traced to thebottom line from other types of cost savings orefficiency improvement. In all cases, the hard savingsare emphasized. In most cases, the soft savings arenot reported outside of PSM in the same way as arethe hard savings.

3. Renegade purchasing and getting internal clients tocomply with contracts and use PSM’s establishedrelationships was noted as an issue for all of theorganizations studied, for a variety of reasons. Theway this was managed varied among theorganizations. Some focused on getting such goodcontracts and demonstrating so much savings that

internal clients would want to use their contracts. Inone case, the organization has a policy to reducebudgets based upon documented purchasing costsavings. In this organization, the business unitswelcome PSM’s support, because they are heldaccountable for reducing their expenditures with orwithout the support of PSM.

Research Question 7. What other unique processes ororganizational structures contribute to the success ofstrategic cost management efforts in the organization?

1. All the organizations studied utilize finance or costmanagement experts to support supplier costanalysis. These individuals might have supplier costmanagement as a significant part of their jobfunctions, or might be dedicated exclusively tosupporting supplier cost management and analysis.These cost management specialists participate on thecross-functional teams, and help develop andimplement the cost models. They have generalresponsibility for helping to identify, measure andmonitor cost-savings initiatives. There are two generalapproaches for the reporting relationships of the costmanagement specialists, as highlighted in Table 1.The cost specialists might report directly to the PSMgroup, either in a controllership function or as costmanagement specialists. The other approach is tohave the cost management specialist report to thefinance/controllership function of the business unit orthe corporation. Neither approach appeared to havean advantage over the other, in that the costspecialists and their reporting and analysis wereviewed as credible regardless of reportingrelationship, and because the supplier costmanagement and analysis aspect of the job wasviewed as important enough to receive a great deal ofattention, regardless of the reporting relationships.The use of cost management specialists to supportthe analysis was viewed as very important, because inmany cases, PSM specialists simply did not have thetime to dedicate to the level of analysis that wasneeded. In other cases, they did not have theexpertise. In still other cases, their results might beviewed as biased, since they were both executing theanalysis and measuring the outcome.

2. One unique approach to cost management used byTele was creation of an internal consulting groupdedicated to supporting costs management andspecial project analysis for that organization. Thespecific focus of this group was to view all of theirproject analysis from a TCO perspective. In addition,because members of the internal consulting groupare not part of the project execution, they have anunbiased perspective.


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3. Deere also created an internal consulting group called“compare & share” to help understand and reduceparts proliferation and increase standardization. Thisteam compares parts with similar features/functionsamong and within divisions to determine whichpart/supplier provides the best value, and educateengineering and other decision makers. The initialcharter was for the group to be together for two yearsto accomplish this task.

Research Question 8. What impact do supplierrelationships have on the organization’s cost managementapproaches?

This question views supplier relationship managementfrom the perspective of the core, or buying organization.

1. All of the core organizations studied agree that theirsuppliers, and the relationship with their suppliers,are becoming more important in general, as theorganizations become more dependent on suppliersfor a larger proportion of their cost of goods, as wellas for improvement opportunities.

2. The organizations studied rely heavily on long-termrelationships with key suppliers. However, some ofthe organizations believe that they have excellentrelationships with their suppliers, while others donot. In all cases, the buying organizations studied arevery large players, and wield substantial purchasevolume in some markets, putting them in a positionof relative power over their suppliers. The twoorganizations whose products are sold primarily inconsumer markets, or to OEMs that sell toconsumers, Chip and LCP, seem to feel the greatestcost pressure and pass that along to their suppliers,even their key suppliers, most directly. Theseorganizations admit the greatest strain in supplierrelationships, although they are both working toimprove those relationships. The other three cases,Deere, Tele, and Praxair appear to have betterworking relationships with their suppliers, in terms ofa true continuous improvement approach, rather thanan approach that borders on adversarial at times.

3. All the organizations in this study engage in supplierdevelopment to varying degrees. Supplierdevelopment involves working with key suppliers tohelp the suppliers improve their performance. All ofthe organizations expect their suppliers tocontinuously improve. Some have formal programs tosupport this, such as Deere’s supplier developmentand value improvement programs, and Praxair’sTARGET program. The other organizations approachsupplier development on an ad hoc basis, devotingresources to suppliers when they can see a significant,

generally immediate benefit. All of the supplierdevelopment efforts are focused on first tier suppliers.

4. Despite all of the popular press, the concept ofsharing cost savings with suppliers is not a commonpractice among the organizations studied. If thesupplier contributes significantly to the developmentand execution of the cost saving approach, there is ahigher probability that cost savings will be shared. Ingeneral, the organizations studied felt such anintense pressure to reduce costs that the cost savingswas often passed along to the end customer, orretained to offset other cost increases.

Research Question 9. What is the supplier’s perspectiveon the organization’s cost management efforts?Each of the participating core companies identified asupplier with which it believed it had worked effectivelyin managing costs and would also be willing toparticipate in this research. The perspectives of thesuppliers are presented in response to this question. Oneof the factors that made the conversations with suppliersparticularly interesting was the timing of the study, whichoccurred during difficult financial times for all of thecompanies involved.

1. Customer cost management pressure has a directand indirect effect on the suppliers. All of thesuppliers acknowledged the importance of cost/pricemanagement, and the need to continuously performin terms of price and value to maintain the businesswith this customer. With the downturn in theeconomy, the supplier to Chip and the supplier toLCP stated that they had felt a great deal of directpressure to cut prices, without much support interms of supplier development. This had causedstrain on the buyer-supplier relationship.

2. It is not the fact of asking for year-over-year pricereductions that creates strain in itself. Rather, it is thesupplier’s perception that the customer will notsupport it in achieving these price reductions, and ismore concerned about getting a low price thanreducing the underlying costs that support that price.

3. The degree of direct customer influence on thesupplier’s cost management effort varied. Thesuppliers to Deere and Chip both indicated that theywere emulating this customer’s cost management andanalysis approach. In both cases, the customerencouraged them to do so as a way of bettermanaging their suppliers, who are second tiersuppliers to Deere and Chip. Both Deere and Chiphave sophisticated cost management approacheswith a high level of resources dedicated to suppliercost management.


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4. All of the suppliers studied also work with theirsuppliers in various ways on managing theirsupplier’s costs. In general, all of the customersstudied had more sophisticated cost managementsystems than did their suppliers. Each supplierindicated that supplier management is becomingmore important to it, and that its organization isincreasing the effort it expends on supplier cost andrelationship management.

Research Question 10. What impact do customers haveon the organization’s cost management approaches?

1. In general, the PSM organizations studied did nothave direct customer contact. As a result, PSM didnot directly feel the influence of customer costpressure. However, the indirect pressure issignificant. In general, the customer viewpoint iscommunicated to PSM in PSM’s role as a member ofa cross functional team.

2. In the case of LCP and Chip, who both deal withvery large and powerful customers that interactdirectly with consumers, standing customer serviceteams are in place to work with key customers tohelp manage and improve cost and performance.These customer service teams within Chip and LCPalso develop a deep understanding of theircustomer’s cost structure. Chip uses thisunderstanding to support negotiations and anticipatecustomer demands. LCP uses the data in this way,but also to help the customer manage its costs.

3. In the case of the only customer with whom theresearcher had direct contact, a large retail customerof LCP’s, the customer indicated that LCP had beeninstrumental in shaping its cost managementapproaches, adding value, and demonstrating truepartnership characteristics. This customer alsoindicated that it is rationalizing its supply base andworking to form closer relationships with itsremaining suppliers.

Research Question 11. Does the organization take a truesupply chain management perspective of strategic costmanagement?

1. All of the organizations studied agreed that whilethey aspire to a true supply chain/supply networkview of strategic cost management, they still haveopportunity for improvement. They all had differentapproaches for improving their supply chainperspectives. Common themes were the need forearly involvement in projects, and a more holisticview of the supply chain. Currently, issues directlyrelated to the customer are communicated indirectly

to PSM. As a result, critical customer issues may bemissed.

2. Not surprisingly, PSM focuses on the upstream costmanagement aspects of the supply chain, related tothe suppliers. It does a good job of understandingand managing the costs associated with the first tiersuppliers. None of the organizations studied focuson suppliers beyond the first tier as a matter ofcourse. Rather, second tier suppliers and beyond aredealt with on an exception basis, as problems andissues arise. The stated policy in all of the companiesstudied was to rely on the first tier suppliers tomanage their own suppliers, the second tiersuppliers to the core organization studied. However,it was acknowledged that there is great potential forimprovement in the second tier suppliers, and thatinvolvement with key second tier suppliers willlikely increase in the future.

Research Question 12. What are the key success factorsand barriers to strategic cost management?

Because overcoming the barriers to successful strategiccost management in the supply chain is closely related tosuccess factors, these issues are discussed together.

1. High-level visibility and reporting relationships forPSM are important for PSM’s initiatives to receivevisibility and attention to support their success.Several of the organizations noted that they hadundergone reorganizations that increased thevisibility and reporting level of PSM at about thesame time that they accelerated their strategic costmanagement efforts. They believed that the topmanagement attention and support were importantto their successful contributions to cost management.

2. The availability of trained, dedicated personnel tosupport supplier cost analysis is also important.Dedicating resources to supplier cost managementnot only shows management support, it also allowsPSM to identify opportunities and deliver results.

3. Credibility in the numbers reported is also importantto the success of strategic cost management. Thismeans that all key players agree on how the numbersare calculated. The numbers must also bedetermined and computed by a trustworthy source,with the emphasis on reporting numbers that can betraced to bottom line cost improvement.

4. Cost management must be viewed as an importantpriority throughout the organization. This should bereflected in performance expectations and the rewardand measurement systems in the organization.


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5. Strategic cost management is not one process, butrather a series of processes and tools that arecoordinated to support organizational objectives. Tobe effective in strategic cost management,organizations need to have good sourcing and costmanagement tools and processes, such as cross-functional sourcing and new product developmentteams, strategic sourcing, target costing, should-costanalysis, and total cost of ownership analysis in place.

6. Organizations must have good information systemsto gather the data needed to analyze spend patternsand monitor price and cost trends for strategic costmanagement.

7. PSM must deliver bottom line cost improvements inorder to earn and retain its credibility and respectfrom top management.

Research Question 13. What is the future of strategiccost management in your organization?

1. Strategic cost management will continue to beemphasized, and even grow in its importance for theorganizations studied.

2. Suppliers and supplier relationship management willgrow in importance as sources of cost savings andimprovement. There is a limit to the amount of year-over-year cost savings attainable from on-line reverseauctions. The long-term opportunities lie in workingmore closely with suppliers.

3. The emphasis on early PSM and supplierinvolvement will continue to grow as a source of costsavings and product improvement. The emphasis oncustomer value in cost management will grow andgain more visibility within PSM.

Implications of the Study

This study has several implications related to PSM’sinvolvement in strategic cost management in theorganization. They are closely related to the results of theresearch questions presented above.

Organizational Support at All LevelsWhile PSM is held to a high level of accountability forstrategic cost management and delivering bottom-linesavings, PSM cannot be successful without extensivesupport from others throughout the organization. Firstand foremost, top management support is critical. It setsthe tone for the attitude that everyone in the organizationhas toward strategic cost management. Through thebusiness unit and functional metrics, top management

determines the nature and extent of cost managementfocus as an organizational priority. Based on this, PSMneeds the support of other functional areas cooperatingon teams that have a primary or second goal of managingsupplier costs. The participants on cross-functional teamsneed to be held accountable for the identification ofopportunities and delivery of results.

PSM also needs specific support from cost managementspecialists, who are assigned to support PSM and cross-functional teams in supplier cost analysis. Theseindividuals may be part of PSM or part of finance. Thecritical requirement is that they have the charter and thequalifications to effectively support supplier cost analysisand management. Supplier cost management must beviewed as one of, if not the most important aspect oftheir jobs. This focus is critical because supplier costanalysis is often specialized and time consuming. PSMand cross-functional teams need to know that there areinternal experts upon whom they can call to supporttheir supplier cost management efforts. Without suchsupport, the analysis may be too complex and timeconsuming to be done as part of PSM’s or the cross-functional team’s regular activities.

Supplier Cost Management is a Good InvestmentThe suggested approach for dedicating resources tosupplier cost management may seem cost prohibitive.However, the organizations studied unanimously agreethat they receive extremely high returns on theirinvestment in supplier cost management efforts. Themoney spent on supplier should-cost analysis, supplierdevelopment, and other tools and approaches pays foritself many times over in terms of reducing costs andbottom-line prices paid to suppliers. For large Fortune500 companies, successful strategic cost managementmay mean the addition of dedicated personnel to focuson supplier cost management. For smaller organizationswhich might not have as great an on-going need, or asgreat an asset base, successful strategic cost managementmay mean diverting resources from PSM and/or finance,and retraining one or more people to become internalexperts on some of the cost management and analysistools mentioned in this study.

Strategic Cost Management in the Supply Chainis a Process and a PhilosophyThe organizations studied indicate that they live andbreathe cost management. It is integrated into all aspectsof their jobs and all dealings with suppliers. Topmanagement and functional support is not enough toensure the success of strategic cost management. Keyinternal processes, such as new product development andstrategic sourcing, must also be designed in a mannerthat integrates an understanding of customer needs, andthe creation of specific cost and profitability goals.


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Credibility in Reporting ResultsThe savings that are attributed to supplier costmanagement must be believable, and traceable to thebottom line. It is important that there is consensus acrossthe organization regarding how the numbers arecalculated and reported. In general, finance reports thesenumbers to increase the credibility of the results. Thefocus is on reporting cost savings that can be traced toreduced spending within the organization.

Supply Chain PerspectiveTaking a seamless view of strategic cost managementacross the supply chain is not yet a reality. In most cases,the inbound view of the supplier is handled by a differentteam/organization than the outbound supply chain viewto the customer. It is critical that somewhere in themiddle, the organizations dealing with the customersmake sure that the customer value proposition is clearlycommunicated to the organization dealing with thesupplier. It is essential that internal organization goalsand objectives be aligned in order to align the goals andobjectives of the supply chain.

Customer-Facing Supply Chain Perspective – In general, thesupply chain managed by the organizations studiedincluded only the first tier of suppliers and the immediatecustomer. A notable exception was two of the companieswhose products are sold to consumers, either through aretail channel or after the product is used as a componentin another product. Both of these organizations had avery close watch on demands and vagaries of the endconsumer, and aimed to anticipate shifts in consumerdemand patterns in order to better serve their immediatecustomers. Who ultimately determines the demand for aproduct, the end customer or the immediate customer, isan important determinant of where the producingorganization should focus its attention.

Supplier-Facing Supply Chain Perspective – All of the studiedorganizations segment their supply bases and use differenttools and approaches for managing different suppliers andpurchases. It is critical to employ a cost/benefit approach tosupplier cost management to use the organization’s limitedresources wisely. In addition, all of the organizationsstudied focus their supplier management attention on theirfirst tier suppliers. They also recognize that there is muchpossibility for improvement in the supply chain in thesecond tier, yet do not plan to focus on the second tier.There could be significant opportunity for supply chainimprovement by working directly with critical suppliers inthe second tier and beyond.

Supplier Perspective on Strategic CostManagement in the Supply ChainThe suppliers to the core organizations studied werequite aware of the importance of cost management and

continuous improvement in retaining their businesswith the buying organizations. While all felt continualpressure to perform, some suppliers felt that thepressure was fair, and other suppliers felt that thepressure had become unreasonable. In order for buyingorganizations to retain good supplier relationships andthe image of fairness in the face of continued costpressure, they should:

1. Be concerned with the supplier’s underlying coststructure and how they can support price reductions,instead of being concerned only with price.

2. Provide resources and ideas to support supplier’s costreduction efforts when requested by the supplier andit is reasonable to do so. If an organization is unableto support the supplier’s cost reduction efforts, itshould explain why.

Suppliers’ Management of Their SuppliersWhile all of the supplier organizations studied wereworking on managing the costs of their suppliers, nonehad a supplier cost management system as sophisticatedand well-developed as did the core organizations whichthey supply. As a result, it might be a good investment forbuying organizations to provide thorough costmanagement training to their suppliers, and help theirfirst tier suppliers develop excellent cost managementapproaches, so that they, in turn, can do a better job ofmanaging their suppliers. This is particularly critical sincethe core organizations do not want to get involved in theinbound supply chain beyond first tier suppliers.

Support for Strategic Cost Management TheoryAs mentioned in the brief review of the literature below,strategic cost management theory embodiesunderstanding and managing the organization’s supplychain, the cost drivers and the customer valueproposition. It is a matter of simultaneouslyunderstanding and managing these elements in relationto each other. The organizations investigated do anexcellent job of understanding and managing theirinternal cost drivers and supplier-facing cost drivers. Twoof the organizations that have a strong management focuson customer relations also do an excellent job ofmanaging the customer-facing cost drivers.

It is not clear from the study how well theseorganizations understand the customers’ valueproposition and translate that across internal functionsand to their suppliers. Except in the case of LCP, and tosome extent Deere, the translation mechanism is indirect,through one or more functions that may have directcustomer contact. This represents an opportunity forpotential improvement.


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Related to this, as mentioned in the section on supplychain perspective, most of the organizations studied do notgenerally have a seamless view of the supply chain fromcustomer to supplier; the customer view and supplier vieware still managed separately in different organizations, withsome interface in the middle. Such coordination would bea complex undertaking, and might require a change inteam structure. The organization that comes closest toembodying a true supply chain perspective is LCP, with itsproduct supply structure. While the argument could bemade that it is more important for LCP to be close to itscustomers because it is a consumer products firm, all typesof customers are becoming more demanding (Fawcett andMagnan, 2001). LCP’s product supply structure has aProduct Supply Vice President who reports into theBusiness Unit President. Also reporting to the VP ofProduct Supply are PSM, engineering, manufacturing,customer service/logistics, and finance. Deere has a similarstructure, although there is a mix of direct and indirectreporting relationships.

Characteristics of Companies with EffectiveSupply Chain Strategic Cost ManagementApproachesThe key characteristics that organizations with effectivestrategic cost management systems should display areshown in Table 25. Table 25 was developed as acomposite ideal of the best characteristics of the coresupply chain organizations studied. It is notrepresentative of any one organization. There are specificattributes related to way the organization understandsand manages the relationship with the customer, itssupplier, and related to their own internal organization.The key organizational characteristics have been dividedinto cultural/organizational issues, measurement issues,and information/communication issues.

Internal requirements/characteristics – Both the customer-facing and supplier-facing characteristics stem from insidethe organization. The internal culture and organizationalstructure create the framework for effective supply chaincost management. Internally, an effective cost-managementculture is characterized by top management support forcost management and a high level of cost and valueconsciousness throughout the company. In addition todedicated resources to support supply chain costmanagement, cross-functional teams are used to identifyand implement cost management approaches. Ratherthan an afterthought, cost management is an integral partof all key supplier processes.

The right type of reward and measurement systems arealso critical to reinforce the cost management culture. It iscritical that the organizations measure what they want toachieve, and the metrics are aligned throughout theorganization, reflecting cost goals as well as customer value

and supplier performance goals. Supply chain performancemetrics and results must be published and receive highvisibility throughout the organization. This requiresexcellent information systems and communication. Part ofthis communication includes awareness throughout theorganization of customer needs and the organization’svalue proposition in serving the customer.

Customer-facing knowledge – Supply chain management isall about meeting the needs of customers better than thecompetition does. In terms of the organization’s culture,the company needs to be customer centric, valuing itscustomers and working with them to meet their needswhile improving the efficiency and effectiveness of thesupply chain. From a measurement standpoint, theorganization needs to understand the needs of the endcustomer as well as market trends, and respond to theseproactively. From an information and communicationperspective, it is critical that the customers’ needs and theorganization’s plans for meeting those needs becommunicated throughout the organization. This allowseveryone in the organization to align his or her effortsaround the customer.

Supplier facing knowledge/characteristics — Effective supplychain strategic cost management relies heavily onsuppliers. Culturally, this means a continuous improve-ment focus on working with suppliers, including earlysupplier involvement. It also means supporting suppliers’continuous improvement with resources and training.From a measurement and reward standpoint, theorganization must properly segment its supply base touse the appropriate types of supplier relationships andcost management techniques. It also needs to measuresupplier performance, and reward the suppliers whoperform well. Clearly communicating expectations andneeds to suppliers is essential.

The organizations studied in this research excel in thethird column of Table 25: supplier-facing knowledge.They segment their supply bases, have dedicated suppliercost management resources, emphasize continuousimprovement, and in many cases develop the suppliersby providing resources to support continuousimprovement. They reward their top suppliers by sharingcost savings or giving them more business. They areworking on improving communications and earlysupplier involvement. One strong recommendation isthat they invest more resources in supplier training. Ingeneral, their first tier suppliers do not have as well-developed approaches to supplier cost management.Since these core organizations would prefer not to workon supplier cost management beyond their first tiersuppliers, the first tier suppliers would likely be muchmore effective if they improved their cost managementsystems, and worked more closely with their suppliers.


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A P P E N D I X A

DEERE & COMPANY

BackgroundDeere and Company is a $12 billion plus manufacturer ofagricultural, construction, and commercial and consumerequipment. It employs approximately 38,000 people, andhas about a $6 billion spend on purchased goods andservices. The supply management organization at Deereemploys about 1,200 people in 50 to 60 operationsaround the world. The mission of Deere Purchasing is toestablish a case for action and drive key cultural changesto create a fully integrated, worldwide, customer drivensupply chain management process.

Recent changes - The supply organization at Deere haschanged dramatically in the past four years. In the early’90s, Deere Supply Management concentrated on trainingand education of employees. Yet that did not have the bigimpact it desired.

Based on benchmarking it did in late 1996, it built abusiness case to convince senior management of the needfor change, that supply could make a significantcontribution if only its level was elevated. By midyear itheld a workshop to define strategic processes, to identifygaps and to launch teams to focus on the key initiatives.By year-end it hired a Senior Supply Management officerat the VP level, the highest level ever in Deere.Throughout 1998, it created Supply Managementleadership teams, defined its strategic processes withbusiness process excellence teams, and developed hiringand training plans. It rolled out the new processes inJanuary 1999, and continues to develop and refine theseprocesses. The current organization is shown below.

With its reorganization, the Corporate Supplymanagement organization went from 30 to 280 people.The largest addition to the group was the logisticsfunction, consisting of 140 people. Of the remaining 140,

about 50 are working on systems and training issues,while the remainder work in strategic sourcing for bothdirect and indirect materials.

The strategic sourcing group at corporate manages about50 percent of the corporation’s total spend, includingvirtually all indirect and about 20 percent to 30 percentof the total direct materials. The factories purchase about10 percent of the total spend, while the remaining itemsare contracted at a divisional level. This represents a bigchange for Deere, which has always operated as a highlydecentralized organization. There is a problem withrenegade buying of indirect materials, but corporatesupply hopes to mitigate this with the implementation ofAriba and the use of on-line catalogs.

The focus of purchasing activities also has changed.Supply management now focuses on threecomplementary areas, each with dedicated resources atthe corporate and divisional level:

- Strategic sourcing- Supplier development- Cost management

Deere saved over $4 million in fiscal year 2000 due tothese efforts. At a recent senior management meetingwhere the Supply Management Strategic plan waspresented, one divisional president commented, “SupplyManagement is the driver of cultural change in thiscompany. It is aligning itself around standardizedbusiness processes that cut across functions, divisionsand plants.”

Major Goals and Initiatives - As stated in Deere SupplyManagement’s (SM) 2001 strategic plan, Deere SM hasfive key strategies supported by 29 key initiatives. Theyare:

Appendix A:Core Company Case Studies

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A P P E N D I XAFigure 5

Organizational Chart of Deere

• • •

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A P P E N D I X A

1. Supply Chain Design: Design a global supply chain todeliver unequaled global performance.

2. Supplier Integration: Achieve leading edge supplychain integration in each of the customer processes.

3. E-Business and Geared to the Customer (GTTC)/SAP:Create a comprehensive e-Business model that yieldsreal-time, multi-tiered supply chain capabilities.

4. Workforce Excellence: Recruit and develop supplymanagement professionals for the future.

5. Innovation and Growth: Create and enable newbusiness opportunities through supply chainknowledge and innovation.

Thus, Supply Management sees its roles as continuing toevolve and grow. One key area of opportunity itrecognizes is greater early involvement in newproduct/service development. While this is happening insome divisions and plants, it is not yet happening acrossthe board.

Cost Management at DeereClearly, cost management is just one integral part of themany initiatives that Deere is pursuing to achieveexcellence in supply chain management. Its overallapproach is to have in place in each business unit costmanagers who can support all of the costmanagement/analysis needs of that unit either directly orin a support role. Some of the specific cost managementinitiatives that Deere has undertaken include:

Figure 6Divisional Organizational Structure

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A P P E N D I XA

• Benchmarking.• Deployment of cost managers in each division and at

the corporate level.• Development of cost models and should-cost.• Target costing for new and existing products.• Standardization through compare and share.• Supplier Involvement in value improvement.

Each of these initiatives is presented below in relation toDeere’s overall cost management efforts.

Benchmarking - Deere merged best practice ideas fromHonda of America, Ford, BMW, and others into its costand supplier management approaches. It brought inpeople from these companies and incorporated their

ideas with those from meetings and seminars, feedback,industry trends, and networking. The basic premise ofthe cost management approach is that Deere can’t train allbuyers to do cost analysis well. It must have specialists.

Deployment of Cost Managers - In the past one to two years,five cost managers have been put in place, one for eachdivision and one for corporate purchasing. These costmanagers are highly trained and skilled specialists, many ofwho have years of cost management/analysis experiencewith other companies. All of these cost managers havesmall staffs that support them in providing cost analysis totheir respective divisions. The cost managers also meetregularly as a team. They have agreed to:

Figure 7Divisional Supply Development Organization

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A P P E N D I X A

• A process for cost model creation.• A process for evaluating cost models.• Where/how to post cost model information on their

internal web site.

Should- Cost Models - Two primary types of should costmodels are developed: historical and theoretical.

Historical based cost models are derived from:

• Market-based information.• Cost detail provided by supplier on quote form.• Inputs from multiple suppliers.

Theoretical cost models:

• “Build up” the costs for a process from the ground up.• Consider issues such as:

■ Space a machine takes up (buildingdepreciation).

■ Number of people on machine.■ Initial cost of the machine.■ Financing for the machine.■ Tooling.■ Maintenance.

■ Efficiency of the machine.■ Other relevant costs and performance issues.

They also develop an understanding of market prices andconditions based on externally published data andhistorical quotes. They are currently working on anumber of cost models, including decals, injectionmolding, stamping, and casting.

The cost managers put together teams that work on thecost models. The teams include representatives from eachdivision that uses the item in a significant way. There is alead for each team. The overall direction for the teamcomes from the cost manager with input from the leadcontrol for guidance. The team includes costmanagement, a supply management specialist,manufacturing, engineers, and representatives from thesupplier’s cost management and manufacturing areas.Cost management efforts often complement supplierdevelopment and value improvement initiatives. Deerehas also purchased cost modeling software for theoreticalcosting on some of the basic processes that are commonacross a number of industries. This provides informationon what it costs to run certain equipment. Deere relatesthese data to historical information. There is a trade-off

Supply Chain DesignExpand Strategic SourcingCreate an Efficient Logistics NetworkImprove Cost ManagementImprove Supplier DiversityIncrease Supplier DevelopmentCreate a Business Partner Satisfaction IndexBuild on the Strategic Supplier Relationship ModelExpand Achieving Excellence

E-Business and GTTC-SAPDevelop Web-based applications to link suppliers withour business processes:

ProcurementSourcingTechnical and product deliveryCustomer supportOrder fulfillmentInformation management and communications

Innovation and GrowthCreate a global supplier networkExpand and leverage web servicesDevelop distance learning capabilitiesCreate a supply chain marketplaceActively support mergers and acquisitions to meet

business goals

Supply Chain IntegrationUse the Integration Roadmap to ensure supply chainintegration throughout:

The Technology Delivery ProcessThe Product Delivery ProcessThe Order Fulfillment, Logistics, andProduction Planning ProcessThe Customer Support Process

Workforce ExcellenceRecruit the best candidates to fill entry-level and mid-

career openingsProvide global training opportunitiesDevelop leadership from within John DeereEnsure clear employee performance goalsProvide career development opportunitiesEnsure employee retention

Table 2629 Supply Management Initiatives

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A P P E N D I XAbetween keeping the analysis simple and developing agood understanding of the process.

In terms of accountability, cost management andstrategic sourcing share the goal of bringing savings tothe organization. Cost management helps evaluatequotes and supports and reports on the progress ofstrategic sourcing from a cost management perspective.The strategic sourcing manager at the divisional leveldrives the cost savings initiatives down to the strategicsourcing and commodity managers. Ultimately, strategicsourcing is totally responsible for executing andbringing home the savings.

Cost management’s focus is to be a resource to strategicsourcing for current and new products in terms of gettingthe right price. Saving money is the ultimate goal of costmanagement, and building the cost models is part ofthat. Cost management has to identify the marketopportunities. Another goal is to avoid any unnecessaryprice increases. When increases are necessary and valid,Deere uses value improvement and supplier developmentapproaches, which are presented below.

The supply chain integration (SCI) manager is responsiblefor all new product programs. The SCI managerintegrates strategic sourcing early into new productprograms. Through strategic sourcing, suppliers may beco-located during the design phase of new productprograms. Critical areas of design focus are large costareas and those areas where there is a major designchange. SCI managers ask cost management to evaluatethe cost structure of the new designs. If there is aproblem, strategic sourcing and supplier developmentmay get involved. There might also be engineer swapswith the supplier in order to get more integration.

Target Costing - Deere has developed a structured processfor new product design. Underlying this approach is thephilosophy that early involvement of critical suppliers andfunctions is key, and that target costs must be set up front.

First, the design engineer checks the design cost(tools/should-cost), which is compared to the supplierquote. If it does not meet the design cost requirements,Deere identifies design issues vs. supply cost issues. Thisprocess iterates with design changes and materialmodifications until agreement is achieved and the targetcost can be met. Deere focuses on different parts of thevehicle during different parts of the cycle. Certain issuessuch as engines drive other cost and design issues. All ofthese activities are undertaken by a cross-functional team.The team divides the pie of target cost into materials;labor, overhead, and so on. There is a team assigned toeach key vehicle module varying from four to 10 teamsfor a particular vehicle.

Today the focus is on getting good cost targets set upfront. In addition, the teams focus on the big cost driversto get the big benefits. Deere is developing a trainingclass built around its approach to target costing forengineering and supply management people.

Cost Management for Existing Products - Cost managementof existing products also follows a well-defined process.

1. Anything with an annual increase over $10,000 froma supplier must be analyzed by the affiliated costmanagement group to see if the increase is justified.A cost manager or strategic sourcing manager cansign off on this.

2. For increases between $10,000 and $25,000, thematerials manager must sign off on the increase (leadof plant purchasing).

3. If an increase is over $25,000, it goes to the Directorof Supply Management of that division.

4. Whenever a buyer requests help to challenge orunderstand an increase, cost management helps.

To analyze cost increases for existing buys, cost managersuse a cost table if available. They may make a site visit toanalyze supplier processes. They may also do anincremental look to see if the cost change is justifiedbased on the functionality change. For example, onesupplier of a $17 part asked for $25 for that part. Afterthe analysis was complete, Deere ended up getting a 15percent across the board decrease on all items from thissupplier. Deere follows a systematic approach to costmanagement, and truly has a center of excellence interms of cost management.

Supply management also tries to understand why suppliersdo certain things, and add certain features. Is there a valueadded? Supply management questions whether featuresadded for marketing or engineering truly create value, andchallenges these. Can Deere justify the cost of adding afeature? It must consider both competition and theincreased price to the customer. If the feature can bejustified, how can Deere do it smarter? Purchasing strivesto understand its markets better and approach thingsdifferently. Cost management is involved with a team thatinteracts with manufacturing engineering, designengineering, marketing, suppliers, and the customers tounderstand the dealer and end user to understandfeature/cost trade offs. The trend is for cost managementrepresentatives from Deere to accompany Deere’s sourcingperson to explain Deere’s cost position to the supplier. Thecost management person often seems “tough.”

Supplier Development - Cost management has done a goodjob with cost take-outs internally. Now, it is focusing onthe outside with supplier development and other valueimprovement. Its focus is first tier suppliers, and in some

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A P P E N D I X Acases even critical second tier suppliers, in order to get afeel for the value improvement opportunity down thesupply chain. Many second tier suppliers are smaller andneed help.

To get focus on whom to bring into supplier develop-ment, Deere looks at gaps and opportunities. Forexample, its 50 top suppliers account for 80 percent of itsspend. With the top suppliers, Deere does a valueimprovement and supply development process if itdoesn’t have the opportunity to bring in competition.

Accountability Through the Organization - Functionsoutside of cost management have felt some accountabilityfor cost management. Cost management is part of thepersonal goal sheet for each person in supplymanagement. This has been spread to engineering,operations, accounting, and marketing so they will feelgreater accountability for cost. Buy-in is improving.Twenty percent of the bonus calculation is based on costreduction, and there is no cap on the bonus. ROI is also amajor factor, along with division-specific objectives.

Execution of Cost Management - Currently, there are sixpeople in cost management at the corporate level,supporting 29 teams that cover common parts and allindirect spend. In all, there are 62 people in costmanagement at Deere. About a third of the 29 teams arecovered by cost models. The remaining two-thirds usemarket-based pricing. The market-based pricing isprimarily commodities, so the team forecasts prices todecide tactics. Teams include members from strategicsupply, cost management, each of the divisions, andtechnical/engineering. On the indirect side, the teams tryto look at buys/costs creatively, not using traditional costmodels. Cost management helps teams understand cashflow issues, and tries to get a better feel for total cost. Italso tries to get teams thinking long-term on going from aper piece mentality to total spend.

On the indirect side, non-standardization issues are bigcost drivers; for example, Deere purchased 220 styles ofgloves. It was able to reduce this to 25 styles/types, andsaved 20 percent to 30 percent. The steps included incommodity analysis at Deere include:

1. Analyzing the industry.2. Organizing in-house information.3. Refining the analysis to narrow objectives.4. Building a proposal to include cost data.5. Evaluating the proposal.6. Building a cost model before deal is completed.

There are still compliance issues with indirect purchasing.Ariba software is supposed to stop this, but currentlycan’t support all stakeholders. On the direct spend side,the Enterprise group loads order information and

controls and sets up ordering. Deere can still do spotbuys, but renegade purchasing is minimal. In setting upthe contracts that cut across divisions, Deere gets a highlevel of buy-in; all key stakeholders are involved.Commodity management works better if there is a long-term, ongoing team to help with compliance, ongoingsupplier relationships, and performance monitoring.

Deere has undertaken additional - complementaryinitiatives to support its cost management approach:JDCrop, compare and share, and value improvement.

JDCrop – JDCrop stands for John Deere Cost ReductionOpportunity Process. The program was modeled afterChrysler’s SCORE program in the mid to late 1990s.Under this program, suppliers submit cost savings ideasto Deere. If implemented, there is generally a sharing ofsavings between Deere and the supplier. In the past fiveto six years, Deere has received over $100 million in costreduction suggestions. This program complements andsupports supplier development and other programswithin Deere.

Compare and share is specifically aimed at reducing partsproliferation and increasing standardization by comparingparts with similar features/functions among and withindivisions to determine what provides the best value. Twosupply management professionals are dedicated to thistask for two years, and work with supply managementspecialists and engineers to identify, prioritize, andexecute cost savings. Compare and share is another costmanagement initiative to:

• Create information to build cost models (originalpurpose).

• Today, it is more strategic. It explores:•• Supply base reduction.•• Overall issues – Europe vs. U.S. sourcing.•• Who will be major suppliers in future.•• How to get engineering involved, engaged, and

how to incorporate in design.

Compare and share is helping overcome decentralizationinefficiencies. While each factory has its own designgroup, compare and share tries to coordinate andstandardize design and components.

Value Improvement - is an approach to improve productquality and reduce product costs by getting differentgroups to talk together and then incorporating the best oftheir ideas. This is a team-based approach to brainstormcost and value improvement ideas with suppliers. Theideas are evaluated, prioritized, selected, and implementedbased on potential. Results are monitored and tracked.Potential ideas are retained for future implementation.JDCrop, compare and share and value improvement haveyielded significant savings for Deere.

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A P P E N D I XAEvents in past four to five years - Recently, Deere appointeda new CEO and chairman, only its eighth in its 164-yearhistory. It has had a large number of acquisitions, themost recent of which was Timberline, a large loggingequipment business. It has made a number of foreignacquisitions and equity investments. It has experiencedsome tough business cycles, with 1998 being a very badyear for the farming economy. And, as previouslyexplained, it has completely reorganized and greatlyexpanded its supply management area.

Challenges - The farm economy in general is very cyclical.Deere has been subject to the economic swings, like the1998 downturn. It is growing its construction andconsumer/commercial business to offset this swing.Global competition and expanding to world markets arealso a challenge for Deere, one that it is wholeheartedlyembracing.

Metrics for Success - The key company metric is ROA.Everyone in the organization receives a bonus based on acombination of business unit/divisional and corporateROA. For supply management specifically, the goals are:

1. No 1 overall rank in A.T. Kearney SupplyManagement Benchmark Study.

2. Five percent annual cost improvement.3. Twenty percent improvement in supply management

productivity.4. Fifty percent annual improvement in cost of quality.5. Ninety percent of purchases covered by commodity

strategies.6. One hundred percent on-time delivery of finished

goods available to promise.

In the future, supply management will continue to growin stature and importance to Deere. For more specificinformation on John Deere’s purchasing and supplymanagement processes, see http://jdsupply.deere.com/.

Case Study Participants:Two Corporate Purchasing DirectorsManager, Value ImprovementManager, Compare and ShareManager, Corporate Indirect PurchasingCorporate Purchasing ManagerManager, Supply Chain Development, Business UnitTwo Managers, Supplier Cost Management, Business Unit

CHIP CASE STUDY

This case study overviews the processes used by Chip tomanage its supply chain costs, with an emphasis onmanaging product life cycle costs and the costs ofpurchased inputs. While not all of the techniquesmentioned below are used by all business units for allpurchases, the breadth of techniques provides anoverview of the extreme intensity and complexity of costmanagement at Chip. Before presenting the techniquesand approaches, it is helpful to get a perspective of Chip’sorganizational structure.

Background and Organizational StructureChip has been a leader in developing technologyenabling the computer and Internet revolution that haschanged the world for over 30 years. Today, Chipsupplies chips, boards, systems, software, networking andcommunications equipment, and services that composethe ingredients of computer architecture and the Internet.Chip’s mission is to be the preeminent building blocksupplier to the worldwide Internet economy.1

Corporate Structure - The technology-manufacturinggroup (TMG) is a centralized organization that carries outthe operational aspects of purchasing, production,testing, and logistics for Chip. Within TMG there is aplanning group that provides customer information to beused in engineering, design, and manufacturingdecisions. Materials is a sub-unit of TMG and includes allaspects of material acquisition, purchasing, supply chainmanagement, materials technology, and a specialprojects/collaboration group. Figures 8 and 9 provide anoverview of Chip’s total organization structure and thestructure of TMG.

Purchasing is very centralized at Chip. Some buying doestake place within other business units, because somenewly acquired organizations have not been fullyintegrated into the centralized system. A majority of thesupplier negotiations, contract development, andpurchasing is performed by corporate purchasing.

Chip is organized around business units. The number,composition, and role of these business units change asthe economy and market change. One of the interestingthings about its corporate structure is that TMG(Technology Manufacturing Group) is treated as abusiness unit and is at the same reporting level as theother business units (see Figure 8). This type of reportingrelationship between TMG and the other business unitscreates a unique matrix organization within Chip.

1Chip’s annual report

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Chip credits its success in cost management to its culture.It is quite cost conscious at the top management level, foreverything from facilities to the cost of travel. There is afrugal mentality. The finance organization viewsoptimizing shareholder value as its mission, and finance isdisbursed entirely throughout the organization, becominginvolved in all key decisions. The organization structure,with finance reporting directly to corporate finance andhaving a dotted line to the business unit, supportsfinance’s big picture perspective. Finance and operationalowners have to sign off on all key TMG decisions. WhileChip has always been cost conscious, the focus andattention on costs has increased substantially in the pastfive years or so, due to increased competition and thedeclining prices of PCs. TMG receives many top-downmandates for achieving cost goals.

Overall Approach to Cost Management withinChipThe target costing process drives the direct materials costmanagement process at Chip. Historically, Chip’s business

units determine what something should cost to make thebusiness’ required profit for that item. The TMG supportsthe profit model by achieving the target cost. Financetries to ensure that the target cost approach works toachieve the desired goals and doesn’t cause the wrongbehavior. This task has become more complex due toproduct proliferation and the wide range of price pointsof the products/components it sells.

In general Chip always uses cost targets in purchasing.Sometimes, the target is based primarily on theunderlying technology and design. However, other timesthe target cost is based upon the target price required tobe viable in today’s extremely competitive market. Havinga firm goal/direction causes Chip to question design,technology, and related assumptions. There is immensecost pressure and challenge, and the goals are gettingmore rigorous. A key objective of target costing is toachieve the target cost in the design stage. If this can’t beaccomplished, there is even more pressure when the itemis in production, where ongoing and rapid cost reduction

Figure 8Chip’s Corporate Structure

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A P P E N D I XA

is an expectation of the market place. That is why it iscritical to continuously keep the target cost right in frontof everyone involved in the new product developmentprocess as well as in the ongoing purchasing of materialsand components used in production.

Target costing and design for cost - Business unit financedetermines what is required in terms of target cost, tomeet its price point and profit requirements. Financethen allocates the target cost among the various costelements that make up a product, including materials,labor, and overhead. Today, TMG is trying to be moreproactive in target cost participation. In the past, TMGreceived target information for one year into the future,which constrained its options for forward planning. TMGis now trying to be involved earlier. TMG, finance,development, and materials talk to business units aboutcost requirements and trade-offs two years into thefuture. Design for cost is a key initiative. Part of thedesign for cost initiative is to understand the cost ofproposed products’ real time through developing designfor cost models, which include various cost trade-offs.

This early interaction helps to intercept cost issues beforea design is firm, while trade-offs are still relatively easy.

Chip also uses target cost models as a way to assess costranges for components that will result in a viable productwithin the context of the total consumer product offering.(Can Chip make the component at a price that will fitwith the other components of the product to create aproduct consumers will buy at a specified price point?)As the products’ costs are developed, individual costcomponents (like freight costs) are evaluated resulting inspecific cost reduction initiatives.

There is still substantial work that can be done at the billof materials level to reduce the cost of a design. In thepast four or five years, significant time has been investedin value engineering of products and processes to helpreduce supplier’s production cost without affectingproduct performance. But this is a reactive approach:design the product, and then fix it later. Today, the focusis on how to design less costly products, eliminate non-value features, and optimize the design to meet technical

Figure 9Chip’s Materials Structure

Quality Finance Legal Human Resources

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A P P E N D I X Arequirements before the first unit of that product ismanufactured. Value engineering is a critical initiativethat complements cost management at Chip.

Other Cost Management TechniquesOther tools used to manage supply chain costs at Chipinclude:

Benchmarking.

Standardized contracts.

Cost driver analysis.

Total cost of ownership.

Should-cost modeling.

Competitive bidding.

Each of these tools and its application at Chip ispresented briefly below.

Benchmarking - Chip benchmarks the market usingsimilar/substitute products to get a feel for what areasonable competitive price is. For example, it hasbenchmarked industry standard versus custom memory.The suppliers of custom memory didn’t want to budgeon price, saying the item was custom. Chip pointed outthat the suppliers had only standard items to produce inorder to utilize their capacity if they didn’t produce Chip’sproducts, and that it really was the relevant benchmark.As a result, the suppliers brought prices way down. Chipis also trying to develop option based pricing withsubcontractors using the real options approach.

Standardizing contracts - Chip also established a commonset of T&Cs to protect itself when the market goes up. Itis trying to get volume neutral pricing – to get best priceall the time, rather than get discounts with volumeincreases. Most favored customer clauses are alsonegotiated with all suppliers wherever possible. Somesuppliers do business with Chip as good public relationsto get other customers.

Chip measures and tracks the results of cost managementinitiatives, for reporting as well as for supporting thebonus structure. Chip looks at cost savings initiatives,and focuses on the initiative until it achieves it. Chiplooks at both the overall impact of the initiatives onresults as well as at the impact of individual initiativeswhere possible.

Cost driver analysis - In focusing on cost reductionmanagement efforts, Chip tries to understand its key costdrivers. For example, Chip does use activity basedcosting (ABC) at the fabrication plants. The focus of ABC

at Chip is not on optimizing cost allocation to individualsteps, but in understanding bigger picture cost drivers,and focusing its attention there.

Key cost drivers - Customer-related cost drivers arecustomization of products, logistics, and specialprograms. Cost drivers with suppliers vary amongsuppliers. Chip tries to consider the type of itemssupplied. When it has bleeding edge technology, Chiprealizes it won’t be the lowest price supplier. Chip makesa conscious trade-off to pay more to get leading edgetechnology quickly, gaining speed to market. For leadingedge items, Chip develops a detailed should-cost modelfrom the ground up. It includes both capital/otherinvestments and bill of materials items. As it becomesindustry standard, the price goes down. Chip wants allparties to:

• Cover all startup costs/investments.• Maintain SG&A and reasonable margin.• Continue to invest in new technology.

As discussed below, Chip determines the should costprice required to achieve a net present value of zero atthe end of the product life with suppliers of leading edgetechnology products. For commoditized products, Chiptakes a life cycle cost approach, considering where theitem is in the life cycle. It negotiates cost based on that,considering that margin decreases over the life of aproduct.

Total Cost of Ownership modeling (TCO) - Chip does looselyfactor total cost of ownership into its materials analysis aswell. It is not at the level of detail of “one supplier is 2cents more to use than another.” The real goal is to havequality requirements that everyone must meet, so thatTCO analysis is not needed. If a supplier doesn’t meetthem, corrective action occurs. Chip can take awayvolume, work to develop the supplier, or take other action.Thus for materials, Chip focuses on bigger cost drivers. Forcapital equipment purchases, which are substantial atChip, a TCO or life cycle cost approach is taken.

Total Cost of Ownership is also called a complete costapproach at Chip. The complete cost approach is anemployed, but still developing, approach to decisionmaking. Its success is heavily dependent on teamingacross organizational boundaries.

Due to its broad reach across organizational boundaries,finance often plays a strong coordination role in getting acomplete cost analysis done. The data for the analysis isusually owned by the operation’s partners, but iscentralized and analyzed through financial modeling.

The following is an example of the TCO process inaction:

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A P P E N D I XAThe business unit brings a new product idea and targetcost objectives (Internet terminal, for example) to TMG.Information on costs for manufacturing, logistics,planning, and component materials are collected to createa cost profile for the product. In the past, this collectionof cost information has been executed in a linear fashion(idea➝ materials➝ manufacturing➝ distribution➝planning) with each cost component optimized beforemoving to the next component. TMG is working to bringthese elements together for simultaneous discussion andconsideration to achieve the desired result ofoptimization in the cost structure as a whole rather thanas optimization of independent components. The lattercan result in sub-optimization of the final total costprofile or a lengthy iterative cost development process.

The optimized cost profile is then communicated back tothe business unit, which, can proceed with the productanalysis. Using market information, competitorassessments, and cost structure information, the businessunits are able to analyze the expected financialperformance of their product/product lines and makebusiness investment decisions. Thus, TCO is an integralelement of the target costing process.

Supply chain issues/equipment issues - Chip is looking atlong-term supply chain design from a TCO standpoint,with more focus on design for high capacity and for lowcost. Chip views the supply chain as a capacity problem.TCO is one of many factors considered in capital andincludes spares and service issues. In negotiation, Chipfocuses on an affordability goal. It has a target for cost bytool, total cost, cost per unit and cost per wafer.Depreciation on equipment is a big cost factor for Chip.

Equipment cost management approaches include:

• Target cost/must-cost from the business units.• hould-cost TCO based on bill of materials plus

usage.• Lowest TCO – Suppliers’ promises versus shortfalls

in performance.• Pre-positioning – what is a competitive total cost of

ownership, how can we get there?• Benchmark vs. other suppliers.

Should-cost modeling - Should-cost models tend to besituationally specific, while design for cost models areinteractive, what-if type models. The use of should-costmodels is a fairly common practice. The development ofthe model helps in gaining a better understanding ofcosts while the results of the should-cost model provide asource of validation for evaluating submitted bids.Additionally, actual cost results which deviate from theshould-cost model help identify areas of focus for costreduction efforts. As an example, the logistics group

maintains should-cost models for ground transportationservices.

Target margins - Should-cost has historically beenvaluable, but does have limitations. To better enabledecision-making, finance incorporates target margins intoshould-cost models. It uses these margins to manage totalsupplier profit over time. Chip creates supplier portfolioswith target margins set for each product based on wherethe product/platform is in the life cycle. It uses thesetargets to negotiate and understand suppliers’ totalmargins and profitability. It provides a higher-level check.It focuses on the big picture – not on micromanagingpennies here and there.

Chip uses this margin data internally to make negotiationtrade-offs, considering where to concede price and otherfactors, versus what to go after to get the biggest impact.It is used for quarterly price reviews and to track ongoingreductions in price. Chip states its opinion on how muchmoney Chip thinks its suppliers can and should make. Itputs a lot of cost pressure on the suppliers. Some sayChip squeezes without regard to the supplier. The realintent is to get cost out of the system where it can. Chipmay engage with a supplier to save costs – or a supplieritself might have to figure out how to cut costs. The goalis to balance competition and cooperation. Suppliers canand do say no to Chip’s demands. Then Chip must eitherrestate its position or find a different supplier.

Supplier cooperation - Cooperation with suppliers on costmodels varies. Assembly subcontractors don’t shareshould-cost information. They are more subject to marketpressures. However unique or proprietary materials lendthemselves well to a should-cost methodology. In case asupplier won’t share information, Chip can use should-cost results of cooperative suppliers with other suppliersof like items. In one case, Chip created a should-costmodel of a material class and found out that all materialsin that class have a similar cost structure. Yet Chip waspaying vastly different prices for items within thismaterial class. The modeled supplier acknowledged thatthe cost structure in this material class varies little, andnow Chip uses the model successfully in negotiatingcosts with other suppliers for that material.

Capital equipment - To develop costs for equipment, Chipdoes a should- cost for the equipment. It actually createsa bill of materials explosion for equipment, using Paretoanalysis to focus on the big items. It also considerssupplier profit margin, using supplier financials andlooking at what is reasonable. The focus is on per-unitcost goals, set by manufacturing using inputs (costtargets) from the business unit. The business unit does allmacro modeling for its products. Finance, working withMarketing develops a must cost, what it takes to meet

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A P P E N D I X Acost targets per unit, per die, depreciation as it is, and asit should be to allow Chip to sell product affordably andearn a reasonable margin. Chip requests a supplier tocome down a certain amount, and has a competitive bidprocess. This approach may or may not achieve the targetcost goal. Chip tries to use facts, share assumptions, andget information from suppliers. But this process is an art,not a science.

Inventory management - Chip is being smart aboutinventory and understanding what flexibility it needs.Inventory requirements change with the life cycle of aproduct. Finance has proliferated a tool to help determinehow much inventory is needed for an item in variousstages of its life cycle. The model provides a framework;individuals still manage the actual inventory levels.

Competitive bidding - Competitive bidding is employed asa way to get the economic impact of competition tobenefit the pricing Chip can achieve. Competitivebidding is usually supported with a secondary method ofunderstanding cost (such as should-cost modeling). Tosupport competitive bidding, Chip strives to always havea second source for any item. If this is not possibleinitially, Chip works to develop a second source.

Supply Chain LinkagesThere is a strong focus on revenue generation for thecompany as a whole. However, in TMG, the focus is stillon cost because benefit side of the equation (revenue) isowned outside of TMG by the business units. As such,TMG is a service organization. However, it is starting toask more questions about business plan product goals,competitive strengths, etc., starting to shift its focus todelivering an efficient supply chain. In the past, therewere more purchasing TCO solutions than true supplychain TCO solutions. Supply chain TCO solutions mustconsider revenue generation.

Internally, TMG has grown tremendously, and as a resultis not as coordinated as it used to be. There is a renewedfocus on cross-functional teams delivering integratedsolutions to business unit problems/requests. A newlyorganized supply chain group that cuts across TMG ispositioning itself to lead the coordination of supply chainbusiness process development for Chip.

Externally, Chip is working more closely with itscustomers and suppliers by tying signals into each other’ssystems (no POs). The more integrated interfaces allowfor reduced delays in information, and better informationis a key to improved supply chain performance. Newtechnologies, such as the XML based RosettaNetstandards, are critical to enabling better supply chain

information flow between partners with incompatibleinformation technology infrastructures.

Supply Chain Modeling/FrameworkThe Supply Chain Operational Reference (SCOR) modelmetrics – plan-source-make-deliver – form the basis ofthe supply chain framework being used for supply chaindesign and evaluation at Chip.2 Using an externally basedapproach is resulting in a better ability to benchmarkwith other companies. Also, Chip is working to take thestandard framework and apply it more directly to thebusiness. As an example, within Chip, the term “supplychain” has come to represent the beginning-to-end flowfor a particular product while a new term, “supplynetwork,” is used to represent the beginning-to-end flowfor a range of products which share critical steps in thesupply chain process.

Chip does not take as strong a supply chain view as itwould like to, but is moving in that direction. Improvingcost management with design for cost is a key initiativeto support this effort. Chip has learned that it is not fairto expect the supplier to improve/lower costs on sub-optimal parts. Thus, Chip needs to design the partsproperly in the first place.

Purchasing/Supplier Impact on CostManagementA supply chain perspective is the key to costmanagement. In the past, Chip told suppliers what itwanted and gave them the design. The suppliers thensupplied Chip according to contract. Previously, Chiphad a major negotiation session with each of its suppliersonce a year, taking three months to prepare its strategyfor a two to three day meeting. This approach doesn’twork well in many areas today. Now, there are morefrequent meetings, quarterly, even monthly, to get pricereductions.

Chip works extensively with suppliers because it doesn’talways know the supplier cost impact of changes itproposes, in terms of yield, cost, etc. It communicatesideas to the supplier (for example, a material change) tofind out how much the idea will cost, even on simpledesign issues. Chip also asks suppliers for cost savingsideas. The key suppliers visit Chip every three monthsfrom Japan. Because most of Chip’s design anddevelopment work is performed in the United States,suppliers must locate and dedicate personnel locally. Inaddition, many Chip engineers live in Asia or visitregularly to help the suppliers develop capability.

Supplier relationships - Chip’s relationship with itssuppliers and contract manufacturers has been

2See http://www.supply-chain.org/ for more information about the SCOR model.

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A P P E N D I XAtraditional, based on the existence of well-documentedcontractual relationships. The importance of the supplierrelationship is increasing and more outsourcing is likelyin an effort to capture the benefits from outsourcing, suchas less capital invested by Chip, better capabilities tosupport seasonal variability, and a strong focus onexecution efficiency due to the survival/profit motive bythe outsource provider. Although the supply chain grouphas taken steps in strengthening supplier relationshipsthrough allocating business on a performance, cost, andvalue enhancement idea submission basis, there is anopportunity for Chip to develop supplier relationshipsthat are more flexible and open. Additionally, Chip needsto continue to work on defining clear expectationsaround performance and controls for its suppliers andthen stepping back enough to let the suppliers execute.

Negotiations - Interestingly, Chip uses the opposite of avalue approach in negotiating pricing on the procurementside. Chip looks at long-term trends, and has developed a“NPV O” (Net present value zero) idea. Under thisconcept, at the end of a project, everyone (suppliers, Chip,customers) recovers their costs, and customary profitmargins, yet no one walks away with the unreasonableprofit. OEM customer pressures are very visible at Chip.

Cost sharing - Price savings are generally shared withsuppliers. Chip estimates what savings are worth inadvance, which also helps set priorities for projects. Howsavings are shared is part of the negotiation process anddepends on market conditions (currency exchange) andother trade-offs. Chip even looks at what its suppliers payfor raw materials on key items.

Finance supports material cost analysis and understand-ing of supplier cost drivers. Materials often comes tofinance to help quantify savings opportunities. Some-times, finance identifies opportunities. Part of finance’scharter is to help identify cost savings opportunities.

Supplier development/communication - From a supply chainstandpoint, Chip looks at a supplier’s supplier when thereis an issue that needs to be addressed. An example of thatis lithography, which involves complex photo equipment.Chip is considering relations with sub-suppliers todiversify risk, get visibility, and stay more on the cuttingedge of equipment. Chip fosters initiatives/consortiumsfor future technology. It is also looking at many morescenarios when planning for manufacturing facilities,planning how factories, people, and equipment cometogether. Chip tries to understand supplier’s processes,and how Chip affects those processes. It collaborates onnew technology and manufacturing processes. Chiprequests suppliers to come down in costs by a certainpercentage generation to generation. Chip looks at TCOfor equipment usage as well as best price.

Chip no longer has to train suppliers in cost ofownership; it is institutionalized in the industry. Chipquestions what suppliers do in terms of costs, at strategiclevel, but does not specifically tell them how to dothings. Chip has breakout sessions dealing with costissues as part of its annual supplier day. If an issue isimportant, Chip manages it by exception, trying toaddress it industry-wide. Chip may go directly to sub-tiersuppliers to address cost issues, and to pre-positioncapacity availability to meet its projected needs.

Employee reward/motivation - The PEP process is theoverall approach purchasing uses to ensure it ispurchasing in the most competitive manner. Savingsplans are incorporated into PEP, and since they impactthe employee bonus goal, such plans are a big issue.Finance rolls up PEP, tracks savings, and owns thesavings calculations to ensure they make sense. Financetries to track true savings to the bottom line. Chipfocuses on value engineering opportunities, identifyingsolo or joint activities to reduce cost. This is the same asdesign for cost; while the latter is done in design, theformer is done once in production.

Role of finance - Chip’s philosophy is that every businessunit owns its own business. Finance’s charter is tomaximize shareholder return. Each person in thematerials organization (TMG) owns cost management.Finance helps the materials organization identify issuesthat should be addressed. For example, in the area oftotal cost of ownership (TCO), what are the key costdrivers? In a given situation, inventory may be moreimportant than price. Chip should focus its effortsaccordingly. Finance also identifies different operatingmodels/approaches that exist for performing a process,and determines which issues it wants to tackle, such as:

• Inventory.• Price.• Warranty.• Obsolescence.

A goal of looking at and developing different alternatives/models is to better understand how to manage the riskbetween Chip and its suppliers. Examples of models forinventory management are Vendor Managed Inventoryand Consignment. In exploring the alternatives and thecost from a TCO perspective, finance:

• Identifies opportunities.• Builds financial models.• Develops trade offs.• Makes recommendations.

Ultimately operations is accountable for achieving costtargets. However, finance enables this process through

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A P P E N D I X Amodel creation, validation, facilitation of model use, andmodel credibility. These models/tools include targetcosting, should-cost, and design for cost. The goal is tohave those in the organization use the models as integralparts of their work. While there has been some success inlinking cost models to design tools, efforts continue tomake design for cost tools more robust and proliferatetheir use throughout design organizations.

Customer Impact on Cost ManagementFrom the customer side, Chip gathers much data on howthe customer makes its purchase decisions. Some endcustomers really look more at the TCO of products thanat price. Chip views its products from a platform level,and develops an understanding of the customer’s bill ofmaterials (BOM) as well as how that customer prioritizesits costs. Chip develops an understanding of how OEMsmake their decisions – as well as the decision makingprocess of the OEM’s customers. Chip’s large OEMcustomers provide Chip their BOM to prove what theycan afford to pay Chip for CPUs. Thus, the negotiationbegins with facts, based on what the market will support,the OEM’s own targets, competitive pressure, andgeography. Chip prefers to direct this discussion to value,and how much each component is worth. While theOEM customers want a BOM discussion, Chip wants avalue discussion, not a cost-plus discussion. Customersdo not always accept the value discussion brought up byChip. The customers push back stating that a given targetprice is what the market will bear for a particular item.

Target costing - Customers do use a target-costingapproach with Chip, and look at expected price declinesover time. Customers look at key components and makethe argument that they can only afford an item in acertain price range. Chip will challenge them on BOMassumptions, and perhaps on margin (which droppedthroughout the industry and supply chain withintroduction of a PC below $1,000). Competitive issuesare then raised in the buyer-seller discussion; issues suchas branding, name recognition, quality, stability ofplatform, and the value of past cooperative efforts.

Customers share retail price targets as well as target pricesfor inputs. In some areas, Chip works with customers(perhaps on mother boards), discussing trade-offs, waysto reduce costs of Chip’s components as well as thecomponents of other suppliers. Chip has created customparts for suppliers as a way to add value.

TCO - Three to four years ago, a total cost of ownershipinitiative was kicked off on the sales side. Chip started towork with its customers to understand how people makedecisions for purchasing desktop technology. Chip foundthat acquisition cost was a small part of what concernedthem. Customers were more concerned with:

• Lack of standardization – expensive.• Installing software upgrades PC by PC rather than

downloading from network.

Chip asked the customers, including both OEMs and endcustomers, how it could help. This resulted in:

• Industry spec “wired for management” built inelements valued by the customer, creating an overallbenefit for the market.

• Network PC – fewer moving parts on the outside ofthe PC, use both network and individual users toconfigure some things, ability to manage networkremotely by downloading some upgrades.

Cost savings ideas - It would be rare for a customer to giveChip value engineering ideas and opportunities, becausemost OEM customers are not technical experts inmicroprocessors. If customers would ask for fewerfeatures, that would help reduce overall costs. Costssaving ideas are more likely to come from the supplierside then the customer. Some companies that Chip buysfrom also use similar technology to Chip in other arenas.So Chip may be able to help them. Chip does sharebreakthroughs with key suppliers, often with supplierswho have good technology but are not proven. In suchcases, Chip has sent in a team to solve the problem, andfix the processes.

Industry ClimateChip has tried to be market neutral rather thanopportunistic. It has tried to share the risks of price andvolume fluctuations with suppliers. But everyone in thisindustry is opportunistic. When the market turns,whoever is in a position to do so will be opportunistic. Itis difficult to negotiate and enforce a price volumecontract with suppliers. Logistics involvement takes on amuch more TCO oriented approach. Decisions are basedon shipping cost as well as damage, liability, tracking,responsiveness, time-price trade-offs, andflexibility/upside in certain regions.

Chip focuses heavily on motivating employees through itsbonus system. Three goals for TMG for this year are:

• How much cost it can take out of the bill ofmaterials versus the initial plan.

• The number of design for cost projects.• How much business is conducted through e-

business.

Opportunities for Improvement in Supply ChainCost ManagementImprovements that could be made to Chip’s supply chaincost management approach include:

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A P P E N D I XA• Looking at critical areas in the supply chain that are

long-term areas, considering whether Chip shouldtake more ownership for some of these items. Howdoes ownership change Chip’s risk profile? What arethe margin opportunities?

• Continuing to emphasize design for cost – focus ontechnologies technology generation – move to costparity from one generation to next, rather thanemphasizing the cost of an individual product.

• Investing is speculative technology for basic researchto take advantage of technological breakthroughs incost.

• Improving relationships with key suppliers.

Success Factors and Barriers to CostManagementOne barrier to better managing cost at Chip is that thecompany intentionally over-designs its products virtuallyall the time. There is somewhat of a “not invented here”mentality for some specifications and requirements thatare actually transparent to the customer. Likewise, thingsthat give Chip a competitive advantage versus acommodity are not always clear.

Purchasing/materials is viewed by the business units asan executing arm rather than a strategic function. Thatsituation is improving. Finance has tried to helpdemonstrate the value added by both purchasing andfinance activities. For example, when they get a targetcost, they try to identify what is commercially viableversus what needs to be designed in or substituted.

There will continue to be a greater cost managementemphasis due to where Chip is in the life cycle of its ownproduct. The market is getting tighter, so there is agreater cost management emphasis, this will help elevatethe purchasing function.

ChallengesPurchasing/materials is viewed as a support organizationby most of Chip. The factory is technically a supportorganization, and the factory views purchasing as asupport organization. The business unit views purchasingand the factory as support organizations. The goal isalways to be world-class, but this proves difficult giventhe breadth of requirements of the various business units.Not all business units believe Chip’s supply chainprovides a competitive advantage for their business.

Overall, cost management gets high emphasis at Chip,and is expected to receive the same or more emphasisover time. The supply chain is viewed as important and,necessary, but probably not a savior to Chip.

Based on Interviews with:

• Four Controllers in TMG, including a CapitalController, a Logistics Controller, a FinancialController and a General Controller.

• A Business Unit Controller.• Four Commodity Managers, including direct and

indirect materials.• A Business Unit Manager (in charge of

subcontractors).• A PSM Strategic Planning Manager.• A Customer Relationship Manager.

LCP CASE STUDY

BackgroundThis organization is a large consumer products (LCP)company organized around business units (BUs). Eachbusiness unit has a Product Supply Vice President whoreports into the Business Unit President. Purchasing andsupply management reside in Product Supply, with adirect reporting relationship to the VP of Product Supply.Also reporting to the VP of Product Supply areengineering, manufacturing, customer service/logistics,and finance. There are one or more finance/accountingrepresentatives supporting each VP, with a directreporting relationship to that VP and an indirectreporting relationship to the Business Unit VP of Finance.The primary goal of this form of organization is to moveLCP away from a functional focus toward a supply chainfocus.

This corporation also has a global business services groupthat manages processes that are transactional in natureand where efficiencies can be obtained from pooling ofresources. This group handles IT, some routine financeand accounting such as payroll, and some MROpurchasing that is common across BUs.

LCP also has a corporate purchasing function. Thisrecently was reorganized and downsized considerably. Indownsizing, LCP eliminated non-value activity andreturned some responsibilities to the BUs, with the MROpurchasing remaining in the global services organization.Today, this corporate purchasing and supply managementfunction acts as a global think tank, looking forinnovative ideas and opportunities for supply chainimprovement and feeding these ideas back to the BUs.

The Product Supply VP for the BU is responsible formeeting the BU cost target for the total delivered cost ofthe product. The total delivered cost breakdown averagesas follows:

More effective purchasing, combined with improvedmanufacturing reliability, have been the primary sourcesof improved profits for LCP over the past 10 years.

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A P P E N D I X A

Supply Chain Cost Management EffortsThe success of supply chain cost management effortsacross the organization has varied, but is improving. Thebarriers to an integrated approach to SC costmanagement include:

1. Fragmentation: Individuals/functions are aware oftheir own issues and responsibilities but not as awareand accountable for those of others.

2. Complexity/Size: Even with seven business units, theorganization is extremely large and complex. It isdifficult to make proactive changes andcommunicate issues.

3. Supply chain cost management is still a new idea. Itis overwhelming right now because LCP has beenfunctional/compartmentalized. The efforts aredependent on BU VP of Product Supply, and eachVP’s understanding varies greatly.

4. Customers are often reluctant to fully share forecastdata and use collaborative planning and forecastingsystems.

5. LCP tends to focus on how to win in LCP’s part ofthe supply chain without hurting the supply chain asa whole. Trying to find win-wins is a challenge. It isstill difficult to get the customer/supplier to seebigger picture. Also, LCP may not see direct andimmediate benefits in price change from improvedsupplier information.

6. LCP optimizes its own costs. The question is, howdoes it optimize the supply chain from end to end,eliminating costs and inventory most effectively?

7. There is a lack of clarity regarding what measuresshould drive the supply chain. LCP has been very

cost driven. It tends to have high inventory levels.Priorities need to be set regarding where to driveinventory out of the system.

There are however, many positive aspects supportingLCP’s approach.

1. VP of Product Supply Structure, providing one-person visibility of all key product supply costs andissues. This individual ultimately has responsibilityand accountability for processes and results. Inaddition, this role is designed to break downfunctional barriers and create a process focus withjoint goals and responsibilities.

2. Corporate Supply Group has provided training andsupport to purchasing and others in each divisionregarding supply chain improvements and costmanagement.

3. Target Costing is utilized by R&D, marketing andproduct supply to integrate internal product costmanagement issues.

4. Supplier cost breakdowns/should-cost analysis isused by LCP to better understand its cost drivers andwhere to focus its improvement efforts withsuppliers. In addition, suppliers of a specializedcontainer have successfully worked collaborativelywith LCP to reduce underlying costs.

5. Flexibility in Supply Chain configuration: Products canbe produced internally or externally depending onwhat is best for LCP

6. Value: Greater understanding of value, not just price,leading to systemic cost and operatingimprovements.

Table 27Total Delivered Cost Breakdown

Category % Primary Owner of Costs

Materials 60% BU Purchasing Director

Manufacturing Expense 20% BU Manufacturing Sites

Logistics 10% BU Sites

Product Supply Overhead 10% BU and Corporate Overhead

100%

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A P P E N D I XA7. LCP has benchmarked best practices of other

companies, particularly those in the automotivesector.

8. Very active, playing a leadership role in e-Business inits industry, working towards facilitating supplychain integration.

Examples of Successful Supplier CostManagementThe supply chain approach used in one business unit isprovided as an example of a best practice at LCP. ProductSupply gets involved early in the new productdevelopment cycle, participating fully in the targetcosting process with R&D and marketing. The targetcosting process begins with a suggested retail-sellingprice. The total delivered cost target is communicated asa percentage of the suggested retail price.

One example of a successful recent target costing/supplychain cost management effort was in the introduction ofan innovative product that was packaged in a specializedcontainer. The specialized container was the largest singlecost element of the product, and was well over theallowable target cost. LCP worked with the specializedcontainer supplier on what it calls “Supplier BusinessDevelopment.” This is an approach it uses for newproducts and product innovations as well as forcontinuous improvement with a supplier.

The supplier was able to reduce the price of thespecialized container by around 35 percent by workingwith LCP. It showed LCP its economics for the product.LCP worked with the supplier, sending in a team oftechnical people, manufacturing people and engineers toset up the process and work with the supplier tounderstand and improve upon:

1. Cost elements.2. Buffers.3. Cycle time.4. Quality.5. Communication.

The specialized container supplier did not want tocommit to making a capital investment for the project.Product Supply presented the entire LCP business planfor the product to the supplier, and the CEO of thesupplier company then bought in.

A decision also had to be made regarding the number ofspecialized container filling machines overseas. LCP andthe supplier looked at the total cost of alternatives.Beyond a certain number of machines, buildingconstruction would be required. LCP agreed to do moreproduction in the U.S. to avoid the investment. LCP used

idle capacity in U.S., to save the supplier money. LCPshares in the savings.

Purchasing works with suppliers to ensure properincentives to meet both party’s business needs. Forexample, in exchange for agreeing to invest in anotherspecialized container machine, the specialized containersupplier received commitments about additional businessin different regions. In providing this incentive, LCPworked to develop a solution that would meet thesupplier’s business needs as well as its own. The key is tofocus on needs of LCP and its suppliers to create a win-win atmosphere.

To support production of the new specialized containers,the organization providing the specialized containermanufacturing equipment mentioned above was giventhe promise that if it delivered on schedule, it wouldautomatically get LCP’s order for the next two machineswithout bidding. The key to LCP was to get the firstmachine out. Such needs can create goal conflict amongfunctions. For example, the purchasing reward systemsare focused on saving money. Purchasing needs tounderstand/not lose sight of strategic issues, criticalsupplies/sources. The VP of Product Supply isaccountable for balancing the goals of timelines,availability, price, and other product-related goals. In thecase of the equipment, time was critical. Thus, theequipment contract included incentives for employees ofthe equipment supplier, including a bonus schedule withmilestones. The equipment supplier’s employees gotreally involved/excited, and succeeded in meeting a veryaggressive schedule. The supplier got a filling machineout in 12 months versus 18, giving LCP a significantjump on the market. Thus, a combination of factors anda number of suppliers were present to make this asuccessful project.

Within Product Supply, building trust, personalrelationships, good communication, and sharing ofbenefits are key elements to long-term supply/costmanagement success. LCP has not been focused on beinga business partner with its suppliers. It has beeninternally focused, in line with its philosophy ofcompetition, externally focused on getting the best pricefrom suppliers. About 10 years ago, it began to workmore strategically with suppliers, including buildingrelationships.

Today, the overriding goal of Product Supply is to providethe necessary capability to meet business needs. ProductSupply’s goal is to be seen as a source of capabilities andcompetencies, there to support marketing, and bringsuppliers innovative ideas to R&D. Product Supplyfocuses its effort based on:

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A P P E N D I X A1. Cost opportunities.

a. Savings it generates are used by marketing foradvertising, promotion, and research, to reduceprices consumers, and to enhance profits.

2. Supporting changes in supply chain processes, such as:a. New product introduction.b. New equipment technology.

3. Supplier relationships.a. Collaborative relationships.b. Competitive relationships.c. Transitioning from one relationship type to the

other.

4. New product launches.a. Distribution center inventory builds (depending

on method of launch).b. Right buffer levels.c. Proper alignment of reward systems across

product supply and other areas of the company.

5. Manufacturing operations excellence.a. Quality, cost, organization, capability, safety, etc.

The order of priority of these initiatives varies by businessunit and from year to year.

The Director of Product Supply is rewarded based onperformance in:

1. New product initiative timing (at affordable cost):setting up supply chains, pre-planning, stability tests,adequate capacity to support new products. Thismeans affordable, not necessarily cost optimized,products at product introduction. Due to time tomarket issues, LCP worries about cost optimizationwhen it makes sense and focuses on the 80/20 rulein terms of leveraging the key cost issues.

2. Cost, cost, cost: This means how to structure thesupply chain to operate at lowest cost, consideringthe capabilities necessary to meet the business needs.

For example, LCP looked at the entire supply chain of oneproduct. It looked at all losses. It took a very regimented,computerized approach, spending four weeks on anintense analysis. Using information gathered on all lossesin that supply chain, it was able to decide which losses topursue in order to eliminate the largest cost drivers/areasof loss. Such analysis involves two phases: 1) plantoperational analysis, understanding what happens withinthe walls of plant; and 2) comprehensive category/productlevel analysis across the entire supply chain.

It found that one of the greatest areas of loss it had waslost time/lack of flexibility in the manufacturing of retail

display units. It worked with the supplier of these retaildisplay units, and within three months cut the processtime in half, while increasing flexibility in the type ofretail displays available.

Insourcing/OutsourcingLCP has long been a manufacturer – doing things in-house,without thoroughly analyzing other opportunities. That ischanging. In the one particular business unit, LCP is:

• Changing what is manufactured by contractmanufactures vs. internal manufacturing.

• Consolidating plants.• Using internal/contract manufacturing seamlessly

along with its own company plants.

In this BU, contract manufacturing is used primarily toexpand capability. This BU uses 10 contractmanufacturers, with which it has close-workingrelationships. Contract manufacturers are viewed asextensions of capability equal to an LCP-owned facility.Outsourcing is value-driven, exploring: “What am Iholistically trying to achieve and is it within the targetcosting for product?” Supply chain flexibility is key tothis BU, along with capability and R&D partnerships.

Supply Chain RedesignLCP is undergoing some major initiatives aimed at supplychain redesign in order to reduce costs and increasevalue. These include reviews of all manufacturingoperations for insourcing/outsourcing determination andtraining key personnel in supply chain design techniques.

Manufacturing OperationsAll business units have been directed to look at all oftheir manufacturing operations, and understand allinsourcing/outsourcing decisions. LCP manufacturingoperations need to be cost competitive with outsidecontract manufacturers. It has great systems, but do they“overdo” these systems? In the last 10 to15 years, LCPhas developed simpler products. Yet it approaches theseproducts like very complex systems/products. LCP fears itmay lose advantage because of over engineering. All BUsunderstand where they add value and where they do not.Now they must review whether they should outsourcewhat is not strategic.

LCP has developed a model based on benchmarking andresearch related to what should and should not beoutsourced. It has trained personnel in each BU to usethe model. Teams consisting of R&D, manufacturing,finance, purchasing, and general management have beenformed in order to provide broad perspective. Each BU islooking at its own processes as a multifunctional team.

The insourcing/outsourcing evaluation is not confined tomanufacturing. All processes/services are under review.

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A P P E N D I XAThis represents a huge and painful cultural change. TheBUs have up to six` months do this review process,develop buy-in to this approach, and come up withrecommendations and transition plans to move LCP intomore ideal supply chains. Each BU is formulating its ownsupply chain design and development.

Training by Product Supply TeamThe philosophy of the Product Supply function is tocreate low cost, demand driven supply chains by tradinginformation for inventory. As such, this group hasundertaken a massive effort to train key people in all BUson supply chain design and cost management techniques.

Although LCP declined to share the specific techniques,overall training includes:

1. Producing to demand: linking the supply chain.

2. Supply chain architecture, including information,material and cash flows.

3. Training tapes on supply chain theory, producing todemand, and initiative management.

4. Collaborative relationships with strategic suppliers.

5. Proprietary supply chain models and tools that workbased on LCP’s own experience.

6. The bullwhip effect.

The corporate supply team acts as internal consultantsproviding training, doing research, and testing theories atbusiness units. The five or six core people on this teamare connected to hundreds more, and have in-houseexperts in place in all business units.

Downstream Cost and Supply ChainManagementOn the customer side, LCP is clearly focused onestablishing long-term relationships with his customers.This emphasis began with a strong relationship with aleading retailer. LCP tends to pass along more of its costimprovements to its customers in the form of lowerpricing than it keeps for itself. It has customer teams forall large customers to help customers determine optimalshelf spacing and layout. It provides research support tohelp customers fine tune or even determine strategy. LCPalso provides this service to small customers, althoughthose teams work with multiple customers. The customerfocus makes sense, given that LCP ties rewards tobusinesses selling more and making more profit.

Product Supply – Globally, product supply focuses onLCP’s relationship with retail customers. The big retailers

consume most of the resources. These are strategiccustomers, tier one retailers such as Wal-Mart, Target,and others. These fully dedicated product supply teamsgenerally include sales, marketing, product supply,logistics, finance, accounting, and IT. Eighty percent ofteam members are non-sales people. Teams like this havebeen in place since 1990. They are well developed inNorth America and Western Europe.

The goal of these teams is to build business withcustomers through various functions and parts of theorganization. For example, logistics works with thecustomer’s logistics group to focus on cost, processes,availability, and other logistical issues. Prior to the teamapproach, all customer initiatives were handled through asales person. Issues did not get resolved, as it was toomuch and too broad for one person. With the teams,many effective approaches have been implemented,including:

- Electronic payments/EFT.- Vendor/supplier managed Inventory.- Logistics programs – help optimize LCP’s systems.- Category management (multifunctional).- Pricing, logistics, merchandising, and specific

projects to increase sales.

LCP rarely negotiates retail price with retail customers.LCP treats all customers fairly/equally in terms of price.LCP teams may help customers by acting as consultantsfor projects and products that LCP doesn’t evenparticipate in or sell. The LCP team develops anunderstanding of customers’ cost drivers/operations,sometimes even beyond the customer’s understanding. Atsome customers, LCP personnel are treated almost asemployees of the customer. They have a great deal ofinfluence, are frequently asked for advice, and areincluded on project teams.

The teams help customers understand/manage categoryprofitability as a whole, by category, and by store. Theyresearch how profitable LCP brands are to the customerand how purchases of LCP products influence otherconsumer purchases. The teams also understand howprofitable the customer is for LCP, and how it drives LCPcosts in areas such as:

• Backhaul performance.• Unloading time.• Cost of the operating team.

The team also works with customers on performanceimprovement. For example, one team developed thestreamlined logistics incentive program. Elementsincluded:

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A P P E N D I X A• A significant reduction in the time required to

unload a truck.• Quality EDI transmissions, so that LCP and

customer map standards the same way.• A customer installing a translator in its system so

that its IT transmissions were seamlessly compatibleto those of LCP.

• A drop and hook program, where LCP trades a fulltrailer for an empty.

Team members interface with whomever they need to –finance, IT, the retail store, merchant, and logistics - inorder to get the job done. LCP’s effort in this area has beenmassive. Overall, the goal with customers is to flip thesupply chain around and become demand driven. Thesupply chain has to be subordinate to the end customerdemand: Don’t push product out, let the system pull.

According to LCP, retailers are overloaded with inventory.The whole industry needs to change. LCP is trying tochange the industry as stores are starting to integrateretail store operations with distribution operations. LCPis trying to manage across organizational boundaries andinto the supply chain. It is trying to understand what isactually driving the supply chain versus what should bedriving it. LCP is focusing on the principle ofdifferentiating and distributing its products as close tojust in time as possible.

Role of Purchasing and SupplyPurchasing is in an evolving state – more involved inoutsourcing and contract manufacturing as LCP movesinto a greater outsourcing mode. In the past, purchasinghelped manufacturing people see what supplier/supplyoptions are available. This is developing into other areas.Today, purchasing helps to facilitate manufacturingstrategy. This involves outsourcing more; people arecoming to purchasing more frequently and see it as afacilitator instead of something that gets in the way, amuch more exciting role for buyers. Purchasing is stillnot involved in some of the indirect service areas such asadvertising, research and development, and so on.

Managing supplier relations is a key role of purchasingthroughout the whole life cycle, from finding suppliers,setting up the relationship, aligning LCP and suppliergoals, and transitioning the relationship to phase out atthe end of the product life. In the past, purchasing wasprice oriented, and delivered price was viewed as theprimary yardstick. But price has been driven down in thepast five years or so. Today, there is a shift to looking atcosts holistically, more like total cost of ownership(TCO), considering issues such as how a material actuallyruns and inventory requirements. This trend toward TCOwill continue. Now, LCP is working to improve suppliersmanufacturing processes, and create synchronousmanufacturing. This involves working more closely with

suppliers on cost (e.g. target costing and cost modeling),sharing proprietary manufacturing technologies, andbringing in the supplier early in the development stage(not the black box syndrome). The goal is to streamlinethe whole supply chain. This is a gradual shift towardsimprovement/streamlining rather than just focusing onprice. This is a more difficult process with commoditytype items, where market pricing prevails.

Sharing cost savings with suppliers varies with thesituation. In general, cost savings and other benefits areshared, based on various criteria. The key is that bothparties will benefit as appropriate.

Reward Structure and OrganizationTraditionally, each function has been rewarded based on acombination of profit/volume and functional rewards.The reward system has recently been changed andbroadened to look beyond profit, including suchmeasures as:

• Total shareholder return – cash, profit, stock price.• Profit and loss, working capital, capital investment.• Forecast accuracy.• Working capital in terms of operating cash flow.

LCP is trying to move away from rewarding behavior thatdoesn’t make sense: e.g. getting the most volume in yourplant. In general, purchasing is rewarded based ongetting the best value, including price, supplierinnovation, capital investment, etc. Customer servicelogistics are rewarded for on time delivery, perfect order,and combining enough volume to ship efficiently.Engineering is rewarded for service to BUs on corporateinitiatives, broad application of its ideas, development ofnew ideas, and service.

The BU is rewarded for delivering projects on time,within budget, and for complexity reduction. People atLCP are heavily trained in cost management. The GeneralManager has responsibility for all sales, costs, and profits- in short, everything. The General Manager thendelegates out total delivered cost and volume. Thefinance and accounting managers leads cost savingsefforts at LCP, supported by product supply andmarketing. A multi-functional team runs the business.Performance of the BU and team are rolled up into eachmember’s performance appraisal. Total delivered cost iskey to the product supply manager. LCP does targetcosting from a consumer standpoint (based on consumerresearch and competition), considering where it can drivecosts out, and make a profit. If LCP can’t figure out howto produce and deliver a product competitively, it mightnot launch that product. Early involvement in theproduct launch process is the key. Everyone is involved atthe idea stage. The disciplines involved change, butsuppliers are often involved.

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A P P E N D I XACase Study Participants:Associate Director of Finance, PSMDirector, PSMBusiness Unit Supply Chain ManagerManager, Corporate Supply ManagementDirector, PSM FinanceDirector, Business Unit FinanceCustomer Liaison, Supply Chain ManagementPurchasing Manager

TELE CASE STUDY

BackgroundTele is a large Telecommunications provider thatcompetes in the local, long distance, and cellularmarkets. Like many of the other companies that werecreated when the telecommunications industry wasderegulated, this company is now the product of severalmergers of baby Bells, and others. The industry has beenfiercely competitive, since it was deregulated. As one ofthose interviewed mentioned, “We spend the company’smoney as if it were our own.” Thus, this company isextremely cost conscious.

Role of Procurement in Strategic CostManagementTele adopts a centralized approach in sourcing andsupports a policy that encourages all contracts andpurchases to go through a single procurement process.The procurement group includes several groups:sourcing/contracting, purchasing strategy and planning,systems and services, supplier diversity and supply chainlogistics, and fleet operations (See organizational chart inFigure 10 below). All the groups are more or lessinvolved in strategic cost management. However, becauseof the diversity of participants, an internal costmanagement-consulting group was formed to collect andanalyze cost data for the entire procurement organizationin a centralized manner, and then provide consultingservice to the internal clients within procurement as wellas clients within the enterprise.

Procurement is responsible for establishing and achievingsavings and supply chain process efficiency targets.Strategic cost management and a continued emphasis onsupply chain management can be achieved only ifprocurement plays a key role in delivering that value tothe corporation.

Procurement works closely with the client organizationsthrough a process called the Client Procurement Plan(CPP) to determine product and service requirements,product selection, and supplier selection. The CPP is aformalized process whereby the procurementorganization meets with its clients a few times each year,

and as new projects arise, to discuss plans, goals, andexpectations. These are developed into plans, and formalfollow-up meetings are held to track progress and modifythe direction, if necessary.

Procurement utilizes a Cross Functional Sourcing Team(CFST) structure to make sourcing decisions. CFSTs arecomprised of members of procurement and clientorganizations, who meet on a regular basis to determinecustomer needs and the value proposition for theorganization. Typical membership might includerepresentation from contracting, engineering, marketing,supplier diversity, supplier quality, ICG, and other keystakeholders.

Within procurement, cost management efforts for new orexisting products or services are driven by strategicsourcing organization (contracting organization). Theseefforts are monitored by evaluating the total cost ofownership for those goods/services, as well as supplier’sperformance in the area of product quality, on timedelivery, and cost of product or delivery non-conformance.

Contract managers leverage high volume materialpurchases to obtain the lowest purchase price through arequest for quote process (RFQ). Value Added Resellers(VARS) are used to reduce costs and improve efficienciesin non-core business activities (e.g. assembly, packaging,installation, etc.). Tele has material planners who workwith suppliers to communicate Tele’s businessrequirements and material forecasts. The suppliers arerequired to reduce their prices year over year via theircost saving and quality improvement practices.

E-procurement allows for ordering to be a distributedfunction across the enterprise, which has always been thegoal and direction of Tele. E-procurement alsomechanizes some processes that were manual before.Strategic cost management in procurement is changingdue to the advances in E-procurement that have thepotential to streamline many current processes.

Internal Cost Management Consulting GroupInternal Consulting Group (ICG) was formed withinprocurement about four years ago when one of thesourcing managers approached the Vice President ofProcurement with the idea that total cost of ownershipanalysis and doing a more thorough, complete analysis ofpurchases could reduce the company’s costs significantly,and improve decision-making. The internal consultinggroup focuses on cost, process, and planning issues forinternal clients. This group gets involved in a variety ofprojects, solely at the bidding of internal clients. There isno obligation to use their services, nor is there a directcharge for their services. ICG mainly serves internalclients within procurement. However, the group may

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A P P E N D I XAservice others within the enterprise either directly orindirectly, including senior management, finance,engineering, marketing, and others.

ICG usually responds to requests from its clients ratherthan actively looking for work opportunities. Some of theconsulting opportunities also come from the seniorleadership team of the company, including the Presidentof Procurement, or any of its Vice Presidents of SupplyChain Logistics and Fleet Operations, Strategic Sourcingor Purchasing and Cost Analysis, as well as theirExecutive Directors, Directors or line managers. Withapproval of the Vice President of Purchasing and CostAnalysis or the Executive Director to whom it reports,ICG has occasionally pursued ideas that it generated.

The ICG is a service organization with a mission tosupport important decisions of all types withinprocurement, or somehow related to procurement.Virtually all of the decisions/analysis in which the ICGgets involved include some type of financial analysis/costassessment. The members of this group have a variety ofbackgrounds, including many years of experience inaccounting and finance, internal consulting in other areasin Tele, as well as purchasing and logistics experience.This broad base lends to the credibility of the group andensures that the right expertise is available for the job athand. ICG also includes, as needed on teams who are notdirectly part of the ICG. For example, many of theirprojects look at various software options. Thus, ICGfrequently works closely with the IT group.

The ICG interfaces primarily with clients within theorganization. It may be involved with suppliers to gatherinformation or to attend joint meetings. However, it isnot a primary interface with suppliers. The informationgathered and recommendations made by ICG areprovided to its clients for the clients to implement. Thus,ICG is a key strategic decision support group rather thanan implementer. In general, it does not have contact withor direct involvement with the needs of externalcustomers.

Examples of projects - ICG is apt to get involved in analysisof projects of fairly significant size and scope. It tends toparticipate in analysis of high visibility projects that areimportant to its clients.

Many of the projects that ICG has been involved inrecently are logistics oriented and/or informationtechnology (IT) focused. For example, on the logisticsside, ICG has been looking at various software to runwarehouse and inventory management systems. Thetypes of projects that the internal consulting group (ICG)gets involved in vary greatly, but includes issues such as:

• Capital expenditure analysis.• Outsourcing/make-buy analysis.• Warehouse location decisions.• Warehouse layout decisions.• Information technology recommendations.• Logistics network decisions, such as trans-shipment

options, material visibility, and equipment choice.• Total Cost of Ownership (TCO) analysis to support

supplier selection.• Supplier evaluation.• Benchmarking best practices.• Assessment of recommendations/decisions made by

external consultants.• General decision support within procurement, much

as an external consultant would provide.• Supply chain cost activity based models.

ICG results - Like an external consultant, ICG presents itsclients with a thorough analysis and recommendations. Itdoes not implement the project. A typical consultingproject would progress as follows:

• Client requests an analysis.• Team/person is assigned to client.• Meet with client to assess the situation and

understand the project charter.• Determine information needs.• Meet with client to develop a plan for gathering

information.• Collect the data.• Analyze the data.• Assemble the data into a package.• Review and verify data and assumptions with key

sources, providing preliminary results.• Formally communicate the results and

recommendation to client, including:•• Executive summary.•• Project charter.•• Assumptions.•• Background.•• Analysis.•• Recommendations.•• Supporting data.

ICG uses a great deal of spreadsheet modeling to developits results. It may also develop what-if spreadsheetmodels that the client can use to check various scenariosand options. The goal of ICG is thus to support informeddecision making, filling in the resource gaps to do theanalysis within the organization.

Contribution of ICG - The ICG fills a gap where there is animportant analysis to be done, generally in procurement,and other groups which either do not have the timeand/or expertise to give the analysis adequate attention.In many cases, this is primarily due to their total

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A P P E N D I X Aconcentration on the day-to-day operation that constrainstheir ability to conduct detailed operational reviews. ICGuses a fact-based, data driven approach to making itsrecommendations. ICG does not tell the client what he orshe wants to hear. Rather, ICG may assess a scenario thata manager presents, and develop additional options. ICGis also in the position to see and understand how theactions and activities of one group or functional area mayaffect those of another group or the enterprise in anunfavorable way. ICG can elevate these problems and getvisibility for them in an unbiased way, because it isgenerally not a stakeholder in the outcome.

Importance of Cost Management at TeleEveryone interviewed agreed that cost management isvery important at Tele. The responsibility for managingcosts is well distributed throughout functions and levelsin the enterprise. Those with budget and/or revenueobjectives, as well as the entire procurement organizationfeel cost pressure keenly. All of those interviewed agreedthat cost management is so important at both anenterprise-wide level and at procurement level inparticular that it would be difficult to further increase itsimportance. Mergers have heightened the visibility of costissues. One of the goals of the mergers was tosignificantly increase procurement savings. That goal hasbeen achieved and exceeded, as savings have been greaterthan planned.

Cost management is one of the procurement group’s fourprimary objectives, along with client satisfaction, processimprovement, and a winning team. Purchasing savingsfactor in as a significant part of individual performanceappraisals in procurement. Team awards and recognitionare also based on cost savings.

There are specific rules as to what can and cannot berecognized as savings, and which savings need to becounted as hard or soft savings, and cost savings versuscost avoidance. The goals and expectations for savings arevery specific and clearly laid out. In general, savings arebased on obtaining lower unit prices for existingproducts. However, Tele is constantly purchasing newitems and leading edge technologies. In these cases,savings would be calculated on the reduction in priceobtained from the best initial competitive bid, to the finalnegotiated supplier price for the same scope of work.This method is accepted by the organization because it isrelatively objective. The total savings achieved throughreducing the costs of products and services andmaintaining these low costs measure the overall valueproposition of the procurement organization. Thistranslates into bottom line business results. Thus, at avery high level, procurement performance is alsomeasured by looking at supply cost as a percentage ofrevenue. The corporation’s expectation that this metricshould improve year over year has occurred.

Supply Chain Management Focus of CostManagement ActivitiesProcurement takes a total supply chain view of strategiccost management. This is evident in the support providedto strategic sourcing and logistics, which are fundamentalenablers to achieving a status of lowest total-cost producer.

Tele’s focus on managing the cost of purchased goods hasincreased over the last five years, and it has recognizedthe significant value that supply chain savings can bringwith the advent of various mergers in 1997-2000. Supplychain savings have been promoted as one of Tele’s keysuccess factors in merger integration activity.

The procurement organization looks at the cost structurefor first, second and often third tier suppliers in order toexamine ways to improve processes that may affectdownstream costs. Tele is growing in the area ofpartnering with its first, second and third tier suppliers tohelp them identify where they can drive costs out of theiroperations and pass them along to Tele.

In executing material contracts, strategic sourcingselection process involves:

• Quality/functionality.• Service.• Price.

Savings are recorded primarily based on the differencebetween what Tele is paying currently compared to what itwill pay under the new arrangement. Strategic sourcingdoes not report internal process savings, as it is primarilyresponsible for reducing cost from suppliers. Utilizing theexpertise of the ICG, strategic sourcing develops,implements, and executes plans that assure the best valuedproduct/service is provided to its clients. The ICG brings astronger focus on supply chain cost that adds to thequality/functionality, service price analysis and thusenhances Tele’s value proposition. With all the Telemergers, the primary emphasis has been to reduce firstcost. Now that Tele is settling into a more stableenvironment and first costs associated with economies ofscale have been achieved, it is expected that the totalsupply chain will be emphasized. As a consequence, moreresearch is initiated to investigate the supply chain impact,i.e. transportation elements embedded in a supply chain.

The goal of Tele is to take a supply chain focus in itsanalysis. That is one of the reasons that ICG tries to use atotal cost of ownership perspective in its analysiswhenever it is applicable. It tries to understand and factorin the impacts of different alternatives on its suppliersand customers, as well as on its own performance. Thereality of the situation is that many projects are verycomplex and far-reaching, and may be analyzed in partby a number of different groups. Whereas ICG might

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A P P E N D I XAlook at the cost and operational issues associated withdistribution center locations, marketing might look atcustomer service issues associated with the samedecision. Thus, while ICG might focus more on supplyside issues, other groups are investigating additionalfactors that affect the supply chain view. The contractinggroup asks major suppliers to provide it with detailedinformation about sources of supply and costs as part ofthe bidding process. This allows them to really under-stand key risks and costs associated with second, andeven third tier suppliers, and ask the first tier supplier tomodify its supply chain to reduce risk and cost.

Cost Management Tools UsedTele’s cost management emphasis focuses on Total Cost ofOwnership, Target Costing, and Operating Procedure 6(OP6). These tools are supported by the use of the ClientProcurement Planning process, as mentioned above.

Tele takes a total view of strategic cost management byfocusing on a Total Cost of Ownership (TCO) model.TCO is a specified methodology for analyzing andreporting the value of first cost savings and other in-process costs. Among all the cost management tools,maintaining/updating TCO’s component prices in aneasily accessible location and format is most difficult.However, it is one of the principal analysis approachesused by ICG. ICG tries to identify all direct effects, andmany of the indirect effects associated with the situationsit analyzes. This tool cuts across many of its projects. It isa primary tool used in analysis of process costs andmake/buy or insource/outsource alternatives. Wherelong-term investments or multi-year projects areinvolved, ICG also uses net present value analysis.Should-cost analysis is also used when trying to developan understanding of a supplier’s cost structure. Priceanalysis and benchmarking of costs and processes amongthe various “baby Bells” that make up Tele also providethe ICG with important information for its analyses.

The contracting process requires an RFQ and decisionsummary to ensure that the sourcing decisions aredocumented as the best overall value for the company.The contract decision summary documents the detaileddescription of why a project is needed, and details how adecision was made and what process was utilized toreach this decision. Thus, it provides clear andconvincing information as to which award rationaleapplies to this project and how it applies to the award.The contract decision summary and target costing areconsidered the most important tools by the supply chain-planning group within procurement.

Besides TCO and target costing, Tele also utilizes acommon set of tools entitled Operating Procedure 6(OP6). OP6 is a detailed set of procedures used to

describe how to evaluate supplier capability and financialhealth, undertake price analysis, conduct the biddingprocess, and document the contracting process. Itprovides a single “One Tele” contracting process thatallows sourcing requirements to be aggregated andcoordinated across Tele for full leverage of the company’sbuying power. All contracts are audited to ensurecompliance to OP6 process and procedures.

Status of Procurement within the OrganizationProcurement is viewed as a key strategic function andhighly regarded at Tele. The organization is involved inthe planning an implementation of key company growthinitiatives, and participates in high-level decisions onSCM direction and value propositions for thecorporation. The overall value proposition of theprocurement organization is measured by the Total Costof Ownership - savings the organization achieves whensourcing products and services and reducing andmaintaining the lowest operating costs, which translatesinto bottom line business results.

Over the last few years, procurement has beenestablished as part of the core business of Tele. As suchits expenses are watched closely at the corporate level.Procurement has quality processes integrated into theorganization to enable successes at each level of theorganization and with suppliers. Cross-functional teamsare in place and empowered to help drive lowest costsourcing and logistics strategies and business practices. Inrecent years, procurement savings have contributed moreto bottom-line profitability than have sales.

However, procurement must constantly prove that it addsvalue to processes and purchases. There is norequirement within the corporation that other areas usestrategic sourcing. They may circumvent the procurementorganization if they feel it does not add value. However,given that procurement does handle a great deal of Tele’sbusiness, it is clear that some feel it is a value addedoperation. It has recently received much positiveattention for the purchasing cost savings generated by themergers. However, some areas mainly think about theprocurement group when there is a problem to be solved.Senior management in procurement, and the seniormanagement team in general is trying to educate otherareas within the enterprise on the supply chainopportunities that exist in virtually all business decisions,and get procurement and ICG involved earlier and morefrequently. An overview of Tele’s supply chain processes isprovided in Figure 11.

Involvement of Other Organizations in StrategicCost ManagementInternal function’s involvement - At Tele, strategic sourcing,purchasing, logistics, fleet and corporate real estate are in

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A P P E N D I XAthe same organization. Design and marketing are tied inthrough the Client Procurement Plan process. Otherinternal functions are usually involved and coordinatedvia a cross-functional sourcing team, which hasrepresentatives from the organizations that are affected bythe specific commodity it is studying.

Various functions are tied to strategic cost management.Strategic cost management begins with an understandingof the organization’s vision or business plan, which iscalled harnessing the power of the supply line. Functionssuch as purchasing, strategic sourcing, logistic, fleet, andinventory management provide a flow of information onbest business processes. These are developed intostrategies that make use of technology innovations,improvements in quality, and negotiating new contractsthat increase revenue or reduce costs. Most importantly,the business plan tries to integrate all of the functions inprocurement and tie all of the decisions, processes, andactivities into a lowest-total-cost life cycle basis (startingwith the raw materials, flowing to the end user).

Suppliers/Customers involvement - Suppliers are involved incost management via training and quality programs.However, currently, Tele does not have a formal supplier-training program for SCM. It conducts ad hoc training inorder to implement supplier performance metrics, relyingheavily on documented TL9000/ISO 9002 methods.Suppliers are also trained on Web-based measurementtools and ensure the integrity of their performancemetrics, according to TL9000 or other criteria.

Customers are involved via client procurement plans thatprovide for client interaction at the senior managementlevel through a semi-annual planning process where Telestaff meet with their clients to identify/discuss their keyinitiatives, which translate into material and servicesrequirements. These requirements are fed to cross-functional sourcing teams, which evaluate and makesourcing decisions. Additionally, the contracting group isorganized by technology/product group and is considereda single point of contact for contracting and technicalexpertise for the client organizations.

The Client Procurement Plan (CPP) includes thefollowing aspects:

• Clearly links the supply chain process to the client’ssuccess.

• Provides an opportunity to dialogue with client andcalibrate on their key objectives, creating buy-in atthe officer team level.

• Proactively focuses supply line issues to create asignificant competitive advantage and increase clientsatisfaction.

• Develops and prioritizes client list - review periodically.

• Schedules attendance at client staff meetingswhenever possible to facilitate participation of keydirect reports and ease scheduling difficulties.

• Schedules one formal meeting per year - use follow-up appropriate to each client (e-mail, conferencecall).

• Integrates CPP into Cross Functional Sourcing Team(CFST) process, taking advantage of established linesof communication and eliminating duplication ofeffort.

• Assesses program effectiveness from both client andprocurement viewpoint.

Potential Improvements to Tele’s CostManagement ProcessTele is proactively engaged in doing more in the area ofstrategic cost management in the future. Tele haslaunched Critical Redesign Opportunities (CREDO) abroad based program aimed at identifying cost reductionopportunities and process improvement initiatives acrossthe organization. The company recognizes that withindustry restructuring and technology change, thecompetitive advantage lies in the supply chain.

The organization has initiated the integration andimprovement of its various information systems. First, theday-to-day purchasing functions (invoicing, billing,tracing) need to be integrated because of multiplesystems and processes introduced through mergers. Tworegions have been converted, while the remaining tworegions are on schedule. Second, much of currentinternal reporting is aggregated information aimed at topmanagement. To remedy that, the organization isdeploying an activity based cost management model forthe entire logistics portion of the business. Tele plans toextend this activity-based tool to corporate real estatedesign and construction functions next. Operating levelpeople have now the capability to understand andsupport day-to-day decisions related to their operation.Along the same line, it would be helpful if there weregreater organizational memory, such as a database thatwarehoused past analyses and captured key process costs,best practices, and other process related information. Thiswould help Tele’s efficiency so that it would not continueto reinvent the wheel.

There has also been a positive trend towards getting ICGinvolved earlier in key decisions, when there is sufficienttime to do an adequate analysis and create a thorough setof recommendations. Continuing along the path of earlierinvolvement in broader issues would also improve Tele’scost management capability.

Case study participants:Director, Contract Savings & ReportsDirector, Supply Chain Performance

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A P P E N D I X ADirector, Supply Chain PlanningDirector-Operations, Supplier DiversityFinance ManagerArea Manager, PurchasingInventory Planning Area ManagerThree members of the internal consulting groupExecutive Director of Market Cost and Strategic Programs

PRAXAIR CASE

BackgroundPraxair is a $4.2 billion company that manufactures andsells a variety of gases and related products and services toa number of industries, including medical and high tech.Because Praxair is in a commodity business, it is under agreat deal of pressure to manage and reduce costs in itsmanufacturing and delivery processes. More demographicinformation on Praxair is provided in Table 28.

Several years ago, Praxair under-went a significant re-engineering/reorganization on the recommendation of amajor consulting firm. The sourcing area was a majorfocus of the reorganization. It is shown it its current formin Figure 12. The sourcing organization has continued toevolve. The major developments in procurementprocesses are shown in Figure 13.

Responsibility for Cost ManagementThe emphasis on cost management at Praxair is veryhigh. The focus is both internal, on operating spending,and external, on money spent with suppliers. Eachbusiness is accountable for its own cost management.Responsibilities are as follows:

• Business Units – each is responsible for the cost ofindustrial gas that it sells.

• Distribution group – responsible for the cost ofdistribution of gas.

• Production/Operations – responsible for the cost torun/maintain facilities.

In sales and marketing, the focus is on revenue growthand cost in terms of the budget. Seventy percent ofinternal costs are salaries/benefits.

There are also certain service groups that have overallresponsibility for cost management within the company:

• Global procurement is responsible for spend withsuppliers.

• Productivity team looks at productivity initiativesthroughout the organization, with a primaryemphasis at the plant level productivity.

• Six sigma team/initiative looks at many projects andanalyzes/creates solutions, to save the companymoney. Many of the issues this team deals with arerelated to Praxair customer satisfaction, such as on-time delivery.

• Energy management group is a dedicated energymanagement team that has existed for the past 10to15 years. Because electricity is one of Praxair’slargest costs of doing business, this focused teamlooks for continuous improvement opportunities.

All of the teams have the overarching goal of generatingmeasurable cost improvements, efficiency, and value aswell as focusing on customer satisfaction. Each isaccountable for delivering major, traceable savings eachyear. Each commits to delivering a certain amount ofsavings to the business units, which is in turn built intothe business unit strategic planning process in terms ofcost reductions.

Purchasing’s Accountability for Cost SavingsThe specific accountability for cost savings in thepurchasing area includes:

• Operating profit impact: Purchasing has saved over$100 million in the last three years. Praxair has asophisticated database and tracking system tomeasure the impact of each initiative, comparingactual vs. planned savings on a monthly basis. Todate, most of the $100 million savings is measuredin expense items rather than cost of goods.

Table 28Corporate Profile: Praxair Inc.

Primary Business: Praxair is a global company that produces and supplies atmospheric, process,and specialty gases and atmospheric technologies.

Key Business Units: North America, South America, Europe, and Surface TechnologiesTotal Sales (2000): $5.043 billionOperating Profit (2000) $707 millionNet Profit (2000): $363 millionNumber of Employees: 23,500Approximate Total Value of Purchases: $3 billion

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A P P E N D I X A

• Capital goods: There is separate measure for varianceon capital expenditures over previous buys. It isharder to clearly measure savings on capital becausePraxair buys different capital each year. One measureof savings being used, but not included in the $100million mentioned above, is whether purchasingspends less than budgeted to achieve the businessunit goals.

• Materials management: This group concentrates onhow to manage cash/inventory. The focus here is oncontinuously reducing inventory without decreasingservice. Consignment and/or supplier inventory aretwo favorite and successful approaches.

When Praxair reorganized, it shifted towards a strongtotal cost of ownership (TCO) focus for external goods

and services. A critical goal for procurement is to delivera quantifiable reduction in spending each year.

Financial objectives are set each year. These driveprocesses. The objectives are set based on savingstranslated in terms of earnings per share. Purchasingconsiders:

• Current initiatives that carry over to next year.• Other ideas for cost savings.

Purchasing presents the cost savings ideas to thebusinesses, and the business units build the savings in totheir business plan. They capture specific, separate lineitems in reporting that show procurement related savings.These appear right next to sales in the internal reporting.Purchasing savings are reported monthly, and must be

Figure 13The Path to Supply Chain Excellence

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A P P E N D I XAconsistent with what the business units report aspurchasing savings.

Individuals within procurement have specific, measurablegoals, in such categories as operating business by country,by commodity, and by commodity manager. These focuson bottom line savings (operating profit impact).

Praxair uses a dashboard system that captures 27measures. There is a sophisticated system to trackprogress versus goals, supported by the globalprocurement impact operating profit database. Costimprovement is part of the commodity managers PMP(Personal Management Program), goals for the year.Progress is measured and evaluated as an input to theannual salary adjustment. For more senior people, PMPperformance also impacts the variable compensationbonus. They are also measured on the fixed cost to runthe procurement organization

Purchasing also considers what it costs to providepurchasing services to the organization. This includeseverything from having the right staffing level to traveland attending conferences. They are held accountable forinternal cost management. The belief is that in order forpurchasing to truly deliver value, it must also control itsown costs. Thus, there is an emphasis on both internaland external cost management. Purchasing is a cost center,so it must convince the businesses to pay for their servicesevery year as part of the annual budgeting process.

Praxair negotiates cost allocation of supply managementto businesses. They do this on an activity based costingbasis, matching the relative support of each person toeach business. Accounting in general is roughly activitybased on key cost drivers. Top management believes thisapproach to allocating departmental costs leads to betteralignment between the service organizations and thegoals of the business unit. Praxair is very results driven.

Purchasing OrganizationUnder the Vice President of Global Procurement andMaterials Management, there are four key purchasingdepartments, as follows:

• Global Excellence, Expense and MaterialsManagement.

• Global Services and Equipment Procurement.• Purchasing Controller.• usiness Development and Supply Chain Excellence.

Globally, Praxair has 200 people who report into theprocurement organization. In North America there are 90people, including 15 in accounts payable. The generalresponsibilities of each are shown in Figure 12. Theorganization and responsibilities continue to evolve.

Business Development Group - The Business Developmentgroup is assigned projects to work on based primarily onprocurement’s six critical successful factors, as identifiedin the strategic plan.

• People excellence.• Sourcing strategy/supply management.• Internal client satisfaction.• Measurement, reporting, and forecasting.• Ease of doing business with.• Globalization.

Each of these factors has a vision or an ideal stateassociated with it. Praxair has developed a transformationmap that has a starting point of 1998 and extends fouryears beyond the current year (see Figure 13). This maphelps identify and prioritize on what projectsprocurement should focus. The mapping process andexecution are managed by the global procurementleadership team, which includes all procurementdirectors. A global procurement director is assigned to beaccountable for each of the six critical success factors.This includes assessing the:

• Historic progress.• Current state.• Desired state included steps identified to improve.

This is an integrated process, a living document. TheBusiness Development group works with the owners ofeach critical success factor to implement programs. TheBusiness Development group includes members withexpertise in people, process, tools, and technology, and asupply chain quality engineer. These individuals workwith directors to identify and develop project plans. TheBusiness Development group also maps its activities,which allows its members to see the impact andinterrelationships among activities, and helps setpriorities. They plan their focus for two years out. Inaddition, the Business Development group receives adhoc requests for support from teams.

Purchasing controller - The controllership function of theglobal procurement group is a director-level positionreporting to the Vice President of Procurement along withthe three other procurement directors. This function wasadded for a number of reasons when the procurementorganization was re-engineered. The reasons for addingthe controllership function include:

• Improving the management of cash flow, includingthe use of appropriate payment terms.

• Helping to determine the savings potential ofprojects.

• Developing appropriate mechanisms for trackingcost savings.

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A P P E N D I X A• Tracking the actual savings potential of projects.• Obtaining business unit buy-in to the actual project

savings.• Working with corporate/business unit Controllers to

reduce budgets by the amount of purchasing savingsrealized.

This function has also been important to developing andmaintaining the credibility of the savings achieved bypurchasing. Credibility of purchasing’s numbers had beena problem in the past. Currently, the focus is on reportingonly savings that directly affect the bottom line.

Praxair views purchasing like it views sales, as a way togrow the business, but with an emphasis on savingsrather than sales. The reporting by the controller lendscredibility to the savings calculations. The controller andhis team report savings, provide direction, educate staff tohelp reduce operating costs within procurement, andmonitor the budget. The controller function works withanalysts within business units to identify monthly spendpatterns. It also works with purchasing to understandspend at the supplier and commodity level. Thecontroller function then goes back to internal clients atthe business units to make sure that they are realizing thesavings anticipated. The biggest reason for not achievingsavings is spending that is out of compliance withnegotiated agreements. Thus, the controller function hasalso educated business partners on lost opportunities as aresult of using suppliers outside of procurement’s contracts.

One of the primary duties of the controller is tocoordinate and ensure consistency in purchasing’soperating profit impact in terms of forecasts, actualreporting and estimates.

He plays a coordination role between global procure-ment, the global business units and the financial servicesgroup. Within the purchasing controllership function, ateam of three analysts supports day-to-day activities.Accounts payable also reports to the purchasing con-trollership. They are looking for synergies here in termsof reducing the workload, and streamlining processes.

There is no real or perceived conflict regarding thecontrollership function’s reporting relationship topurchasing. The controllership area is data driven,provides credible numbers, and shares the basis of itscalculations.

Controller’s span of interactionThe controller works with everyone in the procurementorganization. When procurement claims to have anoperating profit impact, there is substance to it, asverified by the controller function. To determine theamount of savings realized, Praxair compares past spendto current spend, adjusted for volume. It reports savings

over a 12 month period. The initiative drops out of thesavings calculation after a 12 month period. Thisprovides consistent reporting of savings. While mostcontracts are two or three years in length, purchasingonly gets credit for the first 12 months of savings.

Reporting savingsPurchasing/controllership is accountable for reviewingsavings calculations with businesses; purchasing doesn’tget to report savings unless business unit finance buysinto the savings. The controller works with purchasing toget business unit finance to buy in to the savingscalculations in advance. No savings are claimed until anew contract is in place, and goods/services have beenreceived – where savings are actually recognized on thebooks.

Tools are critical to help support reporting anddetermining savings. A key tool is the spend datawarehouse. This has given Praxair the ability to sortspending throughout the world, by region, bycommodity, by supplier, and so on. There are alsosystems to track progress on various initiatives. Thesesystems are key to forecasting and planning of currentand future savings potential.

The controller realizes that the level of emphasis onstrategic cost management in the future is at leastsomewhat a function of the economy. If sales rise, there isless emphasis, because if the top line rises, so doesbottom-line. The role of purchasing in strategic costmanagement processes continues to evolve. The initialemphasis has been finding the suppliers with the bestprice and cost structures. In the last 12 months, reverseauctions have helped significantly in getting results. Soleverage has been important. There is a limit to what youcan do here. Once it chooses a supplier, Praxair looks forimprovement opportunities, asks to benchmark with thesupplier. The next step is to help suppliers manage theircosts.

Strategic Sourcing Processes after ReorganizationThe changes in purchasing/supply at Praxair were madeunder the directive of and with the full support of theCEO and CFO. Prior to the reorganization, purchasing atPraxair had been transaction-oriented. With thereorganization, and the help of a major consultantcompany, purchasing has developed and implemented arigorous 12 step strategic sourcing process. This approachutilizes cross-functional teams to thoroughly analyze theorganization’s current spend and uncover opportunitiesfor improvement. The strategic sourcing process includes:

• Quantifying the organization’s total spend, includingwho buys what from whom.

• Continuously identifying the commodities that affordthe greatest potential savings opportunities.

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A P P E N D I XA• Understanding the market for that commodity.• Developing a should-cost analysis for the

commodity, including make versus buy.• Benchmarking secondary data and internal pricing

data.• Understanding the scope, qualifications and reach of

the current supply base.• Developing steps for improvement.• Implementing action plans, including meeting and

working with suppliers to solicit their ideas andcooperation.

Praxair procurement has demonstrated success byfollowing these processes. But one of the keys to its successis its ability to analyze data. The implementation of its datawarehouse has been a critical improvement to itsoperations. Another factor has been the role of theprocurement controller, who helps track project progressand savings, and helps gain buy-in from the business units.

The steps that are particularly relevant to strategic costmanagement are presented in more detail below.

Identifying opportunities for Savings - There are severalways that Praxair identifies cost reduction opportunities.One method is through the strategic sourcing process.Opportunities also come from reviewing spend data.With Praxair’s data mart, procurement personnel andothers are constantly reviewing the data for opportunities.

Also, a growing source of ideas comes through the strongalignment of purchasing with the businesses today.Business units now pull purchasing in and want theirinvolvement, unlike the past. Business units help identifyopportunities where they know they need help. In somecases, purchasing may attend monthly business unitupdates, and have the opportunity to present ideas aswell as learn about key business unit issues. The exchangeof ideas may prevent the business or purchasing fromwasting time going down unproductive paths.

Cost savings tools - Praxair uses a wide variety of tools togain cost reductions. Their data warehouse is a criticalelement for them to obtain the information required tounderstand their spend, identify and measure theopportunities, and track ongoing results. Praxair uses e-business tools to focus on transaction cost reduction andefficiency. The modular portfolio/piecemeal approach toits software selection and use allows Praxair to choose thetools best suited to its needs. It has also effectively usedB-2-E tools such as electronic bidding, and both reverseand forward auctions in managing and reducing costs,and managing its entire sourcing operations on a hosted,web-based platform. Other cost management tools usedby Praxair include:

• Working with suppliers to manage cost drivers.• Supplier suggestions – give and take.• Price analysis.• Total cost of ownership (TCO).• Target costing for capital equipment.

Total Cost of Ownership focus - Total cost of ownership(TCO) is a key issue for Praxair. To them, it is a primaryapproach for assessing spending on particular goods orservice area. All Praxair procurement members are taughtto look beyond purchase price in assessing opportunities.For example, in purchasing PCs, they consider software;help desk, uptime, etc. They would also standardize onthe PC brand and model number to further save TCO onsupport elements.

TCO assessment is an integral part of the strategicsourcing process. Praxair tries to quantify all the keyelements in the TCO model it develops for a commodity.For example, if it is sourcing cranes, Praxair will considerthe cost for equipment and the operator, as well as thecapability of the crane, and how long it will take thecrane to get the required job done. In many cases, afundamental strategy is to first standardize, then go tomarket.

There are situations where there is a conflict betweenTCO and price. Price is easy to track, so it may receivemore weight than it should. Praxair is developing goodmethods for tracking TCO to overcome this potentialconflict. The best way to get people internally andexternally to understand TCO principles is througheducation. Praxair conducts training with key suppliers,business unit contacts, and sourcing people on TCOprinciples. As a result of this training, Praxair has set uppilot programs with teams to use TCO. This helps theunderstanding and use of TCO.

Praxair’s concept of TCO is to look at all cost elementsfrom a design, supply chain, and usage perspective, anddrive costs out by coming up with better solutions.

One success that Praxair could share was the use of TCOto significantly lower the cost of an imported product thatit formerly brought to a central location and distributed.Praxair has redesigned the supply chain, improving freightand using a third party to distribute. This was a greatTCO example of working with a supplier and consideringthe whole supply chain/processes.

Team perspective - One of the goals of the 1998reorganization was to broaden the perspective and scopeof procurement. Thus, Praxair has cross-functionallystaffed the organization. In addition to getting a bettercustomer perspective, this move has helped relations withinternal customers. They see that their counterparts in

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A P P E N D I X Apurchasing have the same background, understanding,and perspective, and this improves rapport andcredibility.

The use of procurement-led cross-functional sourcingteams is important in improving analysis and facilitatingchange in sourcing practices and execution. The primarypurpose for creating a strategic sourcing team is to lowerthe TCO for the commodity studied while maintainingthe level of service. Praxair also wants to increase thelevel of support and attention it gets from the suppliers,to get a higher allocation of the suppliers’ resources. Thesourcing teams stay together through the implementationand management of the chosen supplier. Some of thegoals of keeping the team together include getting peopleto utilize the preferred supplier, and creating a high levelof commitment to and visibility for the supplier. Theyalso measure internal client’s compliance with thecontract and try to understand why people are not usingthe preferred supplier.

The cross-functional teams vary in membership. Forexample, with the global PC contract, there was a userrepresentative from each region of the world. The teamfor sourcing cranes included a procurement person withan engineering and project management background,representatives from operations who run existing plants(users), engineers, and project management.

Example of Strategic Sourcing: CommodityManagementThe commodity management process is founded on the12 step strategic sourcing process. Commodity managerslead the cross-functional teams. The commodities underfocus vary from year to year. In general, Praxair performsa complete commodity analysis on one to two majorcommodity categories per month.

Supplier interaction on cost management occurs as partof the strategic sourcing process. After the sourcing teamhas internally developed a strategy for TCO improvement,and a formal sourcing strategy document, it involves thesuppliers. It conducts individual supplier workshopswith suppliers that it intends to invite to participate inthe RFQ. Praxair shares with the suppliers one-on-onewhat the initiative is about, the goals, how it views theTCO elements, and their magnitude. The suppliers arethen asked to answer questions about their best practicesfor cost management, delivery, and related issues so thateach can build its case as a viable supplier. The suppliersreceive the questions in advance, so they can beprepared. This meeting validates and enhances thesourcing process.

Based on the workshops, the pool of suppliers invited toparticipate in the RFQ might be reduced. The workshopsalso leave the team very well equipped to write a solid

RFQ. The supplier workshops and supplier inputsvalidate and enhance Praxair’s strategy before it goes outto the market. This allows it to ask the right questions forTCO elements in that situation. As a result, it gets goodresponses from its RFQ process. Any outstanding issuesare clarified before the cross-functional team selects thewinner(s).

The cross-functional team assesses the suppliers’ bidsbased on what they rated as important in the TCOmodel. After selection, they negotiate with the supplierand develop/execute the contract and its terms andconditions. They then notify the internal clients that thisnew contract is available for use, and how to contactthem. The sourcing team engages the chosen supplier inimplementing their relationship and communicating withinternal clients. In some cases, the supplier may holdinformation sessions within Praxair, visiting variouslocations.

Supply Chain View of Cost ManagementSupply chain focus - The aspiration of Praxair procurementis to develop a supply chain view of cost management.This is seen in its extensive use of total cost of ownership.Praxair considers more than price. It also looks atsupplier performance in areas such as quality andelectronic capability. Total cost of ownership is also a keytool for capital acquisition. TCO also comes into play inmanaging internal cost/budgets.

Today, Praxair doesn’t see the entire supply chain withinits procurement area. The business development functionfocuses more on the buy side, up to product delivery. Thesupply management group is not yet dealing directly withcustomers on a regular basis. The sales/marketingorganization is protective of customer relationships, andpurchasing now has plenty to do without direct customerinvolvement.

The sourcing process is integrated with the businessunits, so purchasing gets much front-end involvement.Today, supply management looks at all aspects that touchthe supply chain from design to purchasing to strategy topayment, transport and storage. Supply management isreally looking at all the key elements of the supply chain.The perspective is getting broader.

Supplier cost management - Supplier cost managementoccurs primarily through the commoditymanagement/strategic sourcing process. Praxair askssuppliers for cost breakdowns, and also does its own. Itpresents the cost breakdowns to suppliers, and askssuppliers to tell them where Praxair is wrong. The moreopen suppliers are the ones Praxair wants to work with.This approach worked well on PCs, services, and withsome construction contractors. They agree on profitmargin, and share in the risk on costs. Travel is also

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A P P E N D I XAmanaged in a detailed way, in which the cost managementprocess includes management of the entire overhead.

To facilitate supplier process improvements, Praxairencourages them to use Praxair’s commodity managementapproaches with their suppliers. Praxair does some on-line reverse auctions, and on-line bids; Praxairencourages its suppliers to use a similar approach toreduce their own costs, because it wants its suppliers tobe effective and competitive.

Key Supplier Management and ContinuousImprovementOnce the relationship is under way, Praxair has aprogram for supplier management that it uses with keysuppliers. The process involves meeting with criticalsuppliers to identify key performance indicators (KPIs)such as price, technology and service. Based on the KPIs,they establish a report card, and work with cross-functional teams to get feedback from the variousbusinesses on how the supplier is doing. In addition todoing a formal report card rating each critical supplier,Praxair gets input from suppliers on Praxair’sperformance and how Praxair can improve as a customer.Praxair calls this the TARGET process, because the focusof continuous improvement revolves around acombination of the following elements:

• TCO.• Assurance of Supply.• Responsiveness.• Global reach.• Environment and safety issues (big for some

suppliers).• Technology.

These TARGET elements vary in importance with thebuy. The lessons learned during the supplier managementphase can impact the strategy and focus for that areacommodity, so the whole process is circular. Cost isnormally part of the equation in every situation, but itmay not be the area of greatest importance.

In situations where Praxair has ongoing relationshipswith suppliers, price is still an important consideration.However, Praxair also looks at how to take costs out ofthe system, exploring options in packaging, collaboration,and so on. Praxair tries to work with a total cost ofownership (TCO) approach.

Praxair does a good job of digging into supplier’s coststhrough its supplier management program. It works withsuppliers to find out what Praxair does that hurts thesupplier’s productivity or increases costs. The focus ofcost management is primarily suppliers, but is expandingto include other supply chain elements. There is not as

great a supply chain emphasis for corporate services; theemphasis is more internal. But other areas naturally lendthemselves to a supply chain perspective, such asdistribution costs, the costs of hiring transportation.There is a closer connection to understanding the supplychain. In addition, Praxair gets some feedback fromcustomers through sales, to engineering. This process isnot mature, but it is moving in that direction.

Supplier relations - As a first step of the suppliersegmentation process, Praxair segments its supply basebased upon the criticality of the purchase and thesupplier to Praxair. This is how Praxair determinessuppliers with whom to collaborate, versus those wherethe focus can be more price-oriented. Criticality is viewedin terms of dollar spend, safety issues, quality issues, andother similar factors. Praxair limits the number ofsuppliers with whom it will align to 65 to100. With thisgroup of suppliers, Praxair works very closely tocollaborate on joint efforts for mutual benefit. This is inline with the supply management program TARGET, aspresented above. Praxair is also developing a supplieraward program to formally recognize top suppliers.

Praxair procurement works with some suppliers ondevelopment. Praxair asks its suppliers for year over yearcost reductions on a cost and performance basis. This isnot a formalized process, rather procurement peoplework with suppliers on an individual basis. Praxairknows its suppliers and sees the relative opportunities, sonot all suppliers get the same demands.

Sharing of savings varies with the situation. For example,Praxair outsources the driving of its delivery trucks. Inone case, the drivers weren’t properly filling the tanks.This created an inefficient load, significantly increasingPraxair’s delivery cost and reducing performance to itscustomers. Praxair created a system to measure andachieve a better load ratio, then worked with the supplierand trained the drivers to use this improved system. Thesavings from full loads have been shared with thesupplier. In an ideal world, Praxair would like to makesuch improvements a win-win scenario and provideincentives to suppliers to improve performance. However,this is not always possible due to cost reductionpressures.

Understanding the customer - While the procurementgroup focuses mainly on internal Praxair clients and playsa predominant role with suppliers, it does have anunderstanding of the external customer. Withinpurchasing, specific sourcing managers are aligned withspecific businesses. They become integrated with thebusiness team, which is where they develop theirunderstanding of the needs of customers. This variesconsiderably by business. In the businesses that support

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A P P E N D I X Athe electronics industry, Praxair becomes very involvedwith some of its key customers. However, purchasingalways strives to understand the importance of the endcustomer. Some customers, especially in the electronicssector, are concerned with Praxair quality, and lookclosely at Praxair systems, and Praxair’s interfaces with itssuppliers. However, most of the customer’s influence onPraxair’s supplier relations and supplier cost/pricereduction is indirect.

An example of procurement’s direct interaction withcustomers has developed at the request of Praxair sales.Praxair purchasing has met with a number of customersto explain some of the approaches that it takes to achieveimproved savings and value in procurement, and help thecustomer develop savings ideas.

Early involvement in new products/services - While Praxairis in a commodity product area; it does offer new productdelivery systems and services to its customers. Forexample, it may change the size of industrial gas productlines to fit a particular market. Global engineeringdesigns the gas plants to specification to meet customer’sneeds. Procurement is involved in terms ofunderstanding the specifications of the plant, theequipment needs, and finding the bestsuppliers/contractors to meet the needs.

When offering new physical capabilities within a plant,procurement works heavily with R&D and engineering todevelop and determine plant needs. Procurement hasbecome more involved, and involved much earlier in newtechnologies, so that the process is front-end loaded. Ingeneral, Praxair is creating cross-functional teams earlier,including sales/business unit representatives, operations,engineering, procurement, and R&D. It is a veryintegrated process. Business clients must believe thatprocurement and the strategic sourcing process bringvalue in order to bring them into processes sooner.

Training - Training has been designed for peoplethroughout the organization. In addition, externalcustomers have paid to participate in Praxair’s training.The training is led by procurement. Training programsinclude the 12-step sourcing process, presentation skills,and business processes. Strategic sourcing training hasalso been licensed to a local university. It has a businessdevelopment person that spends a small portion of histime looking for revenue opportunities to fund thebusiness development organization. The goal is tobecome self-funding.

The Role and Image of Purchasing in the FirmPurchasing was not viewed as an attractive place to bebefore the 1998 reorganization. The contributions of globalprocurement are now acknowledged at the top of theorganization. Today, purchasing is asked to participate in

businesses, and is viewed as key member of the businessteam. Purchasing participates fully in monthly reviews withthe office of the chairman, and presents its progress andplans like any other business unit. Purchasing has made agreat deal of effort to develop an organization with a highlevel of credibility and skills. It is their success that hashelped get them more involved. Prior to 1998, thepurchasing focus was primarily on capital expenditures.With the reorganization and the help of consultants, it hasdeveloped a broader focus and a process.

For example, Praxair has had many acquisitions recently.Supply management developed an acquisition process tobuild the synergies of the supply. For example, from aprocurement standpoint, in their healthcare business, thesourcing person who supports the healthcare business isa member of the advance team that visits the acquisition,investigates its suppliers, its purchasing spend,commodities, and so on. The sourcing person then workswith the acquired organization to gain access to thecontracts, see who is has the best contract, understandleverage opportunities, and get the best deal for Praxair.The acquired company may have a better position insome areas. Praxair will use the contract that benefitsPraxair from the first day of engagement once theacquisition is official. The acquired company becomespart of Praxair’s spend profile, with savings goals just likeany other business unit. Praxair has had immediatesavings results in certain cases.

Another initiative that has helped move the supplyorganization forward is the new college recruitingapproach. Praxair now recruits from universities withprofessional purchasing programs, and hires people fromdifferent schools, with new and different ideas.

Purchasing is definitely an area that is respected andwhose input is valued in the organization. This is clear,or it would not be included in critical processes. Atpresent, dependence on procurement delivering costsavings is higher and higher, especially with theeconomic slump.

Purchasing’s Contribution to OrganizationalSuccessFrom the standpoint of the office of the chairman,purchasing’s contributions can be viewed as based on:

• Operating profit improvement.• How effectively it manages the internal fixed

cost/budgets.• How effectively it contributes to the improvement of

working capital.

Within the area of working capital, there are two majorelements:

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A P P E N D I XA• Accounts payable and payment to suppliers.• How well it manages inventory, including:

•• Spares for capital items.•• $10+ million of expense related items.

Purchasing has specific goals to meet in each area. Thebenefits that purchasing will deliver to each business areagreed upon with the business as part of the annualplanning process. The business units incorporate thesavings into their budgets accordingly.

Purchasing saves $30 million to $35 million per year on$1.5 billion spend. To achieve this, purchasing focuses onspecifics; it does not look at every spend category eachyear. The purchasing initiatives are managed like projects.They separate initiatives that generate profit fromcapitalized savings in property, plant, and equipment (P,P, & E).

Why Has Praxair’s Reorganized Sourcing EffortBeen Successful?Praxair’s reorganization of purchasing has met andexceeded everyone’s expectations in terms of improvedperformance and bottom-line results. Some of the keyreasons for this success include:

• Praxair brought a number of key people from salesinto procurement; these people understoodnegotiations issues, sales, and market pressure froma different, but complementary perspective.

• Personnel from R&D, finance were also mixed inwith procurement professionals to create a strongerorganization.

• With the implementation of the data warehouse,procurement can get its hands around all the dataavailable – transforming it to information to makedecisions. There is structure/organization to data.

• Praxair learned the process of strategic sourcing fromMcKinsey Consulting.

• It developed its own internal training programs –new people are on the same page.

• It has very strong support and visibility from seniormanagement leadership support – CEO, VP ofFinance.

Areas of Continued Improvement FocusCost management is a very integrated part of commoditymanagement/strategic sourcing process. When Praxairdoes the annual budgeting, it commits to goals at mid toupper management levels. It is a continual challenge tohave the ongoing commitment of people in theorganization to work on cross-functional sourcing teamssince they have many priorities and responsibilities. Theissue of compliance with selected suppliers could beimproved. Praxair loses some savings opportunity andsupplier leverage when people don’t use the contractual

supplier agreements. However, Praxair is not a mandatingcorporate culture; people can choose. The most effectiveway to improve compliance is through the use of a cross-functional sourcing team, not only during supplierevaluation and selection, but also through implementationof the preferred supplier. Internal compliance is alsoimproving, as Praxair is able to monitor contractcompliance and report the results to business unitmanagement. Because the business unit is heldaccountable for savings through reduced budget levels,business unit managers discuss non-compliance issueswith parties not using corporate contracts and ask themto change when it makes sense to do so. This has provento be a powerful approach for creating accountability.

Future of Cost Management at PraxairCost management will continue to be a strong focus atPraxair in the future. The focal point is on measurableoperating profit, not just price variance. Thus, overheadand budget issues are an important consideration. AsPraxair works through many of the potential savingsopportunities, revenue enhancement will continue togrow in importance. The sourcing group at Praxair is alsoopen to new ideas and opportunities from suppliers andinternal clients to contribute to revenue enhancement.

One concern for the future is the belief by seniorleadership that procurement can deliver the samemagnitude of results year after year. It can’t be done.There is a limit. Procurement must work to educate themon additional contributions that can be made beyondbottom line cost reduction.

In the future, purchasing will look even more at rigorousTCO and process improvement as a way to support theorganization. With the selected suppliers, Praxair will goforward and work with them to create mutualdependence. Both parties can make changes to processesto save money. In turn, Praxair will be loyal to supplierswho perform well and add value.

Case study participants:Three Purchasing DirectorsPurchasing ControllerBusiness Development Manager

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A P P E N D I X B

Center for Advanced Purchasing StudiesResearch Grant Proposal

Strategic Cost Management in the Supply Chain

Submitted by

Lisa M. Ellram, Ph.D., C.P.M., CPAAssociate Professor of Supply Chain ManagementArizona State University

April 6, 2000

Appendix B:Research Proposal

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A P P E N D I XBStrategic Cost Management in the Supply Chain

Research Proposal

BackgroundSince the CAPS focus study, Total Cost Modeling inPurchasing, was published in 1994, there has been anincreased interest and awareness of the cost modeling inpurchasing. Additional cost modeling concepts, such astarget costing, have begun to spread, expanding costmodeling concepts outside of the organization to includefirst tier suppliers. The Role of Supply Management inTarget Costing was the subject of a 1999 CAPS focusstudy. As the author of both of these studies, I believethat there is opportunity to incorporate and expand theseprevious studies to explore cost management throughoutthe supply chain.

Topic of InterestThe primary topic of interest is strategic cost managementin the supply chain. Strategic cost management in thesupply chain is characterized by the following:

• It is purposeful: it supports the organization’s strategy.• It is boundary spanning: goes beyond supply

management both within the organization andoutside the organization (suppliers, customers).

• It is rare: few organizations do an excellent job here.

Strategic cost management in the supply chain is anextremely broad topic. It encompasses upstream costmanagement issues such as target costing, understandingsupplier costs, and cost drivers. It also encompassesunderstanding and managing downstream costs such asfinished goods inventory, logistics, and costs of servingcustomers. It includes consideration of, and response to,cost pressures by customers at all levels in the supplychain. In the broadest sense, strategic cost managementtakes a holistic, total cost perspective throughout thesupply chain.

As this topic is so broad, it could be investigated from anumber of angles. The extent of strategic cost managementthroughout a supply chain could be explored in a survey.This type of study would fit in the category of CAPSresearch that identifies the current state of the practice. Ihave concerns about doing this type of research. Strategiccost management in the supply chain is in its infancy atbest. What are needed are insights into best practices instrategic cost management in the supply chain. Thus, thesurvey results would not be of much interest, nor wouldthey provide much information to CAPS sponsors or theNational Institute for Supply Chain Integration (NISCI),which is co-sponsoring this research.

On the other hand, an entirely different approach,focusing on a research approach that identifies the leading

edge of current practice and applications might be morerelevant to CAPS/NISCI sponsors and NAPM membership.I am proposing to use in-depth, on-site case studies toexplore best practices in strategic cost managementamong leading edge purchasing organizations today.

There has been limited literature explicitly linkingstrategic cost management with supply chainmanagement in general, and with the role of supplymanagement in particular. Based on the research andreview of the relevant literature, trends that I haveobserved, and areas of interest identified by the NationalInstitute of Supply Chain Integration’s April 2000conference, this study will:

1. Identify and study a number of best practiceorganizations across several industries.

2. Explore BOTH upstream and downstream strategiccost management issues and practices.

3. Synthesize these best practices.4. Develop a prescriptive model for world class cost


Specifically, some of the key elements to explore include:

■ Purchasing and the wider organization’s use of:– Total cost of ownership.– Target costing.– Cost information sharing/monitoring internally

and externally.■ Understanding of supplier’s cost structure and how it

relates to:– Relationship/cost management.– Influence on next tiers.– Documentation/improvement strategies.

■ Understanding of profitability of key customers, andhow this affects strategic cost management in thesupply chain.

■ Cost monitoring and management systems,including key cost drivers.

■ Cost management goals, expectations, and theimpact these have on the reward structure.

Research MethodologyClearly, no individual or function within the organizationwill have the ability to address all of these issues. Thus,this research will employ a “snowball” case studymethod, where the initial contact point in theorganization helps identify those parties in theorganization who have the knowledge required toaddress the issues presented above. The goal is to have aminimum of a triad of companies in each supply chain: asupplier, a manufacturer/assembler/service provider and acustomer. If possible, the researcher will attempt to studyadditional nodes in the upstream and downstream supplychain.

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A P P E N D I X BThe researcher will contact the middle of the triad as thestarting point of investigation moving up and down thesupply chain. Based on the nature and breadth of thetopics to be investigated, the researcher believes that forthe research to be successful, it will require the supportof a high level person within the initially contactedorganization. Thus, within the middle organization of thetriad, the researcher would like to interview:

• The high level sponsor to establish an overview ofthe organization’s supply chain cost managementstrategy, and key internal and external contacts.

• Purchasing/supply management.• Accounting/cost management.• Marketing/sales (customer perspective).• Logistics/distribution.• Other internal parties involved in cost management.

In addition, the researcher will ask the initially contactedorganization for contacts at:

• A key account customer.• First tier supplier(s) involved in the organization’s

cost management effort.• Possibly a second tier supplier.

If it is not possible to gain entrée into these links throughthe initially contacted organization, the researcher willmake contact with related supply chain links directly.

The case study research method that I am proposing, asmentioned above, is the use of focused case studies toidentify, synthesize, and report best practices in strategiccost management in the supply chain. The researchmethodology has several critical phases in its formulation.

Phase I- Review the literature to develop anunderstanding of the concepts, previousresearch, and issues.

Phase II- Develop proposed topics/practices of interestto investigate in each area,

Phase III- Protocol development, review and approval.

Meet with a focus group/committee made up of thoseparticularly interested in strategic cost managementpractices to identify their particular areas of interest.These issues, as well as issues identified in Phase II, willthen become the focal point of the research. This willinclude members of the CAPS North American ExecutivePurchasing Roundtable and the National Institute forSupply Chain Integration.

In addition, representatives from this group (andpotentially others) will be identified as members of theadvisory board for the study. They will be called upon to

review interview protocol, review the study scope andaims, and provide feedback through out the study,including review of the final report.

Phase IV- Creation of interview protocol based onPhases I-III.

This phase will entail the identification of best practicesfirms, based on Phases III and I. It will also involvescreening the companies identified to ensure a good fitwith the research objectives, and that the candidateorganizations understand the level of commitmentrequired. The screening of companies will include in-depth telephone interviews/screening to verify:

1. The organization represents a best practice firm interms of supply chain cost management.

2. The organization wants to participate in the casestudy, and is willing to devote the time, effort andresources to host the investigator’s visit.

3. The organization will share samples of their analysesand allow them to be published in the study, eitheras-is, or disguised.

4. The organization will arrange for participants outsideof the supply management function who play majorroles in the process under investigation to participatein the study.

5. The organization is willing to identify and requestparticipation of other supply chain members(customers, suppliers) to participate in the research.

The participating organizations will receive pre-meetingcopies of the protocol so that they can be prepared, andeveryone’s time is well spent. In addition, they will beasked to send the researcher any available printedmaterial on their cost management practices, processes,and policies, as well as general information about theircompany and supply management processes in order thatthe researcher be prepared.

Phase V- Case Studies.

This phase will involve on-site visit(s), gathering ofdata/documents, development of a case study databasefor each organization, supply chain, and the case studiesas a whole. The goal is to involve at least three companiesas links in the supply chain studied.

Phase VI- Data analysis and Report Development.

In focusing on the needs of CAPS and NISCI, rigorousresearch practices will still be employed in gathering thedata, executing the case studies, and analyzing the results.

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A P P E N D I XBRelationship of this Study to Previous ResearchThis study builds on the previous CAPS focus studies,Total Cost Modeling in Purchasing (Ellram, 1994) and TheRole of Supply Management in Target Costing (1999). Thesestudies used case analysis to explore various approachesto total cost modeling/target costing and both adescriptive and prescriptive approach to total cost ofownership/target costing.

Little has been done in the area of strategic costmanagement in the supply chain. There has beenvirtually no work in this broad arena from a supplymanagement perspective. The work that has been donefocuses on certain practices that may support strategiccost management in the supply chain, such as targetcosting (Newman and Rhee, 1990; Ellram 1999). Therehas been limited conceptual work done exploring costmanagement in the supply chain (Cavinato, 1992).

More work has been done in the accounting literature,but that is also not as broad as the research proposedhere. Like the supply management literature, most of thework in the accounting literature focuses on a specificpractice, such as target costing (Kato, Boer, and Chow,1995; Fisher, 1995; Brausch, 1994; Shim and Sudit,1995;) or TCO (Ellram, 1995; Carr and Ittner, 1992).There was some excellent conceptual work doneexploring strategic cost management that includes a valuechain perspective (Shank and Govindarajan, 1992,1993). The concepts developed in that study will beincorporated into this research. More recently, a book waspublished entitled, Supply Chain Development for the LeanEnterprise (Cooper and Slagmulder, 1999). Based on adoctoral dissertation, this book examines costmanagement practices in 25 Japanese manufacturingfirms. The focus of the book is on target costing, but thebroader lessons learned from this book will also beincorporated into this study.

This research proposes to go beyond the current studies,examining the current best practices in strategic costmanagement in the supply chain. A prescriptive modelfor using strategic cost management in the supply chainwill be developed. In addition, an implementationframework will be developed for strategic costmanagement in the supply chain. This should be valuableto practitioners implementing or interested in theseapproaches, as well as to researchers of strategic costmanagement in the supply chain in building anddeveloping future research.

Proposed Time LineThe following represents the proposed time line based onthe use of a case study method.

Activity Dates

Begin literature review Ongoing

Develop proposed topics within March, 2000TCO/target costing for study

Meet with NISCI symposium April 4-5, 2000

Develop research plan based on Completed (this NISCI/other input and revise document)proposal

CAPS approval May, 2000

Select Advisory Board May, 2000

Further literature review/research Summer, 2000as needed

Develop preliminary case study May, 2000protocol

Pilot cast study with preliminary May-June, 2000protocol

Have feedback on case study Early June, 2000protocol

Revise protocol Late June, 2000

Identify/contact best practices April-June, 2000case study firms

Conduct case studies June-October, 2001

Analyze data Through December, 2001

Develop CAPS Focus Study Report by February 28, 2002

BibliographyBrausch, John M., “Target Costing for ProfitEnhancement,” Management Accounting, November 1994,pp. 45-49.

Carr, Lawrence P., and Christopher D. Ittner, “Measuringthe Cost of Ownership,” Journal of Cost Management, Fall1992, pp. 42-51.

Cavinato, Joseph L., “A Total Cost/Value Model forSupply Chain Competitiveness,” Journal of BusinessLogistics, Vol. 13, No. 2 (1992), pp. 285-301.

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A P P E N D I X BCooper, Robin, and Regine Slagmulder, Supply ChainDevelopment for the Lean Enterprise, Portland, Oregon:Productivity Press, 1999.

Ellram, Lisa M., The Role of Supply Management in TargetCosting, Tempe, Arizona: Center for Advanced PurchasingStudies, 1999.

Ellram, Lisa M., Total Cost Modeling in Purchasing, Tempe,Arizona: Center for Advanced Purchasing Studies, 1994.

Ellram, Lisa M., “Activity Based Costing and Total Cost ofOwnership: A Critical Linkage,” Journal of CostManagement, Winter 1995, pp. 22-30.

Fisher, Joseph, “Implementing Target Costing,” Journal ofCost Management, Summer 1995, pp. 50-59.

Kato, Yutaka, Germain Boer, and Chee W. Chow, “TargetCosting: An Integrative Practice,” Journal of CostManagement, Spring 1995, pp.39-51.

Newman, R., and K. Rhee, “A Case Study of NUMMI andits Suppliers,” International Journal of Purchasing andMaterials Management, Vol. 26, No. 4 (1990), pp. 15-20.

Shim, Eunsup, and Ephraim F. Sudit, “How ManufacturersPrice Products,” Management Accounting, February 1995,pp. 37-39.

Shank, John K., and Vijay Govindarajan, Strategic CostManagement, New York: Free Press, 1993.

Shank, John K., and Vijay Govindarajan, “Strategic CostManagement and the Value Chain,” Journal of CostManagement, Winter 1992, pp. 5-21.

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A P P E N D I XC

Abbreviated Research Proposal Sent to CaseStudy Participants

Strategic Cost Management in the Supply ChainA research project

conducted by Lisa M. Ellram, Ph.D., CPA, C.P.M.For the National Initiative for Supply Chain Integration

and The Center for Advanced Purchasing Studies

The proposed research involves in-depth, on-site casestudies to explore best practices in strategic costmanagement among leading edge purchasingorganizations today.

There has been limited literature explicitly linkingstrategic cost management with supply chainmanagement in general, and with the role of supplymanagement in particular. This study will:

1. Identify and study a number of best practiceorganizations across several industries.

2. Explore BOTH upstream and downstream strategiccost management issues and practices.

3. Synthesize these best practices.4. Develop a prescriptive model for world class cost


Specifically, some of the key elements to explore include:

■ Purchasing and the wider organization’s use of:– Total cost of ownership.– Target costing.– Cost information sharing/monitoring internally

and externally.■ Understanding of supplier’s cost structure and how it

relates to:– Relationship/cost management.– Influence on next tiers.– Documentation/improvement strategies.

■ Understanding of profitability of key customers, andhow this affects strategic cost management in thesupply chain.

■ Cost monitoring and management systems,including key cost drivers.

■ Cost management goals, expectations, behaviors, andrelationships and the impact these have on thereward structure.

Research MethodologyClearly, no individual or function within the organizationwill have the ability to address all of these issues. Thus,this research will employ a “snowball” case study method,where the initial contact point in the organization helpsidentify those parties in the organization who have theknowledge required to address the issues presented above.The goal is to have a minimum of a “triad” of companiesin each supply chain: a supplier, amanufacturer/assembler/service provider and a customer.If possible, the researcher will attempt to study additionalnodes in the upstream and downstream supply chain.

The researcher will contact the middle of the triad as thestarting point of investigation moving up and down thesupply chain. Based on the nature and breadth of thetopics to be investigated, the researcher believes that forthe research to be successful, it will require the supportof a high level person within the initially contactedorganization. Thus, within the middle organization of thetriad, the researcher would like to interview:

• The high level sponsor to establish an overview ofthe organization’s supply chain cost managementstrategy, and key internal and external contacts.

• Purchasing/supply management.• Accounting/cost management.• Marketing/sales (customer perspective).• Logistics/distribution.• Other internal parties involved in cost management.

Appendix C:Interview Protocols, Cover Letter and AbbreviatedResearch Proposal

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A P P E N D I X CEach interview is expected to take about 45 minutes totwo hours. Questions can be provided to the participantsin advance.

In addition, the researcher will ask the initially contactedorganization for contacts at:


cost management efforts.• Possibly a second tier supplier.

If it is not possible to gain entrée into these links throughthe initially contacted organization, the researcher willmake contact with related supply chain links directly.

Participants will have the opportunity to review all of thedata and edit for content accuracy as well as forconfidentiality. Nothing will be published without theexplicit permission of participating companies. Theparticipants may choose to have their name/industrydisclosed or disguised.

The time frame of the research is fall of 2000 throughsummer of 2001, with a final report expected late in2001/early 2002.

Interview Protocol Used Inside the Core Company

STRATEGIC COST MANAGEMENT QUESTIONNAIRE

Background (begin with Purchasing)Name _________________________________________Company ______________________________________Division _______________________________________Industry _______________________________________Job Title _______________________________________Yrs in Position __________________________________Years with Co. __________________________________Years in Purchasing ______________________________

NOTE: Your answers to the questions should includepeople, dollars, and activities that report to theorganization headquartered in this country.

1. Approximate total annual sales, 2000 (or latest fiscalyear), in U.S. dollars._____ under $500 million_____ $500 million to $1 billion_____ $1.1 billion to $5 billion_____ $5.1 billion to $10 billion_____ over $10 billionApproximately what is the ratio of purchases ofoutside goods and/or services to revenue?

What is the approximate percentage of your sales toindustrial customers? ___ directly to consumers?___other? ___ (specify source)Would you classify your firm as primarily:_____ manufacturing_____ service-oriented_____ distribution_____ government_____ other (specify)

2. What is the major business of your company?

3. What are the key issues/competitive challengesfacing your firm?

4. Are you currently undergoing, or have youundergone, any major changes in your purchasing organization or practice in the past year? Please discuss.

5. How is the purchasing function organized? Do youhave an organizational chart I could have a copy of?(Names may be deleted if necessary.) Where does thepurchasing function report within the firm?(Reporting chain)

6. Do you have specific, quantifiable written costsavings/cost management objectives for purchasing?Give an example. What is the highest level thatreviews those plans?

7. How is the achievement of purchasing’s objectivesevaluated?

General SCM questions-purchasing

8. How important is cost management within yourcompany?Within purchasing?Explain why you believe this.

9. What is the focus of your cost management effortswithin purchasing?

10. Please describe to me your overall approach to costmanagement within purchasing for:

new products/services.existing products/services.

11. How does purchasing become involved in/developan understanding of customer needs/the valueproposition of the organization?

12. What other functions/groups do you interact withinside the company in your cost managementefforts?Please describe the interaction.

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A P P E N D I XC13. How do you interact with your suppliers/others

outside of the company in relation to managing cost?

Internal issues (ask each function, including purchasing)

14. Who owns the cost management practices within theorganization? Please explain the nature of theirresponsibility?

15. Have you ever benchmarked strategic cost manage-ment practices with other firms? Please discuss.

16. Does your organization take a total supply chainview of strategic cost management? Explain why orwhy not.

17. How are various functions, such as logistics,purchasing, design, and sales/marketing tied in tothe organization’s SCM efforts?

18. How are these functions held accountable for SCMperformance?

19. What do you consider the key cost drivers that youare attempting to manage within your organization?Supply chain?

Supplier Side (Purchasing, Cost Group and/orEngineering)20. Tell me about the way that your firm uses SCM with

suppliers. Is there a basic framework or approachthat your firm uses for each situation of buy or doyou have different approaches? If there is aframework, what is it?

21. Are there a set of common tools, which are usuallyconsidered across SCM models?If so, what are they?Which tools do you consider most important?Which tools do you find easiest to manage and why?Which tools do you find the most difficult tomanage and why?

22. To the best of your knowledge, do your suppliersuse a SCM approach? Do you encourage yoursuppliers to use SCM approach?

23. If cost savings are created, how are they sharedamong members of your supply chain?

24. Do you feel this sharing is equitable? How wouldyou change it?

25. Could you provide me with the name of a supplieror suppliers that you work with effectively on SCMinitiatives to interview?

26. Would you be willing to share with me an exampleof the SCM models that your firm uses for differenttypes of purchases? (Ask to see/have explained, takea copy with me.)

27. Where does the SCM approach reside/exist (paper,mainframe, PC, etc.)? Ask for source of model.

28. Do you use some type of SCM approach foreverything your firm buys? Or does it depend on theimportance/dollar magnitude, etc.?

29. If you don’t use SCM for all situations within a typeof buy, what determines whether or not you use TCfor a given purchase?

30. Are any employees trained on the use of the SCMmodel/approach? If so, how does that training occur?Do you train suppliers in SCM? Explain.

Cost accountability (purchasing)

31. What is the purchasing function’s responsibility forcost/price of purchased goods/services?

32. Are you individually responsible for cost/pricevariances on items purchased? In what way? Is therea tie-in to performance appraisals/merit increases?

33. If purchasing is directly responsible for costs, whatare costs compared to? Do you consider marketprices?

34. Do you feel your firm’s emphasis on managing costsof purchased goods and services has increased,decreased, or stayed the same? Why?

35. How would you improve your organization’sapproach to SCM?

Role of purchasing in the firm

36. Do you think that purchasing is viewed as a strategicfunction in your organization? (A function that is arespected, whose input is valued; who participates inhigh-level decisions?)Please give some examples to support your position.

37. Do you believe that the way purchasing is viewed inthe organization has an impact on its participation inthe cost management process?

38. Do you see your firm doing more or less strategiccost management in the future? What areas will beaffected and why?

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A P P E N D I X C39. Do you see purchasing’s role in the strategic cost

management processes changing in the future? Inwhat way, and why?

40. Is there anything else that you would like to sayabout strategic cost management in general, in yourcompany; your supply chain(s) or purchasing’s rolein SCM?

Thank you very much for your participation!

Questions to Ask Other Functions:Internal issues (ask each function)

1. Who owns the cost management practices within theorganization? Please explain the nature of theirresponsibility?

2. Have you ever benchmarked strategic costmanagement practices with other firms? Pleasediscuss.

3. Do you believe that your organization takes a totalsupply chain view of strategic cost management?Explain why or why not.

4. How are various functions, such as logistics,purchasing, design, and sales/marketing tied in tothe organization’s SCM efforts?

5. How are these functions held accountable for SCMperformance?

6. What do you consider the key cost drivers that youare attempting to manage within your organization?Supply chain?

7. Is there anything else significant about your use ofSCM approach or your implementation of an SCMapproach that you think I should know about?

Customer Side (Sales, Marketing or Accounting…Someone Knowledgeable in These Areas)8. Do your customers use target costing and SCM efforts

in attempting to manage your costs? Please explain.

9. Do you understand the profitability and cost driversin your various customer accounts? Explain.

10. Do you work with your customers in an effort tomanage your costs of doing business with them?Explain how.

11. Who would be a good customer to talk to in termsof capturing your best practices in customer-suppliercost management? Would you give me a contactname and support my interviewing them?

Overall Issues (ask the process owner or owners)

12. Do you feel that you understand your organization’stotal approach to strategic cost management/valuemanagement in the supply chain?

13. Could you please explain the overall approach,including:- Accounting approach (ABCM, etc.).- Key participants within the organization.- How and which suppliers participate.- How and which customers participate.- Overall objectives.- Overall processes/tools included.- Measurement of outcomes.- Results to date.- Key success factors and lessons learned in

implementing this approach.

Questions to Ask Supplier(s)1. Tell me about the way that you interact with

Company X on cost management issues. Forexample, do they give you cost targets, providetraining and assistance, share cost savings, etc.?



4. Does the customer’s approach influence the way thatyou manage costs in the supply chain? Why or whynot, and how?

5. Could you please explain your overall approach tocost/value management, including:- Type of accounting system (ABCM, etc.).- Key participants within the organization.- How and which suppliers participate.- How and which customers participate.- Overall objectives.- Overall processes/tools included.- Measurement of outcomes.- Results to date.- Key success factors and lessons learned in


6. How do you manage your own supplier’s costs, andhow is that influenced by Company X’s approachtowards you?

7. Would you be willing to let me talk with one of yoursuppliers, to get their impression of your strategiccost management approach toward it? Could yougive me a contact name?

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A P P E N D I XC8. Is there anything else significant about your use of

SCM approach or your implementation of an SCMapproach that you think I should know about?

Key Account Customer1. Could you please explain your organization’s

approach to managing the costs of its key suppliers,such as X?


3. Could you please explain your overall approach tocost/value management, including:- Type of accounting systems (ABCM, standard

costing, etc.).- Key participants within the organization.- How and which suppliers participate.- How and which customers participate.- Overall objectives.- Overall processes/tools included.- Measurement of outcomes.- Results to date.- Key success factors and lessons learned in


4. How does your approach to cost management affectyour relationship with your suppliers?

5. How does your approach to cost managementinfluence the total supply chain?

6. Do you undertake any activities or have any desire toinfluence the cost management of your supplier’ssuppliers?- Why or why not?

7. In what manner?

8. Can you give me any examples of ways that you andX have collaborated to improve cost management/value management in the supply chain?




Supplier Request to Participate Sample Letterand Research Summary

Dear Mr.:

This is a follow up to the phone call that you receivedfrom Ms. ____ of “core case study” regarding yourpotential participation in a research project. I am aProfessor of Supply Chain Management at Arizona StateUniversity. “Core case study” is participating in a costmanagement study that I am undertaking for the CAPSResearch and the National Initiative for Supply ChainIntegration. “Core case study” supports both of theseorganizations. I have attached a document that explains abit more about the study, and would be happy to answerany questions you might have.

The study is looking at cost/value managementthroughout the supply chain. I have talked to about 10people at “core case study” about their internal operationsand external relationships. I would like to arrange a timeto talk with you and interview you for the study to get asupplier’s perspective. I would be happy to come andmeet with you at your location in XXX, or we could talkon the phone. I think I would need about 90 minutes totwo hours of your time.

If you are willing to do this, and have a support personwho handles your calendar, could you please e-mail mehis/her telephone number, and I will contact him/her?Otherwise, perhaps you could call me or e-mail meinformation on your availability. I can e-mail you thequestions pertinent to you before we meet. Nothing youdiscuss with me will be written, published, or disclosedto anyone, including “core case study,” without yourreview and approval.

If you need any more information about the project, mybackground, etc., please let me know. You can view mybio at:

http://www.cob.asu.edu/directory/bio_directory_action.cfm?directoryid=73&dept=SCM

My direct phone number at ASU is (480) 965-2998.Thanks very much. I look forward to meeting with you!

Best regards,

Lisa M. EllramProfessor of Supply Chain ManagementArizona State College of BusinessDept. of Supply Chain ManagementTempe, AZ 85287-4706

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A P P E N D I X CStrategic Cost Management in the Supply ChainA research project conducted by Lisa M. Ellram, Ph.D.,CPA, C.P.M.For the National Initiative for Supply Chain Integration andThe Center for Advanced Purchasing [email protected]

The proposed research involves in-depth, on-site casestudies to explore best practices in strategic cost manage-ment among leading edge purchasing organizations today.Specifically, some of the key elements to explore include:

•• Cost information sharing/monitoring internally andexternally.

•• Relationship/cost management.•• Influence on next tiers.•• Documentation/improvement strategies.•• Understanding of profitability of key customers, and

how this effects strategic cost management in thesupply chain.

•• Cost monitoring and management systems,including key cost drivers.

•• Cost management goals, expectations, behaviors andrelationships and the impact these have on thereward structure.

This research will involve a number of supply chains in anumber of industries. The overall findings will besynthesized into a report and published by the Center forAdvanced Purchasing Studies (CAPS). A brief version ofthe individual case studies used to develop the overallreport will be included as an appendix.

Research MethodologyClearly, no individual or function within the organizationwill have the ability to address all of these issues. Thegoal is to have a minimum of a triad of companies ineach supply chain: a supplier, a manufacturer/assembler/service provider and a customer. If possible, theresearcher will attempt to study additional nodes in theupstream and downstream supply chain.

The researcher will contact the middle of the triad as thestarting point of investigation, moving up and down thesupply chain. In this case, that was Chip. In addition, theresearcher will ask the initially contacted organization forcontacts at:



Your ParticipationYour organization has been selected as the key supplier ofindirect/consumables to get a supply chain view in theChip case. The purpose of talking with a supplier is:

• To understand how the customer (Chip) tries tomanage/influence the supplier’s (your) costs andsupply chain both directly and indirectly.

• To understand the nature of the relationship betweenthe supplier and the customer, how they worktogether.

• To understand the basic approaches that the supplieruses to manage its overall supply chain costs.

This research can be conducted on the telephone(interviews of approximately 60 to 90 minutes in length),or in person. The goal to set up the interview is the Juneor July time frame, at your convenience. The researcherwould like to talk with those who are the key contactswith Chip. It would be helpful to talk with someone atyour organization prior to setting up the interview(s), todetermine whom to interview.

Participants will have the opportunity to review all of thedata and edit for content accuracy as well as forconfidentiality. Nothing will be published without theexplicit permission of participating companies. Theparticipants may choose to have their names/industriesdisclosed or disguised. The data will be published byCAPS/NISCI as an appendix of case studies to supportthe overall research case studies. The time frame of theresearch is summer of 2000 through summer of 2001,with a final report expected in fall 2001/winter 2002.

Strategic Cost Management Questionnaire(Supplier)

BackgroundName _________________________________________Company ______________________________________Division _______________________________________Industry _______________________________________Job Title _______________________________________Years in position _________________________________Years with Co. __________________________________


1. Approximate total annual sales, 2000 (or latest fiscalyear), in U.S. dollars._____ under $500 million_____ $500 million to $1 billion_____ $1.1 billion to $5 billion_____ $5.1 billion to $10 billion_____ over $10 billion

Approximately what is the ratio of purchases ofoutside goods and/or services to revenue?

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A P P E N D I XCWhat is the approximate percentage of your sales toindustrial customers? ___ directly to consumers?___other? ___ (specify source).

Would you classify your firm as primarily:_____ manufacturing?_____ service-oriented?_____ distribution?_____ government?_____ retail?_____ other (specify)?



Questions to Ask Supplier(s)1. Tell me about the way that you interact with

Company X on cost management issues. Forexample, do they give you cost targets, providetraining and assistance, share cost savings, etc.?



4. Does the customer’s approach influence the way thatyou manage costs in the supply chain? Why or whynot, and how?

5. Could you please explain your overall approach tocost/value management, including:- Type of accounting system (ABCM, etc.).- Key participants within the organization.- How and which suppliers participate.- How and which customers participate.- Overall objectives.- Overall processes/tools included.- Measurement of outcomes.- Results to date.- Key success factors and lessons learned in


6. How do you manage your own supplier’s costs, andhow is that influenced by Company X’s approachtowards you?

7. Would you be willing to let me talk with one of yoursuppliers, to get their impression of your strategiccost management approach toward it? Could yougive me a contact name?


Customer Request to Participate in ResearchSummary and Sample Questionnaire

Strategic Cost Management in the Supply ChainA research project conducted by Lisa M. Ellram, Ph.D.,CPA, C.P.M.For the National Initiative for Supply Chain Integration andThe Center for Advanced Purchasing [email protected]

The proposed research involves in-depth, on-site casestudies to explore best practices in strategic costmanagement among leading edge purchasingorganizations today. Specifically, some of the key elementsto explore include:

•• Cost information sharing/monitoring internally andexternally.

•• Relationship/cost management.•• Influence on next tiers.•• Documentation/improvement strategies.•• Understanding of profitability of key customers, and

how this effects strategic cost management in thesupply chain.

•• Cost monitoring and management systems,including key cost drivers.

•• Cost management goals, expectations, behaviors andrelationships and the impact these have on thereward structure.

This research will involve a number of supply chains in anumber of industries. The overall findings will be synthe-sized into a report and published by CAPS Research. Abrief version of the individual case studies used todevelop the overall report will be included as an appendix.

Research MethodologyClearly, no individual or function within the organizationwill have the ability to address all of these issues. Thegoal is to have a minimum of a triad of companies ineach supply chain: a supplier, a manufacturer/assembler/service provider and a customer. If possible, theresearcher will attempt to study additional nodes in theupstream and downstream supply chain.

The researcher will contact the middle of the triad as thestarting point of investigation, moving up and down thesupply chain. In this case, that was LCP. In addition, theresearcher will ask the initially contacted organization forcontacts at:

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A P P E N D I X C• A key account customer.• First tier supplier(s) involved in the organization’s


“Customer Name” Participation“Customer name” has been selected as the key accountcustomer to get a supply chain view in the “core com-pany” case. The purpose of talking with a customer is:

• To understand how the customer tries tomanage/influence the supplier’s costs both directlyand indirectly.

• To understand the nature of the relationship betweenthe supplier and the customer, how they worktogether.

• To understand the basic approaches that thecustomer uses to manage its overall supply chaincosts.

This research can be conducted on the telephone(interviews of approximately 90 to 120 minutes inlength), or in person. The goal to set up the interview isthe October or November time frame. If needed, theresearcher would make a trip to visit “Customer name” at“Customer name’s” convenience. The researcher wouldlike to visit with the “Customer name” key contacts with“core company.” It would be helpful to talk with someoneat “Customer name“ and “core company“ in advance ofsetting up the interviews, to determine whom tointerview.

Participants will have the opportunity to review all of thedata and edit for content accuracy as well as forconfidentiality. Nothing will be published without theexplicit permission of participating companies. Theparticipants may choose to have their names/industriesdisclosed or disguised. The data will be published byCAPS/NISCI as an appendix of case studies to supportthe overall research case studies. The time frame of theresearch is summer of 2000 through spring of 2002, witha final report expected in summer of 2002.

Customer Questionnaire

STRATEGIC COST MANAGEMENT QUESTIONNAIRE

Background (begin with Purchasing)Name _________________________________________Company ______________________________________Division _______________________________________Industry _______________________________________Job Title _______________________________________Years in position_________________________________Years with Co. __________________________________


1. Approximate total annual sales, 2000 (or latest fiscalyear), in U.S. dollars._____ under $500 million_____ $500 million to $1 billion_____ $1.1 billion to $5 billion_____ $5.1 billion to $10 billion_____ over $10 billion

Approximately what is the ratio of purchases ofoutside goods and/or services to revenue?

What is the approximate percentage of your sales toindustrial customers? ___ directly to consumers?___other? ___ (specify source)

Would you classify your firm as primarily:_____ manufacturing?_____ service-oriented?_____ distribution?_____ government?_____ retail?_____ other (specify)?



Key Account Customer1. Could you please explain your organization’s

approach to managing the costs of its key suppliers,such as “core company”?


3. Could you please explain your overall approach tocost/value management, including:- Type of accounting systems (ABCM, standard

costing, etc.).- Key participants within the organization.- How and which suppliers participate.- How and which customers participate.- Overall objectives.- Overall processes/tools included.- Measurement of outcomes.- Results to date.- Key success factors and lessons learned in


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A P P E N D I XC4. How does your approach to cost management affect

your relationship with your suppliers?

5. How does your approach to cost managementinfluence the total supply chain?

6. Do you undertake any activities or have any desire toinfluence the cost management of your supplier’ssuppliers?

Why or why not?

7. In what manner?

8. Can you give me any examples of ways that“Customer name” and “core company” havecollaborated to improve cost management/valuemanagement in the supply chain?




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A P P E N D I X D

Dear Ms -----:

I would like to thank you for your help in meeting with me and providing me with information and support on mycost management study. It was really an interesting discussion for me! I have attached a rough draft of characterizationof our discussion on “your company’s” cost management practices in your area. This is only the piece I got from you.Still to come are the overall combined views of the people I interviewed at “your company,” and customer andsupplier’s views. Have you had the opportunity to talk with a supplier to see if one would be willing to speak with meto support this project? I would really appreciate it!

What I would like to ask you to do is look over the attached document and change or add anything that you believewould improve the overall accuracy of this document and paint a fair picture. Feel free to add if you believesomething important is missing or incomplete. Also, delete anything you do not want released. No one will see thisdocument; it will be distilled into the overall summary of “your company.” So don’t worry about grammar,punctuation, etc. I tried to take care of that, but a professional editor will go through the final document. X at yourcompany will also review the final document prior to publication. I will also pass the results on to you. Also, it won’tbe released until late spring/early summer, if that makes any difference in terms of what you are willing to disclose.

Thanks again very much for your help. Could you please provide me with your feedback by 10/23/2001? Feel free tocall me with any questions. Please send me an e-mail, or fax your comments to (480) 965-8629. If you send a fax,please put my name on it.

Thanks again very much for fitting me in to your busy schedule! It was very useful to my study!

Best,

Lisa Ellram

Appendix D:Request to Review Study Letter

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A P P E N D I XE

METAL CASE: SUPPLIER TO DEERE

BackgroundDeere is the major customer to the Metal division of thissupplier. In the area of metals, Deere buys:

• Sheet metal equipment for agriculture/constructionequipment.

• Feeder houses (combine).• Frames/main structural components on tractor.• Hoods, side shields, grill screen.• Fuel, hydraulic tanks.• Misc. fabrication.• Cab for backhoe.

Deere has a similar breadth of purchases with Metal’sPlastics division.

History of cost sharingDeere’s business really took off in the early ’90s. Costmodeling was not as prevalent at that time, but by themid-90s Metal had an open-book policy with Deere

without exception since then. Deere gets whateverinformation it needs. Deere meets with Metal’s accountingfolks, and walks through details of cost assumptions.Sometimes Deere cost management people know Metal’snumbers as well as Metal does.

Deere develops cost targets and shares them with Metalmost of the time. Increasingly, Metal and Deere worktogether to actually establish cost targets. During theinteractions of Deere’s design, Metal provides multiplequotes for different designs for a certain product.

Today, Deere requires its suppliers to share costinformation if the supplier would like a long-termrelationship. People at Metal were probably initiallynervous about cost sharing. However, sharing costinformation takes a lot of emotion out of the privacyissue and does away with a lot of the games in arelationship. Their process involves establishingagreement on gross margin percentage, then looking atcycle times, process time, and so on, to determine whatthe costs should be. Metal and Deere commit to try toachieve a certain percentage gross margin.

Appendix E:Case Studies of Suppliers and Customer

Table 29Buyer-Supplier Case Study Relationships

Customer Industry Supplier Industry Items sold to customerDeere Heavy equipment Metal Precision plastic and metal Precision metal parts

manufacturing partsChip Semiconductors SC Subcontractor of custom Custom integrated circuits

integrated circuits and chips and chipsLCP Consumer products Packaging High technology containers High technology custom

and packaging containersTele Telecommunications Network Manufacturer of network Network equipment

equipment and softwarePraxair Industrial air products McJunkin Pipe, valve and fittings Integrated supplier for P, V, F

and chemicals distributor

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A P P E N D I X EMetal was chosen as sole supplier for Dubuque Workswhen it outsourced en masse. Metal and Deere have amultiple year agreement that establishes Metal’s expectedmargins and Deere’s expected cost reduction for eachyear. The best intent of both parties is to always maintainmargins. However, sometimes, on very mature productswith very high industry pressures, Metal may give upsome margins, sometimes unwittingly. Deere may actuallyquestion Metal if gross margin percentage goes down.Metal and Deere understand each other’s goals. Metalmust support Deere’s goals.

Relationship TodayMetal has had complete cost transparency with Deeresince the mid 1990’s. This includes raw materials, freight,burden rates, including costs by process, fixed overhead,variable overhead, labor, and margins. This informationwas shared with Deere in a variety of ways initially; nowDeere is trying to use a standardized John Deere quoteform throughout the enterprise. Most of the informationfor new business to Deere. When Deere has outsourcedproducts to Metal, in many cases Deere has providedMetal information on its own cost breakdowns such ascost drivers, raw materials cost, cycle times, but notoverhead, union wage rates, and other very sensitive items.

Metal has intense interaction with Deere every day. Eachday both companies visit the other’s facility. Metal getsinvolved very early in design and development to ensurethat new products work on Metal’s existing assets, or tofind the proper next technology to support the process. Ifnew equipment is required to support a process, Metalhas to decide:

• Can we justify it the investment?• Which equipment should we invest in?• Is Deere willing to pay for the costs associated with

this investment?

Deere has made many resources available to Metal fromwithin Deere’s supplier development organization. Forexample, when Deere works with Metal on engineeringimprovements, they establish charter cost agreements thatinclude the scope of project, the resources allocated fromboth sides, and the value to both organizations.

These can be painful activities, but they help drive theright behavior between organizations. In general, Metaland Deere have some sort of shared savings agreementfor improvements made in existing products. Typically,savings are shared 50-50, based on real cost that you cantake out of bottom line as best as can be measured. Thissharing of savings is fair. It is the best way to get buy-into the process from both sides, and the premise of theJDCrop approach: to recognize real cost savings andshare them 50-50.

Deere’s understanding of Metal’s cost structures andassociated issues is high. They do question a lot. It helpsthem better understand issues and from where costs arecoming. They still struggle over price/cost, but there ismore focus on reducing cost, not just price. Therelationship between Metal and Deere is characterized bya commitment on both sides to act as partners. Insupporting Deere, Metal’s goals must include:

Delivery and quality as prerequisites to business.Support of Deere’s achieving excellence goals.Effective cost management.

The objective is to have a long-term relationship withDeere, to understand each other’s business objectives.This is a competitive industry, and whoever excelsbenefits. Delivery and quality are mandates. Whoever hasthe low cost gets the business. Metal must perform. Thereis a healthy tension, the failure to meet objectives is NOTacceptable; Metal must be a low cost provider or it runsthe risk of not getting future projects.

Deere ProcessesDeere has three processes for managing the cost ofcurrent products:

Supplier development: Offering resources to help thesupply base.

JDCrop initiative: Drive/consolidate cost reduction;supplier improvement ideas.

Value Improvement: Events that Deere hosts tosupport suppliers in identifying areas that they cantake cost out while maintaining quality/delivery.These events may be a day or several days long.

In the new product arena, Deere has PDP (productdelivery process). This is the upfront program to establishcost targets and get supplier participation in design anddevelopment.

Deere works from both sides, managing costs bothduring the early/new product development phase andonce in production. Deere may also help suppliersimprove prices by leveraging volume for items.

Deere is improving the way it manages processes forachieving excellence metrics. These metrics are nowconsistent across the board. The supplier quote form thatis used for supplier cost disclosure is also standard acrossbusinesses. Processes are becoming much more standardon a high level. The difference is in the details. Eachfactory within Deere is somewhat different in terms of itsprocesses. There may even be differences with in a singlefactory. Metal focuses on the Deere metrics that drive thebusiness.

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A P P E N D I XEDeere’s Impact on Metal’s Supplier ManagementThe way that Deere interacts with Metal does impactMetal’s supplier management. Cost targets from Deerehave encouraged Metal to look for more informationfrom its suppliers than in the past (it has learned fromDeere). Metal is beginning to use the tools and processeslearned while partnering with Deere. Metal’s purchasingdoes interact with Deere, and understands Deere’ssupplier management processes.

Metal is now working on developing its own method forsupply chain management and consolidate its supplybase to gain leverage. It is using a very Deere-likeprocess. Metal plans to put this into place soon; it hasestablished a core team to implement the process. Metalwas more tactical in dealing with suppliers in past. It ismoving toward strategic processes, benchmarking, andrelated processes. It is moving from many to fewsuppliers and developing cost models.

SC CASE: SUPPLIER TO CHIP

BackgroundSC is both a subcontractor for and a competitor of Chip.The high-technology electronics industry has always hada strongly competitive price orientation. To support thislow cost/low price emphasis, all of SC’s manufacturingfacilities, and most of its suppliers, are located in Asia,where production/labor costs are significantly lower.

Industry Pressure for Cost Management andSupplier ImpactIn the past 18 to 36 months, a shift in industry forces hascreated and supported a change in the cost managementemphasis in this industry. Recently, the end consumershave gained much influence; they are demanding higherperformance, more variety, and lower prices. This is nolonger a high volume, low product variety business. Thishas created greater complexity and higher productioncost. As a result, SC’s customers, like Chip, are puttingmore cost/price pressure on SC. SC, in turn, has putmore cost/price pressure on its suppliers. For example,about 18 months ago, SC approached its suppliers andtold them that it needed a 20 percent across the boardprice decrease to meet its customer’s demands. Thesuppliers responded that this was not a reasonableexpectation, and that the price decrease had to beapproached analytically. In some areas, there might beopportunity greater than 20 percent. In other, moremature products, there was little/no cost savingopportunity.

Supplier CollaborationThus, SC worked with suppliers to develop reasonableprice targets by product, rather than across the board.

Simultaneously, SC developed training courses to workwith its suppliers and own internal customers, trainingthem in supply chain management concepts such ascollaboration, inventory management, the benefits offorecast sharing, total cost of ownership, and so on. Akey concern of SC was to ensure that its suppliers werenot damaged by price reductions, but were focusing oncost reduction measures that support improvedoperational and cost efficiency throughout the supplychain.

Cost Management ApproachesSimultaneously, SC developed should-cost models of keysupplier inputs. SC’s should-cost approach involves:

• Mapping processes.• Breaking down and analyzing all that it knows about

the supplier processes in terms of cost.• Considering what the market will bear based on

market research (target development).• Developing detailed should-cost models.• Estimating supplier’s cost structures.

One output of the should-cost effort was thedevelopment of generalized models for major costcategories. Another result was an understanding of thekey cost drivers of various inputs. This helped SCdevelop price targets for suppliers and get a betterunderstanding of cost issues over a product’s life cycle.Much of this effort was influenced by the high degree ofprice pressure SC was receiving from its customers, suchas Chip. Some of its customers, including Chip, have thesame suppliers as SC. Thus, SC’s suppliers were beingpressured from multiple customers simultaneously.

Supplier EducationInitially, the SC’s suppliers resisted SC’s new approach.They were accustomed to the traditional price haggling.But suppliers came around as SC educated them. Thefocus of SC’s supplier education efforts have been on thesuppliers’ top executives, such as CEOs, and their chieftechnology people. These are the people who caninfluence and set policy for the rest of the organization.SC even developed a class in supply chain managementfor its suppliers to deliver to their suppliers. SC alsoshares some information on its cost structure andprofitability with its suppliers, so that suppliers under-stand the justification for price targets SC gives them.

Importance of Information TechnologySubsequently, SC has also worked with its suppliers onincreased electronic information sharing. This hasallowed suppliers more control in their planning andmanufacturing, and has supported a significant shifttoward Vendor Managed Inventory (VMI). Prior to thisinformation sharing, there was excess inventory at all

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A P P E N D I X Enodes in the pipeline. This is extremely costly astechnology changes rapidly, creating significantobsolescence costs. It is estimated that the annualcarrying cost of inventory is between 40 percent and 50percent in this industry. Today, SC has negotiatedagreements with its customers, making the customersresponsible for a certain amount of inventory based onthe customer’s demand forecasts, moving the wholesupply chain closer to a make-to-order environment. As aresult, SC has been able to reduce its inventory by about80 percent since this approach was implemented. Itssuppliers have had similar reductions, and areenthusiastic about VMI. SC has also been focused on itsown Enterprise Resources Planning (ERP) systemimplementation to improve internal communicationsamong its operations and seven production facilities.

Customer Interaction on Cost ManagementSC’s suppliers have been quicker to embrace the supplychain cost management efforts than have its customers.As mentioned earlier, this market is extremely priceoriented. SC believes that most of its customers still havea price focus. Some customers, like Chip, have developedexcellent tools for understanding the costs that driveprice, which have helped SC’s understanding of costsimmensely. While price will always be important, SCbelieves it is not a sufficient focus for them if they hopeto achieve significant improvements. Thus, SC hasapproached its customers about improving collaborativeefforts.

SC’s customers are more interested in collaborating interms of combining their volume and leveraging it withcommon suppliers than they are on collaborating onimproving supply chain efficiency, combining technologyroadmaps, and other process-related issues. The emphasisrecently has been on how to leverage materials purchasesusing e-commerce tools, like hubs or market places. As inany industry, the players here are all profit maximizers.There is a hesitancy to get too close and share too much.This creates a barrier to true collaboration. SC sticks withsome of its powerful customers like Chip due to its largevolume and market presence. However, the customers’relentless search for deep price cuts limits real alliancedevelopment.

Earlier Involvement in Design OpportunitiesOne factor that distinguishes SC from other types ofsuppliers is that SC is a subcontractor. As a subcontractor,it is more innovative, and generally has more specificdesign capability and expertise than its customers; manyof its customers come to it for its design capabilities.Typically, a customer approaches SC with someinformation on the design/capabilities it desires and atarget cost. SC designs and produces the product.Frequently, the customer will tell SC what material and/orprocess it should use. However, the technology they are

dealing with is very complex and constantly changing, sothe customer may lack the expertise to know whether thespecified material/process will really work. This createstime delays and added costs as SC tries to make it work.SC has been working to educate its customers so that itscustomers get involved earlier in concurrent engineeringefforts, at the concept stage. In cases where it has beeninvolved earlier, it has been able to reduce the totaldesign cycle by as much as 75 percent, achieve lowerdesign costs, make better initial decisions and free upresources. So the early supplier involvement definitelycontributes to improved outcomes as well as enhancedcost management in the supply chain.

Cost Improvement OpportunitiesSC has a process-engineering group that focuses solely oncost improvements. This is a very important group due tothe extreme price pressure on SC from its suppliers. SCalways meets its customer’s target costs. Sometimes itmeets these costs before it knows how it will achievethem, but it always meets them. Technology plays thebiggest role for SC in meeting cost targets. About 80percent to 90 percent of its cost improvements comefrom improving design and application of technology.Only about 10 percent to 20 percent come fromcommercial opportunities such as price reduction ofexisting materials. Most of the commercial pricereduction opportunities have already been squeezed outof the supply base. All of its major customers havededicated resources/personnel co-located in SC’s factoriesto collaborate during the production process. A key toreal improvement is to have very early collaborative/concurrent engineering efforts in design.

Future IssuesSC is continuing to increase its focus on collaboratingwith suppliers, and moving into collaborating with andunderstanding the markets of second tier suppliers.Education has proved to be one of the most valuabletools in improving supply chain performance and costmanagement.

SC has a goal of being a preferred customer to itssuppliers. Relations with suppliers have not always beengood, due at least in part to the continual price squeezes.While the price emphasis will never go away, SC is nowworking closely with its suppliers to facilitateimprovement. SC is co-locating engineers at supplierlocations, emphasizing process and technologyinnovations and improvements, and sharing the savings.SC is also benefiting from the efforts of competitors, whoare working to improve the same supply base.

Case study participants:PSM ExecutiveTwo Customer Account Executives that service Chip

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A P P E N D I XENETWORK CASE: SUPPLIER TO TELE

BackgroundNetwork is a broadband company with a goal of helping“the world communicate, supplying network equipment,software solutions, and integration services forbroadband, multi-service networks that deliver data,video, and voice communications over telephone, cabletelevision, Internet, broadcast, wireless, and enterprisenetworks.” It is in a challenging competitiveenvironment, and most of its customers have beensuffering financially.

Network differs from the competition in that it is smallerthan most of the competition, yet it wins business bybeing flexible and having the ability to meet customerneeds quickly. Network’s competitive posture is one ofbeing very customer service oriented, focusing ondelivery, service, and bundling. This has always been itsapproach. Another area that it emphasizes is relation-ships. It forms very deep and lasting relationships, andhas very good working relationships with its customers.

Focus on Cost SavingsIn the relationship between Network and Tele, there areno specific cost targets as such. As they negotiatecontracts, they do have a good working relationships.Both sides work to maintain margins while Networkprovides year-over-year cost reductions, or adds value.This is common in all negotiations and contract renewals.Network works to understand its customer’s motivation:cost, service or some combination.

In the past, Tele had its own warehousing/distribution.This was extremely expensive, because this is not Tele’score business. Tele bought directly from Network.Network worked with Tele to help it locate a distributorthat could handle Network’s product and non-competitive products that Tele also uses. One order cannow deliver all a technician’s needs in many cases.Network also worked with Tele to help it locate and workwith minority suppliers as distributors. Tele pays a slightmark-up for a huge reduction in administrative costs.Network helped Tele identify critical issues such as thesupport Network needed, the service and software thepotential suppliers could support, and similar issues.

An example of another program on which Networkworked with Tele is that Network participated as a pilotsupplier on Tele’s supplier quality program. The qualityprogram reduced or eliminated Tele’s need for inspectingNetwork’s components, creating significant savings forTele. Tele does not share cost savings with Network. It isnot a standard practice to share cost savings in thisindustry. It is an extremely competitive industry.

Cost is a constant issue in this industry, and in dealingwith Tele, Network’s sales model is not to be the lowprice provider, but to sell based on value. It has to makesure that customers get the service they expect. On astrict bidding war, Network loses.

In working with Tele, Network can look at administrativecosts, and bring Tele new ideas. Tele is willing to considervalue vs. just price, because Tele understands the value oflooking at the total cost and service package. Networkbelieves that in the long run, Tele has gained a great dealfrom looking at the total cost perspective.

As a company, Tele/Network have some joint teams.Network has worked closely with Tele on minoritysupplier development and reporting. Network alsoparticipated on a quality team, as mentioned above. Theywork together on teams on a pretty regular basis. Tele issensitive not to get Network involved in too many things,but the teaming with Tele is growing.

Tele RelationshipNetwork and Tele have a long-term relationship. Theyhave been working together for eight to 10 years. Duringthat time, it has strengthened considerably, becoming aclose working relationship. Network has a team of threeto four account specialists for their key customers likeTele. When Tele calls in, the Network personnel that itdeals with are familiar with its business, the products ituses, the applications, and it’s pricing. That further addsvalue and helps personalize the relationship. This is theway that Network competes; it can’t win based on pricedue to its relative size vs. competition. It works closelywith its large customers on systems and services.

Supplier RelationshipsHistorically, Network has not had as great a focus onsupplier relationships because it is very verticallyintegrated. To a great extent, the raw materials that itpurchases are commodities. However, the focus onsuppliers, supplier relationships, and supplier costmanagement is growing as Network outsources more. Itdoes work with some suppliers on helping the suppliersreduce costs. Network has a top 20 to 25 preferredsupplier program where it works with some key suppliersas long-term partners.

Key Success Factors and Lessons LearnedIn successfully working with its customers on a value-based approach, Network must make a lot of promisesinitially. But the results it helps its customers achievespeak for themselves. Network focuses on delivery of thevalue-added aspects of the relationship. It builds a budgetfor these expenses, supports and plans for value-addedactivities. It must consistently do what it says it will do.Its customers measure its performance and have highexpectations.

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A P P E N D I X EAs a manufacturer to service providers, Network findsthat it may be difficult for the customer to reallyunderstand manufacturing costs, cost structures, etc.Customers would like to believe that if it identifiessuppliers for Network, it would save them money. Butmanufacturing is Network’s business, so it generallyknows where the opportunities lie. Some customers’ costsavings ideas actually increase Network’s cost of doingbusiness. Thus, Network may need to educate customersa bit in that regard.

Overall Cost FocusNetwork’s internal incentive program includes allemployees. As part of that, every person in the companyis evaluated based on his or her contribution to costsavings within the company. This applies to each personin the company, from the mailroom to the factory to keyexecs.

The engineering group is also constantly looking at allphases of engineering: development, manufacturing,continuation engineering (for mature products), and howto achieve cost efficiencies for each product at every stageof its life cycle. The engineers constantly look forcommonalities and ways to improve. There is acontinuous improvement focus that spans the range fromnegotiating better with more leverage to better utilizingthe learning curve, and related issues.

Manufacturing engineers also design and developimprovements in production equipment. They improveon the standard equipment that they buy in order toreduce costs. The cost focus permeates the company; it ispart of the culture of the company. Several years agoNetwork switched to using Economic Value-Added (EVA)as a key basis for evaluating company performance, andits performance has really improved.

MCJUNKIN CASE: SUPPLIER TO PRAXAIR

BackgroundMcJunkin is a family owned and operated, $800 milliondistributor of industrial pipe, valves and fittings (PVF).Ninety percent of its revenues are derived fromdistribution. About one-third of those revenues are tiedinto integrated supply relationships. The level ofintegration varies significantly, from integrating all of thesupplies from various manufacturers and distributors fora customer, to running the customer’s warehouse, stores,and even acting as a full-blown purchasing department,integrated supply is the fastest going aspect of McJunkin’sbusiness. The focus on integrated supply involves onlythose customers whose primary maintenance, repair, andoperating supply (MRO) consumption is pipe, valves,and fittings.

Relationship with PraxairMcJunkin has been in its current integrated supplyrelationship with Praxair since January, 2001. Praxair’saccount representative from McJunkin has worked withPraxair for 15 years in a variety of capacities. The focushas been on identifying and implementing creativepurchasing concepts. As part of its integrated supplyrelationship, McJunkin has a branch site at Praxair’stechnical center. Praxair and McJunkin share virtuallyeverything at that center: equipment, machinery,computers, and so on. The goal is to take all redundantcosts out of the supply chain.

Another significant cost savings effort that McJunkin hasworked on with Praxair is identifying second tiersuppliers of items and eliminating as many as possible.The rationale behind this in a distribution setting is tosimplify the supply chain and reduce number of levelsand times that profit is made. These second tier suppliersare suppliers of other MRO items to Praxair. McJunkincan get them direct over 80 percent of the time, andreduce markups, taking cost out the chain. Praxair usessome proprietary/custom parts that McJunkin cannot getdirect. However, McJunkin serves a number of other airproducts/chemical companies as well, so is aware ofpotential substitutes and is working with Praxair on theviability of these substitutes.

In addition, from McJunkin’s perspective, Praxair hasdone a good job on the front end in managing theseproprietary suppliers, and having suppliers holdinventory. McJunkin now manages most of the secondtier relationships. McJunkin can also get greater leverageeven with some of these proprietary suppliers bycombining Praxair’s volumes with other customers.

Information sharing between McJunkin and Praxair onpricing and other sensitive issues is done at a high level –director level. Information is shared two ways.McJunkin’s computer systems are very secure to protectinformation transfer to or from competitors. The scope ofcontact for sensitive information is very limited to ensureconfidentiality.

Praxair ProcessesMcJunkin is working closely with Praxair on Praxair’s Six-Sigma teams. Some major goals of these teams are toreduce rework and increase contract compliance. Praxairand McJunkin are spending a lot of time talking aboutand working to improve compliance issues, understand-ing the benefits of compliance and related issues.Representative from McJunkin have been accompanyingPraxair purchasing people and others to site locations toeducate users on the benefits of using McJunkin’sautomated ordering system in terms of rework, orderaccuracy, quality, and cost. This improvement effort isviewed as a partnership. Praxair very much understands

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A P P E N D I XEand embraces the total cost of ownership/value concept.This is the basis on which McJunkin tries to establishrelationships with its customers. This approach is muchmore sustainable and mutually beneficial than only afirst-price approach.

Praxair expects McJunkin to be proactive and come tothem with cost advantages. McJunkin has achieved abenchmark/goal of saving $24,000 per month. The newtarget is to do as well or better than this. While it had nospecific goal in mind, it had identified a rough savingstarget. This philosophy of continuous improvement hasbeen going on since the early ’90s. Ideas and suggestionscome from both sides. This is how it developed the ideato share assets in the supply center that McJunkin runsfor Praxair. It is a win for both parties. The continuousimprovement attitude is just part of their culture ofworking together.

Praxair does not share cost savings with McJunkin. Costsavings are an expectation that allows McJunkin tocontinue to win the business, and be presented withincreased opportunities for additional business. Theintegrated supply relationship between McJunkin andPraxair has been in place in its current form for over ayear. The account representative from McJunkin viewshimself as the current custodian of the McJunkin/Praxairrelationship.

Praxair’s Influence on McJunkinMcJunkin has brought many ideas to Praxair and learnedmuch from Praxair as well in terms of identifying andimplementing cost savings. Cost management is anintegral part of the long-term relationship betweenPraxair and McJunkin. McJunkin must continue to proveitself and earn its business. Praxair is tough but fair withMcJunkin.

McJunkin’s Supplier RelationshipsMcJunkin tends to have long-term supplier relationships,and relies a great deal on leverage over both time andquantity with these suppliers wherever possible. In muchof the industry, pricing is based strictly on volume level.McJunkin is beginning to implement some strategicsupplier initiatives and supply base reduction to furtherfocus its volume. It just re-examined its supply base for acertain type of valve, committing to the suppliers, askingfor price and field support advantages, to really form apartnership. If this is successful and provides advantage,McJunkin will spread this idea to other areas where it isbeneficial. In general, the suppliers and McJunkin’sinterests are well aligned.

McJunkin’s Processes for Managing Customer CostsIn the economic recession, McJunkin has found that hereis much more interest in the integrated supply arena.

Companies want McJunkin to provide them with moreservice due to the increased opportunity for cost savings.Customers save a great deal on administrative costs justby not bidding each project. It also lets key customers’maintenance subcontractors buy from McJunkin at thatcustomer’s prices so that the customer can enjoy thesavings.

McJunkin positions itself as the quality player. It uses itfocus on value and life cycle cost/total cost of ownershipas a marketing tool. McJunkin has worked closely withits customers to develop software that accounts for andassigns a value to every available savings opportunity andthen provides customers with regular reports ondocumented savings at each of their locations. Thesespreadsheet summaries, provided by McJunkin, helpcustomers get the big picture on real costs and savings forall aspects of their operations, from a TCO perspective.

McJunkin has designed a system that it calls Value Plus®‚as a knowledge center to support its salespeople indelivering cost-savings ideas to its customers. It is adatabase that breaks down the operations of a facility andidentifies common inefficiencies and solutions providingsales staff with ideas and places to begin. In part of theinitial selling process or the ongoing relationship, theywill commit to a customer for specific cost savings. Theycan also engage in risk-reward sharing contracts, wheresavings are shared once McJunkin exceeds its goals. Thiscreates a greater two-way incentive.

The steps in McJunkin’s Value Plus®‚ system begin withprojecting customer savings based on conducting acomprehensive survey of the supply operations andrelated costs. Next, it tracks the savings againstprojections based on the actual savings achieved. It thenprovides customers with full documentation of theiractual cost savings and regular savings reports. Thisinformation includes savings from faster, easiertransactions, reduced inspections and testing, reducedrework, better life cycle costs, and other factors. Thesavings documentation is available for any time period(including monthly, quarterly, or annually), for specifiedcategories or all categories, at a specific site or company-wide (for national accounts).

Documentation of savings to customers is very important.McJunkin’s value proposition to prospective customers isto work the supply chain costs to the advantage of thecustomer. About 82 percent of McJunkin’s costs are costof goods. It does not have much to cut, so it must addvalue. Most of its internal costs are the costs to serve thecustomer. McJunkin has to educate the customer to focuson the 82 percent of the cost structure, and understandprocess costs, value, TCO.

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A P P E N D I X EThe major sources of savings from Value Plus ‚ includesavings from:

• Improved materials management/availability.• Improved transactions management using numerous

electronic. transactions to help customers reducetime and manpower involved in workflowprocessing.

• Managed services, including outsourcing toMcJunkin storeroom management, integrated supplyand purchasing services.

• Product cost management via standardizing productsand streamlining inventories, suggesting substitutesand ways to reduce consumption.

• Product and process application, enhancing qualityto end incoming inspections and reduce rework,improve life cycle costs.

McJunkin has countless examples to demonstrate howbeing a first price or low-price only buyer can actuallyend up costing the organization significantly more money.

Key Success Factor in Continuous Improvementwith CustomersAbove all, McJunkin identified a collaborativeenvironment, with a clear understanding of theeconomics of the supply chain in working well withcustomers. It helps immensely if the customerunderstands TCO, and there is participation in theintegrated supply relationship beyond purchasing, toinclude the decision-makers in engineering, operations,and other relevant parties. Purchasing needs to havecooperative relationships with other internal groups.

McJunkin also recommends that customers shouldnegotiate savings expectations in their contracts withsuppliers. This creates specific pressure for the supplier,such as McJunkin, to perform and create the best cost-savings opportunities possible for the customer.

Case Participants:Account Executive to PraxairCorporate Account Executive

MAJOR DISCOUNT RETAILER CASE: CUSTOMER TO LCP

IntroductionMajor Discount Retailer (MDR) is one of LCP’s customers.MDR is currently undergoing a re-engineering ortransformation effort aimed at dramatically changing itssupply chain and business model to embrace a customerfocus while fixing its supply chain. MDR is radicallychanging its supply chain, taking a long-term, big-pictureview rather than focusing on how to get the lowest price

today. In the past, rather than providing incentives forsuppliers or collaborating with suppliers, MDR behavedin a reactive manner, penalizing suppliers for a wholehost of non-compliance issues. Thus, instead of directingsuppliers’ attention on how to do things better, its focuswas on how to avoid fees and penalties. This mentalityalso created an adversarial culture between MDR and itssuppliers. Cost management was treated as an issueseparate from supply chain value. Management directedits efforts more in terms of price to MDR than looking attrue costs in the supply chain.

Customer ImpactToday, the focus is on simultaneously understanding thecost and value drivers in the supply chain. The focalpoint is on serving the ultimate retail customer. Thisincludes removing the waste and redundancy from thesupply chain that creates higher cost withoutcommensurate value. For example, MDR’s promotionalspend had doubled in the last five years or so. Yet all ofthese promotions were creating huge costs and supplychain inefficiency, as MDR placed huge orders to fulfillpromotional demand, then drastically reduced buying forthat item. It was buying its customers with low prices,not with value creation. Today, MDR recognizes that inorder for its cost management efforts to be effective, itmust examine how it serves its customers and its ownirrational behavior in its supply chain. It is movingtowards an everyday low price mentality rather than adeep discount and promotional approach.

Supplier Relations in GeneralMDR feels that it has treated all but a few of its keysuppliers as commodities in the past. It recognizes thattrue collaboration is required for both it and its suppliersto be successful. It is moving in that direction.

As a show of good faith to support its move toward morepositive supplier relations, MDR has suspended allpenalties associated with its supplier compliance programfor 100 days. It is re-evaluating its approach to suppliercompliance, and intends to focus on only a few standardissues, such as bad universal product codes (UPCs). Itwill work collaboratively with its suppliers to solve allother problems. It has also responded to suppliers’complaints that it was unresponsive to suppliers’questions and comments. MDR has recently instituted asupplier tracking system to ensure that 100 percent ofthe suppliers’ issues are resolved.

Its overall supply chain direction related to suppliersincludes:

1. Getting the basics of good supply chain managementin place.

2. Rationalizing the supply base.3. Increasing supplier partnerships.

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A P P E N D I XEIt is working on several key initiatives aimed at takingcosts out of the supply chain. Before MDR begins toproactively work directly with suppliers to reduce theircosts, it is developing an understanding of the poorpractices that it employs, and how these practices affectthe supply chain and the costs of its suppliers. It ismoving more in the direction of supplier-managedinventory, and on improving its logistics operations,including quick unloading of trailers rather than usingsupplier’s trailers as temporary warehouses. It realizes thatits own practices represent a large part of the supplychain cost savings opportunity. It sees itself as goingthrough a correction in its business practices. MDR is alsooutsourcing in some areas it would have neverconsidered outsourcing in the past, such as somedistribution. The Chairman of the Board of MDR is onrecord as saying that MDR can have no real improvementand change in its supply chain unless it significantlyimproves its relationship with its suppliers.

MDR’s Relationship with LCPMDR has had a very close working relationship with LCP,so much so that MDR has not historically beat up LCPlike it has many of its other suppliers. MDR credits LCPwith taking the initiative to maintain that relationship.MDR notes that it is difficult quantify all of the savingsthat LCP has generated for MDR. However, LCP has beeninstrumental in helping MDR think about and evaluate itssupply chain philosophy, and recognize some of theopportunities to improve its supply chain. For example,LCP worked with MDR to set up a project to track its outof stock and overstock costs and causes, and help MDRreally see the opportunities for supply chainimprovement in its own behaviors. MDR sees LCP as amodel supplier, and would like to replicate the type ofrelationship it has with LCP with other suppliers.

Case Participant: Vice President of Operations

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A P P E N D I X F

Cost is a driving force in purchasing today, as it alwayshas been. In a recent study entitled, Major StructuralChanges in Supply Organizations (Leenders and Johnson,1998), cost was mentioned as one of, if not the onlydominant environmental pressure causing change inpurchasing organizational structure for all of the 15organizations studied. This was a pressure whether theorganization moved from centralized to decentralized,decentralized to centralized, or to or from a hybridorganizational form. With the growing pressures ofincreased global competition and rising customerdemands, cost is a pressure that no organization seems toescape today. Increasingly, we see companies attributefavorable surprises in profitability performance toeffective cost management. Companies such as JC Penney(Forest, 2002) and General Electric (General Electric2001 Annual Report) show improving profit despitelower sales revenue due to improved cost management

Two CAPS Research studies that focused on costmanagement were published in the 1990s. The first, TotalCost Management (Ellram, 1994) focused specifically onhow organizations try to better understand their truecosts of doing business with particular suppliers, or usingparticular processes. The Role of Supply Management inTarget Costing (Ellram, 1999) examined the target costingprocess and how organizations use it internally and inrelation to their customers and supply bases. One of thefindings of that study is that cost managementapproaches such as target costing are not isolatedinitiatives, but rather one supporting approach in a webof approaches that organizations use to support newproduct development and better manage their costs.Indeed, Cooper and Slagmulder (1999) argue that targetcosting is the foundation of strategic cost management. Intheir book, Supply Chain Development for the LeanEnterprise, they argue that target costing and workingwith suppliers are the foundation and basis for strategiccost management in the supply chain. However, while

they stress the importance of supplier management andproperly segmenting the supply base for costmanagement, they do so from an accounting perspective.Their case studies all took place in Japan, wherepurchasing does not play a major role and, in manycases, does not even exist as a distinct function orprocess. Their book provides an excellent framework andinsights, but does not directly explore the role of PSM instrategic cost management in the supply chain.

Most of the research studies and popular articles thathave been written exploring PSM’s role in costmanagement look at one particular cost managementtechnique such as total cost of ownership (TCO) (Ellramand Siferd, 1998; Degraeve and Roodhooft, 1999), targetcosting (Ellram, 2001b; Newman and McKeller, 1995),cost analysis and should-cost analysis (O’Connor andHopkins, 1997; Burt, Norquist and Anklesaria, 1990)and price analysis (Woods, 1998; Graw, 1998). Each ofthese tools, if applied independently without reference tothe way other cost management tools and processes arebeing used or without regard to the organization’sobjectives, becomes a tactical approach to costmanagement rather than a strategic approach. The goal ofthis study is to look at cost management strategically:How do various approaches to cost management fittogether and support the organization’s overall strategy,value proposition, and extend beyond organizationalboundaries into the supply chain?

The purpose of this study is to use the existing literatureand frameworks to better understand the role of supplymanagement in strategic cost management in the supplychain, looking at both the upstream and downstreamsupply chain issues. To do this, a framework of strategiccost management is used. This theory was developed inthe accounting literature.

Appendix F:Literature Review

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A P P E N D I XFStrategic Cost Management TheoryStrategic cost management, in order to be truly strategic,is grounded in three elements:

1. Developing an understanding of what drives cost inthe supply chain.

2. Understanding the customer value proposition uponwhich a particular business is based.

3. Understanding the organization’s supply chain(Shank and Govindarajan, 1993).

This research examined PSM’s involvement in andunderstanding of each of these key elements of strategiccost management. The first element, understanding ofsupply chain cost drivers, is explored in terms of howPSM interacts with suppliers in cost management, whatcost management tools and processes are used, and howresults are measured. The second element, the customervalue proposition, is examined in terms of how PSMcomes to understand the customer’s needs andincorporates value into its cost management processes.The third piece, taking a supply chain perspective, dealswith how the organization translates customer needs intoits internal processes and supplier interactions. Do theytake a supply chain perspective?

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A P P E N D I X G

This study was conducted to answer the followingresearch questions:

1. How important is strategic cost management in theorganizations studied, and why?

2. How are firms organized to effectively achievestrategic cost management?

3. Who is responsible for conducting cost managementin the organization, and who is accountable fordelivering results?

4. How do organizations determine the focus of theircost management efforts?

5. What specific cost management tools do organiza-tions use to support strategic cost management?

6. How are the results of cost management effortsreported?

7. What other unique processes or organizationalstructures contribute to the success of strategic costmanagement efforts in the organization?

8. What impact do supplier relationships have on theorganization’s cost management approaches?

9. What is the supplier’s perspective on theorganization’s cost management efforts?

10. What impact do customers have on the organization’scost management approaches?

11. Does the organization take a true supply chainmanagement perspective of strategic costmanagement?

12. What are the key success factors and barriers tostrategic cost management?

13. What is the future of strategic cost management inyour organization?

Design

This study was conducted using an in-depth case studyresearch method. This method was chosen to support thebroad and exploratory nature of the research questions of

interest (Yin, 1994; Meredith, 1998). In developing thecontent and research issues for the study, the researcherpresented the research proposal to a group of purchasingand supply management professionals and first tiersuppliers who are all members of an organization calledthe National Initiative for Supply Chain Integration(NISCI). The input of these PSM professionals was usedto modify the research design.

Sample SelectionThe case study participants were chosen using criticalcase sampling. Critical case sampling is a type ofpurposive sampling (Neumann, 1991) that looks forcases that are “particularly information rich orenlightening” in relationship to the questions underconsideration (Kuzel 1992; Yin 1994). The point of thissampling method is to allow for logical generalization insuch as a way that the information in the cases can beapplied to other similar cases. The case studyorganizations were identified and selected in a number ofways. First, members of NISCI who are actively involvedin supply chain cost management were asked toparticipate. Members of CAPS Research also werepresented with the criteria and asked to participate in thestudy during the CAPS Research 2001 ExecutivePurchasing Roundtable North American Venue.

The criteria for participation were as follows:

1. Active involvement in cost management effortsworking with suppliers and/or customers to reducesupply chain costs.

2. Belief that some of your organization’s costmanagement practices are leading edge/innovative.

3. Significant bottom line savings to the organizationthrough supply chain cost management efforts.

4. Willingness to openly share thoughts and processesinvolved in supply chain cost management.

Appendix G:Research Design

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A P P E N D I XG5. Willingness and ability of the initial contact to act as

a liaison to provide the researcher with entrée toother members of the organization, the supply base,and customers.

Upon volunteering or expressing a willingness toparticipate in the study, potential participants received aletter thanking them, and providing them an overview ofthe study purpose. These are shown in Appendix B. Theresearcher then followed up with a telephone interview toconfirm that the organization had the characteristicsdesired, and the willingness to support the study throughall of its phases. Several companies that volunteered toparticipate were screened out at this stage of the research.

Engaging the Core CompanyUpon determining that the core company displayed thedesired characteristics, the researcher spoke to the keycontact who had volunteered to be part of the study, andbegan to set up interviews with key informants withinthe organization. The initial contact may or may not havebeen included as a key informant. The researcher used amodified snowball technique for identifying individualsto interview as part of the case study. In this applicationof the snowball method, an initial informant or group ofinformants was identified. Traditional forms of thesnowball technique begin with a random selection ofinitial respondents (Green and Tull, 1978), which wasnot appropriate in this research. As these informantsparticipate in the research and come to develop anunderstanding of the research and its purpose, theyidentify other informants. This process continues untilthe researcher reaches a point at which the informantscannot identify anyone that they think will addsignificant additional value, or the informants begin tobecome redundant (Kuzel, 1992). This approach wasused to identify most of the participants from the corecase study organizations, all of the suppliers, and the onecustomer organization that participated.

Engaging Others in the Supply ChainAs part of agreeing to participate in this research, all of theprimary contacts were asked if they would be willing andable to help the researcher get in touch with a keysupplier and a key customer with whom the core casestudy believed that it had successfully worked on strategiccost management. Each of the organizations agreed tothis. In reality, making contact with a key supplier and akey customer turned out to be one of the most timeconsuming aspects of this study. The core companyprovided the researcher with one or more suppliercontacts in all cases, and made the initial contact with thesupplier. Despite this, the core company had to interveneon the researcher’s behalf and make multiple contacts inall but one of the cases in order to get any response. Itwas common for five to six months to pass between initial

identification of a supplier and actual engagement. Part ofthis was due to the state of the economy: Many peoplewere changing jobs, being laid off, and under more workpressure than usual. In such circumstances, supportingany activity that is not core to the organization’s successtakes a low priority. The researcher greatly appreciates thediligence of the core participants in following up withtheir suppliers. A similar pattern occurred with theresearcher’s attempts to make contact with the corecompanies’ customers. This was even more challengingbecause the key contact was generally more steps removedfrom the customer, and had to sell to a key accountrepresentative or sales executive the idea of letting theresearcher talk to a customer. This sell did not alwayswork. After repeated attempts and follow-ups with thecore companies and the contacts they provided, theresearcher was able to successfully interview only onecustomer. The difficulty for PSM to gain access tocustomers was in itself a finding. The researcher decidednot to pursue customer contact independently of the corecompany. That would have been a violation of the initialagreement between the researcher and each core company.In addition, the researcher asked one of the corecompanies about the approach of having the researchermake direct contact. The company specifically asked theresearcher not to do this.

Focus of the StudyIn this research, the analysis focused on the PSM groupwithin the core organizations studied. While manyperspectives beyond that of PSM are included in thisresearch, the purpose of this research is to gain anunderstanding of PSM’s roles, responsibilities, andinfluences in strategic cost management in the supplychain. The point of involving parties outside of PSM inthe research is to broaden the perspective and reduce thebias that might come from PSM, or any function,reporting on its own activities. In addition, the focus ofthis study is limited to the period when data collectionbegan to when it ended for each core organization.

Interview ProtocolAn extensive interview protocol was developed for theresearch as shown in Appendix B. The participants wereasked different questions based upon their functionalrepresentation, and whether they were a supplier,customer, or part of the core case organization. Allparticipants received an abbreviated version of the researchproposal, a letter of introduction explaining their role inthe study and the confidentiality issues, and a copy of thegeneral questions that would be addressed in the course ofthe research. The interview protocol was validated by apanel of PSM executives who are interested in strategic costmanagement in the supply chain from PSM’s perspective.The research protocol was also pre-tested on one casestudy organization and modified accordingly.

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A P P E N D I X GConducting the Case StudiesThe interview protocol provided a series of semi-structured, open-ended questions to guide the overalldiscussion with case study participants. Participants werenot prompted with particular answers or ideas; theconversation was allowed to flow. This helps reduceresearch bias and provides a fresh perspective (Yin, 1994;Strauss and Corbin, 1998). In addition, a semi-structuredapproach allows the researcher to delve more deeply intounanticipated lines of discussion, and uncover new,previously not considered insights (Yin, 1994; Crabtreeand Miller, 1992; McCutcheon and Meredith, 1998). Ifthe researcher found a particularly fruitful or interestingissue, she would deviate from the protocol.

The case study interviews were conducted on both thetelephone and in person, based on the availability andpreference of the respondent. The researcher met face-to-face with at least one person from each of the core casestudy organizations. The length of the interviews variedfrom approximately 90 minutes to three hours. Thenumber of people interviewed and their functions variedamong the organizations, based on the snowballtechnique. A summary of the representation of case studyparticipants is shown in Table 4. In all core cases,representatives from PSM and finance/accountingparticipated in the case studies. Individual casessummarizing the respondents’ comments were preparedand e-mailed to the individual respondents forcomments. These were very detailed, beyond thesummary cases included in Appendix A. Participantfeedback was incorporated and the case modified. Asummary case was prepared for the organization andagain e-mailed to the participants for feedback. In one ofthe cases, this resulted in the researcher conducting twoadditional interviews, based on the respondent’s input.

Four of the five supplier cases were conducted on thetelephone. The calls ranged from 90 to 150 minutes, notincluding follow-up. At three of the five supplier casestudies, only one informant was engaged, generally acustomer relationship manager/key accountrepresentative. At one supplier, an executive account

representative and the supplier’s immediate contact wereengaged. At a third supplier, two account representativesand a PSM executive participated in the study. All ofthose interviewed had long relationships (from five to 20years) with the customer. Further, the researcherinterviewed one key customer with whom the case studybelieved it had achieved successful cost managementresults. The interview with the customer was conductedvia telephone with the customer’s Vice President ofOperations, who had worked very closely with thesupplier for several years.

Other Sources of EvidenceIn addition to interviewing multiple informantsrepresenting multiple functions in each of the core casestudy organizations, interviewing a supplier to each ofthe core companies, and interviewing one customer, theresearcher gathered other evidence to support theresearch. This evidence included copies of internal andpublic presentations made by the organizations on relatedtopics, copies of articles written about the companies,organizational charts, copies of internal processes andprocedures, copies of case studies written about thecompanies, previous research conducted related to thecompanies, and information from the companies’websites and financial statements. Gathering these datahelped to support the case study database upon whichthe analysis was conducted. While case study researchmay be inefficient in that large amounts of data aregathered in order to determine patterns and drawconclusions, it provides important insights that are notavailable from other forms of research (McCutcheon andMeredith, 1993).

Data AnalysisThe case studies were coded for analysis using Nud*istVivo® software for qualitative research. This software wasused primarily for between-case analysis. Within-caseanalysis was conducted first by classifying the answersprovided by the informants to correspond with theresearch questions, and then combining all of theindividual cases from one organization into one casestudy representing the organization. The data was

Table 30Case Study Participants

CASE PSM OTHER INTERNAL* SUPPLIERS CUSTOMERS TOTALDeere 6 3 1 - 10Chip 5 7 3 - 15LCP 4 4 2 1 11Tele 8 3 1 - 12

Praxair 4 1 2 - 7Total 27 18 9 1 55

*Titles/positions of each participant are available in the appendices to this report at the end of each case study

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A P P E N D I XGanalyzed using open coding to develop basic categoriesfor analysis, axial coding to link the various categoriestogether, and selective coding to integrate concepts andlink related issues (Strauss and Corbin, 1998). Thismethod of analysis employed a form of an iterativetriangulation process, whereby published data and casestudies, literature, and primary data from caseorganizations are all used to develop an understanding ofthe phenomenon of interest (Lewis, 1998). Many tableswere created to analyze and compare the data among theorganizations studied. This helped identify patterns andprovide insights and additional lines of analysis.

ValidityA number of measures were used to increase the validityof the study, as shown in Table 5. Construct validityaddresses the issue of whether the variable identified isreally the variable being measured. Face validity dealswith whether a knowledgeable person would agree thatthe issues being studied appear to be addressed in areasonable manner. Internal validity addresses whether theproposed cause-and-effect relationships have beenestablished. External validity explores whether thefindings from the study are generalizable to otherorganizations or settings. Reliability addresses whether thestudy’s results could be replicated and would result insimilar findings (Yin, 1994, p. 41).

The use of multiple informants within each case, supplierparticipation, multiple cases exploring the samephenomenon, triangulation of data and the case study

data base, having case participants review the casestudies, and the use of a case protocol all increase thevalidity of the findings (Yin, 1994; Strauss and Corbin,1998; McCutcheon and Meredith, 1993).

Table 31Tactics Used to Increase Validity

Construct Validity -External business executives review interview protocol research proposal-Use multiple sources of evidence as included in the case study database:

• Multiple informants• Internal and external informants• Multiple sources of evidence including presentations, web-sites, published articles

-Have key informants review case study draft report

Face Validity -External business executives review

Internal Validity -Pattern matching-Multiple informants from within the same company review study-Multiple informants from within the same company report on same phenomenon

External Validity -Replication with five core companies and five suppliers

Reliability -Use case study protocol-Develop case study database-Triangulation

Adapted from Yin, 1994; Ellram, and Siferd, 1998.

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A P P E N D I X H

Burt, David N., Warren E. Norquist and JimmyAnklesaria, Zero Base Pricing™, Chicago, IL: ProbusPublishing, 1990.

Connor, Peter E., and Robert K. Hopkins “Cost PlusWhat? The Importance of Accurate Profit Calculations inCost-Plus Agreements,” International Journal of Purchasingand Materials Management, Vol. 35. No. 2, Spring, 1997.

Cooper, Robin, and Regine Slagmulder, Supply ChainDevelopment for the Lean Enterprise, Portland, OR:Productivity Press, 1999.

Degraeve, Z., and F. Roodhooft, “Effectively SelectingSuppliers Using the Total Cost of Ownership,” Journal ofSupply Chain Management, Vol. 35, No. 1 (Winter 1999),pp. 5-10.

Ellram, Lisa M., Impact of Target Costing on SupplyManagement, Tempe, AZ: Center for AdvancedPurchasing Studies, 1999.

Ellram, Lisa M., “Compare and Share,” PRACTIX: BestPractices in Purchasing and Supply Management, Vol. 4, No.4, 2001a. http://capsresearch.org/reports

Ellram, Lisa M., “The Role of Purchasing and SupplyManagement in Target Costing,” book chapter in KeySupplier Management, edited by Christian Belz andJoachim Muehlmeyer, Thexis, St. Gallen, Switzerland/Hanser Verlag, Munich, Germany, 2001b.

Ellram, Lisa M., and Sue P. Siferd, “Total Cost ofOwnership: A Key Concept in Strategic CostManagement,” The Journal of Business Logistics, Vol. 19,No. 1, 1998, pp. 55-84.

Ellram, Lisa M., Total Cost Modeling in Purchasing, Tempe,AZ: Center for Advanced Purchasing Studies, 1994.

Fawcett, Stanley E., and Gregory Magnan, AchievingWorld Class Supply Chain Alignment: Benefits, Barriers andBridges, Tempe, AZ: CAPS Research, 2001.

Forest, Stephanie Anderson, “A Speedy Makeover atPenney’s,” Business Week, April 19, 2002, pp. 92-93.

General Electric 2001 Annual Report, p. 49. http://www.ge.com/annual01/financials/2001_GE_AR_financials.pdf

Graw LeRoy H., “Is Price Analysis a Lost Art?” Proceedingsfrom the 1998 NAPM International Purchasing Conference,May, 1998. http://www.ism.ws/ResourceArticles/1998/98cp29.cfm

Green, Paul E., and Donald S. Tull, Research ForMarketing Decisions, fourth edition. Englewood Cliffs, NJ:Prentice-Hall, Inc., (1978), pp. 210-211.

Kuzel, Anton J., “Sampling in Qualitative Inquiry,” inDoing Qualitative Research, edited by Benjamin F. Crabtreeand William L. Miller, Thousand Oaks, CA: SagePublications, 1992.

Newman, R.G., and J.M. McKeller “Target Pricing — AChallenge for Purchasing,” International Journal ofPurchasing and Materials Management, Vol. 31, No. 3(Summer 1995), pp. 12-20.

Leenders, Michiel R., and P. Fraser Johnson, MajorChanges in Supply Chain Responsibilities, Tempe, AZ: CAPSResearch, 2002.

Leenders, Michiel R., and P. Fraser Johnson, MajorStructural Changes in Supply Organizations, Tempe, AZ:CAPS Research, 2000.

Appendix H:References

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A P P E N D I XHLewis, Marianne, “Iterative Triangulation: A TheoryDevelopment Process Using Existing Cases,” Journal ofOperations Management, Vol. 16, 1998, pp. 455-469.

Maxwell, Joseph A., Qualitative Research Design: AnInteractive Approach, Thousand Oaks, CA: SagePublications, 1996.

McCutcheon, David M., and Jack R. Meredith,“Conducting Case Study Research in OperationsManagement,” Journal of Operations Management, Vol. 11,1993, pp. 239-256.

Miller, William L., and Benjamin F. Crabtree, “PrimaryCare Research: A Multimethod Topology and QualitativeRoad Map,” in Doing Qualitative Research, Benjamin F.Crabtree and William Miller, editors, Newbury Park, CA:Sage Publications, 1992, pp. 3-30.

Meredith, Jack M., “Building Operations ManagementTheory through Case and Field Research,” Journal ofOperations Management, Vol. 17, 1998, pp. 441-454.

Neuman, W. Lawrence, Social Research Methods, Boston,MA: Allyn and Bacon, 1991.

Shank, John K., and Vijay Govindarajan, Strategic CostManagement, New York: Free Press, 1993.

Strauss, Anshelm, and Juliet Corbin, Basics of QualitativeResearch, second edition, Thousand Oaks, CA: SagePublications, 1998.

Woods, Patrick, “Fundamentals of Price Analysis,” NAPMInfoEdge, June 1998, pp. 3-7.

Yin, Robert K., Case Study Research and Design Methods,Newbury Park, CA: Sage Publications, 1994.

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THE CENTER FOR ADVANCED PURCHASING STUDIES (CAPS Research) was established in November1986 as the result of an affiliation agreement between the College of Business at Arizona State University and theInstitute for Supply Management. It is located at The Arizona State University Research Park, 2055 East CentennialCircle, P.O. Box 22160, Tempe, Arizona 85285-2160 (Telephone [480] 752-2277).

The Center has three major goals to be accomplished through its research program:

• to improve purchasing effectiveness and efficiency;• to improve overall purchasing capability;• to increase the competitiveness of U.S. companies in a global economy.

Research published includes more than 55 focus studies on purchasing/materials management topics ranging frompurchasing organizational relationships to CEOs’ expectations of the purchasing function, as well as benchmarkingreports on purchasing performance in 30-plus industries.

Focus study research under way includes: Reverse Auctions; Major Changes in the CPO and Reporting Line; PurchasingEducation and Training in the 21st Century; and the benchmarking reports of purchasing performance by industry.

CAPS Research, affiliated with two 501 (c) (3) educational organizations, is funded solely by tax-deductiblecontributions from organizations and individuals who want to make a difference in the state of purchasing andmaterials management knowledge. Policy guidance is provided by the Board of Trustees consisting of:

Stewart Beall, C.P.M., CAPS ResearchCraig Brown, Intel CorporationPhillip L. Carter, D.B.A., CAPS ResearchKen Carty, Coca-Cola USAEdwin S. Coyle, Jr., C.P.M., IBM CorporationCarl Curry, The Quaker Oats CompanyNeil A. Deverill, Philips ElectronicsHarold E. Fearon, Ph.D., C.P.M., CAPS Research (retired)Edward Hoffman, Eastman Kodak CompanyVince Hrenak, Gulfstream Aerospace/General Dynamics Corp.Edith Kelly-Green, Federal ExpressDaniel Krouse, Hallmark Cards, Inc.Robert Monczka, Ph.D., C.P.M., CAPS Research/ASUWilliam Nahill, Conoco Inc.Dave Nelson, C.P.M., Delphi Automotive SystemsPaul Novak, C.P.M., ISMLarry Penley, Ph.D., Arizona State UniversityHelmut F. Porkert, Ph.D., ChevronTexaco CorporationWilliam L. Ramsey, HoneywellJim Scotti, Halliburton CompanyDavid Sorensen, General Mills, Inc., Vice Chair, CAPS ResearchA. Keith Strange, United States Postal ServiceStephen Welch, SBC Services, Inc.Joseph Yacura, Six Continents Hotels, Inc., Chair, CAPS Research

Center for Advanced Purchasing Studies(CAPS Research)


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Case Study Interviews


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Center for Advanced Purchasing Studies

Arizona State University Research Park

2055 E. Centennial Circle

P.O. Box 22160

Tempe, AZ 85285-2160

Telephone (480) 752-2277

www.capsresearch.org

ISBN 0-945968-56-6

CAPS is jointly sponsored by Arizona State University’s

College of Business and the Institute for Supply Management

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