What is Raw Materials Procurement
In my career, I've been fortunate enough to manage spend of a few raw material commodities. This includes raw materials of gases such as chlorine, rock material such as silicon, and metals such as steel and aluminum.
These are typically your largest areas of spend in any manufacturing based company and make up roughly 50% to 70% of sales revenue [1]. These materials can be easier due to the ability to connect many with an index, but they take an immense amount of focus to manage correctly
Raw materials procurement falls under the category of direct procurement. This means that the the raw material that you are buying will be used or consumed directly into the manufacturing of your company's final product.
Raw materials can come in many forms such as metals, resins, chemicals, gases, and much more. The list of raw materials possible is seemingly endless. In this article we will discuss the top raw material procurement best practices and strategies to best support your supply chain.
Best Practices
When it comes to best practices, there are some primary areas you will need to focus on that will give you the best outcomes when dealing with raw material suppliers. It's always been my focus to apply pressure to raw material suppliers, and it's easy to do so when the spend can be so large.
However, the points below will allow you to reach, at the very least, win-win outcomes. We will discuss the critical nature of demand forecasts, how to understand the market, key items to pay attention to when developing the supply contract, and the management of the supplier after award.
Demand Forecast
Demand Forecast play a pivotal role in buying raws. Knowing how much you purchased in the past can be only half the battle when developing a demand forecast. The future demand is the other half of the equation and can be the most difficult to predict accurately. Future demand is something the supply chain is in a constant struggle to understand.
Spend time with the points below to understand who or what sets the forecast, the systems available regarding demand visibility, what access do you have to these systems, and how accurate is the data driven insights in these systems. If you haven't heard the term "garbage in, garbage out" then get ready!!
Understand Who and/or What Sets the Forecast
Ensure you understand who is responsible in your organization for demand planning. You could have a department that specializes in this. Companies with $1 billion and below in revenue likely do not. You'll likely need to reach out to your material managers or supply chain management team to understand the volume of material. Sales managers typically provide to productio
n managers a single point demand forecast that reflects aggregate expect sales for a given product.[2]
You can pair this with the actual operations side of the house and the production plan. Finally, get the rest of the story in expected volumes required by meeting with your sales team. Combining all of that information can help you make the best in complex supply networks. This will be crucial in having an efficient supply chain.
Understand the Systems available
What systems do the prior teams utilize? You'll need to understand if you use an SAP system or perhaps an Oracle system when it comes to inventory management. Whether it's cloud based or not isn't important. What is important is what your supply chain management team is using and how it interacts with your supply chain. Speak to your supply chain leaders and discover who your system experts are for on the job training.
Once you've understood the system a bit more, you'll need to ensure you have access. I find this can be critical, especially in smaller organizations, to have access to the data yourself. It's annoying to always have to rely on the schedules and workloads of your supply chain professionals to get this data.
Explain to your leadership how this will benefit and streamline the process and leverage that to gain access. Sometimes organizations have very entrenched silos and people can be exceptionally protective over data access.
Accuracy of Data
This will take some work and probably some time. As I mentioned before, the demand forecast is a combination of past, present, and future. Take time to understand how well the production plan plays out to what the future demand was expected to be.
You'll get to the point, eventually, of being able to estimate that margin of error. Especially if your sales team is over enthusiastic about the market they are selling to. This will no doubt allow you to build out a material demand profile of direct materials within your supply chain.
Understand the Market
Understanding the market drivers in your raws space in critical to know the levers that are pushed and pulled. Benchmarking spend, understanding risk, what the key cost drivers are, understanding the inputs, and ability to gather data from social media can help you affect the supply chain in a positive manner in your sourcing raw materials.
Benchmark Your Spend with Revenue of Largest Suppliers in the Market
How much leverage do you have with your raw supplier? Being able to compare your spend with the revenue of your supplier is imperative. If you make up less that 1% then you may not have much leverage. Open dialogue is possible by just asking the supplier if you are in the top ten customers. If not, then quartile would you fall in. They shouldn't have a problem answering.
Understand the Risk to the Supply Chain: Both Current and Future
If the pandemic has taught us anything, it's to be aware of potential supply chain impacts and disruption. What are the current risk impacting your supply chain? What could happen in the future. Being able to construct and complete quality SWOT Analysis will aid you in identify the potential impacts to your supply chain.
Understand the Key Cost Drivers
You are in procurement for a reason and it comes down to risk mitigation and cost control. What are the cost drivers for your raw? It isn't just the cost of inputs to that raw material, it's logistics costs, quality cost impacts that create returns of material, loss production cost due to short supply, lack of available inventory impacts. This is what we understand as both potential costs and TCO (Total Cost Of Ownership).
Understand Inputs to Raw Materials
You may understand your needed material as a raw, but your suppliers will have inputs to it. For instance, ArcelorMittal provides an excellent overview of what goes into producing steel that you can read about here. One company's raw is another's finished good. Being able to understand that next level in the supply chain will help you reduce costs while assisting with the understanding of the production processes it entails.
Use Social Media
Social Media isn't just for teenagers. I've found it incredibly helpful to follow the leading companies in the world regarding my raws. This can also be found in LinkedIn Groups, Twitter, and even Instagram. Don't write it off as something that can't give you information in a timely fashion. It can also help your own professional development by creating networking opportunities with industry experts.
Supplier Contract
When it comes to the contract manufacturer, you must understand that the contract sets the boundaries of the relationship. It's the rules of the game, and the punishment for no playing by the rules could be millions of dollars.
Know Your Packaging Requirements
First, understand the way your production and product management teams want the product to arrive as it pertains to packaging. There may be certain protective containers it has to come in or it could be that some items are more efficiently packaged in certain sized containers. Again, this is something you need to work with stakeholders on to ensure it arrive correctly. Spell out in the contract, the packaging you want the raw to arrive in.
Transportation Method
Often overlooked for priorities in scheduling, you need to ensure the supplier is transporting the raw in the method you choose. This is more than just incoterm related, although you need to identify that in the contract. This entails ensuring that it travels a mode of transportation that doesn't cause damage, spoilage, or other negative effects to the raw. Make sure the mode of transportation is well thought out by your logistics team and that it's identified here.
Know Your Delivery Schedule
If your production schedule is very well thought out and you have a pretty good predictability as to what that production will look like on a daily and weekly basis, then you may be able to go deeper and identify how often the supplier should deliver. This plays a critical role in Just In Time manufacturing when low inventory levels are a kpi.
Know What is Out of Spec Material
Work with your product managers and quality control engineers to define what is within spec and, more importantly, what is out of spec. Make sure the contract defines this as well. When it comes to impacts to your production or costs of returns, you'll need to be able to rely on these definitions to hold the suppliers responsible. SEQENS North America has a great article on what happens with raw materials don't meet spec here.
Know Minimum Order Quantities
When discussing price with the supplier, it's always good to ask the question if certain volumes are more efficient for them to produce. They have their own efficiencies and certain volume runs could be more price impactful than others. If they can provide preferential pricing based on certain volume levels then identify that in the contract.
Supplier Management
You set the ground rules of the relationship within the supply chain with the contract. You management suppliers by monitoring their performance against that contract. Suppliers that perform well get opportunities for additional business when they arise. Suppliers that don't get moved away from.
Monitor KPI's
KPI's should be developed based around what you find important in a good supplier. Break the silos of your company down and bring every stakeholder together to develop this list. Put them in the contract so the supplier has an official notice of what you will be grading them on. Build dashboards to track the supplier and communicate how this is going with the internal stakeholders. This should be done on, at least a monthly basis, to them via email reporting
Business Reviews
The more important your supplier is to your business then the more often this takes place. I've had monthly business reviews with critical suppliers. However, your most critical should most likely be on a quarterly basis. Have them come in for plant walk throughs or visit their location for the review. Have them break down how spend looks along with opportunities for savings. Last but not least, have them report out on how they think they are trending with contract supplied kpi's.
Strategies To Reduce Risk In Management of Raw Materials
Ask anyone in your company what is the role of procurement and they will likely say "to save money." However, that's part of the equation. The other part of the equation is our efforts to reduce risk in the supply chain. Some of the below ideas may help you in doing just that.
Larger On Hand Inventory Levels
Work with your suppliers on what the most efficient lead times are and communicate that to your material managers. It may be worth tying up additional resources in slightly higher inventory levels if there are possible impacts to the supply chain.
Consignment Models with Suppliers
Consignment is an example that I've implemented this with great success, in having suppliers place inventory in our plants that are on consignment. You'd be surprised how much inventory a supplier is willing to put at your location in these models so you always have it available. You'll need to work with them closely on how that model is built out and how it will be managed.
Have More Than One Supplier
If the pandemic taught us anything, it's have a secondary supplier. You can do this through some ERP systems where you can automate purchase orders to be split among suppliers. If you have 2 suppliers you may choose to do 80% to your primary and 20% to your secondary. Work within your organization to understand your system capabilities and if this is a possibility.
Keep The Supply Chain Close
The automotive world an example of this more than you may think. They love deep localization of their supply chain. Having suppliers right next door greatly shrinks the logistics model. It's makes things like driver shortages and port congestion a thing of the past.
Develop Distributors
This should be viewed as a way to develop more than one supplier, technically. A portion of all raw materials will find their way in the hands of distributors. For that reason, develop relationships with key market distributors in an effort to gain access to additional resources.
Monitor Financials
Keep a close tabs on your key suppliers. The last thing you want to find out via the news is they went out of business. Trust me, this can happen. By monitoring financial statements you can see risk develop before the end comes. Duns & Bradstreet is a great resource to do this type of research as well.
Conclusion:
Raw materials are the life blood of a manufacturing company. It will be the largest spend area in your organization by far. Keeping controls over it is a must to ensure you have the ability to meet customer demand. Supply chains can get out of control in a heart beat if you don't. The tips above will ensure many supply chains can work in tandem to the considerable benefits of everyone involved. If you'd like to learn more about procurement best practice, check out our article here on the Top 5 Procurement Best Practices for 2022.
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