Time to Revisit the Costly Ways that MRO Suppliers are Selected

By George E. Krauter

February 16, 2018 at 2:49 PM

Now is the time of the year when procurement managers are asked for plans to reduce "costs" for the year. Most MRO procurement departments are measured on their abilities to reduce the cost of price...not total cost of ownership. Therefore, the MRO buyer will go to MRO distributors with requests for quotes (RFQ), requests for information (RFI), and/or requests for proposal (RFP).

These "Request For's" are almost always accompanied with a price quote request which is formatted into the tried and true "market basket" process. The buyer will assume that all those selected to respond are equal in the services they provide and have equal purchasing powers for the lines they represent. By picking the supplier with the lowest price, buyers can show management the best price reduction, equal supply support, and be rewarded for their apparent levels of expertise.

The Market Basket selection process for MRO is generally accepted as a valid method to acquiring the optimum MRO provider (In my experience, mainly because people cannot think of an alternate method that will be accepted by senior management).

Below are listed the facts and fallacies of the "market basket" process as they relate to MRO supplier selection.

FACTS (Generally):

  • To be significant for a RF process, the company must be consuming one to two million dollars in MRO materials. This means that there are probably 10,000 SKU's (stock units) or more, as consumption increases, in the storeroom. 
  • 50% of MRO needs are not stocked in stores.
  • Storeroom requests are only partially filled or not filled at all 24% of the time.
  • OEM parts indigenous to the company's operation make up 30-35% of the stocked parts (SKU's)
  • It takes an average of four to six months from the creation of an RF to the assignment of a contract.
  • The part supplied by the incumbent (the part now on the shelf) could be different (cheaper) that the brand described in the parts catalog.
  • The parts catalog listing of SKU's for MRO has the following discrepancies:

                 > Duplicated parts under different SKU numbers.

                 > Inadequate descriptions.

                 > Descriptions known only to the incumbent supplier

                 >   Inconsistent unit of measurement data.

                 >   Outdated pricing information

                 >   Outdated usage.

                 >   Obsolete parts.

                 >   Parts with one cent unit "price holders"

   FALLACIES:

  • RF's will contain less than 5% of the total number of listed SKU's. Respondents will low ball price quotes knowing they can make up margins on parts that are not quoted.
  • Requests for pricing for more than 500 SKU's are either turned down or partially quoted.
  • Not all respondents will quote all SKU's requested claiming various reasons for their lack of quote (i.e., not enough information, not within their ability to supply, etc.). Only those SKU's quoted by all respondents should be compared in the analysis which is not always the case. 
  • Since 50% of MRO needs are not stocked and, therefore, have no price history for comparison, those suppliers assigned to these categories will also supply these non-stock parts at increased margins.
  • The fill rate requests for parts are only at about 76%. When there is an immediate request for a part that is not available in the quantity needed (especially when feared downtime looms), price quotes are quickly discarded. "GET THE PART HERE NOW, NO MATTER THE PRICE!!!" 
  • Duplicated parts have different pricing; which price will be compared to which price quote?
  • A price could be quoted assuming it applies to a particular description which it is not.
  • The unit of measure listed in the catalog could be different from the unit of measure actually received into stock and/or issued. The unit of measure quoted will vary among respondents affecting the analysis.
  • Price comparisons quoted in the RF responses contain the respondent's cost of goods plus a gross profit. These price quotes are current; if the stores catalog is not kept up to date (a common occurrence with MRO), price comparisons are inaccurate.
  • Any evaluation of pricing must have an extended usage multiplied by the unit price. A "one- on one" tally is faulty since MRO usage varies per SKU, per product, and per project.
  • Out dated pricing will skew results.
  • OEM parts are sometimes on RF's which are normally supplied by manufacturer (by definition) and, if quoted, do not contain a functional discount for the distributor.
  • An incumbent who is also a respondent has the opportunity to know what brands are acceptable to maintenance regardless of what is quoted; they can quote the low- price brand when others are quoting the brand on the RP. Along these lines, a respondent can deliberately quote a lesser brand to get the contract and then, when the quoted brand is rejected, feign ignorance and be allowed to supply the correct part at a higher price. It is totally impractical to re-quote the RF.
  • In the RF process, time of quote to time of shipment can be close to nine months and even up to a year. Knowing that, consider that most companies will consume inventory before placing orders with the new supplier. If the new supplier has used loss leaders to get the contract, they can come back to the MRO buyer to ask for relief because pricing has changed (upward...never a complaint if downward). The buyer has little recourse but to grant the relief, because the buyer cannot take the chance of lack of performance (affects plant reliability), Again there is no way to go through another RF process to find another supplier. 

Alternatives to the market basket process:

As noted above, RF's for MRO parts are sent to MRO distributors for price quotes. These companies are authorized distributors for manufacturers who sell their products (with some exceptions) through distribution exclusively. Prices submitted are based upon the distributors operational costs, profit requirements, short term sales needs, and mostly, their ability to squeeze their suppliers with extended discounts and longer terms. Therefore, the MRO manufacturers constitute the supply chain function that determines optimum price levels. For the major categories of MRO consumed (small number, major buys) price negation should be a joint negotiation involving the MRO buyer, the manufacturer and the selected distributor.

Select the supplier based upon their ability to lower the total cost of product at point of consumption also known as total cost of ownership (TCO). Tell the supplier the price reduction requirements desired by management and make sure the selected provider remains profitable throughout the term of agreement (which should be open end).

Outsource the entire MRO supply chain to MRO management experts and require KPI goals and performance measurements that will satisfy management.

The example below illustrates a real life high cost situation that resulted from the use of a low-price supplier.

A large multi-plant food manufacturer with a strong corporate purchasing presence selected the low-price supplier based upon data obtained from a market basket process. The supplier's closest location was 100 miles from the plant. The plant MRO buyer was also responsible for inventory reductions and control. The buyer noticed that inventory was increasing and could not find out why. An investigation showed that the selected supplier had quoted so low that their return was under 5%. Therefore, they would compile orders and deliver only twice per month to save costs. Meanwhile, back at the plant, parts were needed so maintenance personnel with purchase cards bought what they needed in package quantities which went into stock. When the orders finally arrived from the corporate supplier, the excess went into inventory causing the unnecessary inventory increases.

This is just one of the situations that add total cost to the market basket process. Organizations looking to streamline MRO costs should consider an alternative approach.



Tags: RFP process MRO cost control RFQ Process RFI process MRO Supplier Selection
Category: Blog Post

George E. Krauter

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George Krauter, former founder and president of Industrial Systems Assoc. [I.S.A.] has retired as vice president of Synovos.

Currently, he has initiated, "George Krauter Consulting [GKC]"  for effective reliability and cost recovery for consumers  of MRO materials. George is a recognized authority on the management of the MRO supply chain and support for maintenance reliability programs. His book, "OUTSOURCING MRO...FINDING A BETTER WAY" is available from Amazon and from Reliability Web.com.

He is published in Uptime, Modern Distribution Management, and Supply and Demand Chain Executive. George has conducted seminars across North America, in Europe, and in the U.A.R. as well as a guest speaker at Temple U., Howard U., Duke, and MIT.

George is a graduate of Temple University; he lives with his wife, Joyce, in Bucks County, PA. All grand kids live within eating distance. He can be reached anytime:   georgekrauter@comcast.net.



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