The Secret Weapon for Fighting Inflation
Leah Archibald: Rising costs are hitting manufacturers double whammy. First, you’re hurting from components cost as the cost of raw materials continues to fluctuate in the wrong direction. On top of that, rising labor costs are increasing your uncertainty as to when and whether you’re going to be able to get your products out the door. What can manufacturers do to right themselves amid this destabilizing trend?
The Secret Weapon for Fighting Inflation
The secret, according to today’s guest, is getting visibility into your suppliers’ inputs and processes. You need to not only understand their value chain but share this information in a way that gets all parties on the same page and heading towards a win-win.
Jason Krajcovic is an expert at finding a way forward when typical market-based sourcing strategies aren’t working. As a principal at Carney, Jason helps clients, particularly in industries with highly engineered goods or products like automotive, aerospace and defense, and industrials, get real value out of their value chain. Jason Krajcovic, welcome to the podcast.
Jason Krajcovic: Hi. Thank you. Thanks for having me.
Leah Archibald: First of all, why don’t you tell me what is the traditional approach to procurement and why is it not working in this inflationary environment?
Jason Krajcovic: Well, I think the traditional approach to procurement is, one, supplier pit against a buyer. It’s very combative.
Leah Archibald: Zero-sum?
Jason Krajcovic: Yes, and it’s me verse you. My kids are getting fed tonight or yours are, and so you can imagine a lot of conflict arises from that situation. And it’s hard to get to that win-win approach that we’re always taught you need to get to in negotiations.
New Approaches to Supplier Negotiations
Leah Archibald: So you’re saying win-win negotiations are kind of rare in the procurement world. Does the current climate of fluctuating materials costs and economic insecurity make this dynamic worse?
Jason Krajcovic: Oh, certainly. There’s a ton of uncertainty out there. I don’t know if you follow aluminum pricing lately. It was way up. It’s come down again. And I think that no one knows how to price aluminum going forward. In that type of environment, you can deal with that one of two ways. If you’re a supplier, either you’re going to price in some amount of uncertainty, or you just deal with it transaction by transaction.
That’s not efficient. No one wants to have repeated negotiations over and over again. We want to focus on more strategic things, like growing our supplier relationships and growing the business. You can’t do that if you’re going contract to contract.
Leah Archibald: So let’s take this example of aluminum pricing and say I’m in a relationship with a supplier where aluminum pricing really matters. What would creating a win-win negotiation look like in this context?
Jason Krajcovic: With aluminum pricing, let’s tie it to a market and revisit it every month or two months. And whatever the index says, we’ll pay that, as opposed to fixing it at $10 per part or whatever. If I’m buying from a machine shop, I don’t want to have a discussion about aluminum every month. That’s out of my hands. That’s out of the supplier’s hands. But if we take that off the table, we can start talking about the things that really add value. Are there more efficient ways we can produce the components we need? Are there different process improvements? Can we move to a lower cost location? We should be focusing our discussions with our suppliers on the places where they can add value, not on things like material costs.
Leah Archibald: So it sounds like in this aluminum example, what you’re trying to have with your supplier is an accurate model of should-cost, which involves the fluctuating price of materials. But if you could somehow put in the fluctuating price of materials, have that roll into this model, and have it spit out an accurate should-cost for both you and your suppliers in a way that you could both agree on, that would take away a lot of these repeated negotiations that are dragging down everybody’s time.
Jason Krajcovic: Yes, certainly. And it can extend beyond materials. We can talk about labor and overhead and all that. The benefits of the should-cost model is creating transparency.
What Is Should Cost?
Leah Archibald: Can you tell me a little bit more about what should-costing is and how, technically speaking, to get to an accurate should-cost?
Jason Krajcovic: Should-costing has been around for a long time. It’s a very powerful tool, and essentially, it is creating a model of what a given component should cost. That means: what’s the material cost? What’s the labor cost? What’s the overhead? How much electricity are you expending to use in your machines? What’s the maintenance required with that? And that includes SG&A and profits.
So you’re really creating visibility. Again, we’re going back to what we’re talking about with traditional procurement. Traditional procurement is usually, “Well, I want to pay X price for something.” And someone else saying, “I want to offer Y price to you.” And you negotiate on that price. Compare that to getting a should-cost. We can take out materials because that’s fluctuating and we can index that. Then let’s talk your about your labor. Let’s talk about the hours you’re putting into this. Are we making different assumptions about how hard this part is to produce that we can align on? Or find common ground to reduce costs?
Ultimately, you can create a lower price. But you can only get there with should-costing and transparency.
Getting a Lower Should Cost with aPriori
Leah Archibald: Do you have any examples from your experience with clients where either should-costing brought in a deeper level of security within the supply chain or brought in additional value through the value chain, maybe improving processes or decreasing costs somewhere else?
Jason Krajcovic: Yeah, I had such a client. We were looking at this housing, and we were trying to figure out with the supplier why it was costing so much. It didn’t make much sense. We popped it on the aPriori tool when we did a should-cost to the model, and it turned out there was one hole that was at this off-axis. Because the hole was being drilled at this other axis, you had to go from a three-axis mill to a more expensive five-axis mill. So the supplier was taking time on their valuable five-axis mills to produce this part. And so we were able to highlight that with the aPriori tool, and then ultimately we took it back to engineering to ask: Why is this hole coming at this angle? It was purely from a cosmetic reason; there was no functional aspect to it.
Leah Archibald: It was a beautiful hole.
Jason Krajcovic: [laughter] It was a beautiful hole. Yeah. I mean, it made a hose come out at a certain angle, but at the end of the day, it didn’t matter. And I think that’s where this becomes really powerful. We all want to make product designs that are aesthetically pleasing and whatnot, but is it worth 5% of the cost of the component? That’s a different discussion. When you can bring that cost transparency, not only to the supplier but between procurement and engineering, it’s incredibly powerful.
Fighting Inflation with aPriori
Leah Archibald: So let me tell you my hunch, and then you can tell me if you think it’s correct. At the top of the show, I talked about the secret weapon for fighting inflation as should-costing. Because my idea is if we can all get accurate visibility into our cost all the way down to our suppliers, and maybe in the other direction to the design engineering team, we can really see where inflation would impact the cost of our products, and we can already start to hedge against those risks by either having multiple sources for raw materials or having different designs in the works to take some weight or material out of our particular product. Am I right, or am I crazy? Do you think that should-costing could have some big effect in fighting the risks of an inflationary climate?
Jason Krajcovic: I think it’s crucial in this type of climate. I’m seeing a lot more receptivity from our clients. If I know that a given part is 20% material cost and 30% labor, I can appropriately hedge my indices for a key raw material.
Maybe I need to reconsider my manufacturing location. I can do all that with a should-cost model. And if I’ve got a good one like aPriori, it’s as easy as just changing my factory location; I can see the impact of where I would move that component and what the benefits would be for me.
Leah Archibald: So for you and your clients, are you worried about the current economic condition, or do you feel like you’ve got it in hand and you’re ready to fight the risks?
Jason Krajcovic: I think everyone’s always worried regardless, right?
Leah Archibald: Honest answer.
Jason Krajcovic: No one can really predict the future. So being ready to respond to these things as they arise is very powerful.
Leah Archibald: Jason Krajcovic, thank you so much for joining me on the podcast today.
Jason Krajcovic: Thanks for having me.