Is There Really a Purchasing Silo, and Does It Limit Organizational Competitiveness?

My recent book, “Better Business: Breaking Down the Walls of the Purchasing Silo,” is based on the proposition that purchasing isn’t integrated into the overall enterprise at most Original Equipment Manufacturers (OEM)s, and, as a result, the function’s positive contribution to the bottom line is dampened or, at the extreme, stifled.

I’ve justified my position by showing how lean supply chain performance—which should be the goal of all supply management departments—can lead to better business by impacting executive-level performance metrics.

With this article, I will explain these assertions by examining four scenarios: two related to silos between purchasing and their own factory operations, and two involving silos between purchasing and suppliers.

OEM Customer Fill Rates

Customer fill rate is an important executive-level metric. In fact, it may be the most important. The metric quantifies the percentage of time the company has product available to sell to a customer when that customer wants to buy it. Of course, there is usually a period of time a customer will wait for a product that is not available before moving on to a competitor’s offering, but this time—under normal market conditions—is not very long and is getting shorter.

How many purchasing personnel are aware of their employer’s customer-fill-rate goals and performance, and why does this matter? In my experience, not many are aware. The challenge in maintaining customer fill rate manifests itself when actual customer demand varies from what was forecast. And in markets today—especially consumer markets—demand is becoming more and more difficult to forecast. This is due to a variety of issues, including an ever-increasing availability of SKUs within product lines, the commodization of many end-use products and customers’ on-demand expectations that have them willing to switch to a competitor.

Customer fill rate is an important metric since it ties a company to its customer base. In my mind, metrics that do this are usually the most important in understanding what is required for a company to maintain and/or increase its competitiveness. And there is an important—and often unrecognized—tie between this metric and supplier management, which will be discussed under the next example.

Pre-built, Pre-positioned Finished Goods Inventory

Finished goods inventory is a bandage OEMs apply to maintain their customer fill rates when they do not have the inherent capacity and/or flexibility within their extended enterprise—not just their own factories—to do so. Finished goods inventory is costly to build and maintain. It can negatively affect company financials when it is over-built—either in overall or SKU terms—and must be discounted in order to sell.

The conundrum, here, is that while a larger percentage of OEM factories have focused on increasing their own capability to support varying customer demand, they have applied few or no resources to facilitating their supply chains’ ability to do so. The issue, then, is extended supplier lead times and/or lack of capacity. In my mind, when OEMs don’t facilitate increased order fulfillment flexibility outside the walls of their own factory—at their strategic suppliers—they are making a big mistake, which greatly contributes to an external purchasing silo.

I’d like to make an observation. As a technical buyer in the late 1980s, I spent a lot of time in my suppliers’ factories learning about how they manufactured parts, gaining a first-hand appreciation of their operational capabilities, strengths and weaknesses. Today it is not unusual for buyers to avoid on-site supplier visits—even to those suppliers considered strategic—in an effort to reduce purchasing departmental costs. In effect, this means that buyers today, for the most part, manage their suppliers from their desks, based on performance metrics—typically price, on-time delivery and as-delivered quality.

So even if an OEM had supplier development resources available, a supplier’s lack of order fulfillment capability would only become apparent when it was unable to flexibly support varying market demand. In other words, supplier development would be reactive/tactical instead of proactive strategic, essentially focusing on assisting the supplier in “firefighting” efforts. Most OEMs I know don’t rely on firefighting to address internal risks, so it is another conundrum that their primary support—if any—is related to firefighting.

As a result, if you ask most buyers, they likely do not have a firm understanding of supplier capacity by specific part number or the critical-path lead times to support forecast demand. This lack of knowledge increases the height and thickness of the walls of purchasing’s silo by reducing—or eliminating altogether—a buyer’s understanding of supplier operational capabilities, including order fulfillment flexibility.

If you were to ask most buyers what the amount and cost of their employer’s finished goods inventory is, they would probably have no idea; i.e., an internal silo.

Supplier “True” Lead Times

It is important to make a distinction between quoted and “true” lead-times. To shorten the discussion of this, I’ll make the following two general observations. First, most suppliers quote lead times based on what they think they will need to get an order, hoping that they’ll rarely be asked to support this. In other words, if customers request changes in the quoted lead times, it will either require supplier firefighting efforts to meet them, or they will not be met at all. This situation was what I typically saw during the 10 years I consulted. In fact, I had one client that routinely ordered three months ahead of need since they figured that all of their suppliers would be able to react to changes in orders within that time span.

What OEM customers should require is that suppliers quote lead times based on factory physics; i.e., the time it would take to satisfy an unexpected customer order through the operational critical path. This means without pre-built inventory. Knowledge of this would either allow a purchasing department to offer a supplier development assistance in reducing lead times or facilitate a supplier right-sizing its required pre-built inventory. And indeed, most suppliers I’ve worked with over the years don’t, themselves, understand their “true” lead times and quantify their pre-built stocks of inventory without much basis, instead “shooting from the hip.”

If asked, I don’t think buyers at most OEMs would be able to cite their supplier’s factory-physics-based lead times.

Supplier Part-Specific Capacity

Although capacity is tied very closely to lead time, there are separate issues important enough for the topic to merit its own discussion.

From an OEM’s point of view, there are two primary approaches to capacity planning. First, when the OEM is relying exclusively on a supplier’s existing internal generic processes for production of their projected requirements. The most frequent example of this is when suppliers operate job shops. Second, when the OEM needs to purchase special tooling to be used on a supplier’s equipment.

Read more of Paul Ericksen's supply chain management articles.

I’ll discuss the job-shop scenario first. When an OEM relies on general supplier processes, it is competing with the supplier’s other customers for processing time on generic machines. The point here is that this means supplier capacity is based not only on the supplier’s own forecasts and error; it means that available capacity is related to their other customers’ forecasts and error. This adds an element of uncertainty as to whether adequate capacity will be available to support the spectrum of specific OEMs’ requirements. When different OEM forecast errors either overlap or are excessive, it’s my experience that customers the supplier considers the most important get the business, while the others are triaged, implying some customers will not have their schedules supported.

The above situation can be magnified when a large percentage of a supplier’s customers share seasonal demand.

In the second case, most OEMs I’ve had experience with try to minimize their purchased-part tooling costs. Because of this, they tend to budget for a “best case” scenario. When this happens, even when a tooling and supplier equipment is dedicated to a particular OEM, capacity planning hasn’t included a Plan B to account for “lack of supplier capacity,” increasing “true” lead-times without the supplier having pre-built inventory.

An ironic point needs to be made here. When the above situation occurs, it often results in lower supplier “on-time delivery” performance. Yet the root cause of that performance is the customer’s lack of tooling budget!!!

Do buyers today know supplier capacity that doesn’t fit in to best-case conditions—and if not, do they have a plan B? I doubt it.

So, what could happen if buyers were aware of the above four metrics? They’d understand that it is their suppliers that are the primary cause of their employers having to rely on pre-built finished goods inventory to maintain customer fill rates. Based on the costs of this, they could justify some level of additional resources to purchasing—with the payback happening when the OEM is able to reduce that inventory, which the purchasing function should then get the financial credit for. And when that resource has been paid for, the OEM will reduce order-fulfillment-related costs significantly, which would be a major step in breaking down the walls of the purchasing silo!

I could go on and on with more scenarios and questions that should be important to buyers, and I do in my book. If you thought the above discussion interesting and valuable, you might want to order it.

Paul Ericksen’s book is Better Business: Breaking Down the Walls of the Purchasing Silo. Ericksen has 40 years of experience in industry, primarily in supply management at two large original equipment manufacturers.