How to Achieve Hidden Procurement Savings
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Whether it’s “the way it’s always been done” or just short-sighted thinking, typical procurement practices are fundamentally flawed.
It’s not that the current procurement best practices don’t work; it’s that they risk incurring a multitude of otherwise often overlooked costs because they typically aren’t part of the process. As a result, significant savings opportunities are missed.
Revealing this is surprisingly simple and straightforward. The following example of a common instance of fleet vehicle procurement illustrates this quite effectively.
But, before we do this, some associated background information is useful.
Let’s start with a common supporting requirement for most fleet’s procurement process: specifications.
There are a couple of fundamental premises involved with specification development. One is whether the specifications are aimed at specifying a specific item, or, qualifying candidate items for selection through a bid or similar process.
Clearly, if specifications are written to favor a specific item (as many salespersons will promote), this can result in missed opportunities. For fleets, this can incur additional costs for customers and the parent organization as well.
The second premise or approach with specification development is to under-specify, over-specify, or optimize the needs of the equipment based on its identified required functions.
Considering both of these premises’ can profoundly affect procurement results; with costs, quality, and performance. Some of these impacts may be readily apparent, but others may not be.
To ensure these opportunities aren’t excluded, an “all- inclusive” specification approach with all candidates’ equipment meeting the fleet requirements is preferred.
Similarly, depending on the fleet environment, the decision to over-spec, under-spec, or optimize equipment specifications can significantly impact costs, quality, and performance.
For example, if a fleet is forced to retain equipment well beyond either their lowest lifecycle cost (LLC) or effective service life, over-spec’ing equipment can be advantageous and result in significant savings. The concern here is with under-spec’ing, and the resulting higher costs due to unnecessary maintenance and downtime that could have otherwise been minimized or avoided.
Similarly, if a fleet has the opportunity to utilize LLC replacement schedules, optimum specifications are advantageous to maximize savings. In this case, either over- or under-specifying both result in unnecessary costs. With over-spec’ing resulting in misperceived short-term savings, and the under-specifying resulting in features adding little or no return on investment.
There’s more to specification develop
ment that deals with optimizing fleet size and related utilization.
Specifications have a large bearing on both equipment performance and capabilities. These play a large role in the equipment requirements, costs, and utilization. Often this is overlooked, under-estimated, or even ignored in misguided short-term savings aspirations with specification development. This was covered in an earlier article “How to Optimize Your Fleet” in the September/October issue of Fleet Financials.
Most fleets typically utilize a request for quotation (RFQ) or request for proposal (RFP) approach to sourcing equipment. This is based on seeking competitive bids from competing suppliers for procuring items meeting the applicable specifications. This is commonly accepted practice and actually quite effective in principle. Where savings are “left on the table” is with the bid selection decision-making process.
Most RFQ and RFP selection decisions are made based on two primary criteria—price and delivery. The thinking is that the lower price, combined with an earlier delivery, results in lower costs.
On the surface, this appears to be well-founded. In reality, this is fundamentally flawed thinking as it overlooks equipment life costs. And, these costs can overwhelm any initial procurement savings, as you’ll see.
Let’s examine a simple example with a fleet vehicle, in this case an automobile procurement.
To keep it simple, let’s say we have a fleet of 100 automobiles; where most are of one manufacturer – Brand A. And, there are no Brand B units currently.
Say the fleet has three bids (Brands A, B, and C) to consider for the purchase of 10 units. Continuing with the example, say Brand B is the low bid—being $500 less than its next competitor, Brand A. And similarly, Brand B has a delivery time quoted one week earlier than the other two bids.
In a traditional process, unless there were extenuating circumstances, Brand B would be chosen since it’s both the lowest price—appearing to save $5,000 for 10 units—and a week earlier quoted delivery.
What could be wrong with a $5,000 savings and an earlier delivery?
This is where most fleet managers have an answer to this question, and where many procurement managers might struggle to understand.
The short answer has to do with fleet equipment, since there are a lot of other potential costs that are completely overlooked by analyzing price and delivery alone. These hidden costs often far exceed the incidental savings with initial price and perceived delivery savings.
Using an example with an automobile purchase (the simplest form of a fleet vehicle) to illustrate this is quite effective.
Let’s examine this from a long-term or LLC perspective. Let’s assume the Brand B price is $30,000. Similarly, let’s assume one week’s delivery time cost savings is estimated at $100—for a total savings of $1,000 for the 10 Brand B cars.
This represents a total procurement one-time savings based on price and delivery of $5,000 plus $1,000; or $6,000.
Now, let’s look at some other potential long-term costs we might be over-looking with this traditional approach.
First, there might be fuel savings. Let’s say Brand A gets 32 mpg, whereas Brand B gets 28 mpg. And, in this example these automobiles typically are driven 15,000 mile/year, assuming an average $2.50/gal. cost of fuel, this represents a savings of Brand A of $167/vehicle/unit/year in fuel costs.
But, this is only one of many operating and maintenance costs that fleets and its customers experience.
Let’s further examine the maintenance-side of operating these automobiles. These include labor, parts, and downtime.
Earlier, I mentioned that Brand A was the dominant auto brand in the fleet, and there are no Brand B units.
The fact there are no Brand B units can affect maintenance costs. First, there may be additional technician training requirements. And similarly, there are the additional parts inventories and control costs. In this case, let’s estimate the training to be $500 and the added inventory cost to be $100 for the 10 units.
But, there are still more maintenance cost considerations. Say Brand B is both less reliable and requires more preventive maintenance. Furthermore, its warranty offers less coverage, as well as being more costly. In this case, these are estimated to cost $20 per unit/year, or a total added cost of $200 per year for the 10 automobiles.
Speaking of dealer support, let’s add that the dealer of Brand B has a history of making misleading claims—in this case, the promised delivery.
Added to this, in the past the Brand B dealer delivered units out-of-spec that had to be returned for retrofit—causing both substantial delays as well as additional issues with associated costs. For this example, this one-time risk is estimated at $100/car, or $1,000 for the procurement.
Another principal cost consideration with fleet equipment is resale value. This can vary by both the age of the equipment and by brand. So, for this example, let’s say the Brand B automobile is estimated to have a resale value of $500 less than Brand A at the end of five years (this fleet’s average automobile replacement schedule)—amounting to one-time estimated added cost of $5,000 for the 10 units.
While this is only a partial list of fleet equipment life costs, they are both real and significant to the procurement decision-making process.
In this case, Brand B has hidden added costs over five years for these 10 automobiles: $8,350 for fuel, $100 for parts, $500 in additional training, $1,000 in maintenance and warranty considerations, $1,000 in added risk, and $5,000 lost resale value.
With only price and delivery procurement decision-making, we had Brand B with a net savings of $6,000 over Brand A.
From a life cost perspective, we have added hidden life costs of $15,950 compared to Brand A.
The net result would be Brand B incurring almost $10,000 in additional costs. In other words, selecting Brand A would result in essentially $10,000 in savings over the five year life of these 10 units.
Which appears to have the most effective approach? It’s an entirely different answer than just looking at price and delivery.
The goal here isn’t just to identify opportunities, but to explain how to achieve them and realize these savings.
I entered my fleet career as both: the first fleet engineer in my firm, and as an entry-level engineer—with no prior fleet experience or knowledge.
Obviously, this posed a number of challenges. But, unbeknownst to me it was an advantage in two ways with the procurement process. One was approaching it by going “back-to-basics”—realizing that the lowest lifecycle cost (LLC) approach was fundamental to achieving lowest costs.
Once this was identified, I had to develop a methodology to compare equipment bids based upon evaluating the multitude of all of the life cost criteria.
At first, I relied entirely on what was then known as a “Systems Approach.” This was developed by NASA to evaluate multiple alternatives with numerous complex criteria.
This involves assigning comparative performance values (from a scale of 1-10) for each bid’s cost criteria based on each of their estimated life costs. To evaluate these appropriately, these were “weighted” based on their overall cost to the equipment’s total life cost. The product of the two creates a quantitative measure to compare each bid based upon their overall estimated life costs.
This proved particularly effective. In the end, we arrived at a total of 17 evaluation criteria for vehicles and equipment to compare their life costs.
What I later discovered is that this worked well for “variable” comparison criteria. What it did not support was mandatory requirements. So, this over-riding criterion was added to the process.
With this systems approach, combined with a mandatory “go/no-go” requirements analysis, our fleet came to possess a very effective procurement process. This served to both minimize our life costs, and maximize our procurement savings opportunities.
Additionally, because at that time we retained equipment typically far beyond even effective service lives, we also over-spec’ed the equipment. This added to our fleet success, since prior to this equipment had been under-spec’ed to “save money.”
It’s useful at this point to highlight the inherent issues with applying LLC procurement process. These include the fact that it is subject to criticism, and it requires more resources, including analyses and research.
There are two sources of criticism, and they are both related. First, the LLC approach is unconventional. As a result, it makes some people—often, but not limited to, procurement—uncomfortable.
As a result, it requires explaining. While simple, it’s something some aren’t interested in or don’t want to spend the time to understand. This is one hurdle.
Another comes with understanding. In this case, some will claim the LLC “systems approach” is entirely subjective and thus flawed. This is in the sense that it is based on future costs. As a result, the claim is they can’t be verified and are thus invalid or unfounded.
An executive might think: “If it can’t be quantified, it’s not real.” This is a similar line of thinking.
Fleet managers often deal with costs that can’t be quantified; but are quite real.
Examples include fleet downtime and breakdown costs. Even if you can accurately identify the directly associated fleet costs with these, what about the customer costs such as lost appointments with external customers, rescheduling, vehicle/equipment replacements, lost productivity, etc?
Just because someone doesn’t know what the costs are; doesn’t mean they aren’t real and significant.
In this case, with the hidden procurement costs, they can be identified and estimated. Overlooking them entails much more risk versus any errors in their estimation.
Addressing the underestimation of these hidden costs is one approach to offset criticism. Another is to utilize both historical information and data (if they are available). Still another is to rely on external sources; including other fleets, consultants, or even periodicals, such as Fleet Financials and Automotive Fleet magazines.
This is another choice for fleet managers: continue with known higher costs because it’s easier, or, challenge conventional thinking—with the potential rewards and risks.
For those interested further in similar best practices, the book FLEET SERVICES: Managing to Redefine Success is available from the SAE International.
About the author: Tim King retired in 2008 following a 30-year career with what is now NVEnergy, an electric utility based in Las Vegas. He is the author of Fleet Services: Managing to Redefine Success.