By: Socrates C.T -- Principal Analyst - Indirects
30 May, 2018
With the advent of e-commerce and e-procurement, the spare parts industry has emerged as one of the highly competitive online business-to-business (B2B) marketplaces. The recent entry of Amazon to this competition is a vital sign of a huge shift to the maintenance, repair, and operations (MRO) suppliers in terms of part pricing and delivery. Suppliers are rethinking their strategy in this business, which had a transactional model earlier. What meaning does it hold for an average business consumer? This provides them with an overarching opportunity to leverage their MRO spend better. The white paper discusses some emerging best practices and developments in MRO procurement and ventures, which are beyond conventional wisdom, such as supplier consolidation, outsourcing services, and inventory management and aim to tackle one of the challenging procurement categories.
Industrial distribution as a segment has multiple categories, and, more often, the strategy of mature buyers depends on criticality of the spares
MRO Categorization Overview
Source: Beroe Analysis
Though the subcategory trees of MRO differ in the product perspective, the pricing and contract models are very similar. However, the pricing, contracts, and services offered by the suppliers have evolved over time. Few companies in the mechanical spares sector have moved from discounting catalog list price to a complex cost-plus model. This change has impacted MRO items that were purchased in small quantities and transitionally, and the only aim during purchase was the reduction of the acquisition price. Therefore, with the changes in the pricing and contracting models, a procurement organization should redefine its sourcing strategy to improve negotiations and find a deal to leverage its MRO spend better.
Gaining visibility into the MRO spend is one of the critical areas for overall MRO management, and it is very useful for negotiation.
Source: Supplier Interaction, Beroe Analysis
Apart from conventional practices, such as planning MRO orders using criticality analysis, the demand analysis, minimum order quantities (MoQs) and volume aggregation, emerging practices indicate data integrity and clarity of order information supports negotiation. Information such as manufacturer part numbers and the name of the original equipment manufacturer (OEM) is critical for evaluating the suppliers’ prices. A completed bid must have clarity regarding the aforementioned information along with Unit of Measure (UoM) standardization. An apples-to-apples comparison of various supplier prices for the accurate items is hygiene when it comes to MRO contracts. Furthermore, providing estimated annual volumes can act as an important factor for discounts. Additionally, allowing suppliers to recommend alternative brands or cross items can further reduce costs and help in maintaining a status quo or increase durability of MRO spares.
Though it would be challenging to arrive at a cost structure for spares item-wise, it is prudent to understand the cost basis of various MRO categories at a higher level. Understanding the impact of the raw materials used in a spare parts group and associated labor utilities charges form the basis for determining the cost of goods sold (COFS). An example would be the impact of copper on cables and steel on bearings. Specialized procurement intelligence firms have detailed cost structures for the MRO category groups and procurement organizations can leverage on these cost structures. Other opportunities include specification optimization, long-term contracts, and customized ordering.
Cost Analysis and Traditional Savings Parameters
|Major Cost Components||Description||Future Trend||Impact on the Buyer|
|Raw Material||Costs associated with the various materials used for manufacturing the parts|
|Labor||Prevalent market wage rates for labor|
|Administrative & Overheads||The other costs that are not involved in the direct development or production of goods or services.|
|Logistics Cost||All the costs associated with the movement of goods across a country or across the globe|
|Profit Margin||Suppliers add an extra cost to the total cost of the product|
|Parameter||Description||Impact Level||Savings Potential|
|Specification Optimization||Personnel must see whether the specification that has been supplied is the required one or even a lower specification will serve the purpose.|
|Contract and Volume Negotiations||Attaining volume based discounts from the suppliers.|
|Long-term Sourcing Strategy for MRO||Proceeding with long-term contracts that would benefit the MRO product categories in order to obtain discounts and rebates from the suppliers|
|Supplier Consolidation and Optimization||The buyers should reduce the number of suppliers to attain cost savings|
|Low Cost Suppliers||For less critical items, it is beneficial to engage with the local suppliers rather than a category specialist and review the benefits provided by a preferred supplier as opposed to paying the market costs|
|Customized Ordering||Compare volume usage over time and future requirements to gain insight, and bundle orders to gain maximum profits. Use channels like online ordering to reduce time and cost. Target the cost savings and then engage with distributors.|
Source: Expert Interaction, Beroe Analysis, Beroe Analysis
Such analyses are critical for facilitating the strategic sourcing of spare parts; this is because most of the MRO procurements focus only on pricing and not on the cost.
Traditionally, MRO Suppliers would provide discounts based on their catalog/list price. However, trends show that many large national distributors are using cost-plus models. This would help the buyer to get discounts on direct margins and to avoid discounts off the price or web price mentioned in the catalog/inflated list. This would reduce the overall procurement cost. There are also changes in annual rebates and tiered discount structures. With growing competitiveness in the MRO market, the supplier margins are getting reduced, as the suppliers are aiming at increasing their overall sales. While the benefits are not transferred to all the buyers, they are leveraged by major and aware buyers. Additionally, each category offers different margins, discounts, or rebates. Understanding the cost basis of categories and margin ranges would give a holistic picture of the degree of negotiation possible in a particular category. A market study can develop a Procurement Organization’s awareness regarding prevalent margins and discount ranges that are provided by suppliers at different spend levels.
Most Used Distributor Pricing Model for MRO Spares
Typical Margins-Discounts-Rebates for MRO categories
Source: Expert Interaction, Beroe Analysis
During MRO sourcing engagements, the key constraint is to cover all critical aspects of the products or services in the RFx; this is because the product base usually comprises high volume and a high product mix. There might be chances of the dilution of suppliers’ information due to complicated specifications and supporting documentation, and there may be difficulty in pricing every item accurately and strategically. The market basket methodology can help to structure bids and evaluate suppliers, based on a representative sample of products or services included in a particular category. The basket of items should belong to a high-spend category that must comprise between 60 percent–80 percent of the overall spend over a 12-month period. The rest of the items can be negotiated in the subsequent rounds of engagement.
However, this 80/20 rule has the risk of not covering the bottom 20% of items, which might require an additional supplier who goes against the supplier consolidation strategy. It is prudent to complete the round of RFx and bid to the existing suppliers after the first round of proposals; additionally, getting an additional leverage will further reduce the overall cost of ownership. This would introduce transparency and clarity concerning the total category cost among the collaborating suppliers, before the sourcing engagement
Market Basket Process to Optimize Sourcing Engagement
Source: Strategic Sourceor
Overall, for sourcing a complex category with a high product mix, it is suggested to receive initial pricing from suppliers before enquiring about the costing of each product. This would facilitate the comparison of competitive rates with less effort. The RFx process should be the starting point for contract negotiations. From evaluating pricing structures for critical items, analyzing COGS/ margins, negotiation on rebates based on annual spend achieved, to assigning order bonuses, all information should be gathered during the RFx process. The basis for all such activities is to gain clarity of MRO spend data, which is shared to the suppliers. It is significant to manage a clean data sheet to realize substantial savings during MRO procurement.
The recent entry of Amazon has added to the competitiveness of the supplier base for industrial distribution. However, MRO sourcing goes beyond the ease of ordering, price points, and product lines. MRO procurement is benefited by supplier relationships, account management, and inventory management. Efficient negotiations through price modeling, cost structures, and basket methodology can help improve all the above strategic parameters. Additionally, there are traditional criteria, such as supplier lead times, VMI implementation, E-procurement platforms, and services offered, which have been proven to provide holistic opportunities for cost savings in this category.