Have you jiffy lubed your contract ?
Inflation is driving everyone crazy, and not only are costs going through the roof, but parts are not available when needed. Manufacturers and producers are having to adjust their sales and production forecasts as goods are costing more to make, and demand is slowing. Consumers are thinking twice before buying due to inflated prices and the higher interest rates that they must pay to finance their purchases.
There is no better time than now for manufacturers and producers to make sure that their contracts for goods and services are fit for purpose and have no leakage. Capitalism has always baffled me, as it teaches one business to profit at the cost of another using asymmetry in information. The better one can understand how the other business works, the smarter one can be in negotiating a good contract. A business must make money to be a thriving concern and its reasonable if a business makes a fair margin on the product or service it sells. But nothing has pained me more as a supply chain professional than to find out that a supplier has extracted more out of a deal than we would have wanted to give.
Most companies have escalation and de-escalation clauses in contracts that predict how the costs will adjust based on indexes. Steel prices, cost of chemicals, transportation costs all typically adjust based on indexes tied to the cost (scrap prices for steel, feed stock for chemicals and fuel prices for transportation and logistics). Based on the contracting practices companies deploy, they have the ability to temper the cost increase in an inflationary market, so their budgets aren’t exceeded. These types of cost escalations are transparent and can be predicted based on the indexes. This is not what we will be discussing in this write up.
Most people should be familiar with bundled pricing when purchasing a product. The whole is sometimes cheaper than the sum of its parts. When you go get an oil change for your car, you typically get a bundled price for the replacement of the oil and filters and the disposal of the dirty oil. The bundled price you get at Jiffy Lube is usually much cheaper than the sum of its parts. If you pull up a maintenance contract for rotating equipment in your enterprise, you will often find that you are paying for the oil,filters and disposals separately. Typically, when negotiating a contract, a supplier provides a price list which you may compare against your other suppliers and realize you are getting a good deal. But you may not be paying attention to how you are likely to use their service. This is one of the first things you want to investigate when you are establishing a contract. Unless you conduct a systematic exercise to eliminate the occurrence of these in your contract(s), and develop a methodology that prevents it, you are likely to see these creep back in. A common place to start would be to pull all your maintenance contracts and look at how these contracts are set up. You may find a lot of low hanging fruit that can save you beaucoup dollars.
This does not manifest only in maintenance contracts and is usually commonplace in a number of service contracts too. Take constructions services for example. On any construction activity you typically pay rental for the equipment (backhoe, trackhoe, forklift, etc), labor charges for the operator who operates the equipment, and the crew lead who manages the work, etc. The price list submitted by the vendor usually has all this listed ala carte. Many vendors do provide equipment with operator rate included, but often times there are so many items in the price book, that the person requesting the service may unknowingly pick up the ala carte items instead of the bundled price. It’s critical to make sure that price books are set up effectively without giving multiple options for the same type of services to avoid price leakage.
One other common occurrence in construction that causes leakage is the lack of dedicated crew rates in the contract. Not all work is ad hoc and much of the work is planned activity and executed campaign style. A contract crew is on site for the full workday for months and yet you are being billed hourly rates. Hourly rates make sense when the crew is not on site for the entire day as there is no guaranteed work and the supplier will need to bear the costs of paying their employees and deal with the uncertainty of having them on the bench when there is no work. But when a crew is on site for the whole day it would be prudent to negotiate a bundled rate for the dedicated crew which might include multiple pieces of equipment and labor.
Another practice that’s common with contractors to continue to nickel and dime you would be to charge per diem for services where the crew must stay overnight close to the work location. When necessary paying actuals for these costs probably makes more sense. But ideally pushing the contractor to think through the cost of their travel and bake it into the rates as a bundled rate would be a good approach. If you adopt this approach, you must be cautious to check if the contractor is still incurring that cost in the long term. They may have an office a few hundred miles from your work site at the start of the work but might have opened a satellite location closer to the work site soon after. When that happens, they should not be billing you the rates which have the per diem included. Clearly this implies that there is a lot that needs to be done to measure the efficacy of your contract pricing as well as how you are buying the service after the contract is put in place so you can pay only what is required for the goods or service.
Another frequent element that spikes up your cost is expedite fees or hot shot fees as you might be calling them. Most companies don’t have policies and do not periodically review their expedite costs and document the rationale for requesting an item to be delivered in a rush. The terminology we used in the manufacturing company I worked in at the start of my career was hot, very hot and extremely hot. When everything is urgent it is hard to prioritize and when you try to rush everything your unplanned costs go through the roof. So as an operational manager keeping tabs of the expediting costs is key to keeping costs under control. Defining what constitutes an expedite is a challenge as there are no well-defined rules and well delineated approvers for an expedite. If the requestor is a maintenance operator or a mechanic in the field, they are only looking at closing out the job they have been assigned and not looking at the bigger picture on costs necessarily. If a specific job was more important than another bartering parts from one task to another so the critical task can get done would have solved the problem without incurring an unnecessary expedite fee.
But let’s leave that aspect aside and look only at expedite fees. If you have Amazon Prime for Business you can get one or two business day deliveries on millions of items. Agreed Amazon is still far from stocking every item your business might need and you may have to rely on distributors or your suppliers for spare parts. But when an expedite is requested no options are discussed other than instructing the vendor to provide the part immediately. If a pricing conversation had ensued the vendor might have said I can have it you on Monday for no extra charge, and there could have been no expedite fees. But most often that conversation does not happen, and the part arrives on Friday by FedEx or UPS Next Day and the part stays in the warehouse till Monday waiting for the crew to pick up on Monday morning. In times of acute shortage like what happened recently with chips, sometimes adopting the philosophy of robbing Peter to fix Tom is more applicable. We have found that field operators and mechanics are in the habit of hoarding parts on their trucks and since there is no good visibility into what inventory is available in trucks, often times companies are paying extra for parts that are actually in one of their employees or contractors’ trucks. Another issue that drives expedited is a lack of forecasting and seasonal demands for parts. For example, in areas prone to stormy weather in spring, stocking up ahead of time could help manage expedites when there is a run on your batteries and transmitter due damages due to lightning strikes.
Lastly exploring whether the right contract is used for the right service is also worth exploring. As the task of uploading a price book is tedious, contract specialists just upload the entire price book provided by a contractor. These price books include all kinds of parts and services and opens the contract for being used by someone unknowingly for a product or service that the supplier is not meant to be used for. The best way to illustrate this is using an example. Let’s say you have contracted with a provider X for hauling your waste. They are a specialist in waste hauling and give you an extremely competitive rate. Fast forward a few months and the operator in the field notices that trash bin is overflowing. So, he calls his favorite contractor and asks them if they could haul away the waste. The contractors never say no when such an opportunity comes up. Of course, they haul away the waste satisfying the operators’ need at a 2X or 3X premium. Finding instances such as this and fixing them are an easy way to save money for your company. The key to this is of course ensuring that you have fit for purpose price books loaded into your system.
Title credit goes to Brian Pugh my former boss who was the first to use this in the context of contracting
