Cost driven decision making
How relevant should a cost driven approach be to purchasing? Using ‘cost’ as a primary/key driver for direction has lead many organisations and sectors to engage in a race to the bottom, the only questions have been who gets to the bottom first and how hard they hit. It is true, however, that cost driven arguments have lead the way and influenced the direction of business strategic decision making over the last few years, largely driven by the globalisation agenda. The wide spread push for out sourcing, the employment of people from countries with lower labour costs, immigration and increasing levels of sub contracting are all outcomes of these cost driven strategies being implemented. However, costs are now rising as global development takes place, it is also apparent that political pressures are rising to bring work back home, as a consequence the direction of travel is likely to look at reversing, or at least modifying, many of the earlier cost driven decisions.
Cost or value is a key question
It can be demonstrated by using a value based model that time is a key component of project execution, going faster has a value that justifies higher costs, this is frequently overlooked. To be fair it is often difficult in a cost driven world to argue that you can increase returns by spending more, at this point the arguments against tend to focus on the risks, rather than looking at the opportunities.
In many situations higher performance may lead to lower costs as part of an improvement of execution quality, this can be shown to be another very powerful lever to deploy. There are many studies that demonstrate this; however, they are unlikely to give a short term improvement, over the medium to longer term is where these approaches really start to show significant benefits. Good examples are Lean in its many forms, TPM (Total Productive Maintenance) and JIT (Just in Time).
Future approach
Purchasing is always a key requirement for Projects, the suggestion now is that the focus should be on a value driven approach with continuously improving performance at its heart. The aphorism that ‘you get what you pay for’ is still true, only this time it is a value based question not a cost driven one . The other key point is that you need to know exactly what the value you are looking for is, sometimes it is not obvious. By understanding what the value sought is, then you can then purchase exactly what you require or certainly stimulate the development, to do this requires clear vision, good supplier market knowledge and trust. To generate the required trust also raises the question of building long term supplier relationships, this is not typically necessary when pursuing a cost driven model.
Design case study
The first example of the trade offs to be made concerns two similar capital projects in the chemical industry, one in the USA and another in Japan. For the USA project sub contract design labour was used, this needed to be recruited, coordinated and managed, a not inconsiderable task in itself, before the actual design and engineering was to take place. For the Japanese project the main contractor had a full in house design capability. The hourly rate differences were stark, with the Japanese labour rates over twice that of those in the USA. The question was asked as to why we could not offshore the design for the Japanese Project? It took considerable work to persuade the senior management that keeping it all in Japan was the best way forward. Turning quickly to what actually happened; the total design costs in Japan were far lower than for the USA, plus the design was of a far higher standard, virtually eliminating rework in the construction phases. The reason for this was the far greater skills and teamwork of the in house designers and engineers in Japan dramatically reducing the hours required both for design and execution.
Construction execution case study
The second example concerns the installation of Wind Turbines, where very large cranes are used to complete the main erection. The site equipment and labour costs for turbine erection are very expensive, the two key elements to examine here are the time it takes to erect the turbine and the time to move the crane. For the project leadership the question is whether you try to minimise the daily costs or maximise the erection rate? The former is a short term cost driven view, the latter a holistic value driven performance question. The results on the ground are that increasing the erection rate is the way forward, although the daily costs increase, the total costs tend to be lower with project risks reduced, this has been demonstrated on many sites across Northern Europe, particularly the larger ones. Not surprisingly reducing the daily rate is still a very common approach taken in the industry, it is superficially easier to do, yet the real benefits accrue when increasing the site execution performance is the main objective. It is worth mentioning that when talking about performance with suppliers it is possible to have a positive ‘win win’ conversation, with a cost based approach the discussions will always tend to be defensive.
Summary
The requirement for clear long term strategic vision will be increasingly important as we move forward, the anticipated trend is that a focus on value and performance will be an important part of project discussions. This has major implications for both purchasing, suppliers and project leadership, this is where the real challenges are to be expected to meet the future competitive environment.