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Exploring Supply Chain Cost Drivers

Proven methods for making your process better, faster, and cheaper
  • Gary A. Smith
July/August 2016

How do you describe and identify a cost driver? Most supply chain and operations management professionals probably have their own definitions and examples. In the APICS Dictionary, 14th edition, “cost driver” is synonymous with “driver” and is defined as, “In activity-based costing, an operation that influences the quantity of work required and cost of an activity.” In his book Extreme Government Makeover: Increasing Our Capacity to Do More Good, Ken Miller identifies five drivers of cost: time, transactions, mistakes, specialization, and management. Miller’s book may be about process improvement in the public sector, but many of its lessons can be applied to private-sector businesses as well.

Time

As a driver of expense, time means that the longer a task takes, the more it costs to complete. This involves direct and indirect labor (cost per time unit) and all of the various cycle times of procurement, warehouse operations, conversion, transportation, and so on. It includes time related to both value-added and non-value-added activities. Costs attributed to value-added activities can be passed on to the customer and even become new sources of revenue. Non-value-added costs cannot. Rather, these require an increased inventory investment to cover not only demand variation and variability, as illustrated by the bullwhip effect, but also the added time needed to move material along the chain.

Time can be further complicated by Parkinson’s Law, which states, “Work expands to fill the time available for its completion.” Historian and author Cyril Northcote Parkinson observed that organizations often become more inefficient as they grow, and usually the people who put in the longest hours—not those who are most efficient—get rewarded.

Luckily, time issues and the effects of Parkinson’s Law can be eased through a number of methods. The first step is to develop a detailed value-stream map of the process. From here, possible solutions may include removing bottlenecks by adding capacity; saving time by automating processes and information; identifying and eliminating non-value-added activities, such as staging; and many more related opportunities.

Transactions

Transactions, like time, are a direct expense. Thus, as transactions increase or decrease, costs respond proportionally. Transactions unfortunately can include noise—meaning ordering too much product or the wrong product, which results in returns or credits and the additional costs of re-receiving and restocking. The solution is to continually optimize transactions by automating the procurement process and using blanket orders and long-term contracts. As the cost of each transaction is reduced, the cost to procure drops as well.

Mistakes

A mistake, unlike time or a transaction, does not have a positive side. A mistake always costs money and usually requires rework. Avoiding mistakes can be costly as well—for example, designing a process around a very small chance that a problem will occur, such as inspecting 100 percent of inbound purchase orders to ensure that they meet specifications, when typical rejections run only in the 1–3 percent range. The result is a receiving bottleneck and unnecessary expenses. My sage advice here is to not make mistakes—or at least be sure to learn from them.

Specialization

The fourth cost driver is more subtle. Specialized processes are implemented in an attempt to simplify work by dividing and conquering, but they can create imbalances between supply and demand, hindering the efforts. Specialization creates additional handoffs, adding complexity and forcing each specialty operation to be tracked and managed separately. It also creates bottlenecks when workers trained in the specialized process are absent.

Unnecessary specialization can be avoided by creating new products or services that use existing processes whenever possible. Augmenting capacity to existing production lines through the addition of new products makes them more productive and adds useful equipment life. Furthermore, when both existing and new products can use new techniques and technologies, return on investment amplifies, and investment is more attractive.

Management

A manager’s job is to provide efficient processes that benefit customers, but many times the upshot is added complexity. The goal should be to simplify things by eliminating controls that steal productivity. Use the DMAIC (define, measure, analyze, improve, and control) methodology to improve capacity issues and minimize or eliminate non-value-added processes. The result will be an organization that can move faster. And, as noted previously, once a process is fast, better products and services can be produced at a lower cost for all. 

Gary A. Smith, CFPIM, CSCP, is vice president of the division of supply logistics for New York City Transit. He may be contacted at gary.smith@nyct.com.

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