Forecasting long term procurement spend
Filed Under Blog
One of the common challenges many businesses face is how to cost long term projects. Typically these projects will see materials procured over a number of years with the pressure that the project must meet a forecasted profit target therefore relying on costs to be maintained to an acceptable level.
Long term projects such as these are commonplace. Tenders or bids are often the start point for many, this is often where cost targets become established. This requirement to maintain costs can be commonly characterised for any product that has a lengthy life cycle/life span – this may be as a result of lengthy development and then production/ manufacturing periods (for example in the aerospace sector) or in FMCG where volumes of product will be manufactured during the life span of the product. Whatever their origins – for long term projects/programmes, costs frequently have to be maintained or increasingly improved upon to maintain competiveness.
Once a long term cost model has been established the challenge to maintain it often falls to the strategic procurement team to devise a strategy that can deliver the required materials at the right price during the lifecycle of the product. This will usually require analysis of a significant bill of materials and the creation of a plan that can meet the objective. Understanding the view of the long term cost requirement is often the facilitator for supply chain strategy – for example planning a project over 10 years can see where squeezes on margins occur which can intern drive changes in the supply chain to recover profit levels.
There is a fine balance in defining how much of the long term costing is based on fact (backed up by supplier quotations and/or contracts) and how much is based on pure forecast . Forecasting is an inherently risky process, its crystal ball gazing and you wont capture all of the challenges/risks inherent within a 5-10-15 years project. Near term planning will undoubtedly be more accurate than long term planning. But both will improve with closer dialogue with the relevant suppliers and more detailed understanding of the commodities that will be procured.
What can influence material cost over the medium to long term?
Whilst this isn’t an exhaustive list – materials can be exposed to any number of variables that can influence both their price and availability over the long term – these include:
• Effects of Annual Escalation/Inflation
• Supply and Demand rates within the market
• Labour rates
• Obsolescence issues
• Currency fluctuations
• Innovation and Efficiency Gains
Strategy
Given these challenges coupled with a need to accurately predict long term costs what strategies can be employed? Here are two common methods
Contracts and Long term agreements
One of the most common methods for long term business models is to utilize long term agreements with suppliers that dictate what costs will apply during the contract term – this can articulate the likely cost during the duration of the contract coupled with the inclusion of any commercial requirements which help alleviate risk to the buying organization.
LTA’s can be a double edged sword – its very probable that commodity markets will see pricing fluctuation over a number of years and this move can be downwards as well as up – if an LTA fails to describe what will happen in such events where costs improve then the opportunity for savings can be missed. LTA’s can be fraught when agreeing costs so it’s imperative that the relationship with the supplier is developed and that the agreement can be as mutually supportive as possible (its no good having an agreement that potentially forces your supplier out of business!)
Strategic Stock holding
For commodities that may see wide cost variation or be susceptible to obsolescence one option to mitigate price rises is to procure long term stock holdings – clearly this requires careful thought and a suitable business case as it can require substantial expenditure at an early stage where revenues may not yet be guaranteed. Many organizations will look to their supply chain to use such methods (keeping their own stock holding to a minimum but passing the responsibility onto its suppliers).
Don’t forget cost reduction opportunities
Most businesses will have initiatives that will attempt to deliver material savings to the businesses and any long term costing should consider these projects together with point of embodiment – this is especially true as development activities move into their production phase and opportunities such as greater buying volumes (and therefore leverage) or manufacturing improvements/efficiencies become relevant.
Long term plans are plans!
One risk is that forecasts can present an unreal expectation of what can be achieved and result in costs being accepted that cannot actually be achieved resulting in poor profitability and distrust o f procurement. Things will happen – its unrealistic to expect that issues will not occur – however getting a view of long term pricing can provide a unique view point into the challenges that could affect the business and help devise a procurement strategy that not only delivers material but delivers it to cost as well.