Achieving Cost Leadership in the Digital Economy
The digital economy can be a treacherous place for product brands. In this rapidly changing ecosystem, companies have less time to achieve returns on research and development (R&D) investments and innovative new business models. And lower barriers to entry and shorter product life cycles mean that cost reduction negotiated over time will not guarantee the kind of cost leadership required to meet profitability targets. In order to achieve cost leadership, product brands need to prioritize the development of procurement intelligence and domain expertise.
Missing Ingredients in the Recipe for Cost Leadership
Cost leadership in the procurement world has two drivers: the technical architecture of a product and the cost architecture of a product. To illustrate this paradigm, it helps to look at a hypothetical scenario where these two forces intersect. For example, let’s say a company plans to bring a new wearable to market that would require the use of a semiconductor component known as a CPU. Alpha Labs, Beta Industries and Gamma Incorporated represent three suppliers of suitable CPUs. At this point, the product brand’s engineering team would usually provide a recommendation as to which supplier should be used to realize the technical architecture. This recommendation would be made almost entirely on the technical merits of each supplier’s offering. Inauspiciously missing are similar recommendations regarding the cost architecture for the wearable device.
In this hypothetical situation, Alpha Labs builds its CPUs on a 12 inch wafer at a cost of $1000. Beta Industries builds that same part on an 8 inch wafer for $800, while Gamma Incorporated produces its CPU on a 6 inch wafer for a cost of $600. If all 3 suppliers have the same die size of 1 inch, the cost per die is different, and in Alpha Labs’ case, it is significantly cheaper for them to produce. In this all too common scenario, a lack of procurement intelligence and domain expertise impede the procurement specialists’ ability to secure cost leadership.
The Role of Procurement Intelligence And Domain Expertise
“Procurement in the digital economy isn’t just about negotiating the right price for a part number,” says John Caltabiano, Jabil Vice President of Supply Chain. “It’s about architecting the product with cost leadership in mind.” In order to achieve this, two critical elements are required. In the wearable device example, the first crucial variable is intelligence on Alpha Labs, Beta Industries and Gamma Incorporated. The second is domain expertise that will allow the procurement specialist to make savvy sourcing decisions using this unique procurement intelligence.
John Caltabiano, Jabil VP of Global Supply Chain
Information is intelligence and luckily for product brands, there has never been more information regarding suppliers, commodity prices and the broader market. The key is building digital systems that can connect, collect and validate all of these external sources of structured and unstructured data. In response to this need, Jabil has built a Procurement Intelligence Platform (PIP) with rich information on parts, categories and suppliers — what we call the DNA of the Supply Chain. This data could be as specific as purchased research from an institution like IHS Markit or as innocuous as a press release about the opening of a new 12 inch fabrication facility in Taiwan. By collecting this information and making it available to key stakeholders at product brands, we can begin to drive optionality and better decision making about product cost architectures.
But intelligence alone will not do the job. In order to secure cost leadership, product brands require the domain expertise around the category to make use of the information. “It’s kind of like asking a baseball coach to manage a soccer team,” said John Caltabiano. “Even though the baseball coach has coaching skills, the fact that they don’t have the domain expertise in soccer means they won’t be equipped to drive a positive outcome.” Without having this level of insight into the supplier ecosystem, it becomes very difficult to understand where you stand.
Strengthening Offense with Intelligence and Domain Expertise
Traditionally, a procurement specialist may be told that they need to purchase CPUs from Beta Industries due to their perceived technical superiority. Perhaps these CPUs have a production cost of $2 and a resale price of $3. Based on the recommendation from the engineering team, the procurement specialist would source from Beta Industries and begin negotiating a yearly cost reduction cadence based on the maturity and cost of the CPU technology as it ages. If the procurement specialist managed to secure a 10 percent yearly reduction from the $3 starting point, the following 4 years would look like this:
Year 1: $3.00
Year 2: $2.70
Year 3: $2.43
Year 4: $2.19
Before the digital economy and the era of shorter life cycles, securing this 10% reduction would make the procurement specialist a bonafide hero. But in this day and age, this methodology leaves food on the table. Through procurement intelligence and domain expertise, could the specialist have secured a lower price through Alpha Labs or Gamma Incorporated? What if purchasing from Alpha Labs would have allowed for a year 1 starting price of $2? While this example is oversimplified, it’s easy to see how a greater level of intelligence and domain expertise can provide huge dividends. By starting at the $2 dollar price point and forfeiting yearly cost reductions, you can achieve a much better financial result.
Strengthening Defence with Intelligence and Domain Expertise
The modern procurement specialist is under immense pressure from the CFO, the product line manager and occasionally the CEO to reduce cost. Without the combination of intelligence and domain expertise, the specialist doesn’t stand a chance. How can you know whether or not you have a good price, and a defensible position, when you don’t have visibility into all of the other options? From a defensive perspective, combining procurement intelligence and domain expertise allows procurement specialists to be confident in their cost. This assurance allows the product line team to focus on the remaining cost leadership elements of architectural cost and pricing strategy.
While nothing can guarantee a cost leadership position, the combination of procurement intelligence and domain expertise will absolutely improve your position. And in an age of shrinking product life cycles and lower barriers to entry, this is becoming a bigger priority for all companies. Jabil’s procurement managed services are designed to leverage both our customers and Jabil’s procurement best practices to produce superior outcomes. “What we’re excited to do for companies in this new environment of cost-leadership and shrinking time-to-market, is help them with intelligence and domain expertise,” said Caltabiano. “Our services are a la carte, from ideation to customer experience and customers can bring us in anytime in the procurement cycle.”