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Direct materials: You need to focus on more than cost


May 17, 2022

It used to be that when anyone thought about direct materials, it was generally a sourcing cost-reduction play: Which vendors can provide the desired materials at the best prices? Then came COVID-19, which has caused everyone to see direct materials in a completely different light. For example, according to Accenture research, 52% of manufacturers said their inbound materials were delayed over two weeks—a major disruption. This is particularly evident in the pandemic-driven shortages many supply chains are encountering. The dearth of semiconductors is one of the most visible, with far-reaching impacts on virtually every industry. And this could be an enduring situation: Intel’s CEO has said the chip shortage could extend into 2023.

Many companies now face some big challenges across the direct materials value chain—from designing, planning, engineering, and sourcing, to making, moving, and servicing finished goods. And these challenges are less about costs and more about supply, sustainability, and resiliency. In fact, because they’re preoccupied with costs, companies are leaving significant value on the table.

For example, reducing product complexity and optimizing the product portfolio can generate a 30% increase in value. Better supplier relationship management and should-cost modeling by procurement could contribute to a 25% boost. More effective requirements and production planning could move the value needle by 10%. And reducing carbon emissions and increasing circularity could create 20% more value. 

How can companies capture the value they’re overlooking? It requires a collaborative, cross-functional, and data-driven approach that ensures resilient, cost-effective, and responsible direct materials flows. We call this approach Integrated Direct Materials Management (IDDM), which leverages data and analytics and is built on three pillars:

Three pillars of Integrated Direct Materials Management (IDDM)
Three pillars of Integrated Direct Materials Management (IDDM)

The first pillar, strategic cost management, focuses on four key initiatives:

  • Complexity reduction: using a cross-functional mindset enabled by advanced analytics to reduce complexity across product portfolio, raw materials, and downstream supply chain processes to better align demand and supply structure and drive more standardization/modularity during the design phase.
  • Right shoring: building a supplier base that helps a company meet its quality, cost, delivery, and risk (QCDR) goals, including movement toward near-shoring or local providers to diversify risk.
  • Should-cost modeling: challenging business requirements with a “zero-based” mindset, instead of basing decisions on what the company historically has paid, using top-down parametric costing and bottom-up mechanistic costing.
  • Commodity risk price management (CRPM): developing commodity purchasing and trading strategies, price forecasting, operating model, governance structure, and processes to reduce and hedge procurement risk against price volatility.

The second pillar, new ways of working, encompasses two key initiatives:

  • Global operating model design: Creating and implementing global operating models and a cross-functional, -business unit, and -geography approach that drives connectiveness, consistency, and scalability across the enterprise and ensure collaboration and innovation from product design to sourcing to manufacturing.
  • Digital procurement and ecosystem: Deploying a connected, digital source-to-pay platforms to help procurement professionals derive data-driven insights that accelerate business value creation, with a focus on customer centricity.

The third pillar, responsible and resilient sourcing, includes four initiatives:

  • Nth Tier visibility: Deploying a supplier risk management solution to secure the supply base, remove supply uncertainty, and build further resiliency by sensing, predicting, monitoring, and simulating supplier performance.
  • Supply chain resilience test: Using a digital twin to model disruption scenarios and identify the most critical failure points as well as customers and products more exposed to external shocks in supply and demand.
  • Inbound supply control tower: Enacting a cross-function, cross-enterprise transformation that aggregates critical supplier data and matches supply signals with demand signals to drive flexible, cost-effective, and accurate order fulfillment.
  • Responsible sourcing: Balancing traditional and new procurement priorities to deliver not only on profitability and growth, but also on responsible business practices across the supplier base.

The Integrated Direct Materials Management approach can be implemented in full or by pillar, depending on a company’s specific needs. Either way, it can generate significant, tangible benefits, as the recent experiences of several companies illustrate:

One company, a multinational technology supplier, applied a digital twin-driven supply chain stress test to pinpoint supply chain weaknesses and conduct Nth Tier mapping for select categories to identify critical component supply chain risks. The insights gained during the effort enabled the company to develop category-specific risk mitigation strategies it could use in the face of disruptions.

A pharmaceutical company executed global strategic sourcing and “make versus buy” initiatives to uncover a savings opportunity of approximately 30% for Active Pharmaceutical Ingredients (APIs). The company also identified opportunities to improve its current sourcing process and optimize its finished goods product portfolio, resulting in 5% additional savings.

A third company, a global toy manufacturer, conducted a product development assessment to determine how the company could address the issue of increasing product costs (COGS) through complexity reduction, nearshoring, should-cost modeling, and tooling cost optimization. The result: the implementation of enterprise-wide should-cost capabilities to align marketing, sales, engineering, and procurement, which reduced COGS across four product lines by 3% and generated 5% to 10% resin savings.

Keys to building the future direct materials value chain

  • Break the silos: Adopt an integrated approach to the end-to-end direct material value chain.
  • Build digital DNA: Use data and artificial intelligence (Al) to make sound decisions and find the optimal balance across cost and resiliency.
  • Create a COE: Establish a Center of Excellence (COE) with specialized analytics skills to drive consistency and scalability to support business needs.
  • Collaborate to innovate: Rethink relationships with suppliers and larger eco-system players. Collaborate to find new sources of growth through innovative ideas.
  • Develop future-ready workforce: Establish an agile and nimble operating model with a digital workforce for a future-ready organization.
  • Pursue a sustainable purpose: Build sustainability into the fabric of the direct materials value chain to drive stakeholder value growth and improve brand value.

As companies continue to face disruptions and change on a large scale, they need to really think more holistically about direct materials, including the technology, workforce, skills, and sustainability implications (see above). Doing so can enable them to capitalize on the wide range of opportunities to positively influence direct materials from product design to servicing—and begin to capture the substantial value that’s waiting to be unlocked.

It’s not just about managing direct materials in silos anymore. It’s about managing the end-to-end direct materials value chain—from designing, planning, engineering, and sourcing, to making, moving, and servicing finished goods.

See more Supply Chain & Operations insights.

This blog was originally published on September 28, 2021, and was updated with new information on May 17, 2022.


Anshul X. Singhal

Managing Director S&C, SC&O, Growth Markets Resilience Lead