Reference no: EM132232939

Total Cost of Ownership and Strategic Sourcing Mini-Case

Alpha Paper Case

Background:

Prior to being acquired by Big Paper Co several years ago, Alpha Paper was one of the world’s largest producers of paper, with 20 plants in nearly 20 countries. The papermaking process requires that wet pulp slurry be deposited uniformly on a continuously moving fabric belt. The fabric belt (known as “fabric” in the industry) is approximately 12 feet wide and the belt is about 60 feet in circumference. Fabrics are woven to enable the water in the pulp to be drawn out through the fabric, so that when the pulp leaves the end of the belt, it is in a semi-solid, rather gelatinous form. Once leaving the fabric belt, the pulp goes onto other machines, which further dry and then press the pulp into paper. Fabrics cost approximately $25,000 each.

For years, each plant’s procurement team had negotiated with fabric vendors. Knowing that the sales price was about $25,000 (a simple “component cost” to Alpha), the procurement directors were always rewarded for driving costs down. Every buyer was trained in being a tough negotiator; they all knew that there was 5–10 percent that should be driven out of the sales price.

Each year the procurement group aimed to push prices down, thereby driving down the profit for the fabric manufacturers. This was usually done through fierce annual competitive bidding events and negotiations. At the end of the year, rewards were allocated to those buyers who got the most favorable pricing. Moreover, for years, Alpha’s procurement department patted itself on the back for doing a wonderful job at keeping both the supplier’s profits and Alpha’s prices low.

Despite having the lowest profitability in the industry, Alpha’s purchasing managers were all confident that they were doing their part to get costs down to the lowest level possible.

New Procurement Leadership:

You’ve been brought in by a new CPO, who is trying to transform how the company does procurement. She is in the process of establishing a global sourcing organization and transforming to a hybrid (center-led) procurement structure.

You are one of four recent college graduates who are part of the new Procurement Leadership Development program. Since there are still a number of more senior positions to be filled, the CPO has asked you to take the lead on a special “stretch” assignment. It’s a tough project for a recent college grad to lead, but you’re thankful for the opportunity. You will be leading a project team that includes the other recent college graduates.

Your “Stretch” Assignment:

The CPO has asked you to review the existing sourcing strategy for the fabric and make a recommendation for a new strategy. You have developed a project plan and conducted some initial discovery, data gathering, and analysis.

The initial discovery workstream includes ten (10) internal interviews, data gathering, secondary research, and fifteen (15) interviews with suppliers and industry experts. The findings are summarized below:

Findings from Internal Interview and Data Gathering:

While replacing fabrics, the paper machine must be shut down, at a cost of nearly $100,000/day to the paper company (because paper manufacturing requires a continuous process, and the machine is considered efficient only when it runs 24 hours a day). Each plant operates 365 days a year.

It takes about 8 hours to put fabric on a paper machine. It takes two men 8 hours to change a fabric at a burdened labor rate of $45/hour.

In Alpha’s plants, Fabrics lasted an average of 40 days.

Most fabrics broke on the machines.

When a fabric broke, it normally had less than 10 percent wear. • Carrying costs are usual calculated at 20%

Seventeen companies supplied fabrics to Alpha around the world. Each plant manager had a “favorite” supplier, but there was no compelling reason for using one supplier over another. Procurement assumed it could use the large number of suppliers in a competitive manner to keep the purchase prices low.

Cost of Goods Sold (COGS) for most suppliers was about 35 percent and R&D was 3–5 percent.

Most plants had 4–6 fabrics in inventory.

Insights from Supplier Interviews and Secondary Research:

• The industry average fabric life span was 60 days.

• The industry benchmark fabric life span for one paper producer was 470 days.

• Only three suppliers were interested in helping Alpha increase fabric longevity.

• None of the suppliers believed their fabrics were at fault for Alpha’s low life span; all blamed either the operators or the machinery manufacturers.

Assignment:

1. Identify 4-5 key cost elements (buckets of cost) that should be included in a TCO analysis

2. Identify the cost driver for each cost element (cost driver is how the costs change)

3. Based on what you read in the case, what are 2-4 sourcing strategies you might consider (2-4 bullets with a brief explanation of why e.g., I would use sourcing strategy X because....)