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Taking stock of your supply base

Supply-base management is one of the most important functions you’ll likely ever handle or oversee. Why? Manufacturing and distribution firms without a capable supplier network suffer competitively in the marketplace — and, ultimately, their bottom line will feel the brunt. Here are some strategies to consider as you assess the supplier base for your manufacturing or distribution business.

Reducing your suppliers

Your most important supply-base management decisions are related to the quality and number of suppliers you use. The thinking used to be that, if a business had a large number of suppliers, the atmosphere would be highly competitive, and it would get lower bids for products and services than if it stuck to a few favorite suppliers.

One risk with this approach is that, if there are some suppliers on your bidding list you never give business to, they may lose interest and be less available to you. Those suppliers also are less likely to offer competitive pricing than those you use regularly.

Supply-base reduction is now considered good business practice. The idea is to concentrate on fewer suppliers (perhaps just two or three) and develop closer relationships with them — better pricing will follow.

Research has supported this strategy. One study, Optimizing a Return on Business Complexity: Performance Metrics and Practices of World-Class Companies from The Hackett Group, a business process advisory firm, showed that businesses dramatically cut the cost of procurement spending and the procurement function by reducing the number of suppliers they worked with and focusing more spending with key suppliers. The study analyzed other studies on supply-based reduction over an eight-year period.

When making a decision about reducing the number of your suppliers, you also need to take current economic conditions into account. See section below “Factor in the economy.”

Lowering the cost of materials

Another supply-base management technique involves developing a commodity strategy: a plan for how your company will reduce costs, improve quality and service, and decrease the number of mishaps within a particular commodity that you use. Your strategy should include an overview of the commodity in the marketplace, supply of material, forecasts, past yearly purchases, past cost reduction savings, supplier certification ratings, and current supplier contracts and programs such as rebates or consignments.

Some manufacturers also include information such as the suppliers’ market share in the industry and a comparison of suppliers within the commodity. The importance of the commodity to your business also should be noted. For example, a manufacturer of upper-end, traditional clothing may want to describe the importance of natural fabrics, like wool and linen, to its customer base.

Negotiating contracts

With the economy down and suppliers eager to keep their remaining clients happy, it may be an excellent time to negotiate a lower price on the items you purchase. You can negotiate from a position of strength by using the following suggestions:

1. pool purchases within your company to maximize leverage
2. allow suppliers to use any appropriate, advantageous contracts your firm has for which they qualify, such as MROs (maintenance, repair and operations)
3. train your purchasing staff in contract negotiation

Remember to approach negotiations realistically. If negotiations fail, there may be a competing supplier who can fill the void. But a supplier that understands your specific needs — and fills them dependably — has value.

Shopping globally

If you’re like some businesses, you may find that shopping for supplies globally is worthwhile. CAPS Research, a nonprofit organization for supply chain issues, conducted a survey in 2007 entitled Succeeding in a Dynamic World: Supply Management in the Decade Ahead. Half of the businesses responding said they planned to spend more than 40% of their supply/services budget outside of the United States by 2010. And one-fifth of the respondents said they expected more than 80% of their supply/services spending to be done globally.

Cost is the most obvious reason for the large increase in global spending. But if you go this route, make sure that quality and service don’t suffer from the transition.

Participating in online auctions

Your supply-base management strategies should take into account the options made available through the Internet, including the reverse auction. This is an online declining-price auction between you and a group of prequalified suppliers.

Although this practice, in which suppliers compete for your business by bidding against each other in real time, may have peaked several years ago, the process still offers another opportunity to shop around — and perhaps replace a supplier on your list.

Evaluating your suppliers

Whatever suppliers you’ve settled on, you’ll want to keep a close eye on their performance. A good way to do that is via a supplier scorecard, with which you track suppliers’ performance over a set period of time — say, a year — to evaluate their consistency.

Your accountant can help you set up a scorecard spreadsheet. Be sure to include key performance indicators that measure your suppliers’ success in terms of quality, cost and on-time delivery.

Crafting an ideal supply base

The quality and cost of the supplies you use are crucial to the success of your manufacturing or distribution business. So, carefully consider the management strategies you use to build and evaluate your supply base, tailoring them to your business’s specific traits and needs.

Factor in the economy

When determining the optimal number of suppliers to maintain, factor in the down economy of the last two years. You may not want to keep the number of suppliers at a bare-bones low at a time when many businesses are suffering financial instability.

Your business could be left in a pinch to find the quantity of the supplies it needs if a core supplier closes its doors. It’s probably better to leave some buffer room. 

Manufacturing Monitor
Winter 2010

Is “IFRS light” right for you?

Small and midsize manufacturing firms should consider whether converting to International Financial Reporting Standards (IFRS) in their financial reports is to their advantage. Private companies can use the simplified 230-page version, IFRS for SMEs (small and midsize entities), released last July by the International Accounting Standards Board (IASB). The full-length IFRS, which is aimed at public companies and used in about 100 countries (but generally not in the United States yet), weighs in at about 2,500 pages.

Less complex, more relevant

IFRS for SMEs, which is frequently referred to as “IFRS light,” lays out a system for accounting and financial reporting that could replace U.S. Generally Accepted Accounting Principles (GAAP). Many of the principles in the full IFRS for recognizing and measuring assets, liabilities, income and expenses have been simplified. Topics not relevant to SMEs have been omitted, and the number of required disclosures has been greatly reduced.

Some CPAs believe that a switch from GAAP to IFRS will take a cultural adjustment because the change in approach is vast. GAAP is based on complex, industry-specific rules and exceptions; IFRS is based on principles, allowing CPAs greater leeway to exercise professional judgment.

For example, the capitalization of leases under IFRS would be based on “substance over form” rather than on specific rules, as is the case under GAAP. Also, the last-in, first out (LIFO) inventory accounting method is not allowed under IFRS.

Benefits over GAAP

IFRS for SMEs is considered to be beneficial to entities attempting to procure international investors. But some accountants say that converting to IFRS might be detrimental to domestic companies until the standards are more well known, because most U.S. lenders are more comfortable with GAAP-based financial statements.

On the other hand, the AICPA has said that private companies may find IFRS for SMEs to be more relevant and less costly to use than GAAP. That echoes the IASB’s sentiment: It’s gone on record as saying IFRS for SMEs is a response to “strong international demand from both developed and emerging economies for a rigorous and common set of accounting standards for smaller and medium-sized businesses that is much simpler than full IFRSs.”

Ask for advice

Small and midsize private firms should consult with their accountant about whether converting to IFRS light will be advantageous and when such a conversion in financial reporting should be made.

Manufacturing Monitor
Winter 2010

Recoup sales and use taxes
Reverse audits ensure you’ve claimed appropriate exemptions

In an economy where there’s no room for unnecessary expenditures or costly mistakes, many manufacturers are turning to the reverse audit to make sure they haven’t overpaid sales and use taxes.

Why you may be overpaying

In most states, manufacturers are exempt from sales tax on equipment used in manufacturing or recycling, and many states don’t require them to pay taxes on the utilities and chemicals they use, either. In some states, custom software, computers and peripherals are exempt if they’re used for research and development projects.

With most state sales taxes now between 4% and 7%, it’s worthwhile to be sure you’re receiving all the exemptions to which you’re entitled. And unless you’re diligent about claiming exemptions, you’re probably missing out on some.

Most manufacturers have sales and use tax compliance systems to guard against paying too much, but if you haven’t reviewed yours recently, it may be functioning improperly. Employee turnover, business expansion or downsizing, and simple mistakes all can take their toll on sales and use tax compliance policies, and you may be paying more than you should.

Reverse audits can go way back

A reverse audit should include an examination of your tax compliance systems as well as your purchasing records. For example, your accounts payable department may be tasked with spotting exemptions that purchasing hasn’t requested, but are they doing it?

The audit should extend across your business, going back as far as the statute of limitations on state tax reviews. If your state sales tax auditors can review all records for the four years preceding the audit, for example, your reverse audit should encompass the same timeframe.

Timing is everything

A good time to consider a reverse audit is when state tax laws change. Sales and use tax exemptions typically don’t apply to local taxes, and changes in state regulations may be easy for your staff to overlook at first. If a state in which you do business has revamped its tax laws, use a reverse audit to be sure you’re not missing additional opportunities for tax savings. Your tax advisor can help you stay up to date on tax law changes.

In the current economy, you may not be undertaking any major capital projects, such as adding manufacturing space. But, when you do, it will be an excellent time to conduct a reverse sales and use tax audit. Even if you can’t justify a full, companywide audit because of time or staffing constraints, you can audit transactions associated with the project. During a capital project is when you’ll be buying equipment and supplies that are most likely to qualify for tax exemptions. If you can spot overpayments during the process, you can act to resolve them promptly.

Overpayments can happen anywhere

What types of payments should be reviewed? You may have made sales tax overpayments on components of your manufactured products as well as on the equipment you use to make the products. Other areas where overpayments may occur, depending on state laws, include warehouse equipment, software licenses, safety equipment, maintenance fees and so forth.

When considering whether you may have overpaid taxes in these and other areas, a clear understanding of your operations is key. You must know where your manufacturing process begins and ends, for example, if you want to ensure you’re receiving maximum benefit from industrial processing exemptions.

Also remember that, if you have plants or sales offices in more than one city or state, your sales tax records may be decentralized. Don’t overlook any sites.

Database software can help

Thanks to advances in technology, database software is available to help identify where overpayment is most likely to occur. Select random samples of invoices for review and use the results to project total overpayments.

In some states, such statistical sampling is an accepted method for projecting overpayments. In others, you’ll be required to complete a detailed review of all purchases. So before beginning a reverse audit, it’s important to understand sampling requirements and tax exemptions for every state in which you do business.

Findings pinpoint weaknesses

Your external sales tax auditor generally will provide you with a written report when the audit is completed. In addition to helping save you tax dollars right away, the findings can be used to pinpoint weaknesses in your compliance system for future tax savings.

Manufacturing Monitor
Winter 2010

TRENDWatch
Public opinion and manufacturing careers: The bright side

A recent survey from Deloitte LLP and the Manufacturing Institute shows a disconnect between the public’s perception of the importance of manufacturing and the desire to make a career out of it.

The survey, Public View on Manufacturing: 2009 Annual Index, revealed that, while 71% of respondents view manufacturing as a national priority, only 17% consider manufacturing among their top two industry choices for starting a career. And only 30% of parents say they’d encourage their children to pursue a manufacturing career.

Is the glass half empty or half full?

While the gulf is wide between the public’s high opinion of manufacturing and its less enthusiastic embrace of it as a career choice, there’s a bright side when it comes to community support and career recruiting.

For example, according to the survey, 59% of respondents agree that the U.S. manufacturing industry effectively competes on a global scale. And 80% believe that America’s manufacturing base is either important or very important to their standard of living.

Also, when asked what industry they would most want to have creating 1,000 jobs in their community, respondents listed manufacturing as their top choice, beating out technology, energy, health care and other high-profile fields.

Bottom line: The survey shows there’s no doubt that Americans understand how critical manufacturing is to our country’s economic well-being.

What’s behind the disconnect?

So, why did the survey respondents express such little interest in manufacturing as a career for themselves or their children?

According to Emily DeRocco, president of the Manufacturing Institute, people have an outdated image of manufacturing and the career opportunities available. “Cutting-edge technology has transformed manufacturing in ways that are hard to imagine if you haven’t visited a factory lately,” she said.

In fact, manufacturing jobs now often require postsecondary education, skills certification and credentials across a broad range of high-quality, middle-class career paths.

You can help close the gap between perception and reality as you present your business to the community. Consider opening your plants for tours and educational outings, offering internships, and visiting schools to spread information about challenging and well-paying manufacturing careers. These are chances to communicate what skills are needed for a career in U.S. manufacturing today and what degrees are desirable.

Note: Commissioned by Deloitte and conducted by an independent research firm, the survey polled a nationally representative sample of 1,000 Americans in May 2009. The study has a margin of error of ±3 percentage points.

Manufacturing Monitor
Winter 2010

What’s your plan when taxes and interest rates rise?

If you believe, like we do, that taxes and interest rates will rise at some point, what’s your plan?  Are you going to “grin and bear it”, and give the IRS more of your money, or are you proactively searching for ways to keep more of your money, and increase your income when rates rise?  How are you being proactive?

Our team is actively searching for investments with imbedded losses that can be used to offset gains.  What is the amount of imbedded losses in your equity portfolio?

Additionally, we are shortening bond portfolio durations, and increase credit quality.  What is the duration of your bond portfolio?  Do you know how much your portfolio might decline when interest rates rise?

If you don’t know the answers to the last three questions, give us a call, and we’d be happy to help.

Securities are offered through LPL Financial, member FINRA/SIPC

For more information about Alpern Rosenthal's Financial Services LLC please contact:

Adam Yofan, CPA
Vice President
412.281.5201 x390
ayofan@alpern.com