The true cost of MRO

RS Components Cost White Paper - MRO Finance
The various cost saving strategies will be covered in forthcoming RS white papers.

RS Components (RS) shares its white paper – part of a series covering best practice maintenance, repair and operations (MRO) procurement – exploring why its complexity can disguise the scale of its costs, as well as, frustrate attempts to achieve cost savings.

The complexity of MRO procurement means that organisations spend a disproportionate amount of time sourcing and purchasing items that are of relatively small value, both individually and in total.

RS Components Whitepaper PQ Dec 2015These process costs are largely invisible, and therefore tend to be underestimated or even ignored, but can be significant.

To put it into perspective, if an organisation’s MRO product spend budget is £100,000, it is actually spending more than £300,000 in total procurement costs.

MRO complexity disguises savings opportunities

MRO is complex. Multiple stakeholders; multiple sites; diverse product sourcing; numerous suppliers; inconsistency of procurement systems employed, and other factors all add to the complexity; and that complexity adds to the cost.

Yet, when companies evaluate cost-drivers within their organisation, often MRO costs are overlooked, as costs historically are only on average 20% of the total cost of goods sold (COGS) for a typical company.

This low percentage of COGS leads companies to focus their attention elsewhere in reducing costs – usually trying to concentrate on becoming efficient in sourcing and procuring direct goods.

RS Components Whitepaper - Fig 1
RS Components Whitepaper – Fig 1

Such lack of focus on MRO, leads companies to use a price-led procurement strategy which, though successfully implemented in direct procurement, is counterproductive in MRO.

Yet MRO processing costs typically represent 80% of the organisation’s total processing costs.

From a financial performance perspective, while it takes a 10% increase in revenues to achieve a 20% increase in earnings per share, a 1% decrease in operating costs gains the same result.

With such huge tangible returns, it is essential to look afresh at the cost structures, especially product and process costs, through a total product procurement (TPP) perspective, rather than through the narrow lens of direct goods procurement or price reduction.

A fresh look at cost components

Product costs, which are visible on invoices, make up about 60% of the total procurement costs, while 40% of the purchasing expenditure is spent on non-production activities.

These costs are made up of process costs incurred in sourcing; procuring; stocking, and managing the products.

RS Components Whitepaper - Fig 2
RS Components Whitepaper – Fig 2

The numbers for process costs can be significantly higher in various industries, especially those with multiple sites and non-standard procurement processes.

MRO product purchase costs account for a maximum of 15-25% of these invoiced costs. The number remains small as these products don’t constitute a part of the end-product, but are about ‘keeping the machines running’ effectively and efficiently.

Though this is unsurprising to experienced procurement professionals, it enables us to put a monetary value on MRO process costs to show their ‘expensiveness’.

It also enables us to see and compare MRO product and process costs together and so come to multiple decision points.

These insights on the enormity of MRO process costs were corroborated from multiple white papers by a team at Manchester Business School (MBS).

While some have mentioned it through workload terms, such as the one by Van Wheele (2005) which states: “’Typically, MRO items account for 80% of the procurement department personnel workload’; or in terms of number of dollars by Hawking (2004) ‘[while] indirect purchases account for 80% of total number of purchase order’, or in dollar terms as stated by Roth (2008) ‘MRO represents about 20% of the total spending for materials, but consumes about 80% of the process expenses.”

RS Components Whitepaper - Fig 3
RS Components Whitepaper – Fig 3

Though these cost components were known, what was not clearly stated, which this study with MBS brought to light, was that about 80% of the process costs could be attributed to MRO processes (Figure 3).

Implication

The MBS research shows the interrelation of workload, pounds spent and number of orders to make the conclusion that organisations spend a disproportionate amount of their time procuring MRO items which are of a very small value, both individually and also in total, so fitting the Pareto split perfectly.

The implication is that MRO costs as a whole make up 47% of product procurement costs.

If the total product procurement costs are now rearranged to look at MRO costs together, and direct product costs together, it becomes apparent that MRO constitutes 47% of an organisation’s material procurement costs (Figure 4).

This is a critical insight that has, until now, never been backed up by quantitative analysis.

RS Components Whitepaper - Fig 4
RS Components Whitepaper – Fig 4

On an individual product basis this has been mentioned in white papers, Roth (2007) states, “An average per purchase procurement processing cost of £100. When you compare this to the average MRO order purchase size of £100 that means for every average purchase there is a 100% increase in total costs due to soft dollars”; however, such small amounts aggregated across all your process costs result in a significant spend size.

This means that if your MRO product spend budget is £100,000 then you are spending £300,000 in your total procurement costs.

Conclusion

As it is such a major component of an organisation’s procurement costs (47%), and as it has unique characteristics, MRO procurement needs a deeper understanding and a refocus.

RS Components Whitepaper - MethodologyWith process costs representing as much as double the average product costs, MRO process costs can present a great opportunity to realise significant cost savings, through various acknowledged procurement improvement strategies.

This, along with the understanding that MRO, through its unplanned nature, is different from direct procurement, leads to a conclusion that MRO procurement strategy needs to have a different and an equal focus in cost saving strategies.

The various cost saving strategies will be covered in our forthcoming white papers.