As seen in Recharge News on 20 May 2019:
OPINION | From grocery to healthcare, industries are pooling their demand to gain economies of scale – why not do the same in wind, asks Ed Wagner
As seen in almost every other commercial industry, supply and inventory managers have implemented strategies to reduce their inventory costs through “buying groups”.
A buying group is a term for buyers to aggregate their demand to achieve better outcomes such as lower prices and faster delivery since the buying group purchases with higher volume, effecting the business decisions of suppliers.
For example, at Staples, Amazon or Whole Foods, buying is done with demand forecasts to achieve the lowest cost, and at the same time, maintain the levels of service and quality demanded from their customers. Why not have buying groups in the wind industry?
We know that the large operators have established relationships with their suppliers to get the best possible pricing. However, no matter how large those operators are, they buy as a single company with a single supplier. In the mid-market, operators have less clout and less capability to drive improved pricing. They, too, buy as a single company with a single supplier. In both cases, buying groups could aggregate demand and drive lower costs. Today, the accepted vehicle for pricing is a standard Request for Quote (RFQ), but in the future, we could see auctions and reverse auctions using buying groups as a basis for increased leverage.
Let’s look at an example of a hospital buying group called Novation. Novation includes 2,911 hospitals with purchasing of $37.8bn a year, covering 40% of the staffed beds in the US. The buying group maintains agreements with more than 600 suppliers and distributors, representing nearly 90% of the products that healthcare organisations purchase. This may be an extreme case, but clearly demonstrates the power created when organisations pool their resources for improved pricing.
For aerospace, Zodiac Aerospace and Safran merged to create the world’s third largest aerospace company to offer its customers a portfolio of aircraft propulsion equipment. Safran now offers most systems and equipment used by aircraft as either original equipment or for the aftermarket: engines, cabins, landing gear, seats, avionics, electrical systems and more. For aerospace, this buying group now represents one of the prime sources of parts for the industry.
Impact on Suppliers
It’s not possible to force suppliers to lower price and margins and expect them to remain healthy and available long term. In fact, the pressure on the supply community is forcing mergers and acquisitions and movement of manufacturing to China and the far east. While this may sound like a natural transition for the wind industry, it clearly damages the established centre of supply chain expertise in Europe where the bulk of our OEM community was founded and based. The European community is against protectionist activities for suppliers and wants free markets to continue.
The most discussed options for the supply community has been to innovate and create new products. We’ve seen that innovation in larger turbines, larger blades, improved reliability and digitalisation. And yet, our suppliers are under increased pressure to expand their services business as capital purchasing declines. The supplier solution is affectionately called “The $11 Problem” – for every $1 in capital purchasing, the operator is required to spend $10 in services, including long-term service agreements. This is an extraordinary sign of the lack of innovation in the wind industry.
Enter buying groups, which have the power to provide long-term demand and stability for the supply community. As said above, buying groups can force lower prices, but suppliers will need incentives to ensure their needs get met, too. For example, it’s reasonable for suppliers to require multi-year purchasing agreements in exchange for deeper discounts. A 3-to 5-year purchasing agreement would allow suppliers to better plan their inventory, especially for complex major components. This alone would improve supplier margins, but there are other ways to recoup more margin.
Suppliers are desperately seeking operating information from the field that defines how their products are being used in the “real world”. Without the operating information flowing to the supplier, the supplier is forced to make assumptions about loading conditions and demand forecasts that don’t represent the use cases globally. If suppliers were able to get actual operating information back from the community, they could use the information to innovate and potentially create products for specific geographic and wind conditions. In some cases, supplier products are over designed and would give the suppliers opportunities to reduce costs.
Finally, through the use of digitalisation, suppliers could begin to reduce their marketing and sales overhead by having a closer “digital relationship” with their customers, including preferred supplier agreements. In fact, we’re now seeing automated buying through new maintenance and life extension applications interfaced through Enterprise Resource Planning to the suppliers that would virtually eliminate the overhead in the supply channel.
While these opportunities to improve margin may sound aggressive and far-fetched, consider how removing multiple layers of cost is affecting the insurance industry. These are reasonable strategies for suppliers to recoup margins lost through the impact of buying groups.
So, there must be a balance, two sides of the same coin, that allow buying groups to form and lower the cost of purchasing, and at the same time maintain or improve the margins for suppliers.
Digitalisation and the emergence of buying groups
Supply forecasts for most operators are based on demand requirements from previous years. If you ask most supply and inventory managers what their requirements will be going forward, they’ll look at the historical data for planning. We also know that as complex machines like wind turbines begin to age, they require more maintenance, component replacement and care.
So, we have a dilemma. If we assume failure rates for assets will be the same next year as they were last year, then we’ll make a mistake contributing to the unplanned maintenance costs most operators are seeing in O&M. Only recently are we seeing tools that will allow operators to forecast demand based on long-term predictions. These systems like Sentient Science’s DigitalClone create multiyear replacement forecasts based on simulated failure rate assumptions and they are now being used as the basis for more accurate inventory planning and lower cost Terms & Conditions with preferred suppliers.
“This is not rocket science, but the natural evolution of an industry using its resources to become more competitive.”
Using multiyear forecasting technology and buying groups, operators now have new tools to lower cost and extend the life of their assets instead of allowing the assets to fail. The buying groups create economies of scale not seen in the wind industry, but common in other industrial markets.
The economies of scale require aggregating accurate demand profiles from multiple operators to create RFQs with discounting structures approaching 30%. This represents a definitive case for the power of digitalisation affecting lower cost of operations, inventory and LCOE.
This is not rocket science. It is the natural evolution of an industry using its resources to lower its costs and become more competitive. Buying groups, whether aggregating the demand of smaller mid-market operators or the demand from the largest global operators and utilities, have the power to change the industry, and help us achieve the cost targets needed to keep us all in business.
Ed Wagner is chief digital officer at Sentient Science