Implementing and Using TCO Principles at Scott Paper

Prior to being acquired by Kimberly Clark several years ago, Scott Paper was one of the world$$s largest producers of paper, with $20$ plants in nearly $20$ countries.

The papermaking process requires the 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 Scott$),$ 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 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. At the end of the year, rewards were allocated to those buyers who got the most favorable pricing. Moreover, for years, Scott Paper$$s procurement department patted itself on the back for doing a wonderful job at keeping both the supplier$$s profits and Scott$$s prices low.

Scott Paper$$s profitability was among the lowest in the industry, making it ripe as a takeover target. Nevertheless, the purchasing managers were all confident that they were doing their part to get costs down to the lowest level possible.

In $1994,$ a new VP of procurement, Ted Ramstad, arrived on the scene and began challenging traditional thinking. In an effort to understand the real cost of the fabric, Ted began conducting a reevaluation of cost$.$ The following internal data were gathered:

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

$$ It takes about $8$ hours to put fabric on a paper machine.

$$ 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.

$$ Seventeen companies supplied fabrics to Scott around the world. Each plant manager has 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.

While most of the buyers were unconcerned about this information, Ramstad and his team, applying TCO thinking, began probing and asking more questions:

$$ How can we lengthen the time a fabric lasts on a machine?

$$ How long should a fabric last?

$$ Are we getting the best fabrics from our suppliers, or just the cheapest?

$$ What suppliers are providing the research and development to give us better performance from our fabrics?

$$ Would fewer suppliers give us volume$-$purchasing power?

$$ Could we build win$-$win incentives to get more value from our suppliers and their fabrics?

$$ Where is there significant $$non$-$value$-$added$$ in the system?

$$ What benchmarks should we be using to be $$best in class$?$

$$ If the $$absolute component cost$$ of a fabric is $$25,000,$ what is the total cost of ownership and how does this compare as a relative competitive advantage?

Armed with a new focus and an energetic spirit, Ramstad$$s team began a worldwide search for answers. Fabric suppliers were interviewed, and information was gathered regarding competitors, indicating:

$$ 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 Scott increase fabric longevity.

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

A crucial juncture:

Now come the real test. In a $$Simple Accounting Component Cost$$ world, fabrics clearly cost $$25,000$ apiece. However, Ramstad stuck his neck way out and maintained that this was only true in a narrow, absolute sense. In a broader, $$relative advantage$$ perspective, the formulation of the cost looked radically different. Ted decided to employ a variation of the traditional TCO methodology. He decided to at the incremental cost of not purchasing the most intuitively attractive fabric $($the one whose life is $470$ days$).$

Here$$s what Ramstad$$s TCO calculations looked like