This morning I told you how year-over-year savings targets are costing you a small fortune right now. Now I’m going to tell you how they cost you a large fortune over the long term.
Typically what happens in a company that gets serious about cost reduction as a result of a knee-jerk survival reaction in a recession is that, if they can attract one, they bring in a top-notch CPO. This CPO pulls the weeds out of the organization and replaces them with strong trees, acquires some decent tools (or at least access to some on-demand SaaS tools), institutes good processes, and brings in expert consultants to assist on the strategic sourcing of key categories where her team is weak. Over the next couple of years, the team kicks ass and exceeds their savings targets and everyone is happy. The corporation is saving money and the team is getting lots of kudos and bonuses for a job well done.
But then the inevitable happens. The economic cycle runs its course, the next economic boom occurs, demand for raw materials skyrockets, and prices go up, often significantly. As a result, it becomes impossible for the CPO and his team to get any year-over-year savings in any of the high-spend categories, which they had negotiated down to razor-slim margins when the supplier was desperate. (After all, not only is the supplier being offered a lot more money for a limited supply, but the supplier can’t even cover its input costs at last year’s prices.)
Then management, used to price reductions and unwilling to admit, and sometimes unable to even understand, the new market reality, makes another knee-jerk reaction and fires the CPO, with no plan for cost containment — which is much more important than cost savings. A monkey with an auction platform and the ability to use Google and access a D&B report can save you money in a recession when dozens of suppliers are desperate for your business (and will happily forego profits for a chance to survive). But only a true Procurement Pro can contain costs in a boom market when the supplier holds all the cards. A true pro can contain cost increases to only 10% when production costs go up 20%+ through skillful negotiations, collaboration, innovative delivery options, and so on. Everyone else will be lucky to secure supply at a 20% increase, which is what the company will end up having to accept without a procurement master at the wheel. And you’ll end up losing so much money that I don’t even want to attempt to calculate how much it will be, since the profuse bleeding won’t even begin to slow until you get a new CPO at the wheel, who’ll be hesitant to accept knowing that you’re last CPO, who was a superstar, didn’t make the cut.
You see, it’s not how much you save, because there is no such thing as savings. All “savings” means is that you were paying too much in the first place. What matters is the best deal with the greatest total value for every sourcing event, and a performance that outdoes the market average. When you start measuring that way (against competition, indices, and carefully researched should cost models), and calculate year over year improvements appropriately, that’s when you see real performance. Until then, you’re running a marathon you cannot win.