How Should You Calculate Cost Reduction?

As per a recent article over on Supply Chain Digest on how there are many roads to the same goal when it comes to calculating procurement savings, there are almost as many methods to calculate cost reduction as there are people to do the calculations. And while some will be better than others, many, depending on one’s point of view, will be about the same from an objective (trending) viewpoint. This lead one to ask, independent of organizations and balance sheets, if there is one method, or a set of methods, that are arguably better than the rest of the pack.

Without a stick to measure against, there will be no way to judge effectiveness, so we will start by introducing a set of sticks, namely:

  • Objectivity:
    The calculation should be formula-baesd and (completely) objective, not based on subjective approximations.
  • Trend(& Benchmark)-Compatible:
    The calculation should be repeatable on a monthly, quarterly, and yearly basis and lend itself to the plotting and identification of trends.
  • Index-Based:
    Where market data is required, the calculations should be based on index data, not single supplier bids.

This says that, of the list of 26 methods of setting savings targets, from a recent CAPS survey that was printed in the article, the following six are probably more effective than the others:

  • annual sourcing effectiveness planning that identifies projected spend by commodity, region, etc. and then establishes savings opportunities from consolidated leverage, value engineering, negotiation, etc.
  • based on history and market intelligence
  • based on projected commodity price trends, demand growth, competitive pressure, etc.
  • “bottom up” approach based on projections of new purchases, expiring agreements, and pricing trends
  • historic performance and spend volumes (projected) against corporate overall cost targets
  • historical spend data, and CAPS Utility Industry and Cross-Industry benchmark data