Daily Archives: September 30, 2016

Category Aggregation – How Far Do You Go?

Category Aggregation is one of the tried-and-few methods for spend leverage in Procurement — aggregate a bunch of items, go to market simultaneously, and demand big discounts for big awards. The first time a significant category of significant size is aggregated, and offered up, the organization will see savings … often significant savings.

But does the spend have to be aggregated to get the savings? Let’s examine the likely reasons why a supplier will offer up savings.

  • They were making a fat margin and could give it up.
    For example, maybe a healthy margin for the industry, unbeknownst to your organization, is 10% and they were making 15% (because of internal efficiencies or collusion that prevented you from knowing the true margin). In this case, they would be happy to sacrifice 5% to triple their business.
  • What’s lost on unit is made up in volume.
    If volume allows them to not only maintain their profit level but potentially increase it, they are likely to go for it.
  • Big orders allows them to get discounts on raw materials.
    Smarter suppliers may realize that the more volume they can commit to, the better prices they are likely to get and offer discounts based on projected cost savings on raw materials.
  • Big orders allows them to operate more efficiently.
    Some suppliers might have plants that operate most efficiently at large volumes, and will take slight margin cuts to maintain peak production level (and enough cash flow to pay the workforce without expensive “payday” loans).

If you look at these reasons, it would seem that the best way to get better savings is through aggregation as this is the only way to make the buy more enticing. But is it?

Not necessarily. Let’s start with the fact that suppliers might be willing to give you price reductions if they get price reductions. You could always give them price reductions from the get go by buying raw materials your organization uses a lot of across categories at prices better than smaller suppliers could get and, as part of every bid, noting that they will have access to necessary raw materials at a reduced cost when serving your organization. They can pass this savings on to you as part of their bid.

You can also engage your best engineers and production consultants to create detailed should cost models that take into account market pricing on raw materials, labour rates, energy costs, and average production line maintenance costs, tack on a fair margin, and use this information as leverage in negotiations in conjunction with open book costing requests. You can ask not only for a price breakdown, but compare it against expected prices and see which suppliers are trying to keep the wool over your eyes, eliminate them, and work with those focussed on win-win cost reductions. (You’ll allow them to maintain a healthier than average margin if they cut your costs by using your lower cost supply, optimizing production runs, and implementing the lean process improvements you dictate.)

You can guarantee them a certain revenue in the following year if they meet performance targets. (For example, if they maintain an on-time delivery of 90%, a defect rate of under 2%, and costs are maintained, in 12 months you will guarantee their annual revenue will increase by 50%.) Now, you might think this is hard to do, but with an optimization-backed sourcing platform, you can dictate minimum award requirements in a scenario, or determine impact across a set of scenarios, and pick the categories where an additional award will most benefit your organization.

You can allow them to specify optimal order sizes based on their factory. For example, if they produce 10,000 units a day, you should order multiples of 10,000 at a time — otherwise, they might have to switch dies, etc. during the day and take down the production line while staff are still on the clock. Tying order sizes to production runs means that they only have to reset the production line once a day, before or after a shift, and the supplier can keep their overhead down.

Aggregation is not always necessary, but sometimes it does make sense. Why do three sourcing events for essentially the same product or service? Especially when you can do one, implement one or more of the above strategies, and potentially identify more value than your peers. In other words, you should aggregate when it makes sense, and be aware of the 6 Critical Success Factors for an Aggregation Approach, as summarized by the public defender, but not depend on this strategy or overuse it.