Category Archives: Cost Reduction

The Essence of Good Working Capital Management

In yesterday’s post we noted that playing games with working capital only costs the organization in the end; specifically, for every 10% of working capital an organization messes with, it loses 1% of total working capital (or 10% of the working capital messed with). Not a good deal, any way one wants to look at it.

Working Capital doesn’t have to be hard to manage. While an expert can get quite sophisticated about it, all one really has to do is:

  1. Get a good grip on receivables
    What is the organization expecting from sales and when; what reimbursements is the organization entitled to and when; what tax rebates is the organization expecting and when.
  2. Get a clear picture on fixed payables
    What is the average monthly payroll, the average monthly overhead (rent, utilities, etc), and regular non-monthly expenses that are projected over the next year.
  3. Get a good estimate of average disruption costs
    When a receivables disruption has occurred — regardless of if it was due to a late payment, lost customer, lost sales from a competitive product, or market delay due to a supply chain disruption — how much has it cost on average and how long has it persisted. This is the contingency fund that is required (and can be amortized monthly over the next twelve months).

Once this is known, the organization knows how much cash it has to work with every month. Only then can it truly begin working capital management and determine when it should pay early to take advantage of an early payment discount, borrow to pay on time to prevent costs from rising (as the supplier’s cost of capital is much higher than the organization’s), pay late and pay the penalty (as the organization’s cost of capital is higher and/or the supplier is able to bear the burden of payment late more than the organization is able to bear the burden of paying on time), or get innovative and work with the supplier to reduce costs across the supply chain. Without a solid understanding of cash flow, working capital management can’t even begin. And good working capital management definitely doesn’t involve booking revenue early, paying suppliers late, or other quarter and year end games to present a rosier picture than reality, because these games always get discovered and the organization always loses, in hard dollars, in the end.

An Informative Piece on Making Better Decisions with Cost Modelling

The ISM recently published an informative piece on how to “make better decisions with cost modelling”. Given that projected cost modelling can help supply management organizations reduce procurement costs and generate information that could improve cost performance throughout the supply chain, proper cost modelling is something every organization should have a good grip on.

The breakdown graphic is very good. The cost of any particular good is:

  1. the direct material costs plus
  2. the direct labour costs plus
  3. the indirect overhead costs plus
  4. the (amortized) SG&A costs (of the organization) plus
  5. the (amortized) R&D costs plus
  6. the profit margin

The last three costs in particular should not be overlooked. While they will typically be small in comparison to the other costs, they are there, and they cannot be driven to zero no matter what the volume requirements or the economies of scale. They will always exist, and squeezing a supplier’s profit margin to unreasonable levels seriously jeopardizes the health of the supplier. In addition, while tempting to do so, SG&A costs that are not directly applicable to the good being produced should not be included in the indirect cost. While the indirect costs can be reduced with production line efficiency, SG&A cannot.

And cost models are not hard to build, at least approximately. Direct material costs can be estimated using public indexes, direct labour costs can be estimated using government statistics bureau data, overhead costs can be estimated using government statistics bureau data and industry averages, SG&A can be estimated using public filings, R&D cost ca n be estimated as an industry average percentage, and profit margin can be estimated using a fair percentage.

Furthermore, cost models are even easier to correct. Simply state that, unless the supplier proves the model wrong, you will assume that it is right and base your negotiations off of it.

And once you have a correct cost model, you not only gain deep insight into a supplier’s costs, but into their inefficiencies. For example, you will learn where they are spending too much on raw materials, whether or not they are not competitive in labour costs, and where their processes are inefficient. Then, you can work with them to either help them negotiate better contracts with their raw material suppliers or buy on their behalf (with a larger aggregated demand that you can use to leverage a better contract) and to remove inefficiencies from their processes. This can create win-win situations and give you preferred customer status, which will be beneficial if demand outstrips supply.

Your Free* Holiday Gift from BravoSolution

Those of you who are BravoSolution customers should have already recieved Sourcing Innovation’s latest white-paper on the Top Ten Things to Do in 2013 to Control Costs in your inbox, and those of you who aren’t can download it from BravoSolution’s site (registration is required).

If you were following @sourcingdoctor on that which calls itself Twitter on Saturday (Dec 15, 2012), you would have received a sneak peak into two things that will tank your Supply Management Organization in 2013 if you’re not ready, which were culled from this paper, and those of you who weren’t can still follow @sourcingdoctor and read the post (tweeted in 140 character increments) in his tweet history. (Be sure to use Twitter or another twitter feed reader that presents tweets in reverse chronological order or you will be reading the post backwards.)

For those of you who disdain that which calls itself Twitter, this is why you want to download this paper:

  1. It cleary identifies and explains the seven fates that are going to tank your Supply Management organization in 2013.
  2. It points out the seven elements missing from your Supply Management organization that are exposing your orgnization to the seven fates.
  3. It lays out the ten competencies that you have to master in order to acquire the seven elements that will allow you to fend off the seven fates.
  4. It’s what you need – now. And it’s cool.**


* Registration required.

** Actually, it’s awesome, but making it too obvious wouldn’t be modest.

Good Advice and Bad Advice for Controlling Transportation Insurance Costs

Inbound Logistics recently ran an interesting article on controlling transportation insurance costs, which can be quite high if you are transporting high-value items (such as electronics and pharmaceuticals) or high-risk items (such as alcohol and tobacco). The tips can be grouped into three categories, average, good, and bad. In this post we will review the good and the bad, which, in the latter case, might also be just plain ugly.

The good tips were:

  • Become a Partner in Loss Prevention
    It’s amazing how much control you have over keeping your shipments safe, and the safer your shipments appear to be when the underwrite does her analysis, the better off you are. You can make sure that your trucks and facilities are always secure and monitored, you can make sure that at least two people are involved every time something is loaded or unloaded, and you can insure that any potential security breaches are dealt with quickly and efficiently.
  • Operate in Full-Disclosure Mode
    The more your insurance company knows about your operations, shipment preparations, supply chain, and logistics, the more informed underwriting and pricing decisions it can make and the more comfortable it is with giving you the benefit of the doubt when there is one, and a lower rate.
  • Limit the value of individual shipments on single conveyances
    Limit the value of individual shipments on single conveyances. This isn’t life insurance. It doesn’t help you to have more coverage then you will ever need.

The bad tips were:

  • Seek out transportation providers willing to offer higher liability limits.
    Just because they are willing to offer higher limits does not mean that they are safer. It might just mean that they are more desperate for business. You want the safest providers you can find, as that is what is the most likely to help you lower your premiums.
  • Shift Cost, Obligations, and Risk of Cargo Loss to Your Trading Partners Earlier in the Transaction
    This is equivalent to telling your CFO to improve working capital by extending days payable outstanding. You don’t reduce costs by transferring the problem to someone else. You increase them. Just like extending DPO forces your suppliers to borrow more money at higher interest rates for longer periods of time, which results in them charging you higher prices, shifting risk to your buyers prematurely just results in them demanding lower prices as they have to pay higher insurance costs and factor that into their TCO. Dumb, de-dumb, dumb, DUMB!

Vinnie Mirchandani on “The Costs of Software Renewal” (Repost)

This post was originally posted there years ago today on October 22, 2009. Given that three years is a typical mid-term renewal timeframe, I think it is important to review Vinnie’s advice as renewal season is now upon us!


Today’s guest post is from Vinnie Mirchandani of Deal Architect and New Florence. New Renaissance. Vinnie, a founding member of the Enterprise Advocates, is a tireless advocate of trends and technologies that can help buyers get more for less.

Ray Wang gives us a timely reminder that “Labor Day (US & Canadian Holiday) traditionally marks the end of summer BBQ’s, the beginning of the fall conference season, and yes, the time to begin a review of your software maintenance contacts that expire at the end of the year.”

I would say start with that — and then keep going. Take a look at all of your contracts that renew through the end of 2010.

Several good reasons to this include:

  • Establishment of a savings target on the total maintenance spend for 2010.
    Have your staff focus on every software contract, especially those that have been “auto-renewed” for years now because they were “small” and fell under attention thresholds. If you make the overall target part of a compensation plan for key IT and procurement staff, you’ll quickly find that Thar’s gold in them yellowing software contract files.
  • Multi-year maintenance deals which looked good when signed may now be overpriced.
    Current market trends are driving the cost of maintenance down, especially through third party services. Don’t assume they cannot be re-opened. (See Marc Freeman’s tips for “renegotiating with integrity” on the ISM site.)
  • If you don’t start now, you might not finish the renegotiations in time.
    Don’t overestimate the ability of your team to get organized — or underestimate the ability of the vendor team to stall — beyond the end of the year. If maintenance expires, and something goes wrong, you could be at the vendor’s mercy in renegotiations. Formally document your new process and let the vendor know next year will be different. Furthermore, be sure to allow 6 months for the renewal negotiation next year.
  • Even if you are looking to migrate, you will still need incumbent vendor support until the cut-over occurs.
    This holds true whether you are looking to migrate away from the incumbent vendor to SaaS, or to third party maintenance, or to do-it-yourself support (and readers of Deal Architect will know I am a broken record on the subject of considering all of these options). This will likely push you into 2010 planning and funding.

So, use Ray’s call for intensity over the next 3 months and build momentum for another 12 months. The payback will be huge — software maintenance continues to be one of the items on the IT menu with the most “empty calories“.

Thanks, Vinnie!