Category Archives: Cost Reduction

You Don’t Need to Fish to Identify Savings Opportunities in Indirect Procurement

A recent article in the SIG Newsletter on “How to Identify Savings Opportunities in Indirect Procurement” gave a fisherman’s perspective on how to identify savings. It wasn’t bad, and went something like this:

  • The “big catch” comes from understanding the entomology
    Just as an angler must understand the feeding opportunities created by a trout’s main source of food – bugs – a Procurement Professional must understand the current business climate and the opportunities provided that, when intersected with the right plan at the right time, will create success.
  • Match the Hatch
    Trout opportunistically feed at the time of the hatch (when fly larva emerge and float to the water’s surface to dry their wings). A skilled angler will know when a bug hatch is occurring and match the fly to the hatching bugs to increase the catch. Similarly, a skilled procurement professional will identify which business trends are hatching and what elements need to be considered to create a category “catching” opportunity. She will start by prioritizing categories by ROI, developing a change management strategy, and focussing on internal and external adoption requirements.
  • Fish With a Guide
    There’s a big difference between traditional spincasting rods and fly rods and moving from one to another can be intimidating even for an experienced angler. The best way to move from one to the other is through a guide — an expert who already made the transition, learned from past mistakes, and who can help you overcome your fears and take you forward. In Procurement, a good guide will help your company create a strong indirect program through:

    • Analysis (Opportunity Evaluation)
    • Strategy (Best Practices)
    • Implementation (Adoption)
    • Management (Sustainability)
  • Approaching Indirect Procurement Services is Just About “Getting it Done”
    Intimidation and uncertainty can create a paralytic environment. Be empowered. If fish are analogous to categories, then plan where you want to fish and what kind of fish you want to catch. Determine where the fish are and if you can access them. Then, set out with clear goals and enlist the help of a good guide. The results can be that “big catch” or a series of smaller fish that add up to a great day or quarter.

And it overviewed some of the more common reasons why companies are not taking a more aggressive approach to indirect services expenditures, which include:

  • Fragmented buyer base
  • Difficult to transactionally manage (no comprehensive systems — too many point/niche solutions)
  • No detailed, real time visibility
  • Big change management issues
  • Not properly staffed to ensure adoption & sustainability post sourcing
  • Focused on direct materials & services
  • No internal expertise
  • No executive sponsorship

And it even indicated the most common indirect categories organizations were going after.

So it wasn’t bad. But it wasn’t that good either. It didn’t dive into how to detect a business climate that was prime for “a big catch”, how to detect “hatching” trends early in the game to be ready for an opportunity that is about to become prime, how to identify the right “guide” for your business, or the best way to “Get it Done”. As we indicated in a recent post, this will require stakeholder involvement across the board — and this is where the fly fishing analogy breaks down. You fly fish alone. You need to source indirect categories in a team. Furthermore, the right “guide” might be category dependent (as IT [targeted by 76% of businesses surveyed] and Travel [targeted by 84% of business surveyed] require very different knowledge bases and skill sets), trends are often very dependent on a sector, and a “big catch” will vary depending on business spend patterns, industry, and the overall economic climate (and the supply / demand [im]balance). And while these answers may be organization specific, they need to be answered to insure success.

Cost Control – Hwong Style

Those who know Henry, who, before taking on a VP role at Rearden Commerce, held senior roles at Ariba, Provade, Elance, PeopleSoft, and Moai, know that he’s on the ball when it comes to Sourcing and Procurement. Thus, I was very interested to see what his prescription for Cost Control was as he was relatively quiet during his time at Ariba where he took on a more internally focussed role.

But, as per this recent article over on CPO Agenda on “How to Control Costs”, he’s back in the spotlight and eager to share his wisdom with the world.

According to Henry, the secret to cost reduction is not to put more spend under procurement’s control (which is hailed as the holy grail by at least one analyst firm), not to enable enterprise-wide visibility (which is hailed as the holy grail by providers of spend visibility software), and not to put an end to off-contract purchasing (which is hailed as the holy grail by consulting firms a-plenty). While each can reduce costs, the real sercet is to moving towards a more holistic approach to managing the entire lifecycle of a purchase. This is because a platform model that supports the entire procure-to-pay process (and as many categories as possible), gives procurement chiefs the one common driver behind all of the strategies reflected in the survey responses: control.

What a CPO really needs to reduce costs is control over those costs, and, more specifically, control over the processes that drive those costs. Some categories should be purchased centrally, others should be decentralized. Some should be purchased on multi-year contracts. Others should be purchased on a spot-buy every day, week, quarter, or month. Some categories should only be bought on contract. Some should never be bought on contract. The CPO needs the control to ensure that the right policy is followed for every buy. That is the ultimate key to cost control.

In addition, if you really want to control cost, instead of consolidating the supply base, which is the first instinct in 3 out of 5 procurement professionals, you instead expand the supply base. As Henry says, while consolidation presents you with fewer throats to choke, it also increases your exposure to disruption if one of those suppliers fails or has a quality / delivery issue. Plus, when you give users fewer choices, the immediate impact will be an increase in off-contract buying. Thus, if you want to make an impact, you expand the supply base since working with more suppliers can actually increase compliance and interestingly enough reduce costs, as the procurement team has more leverage to work with when negotiating terms.

Finally, if you’re really serious about cost control, you tackle the biggest obstacle of them all — the cultural obstacle. Procurement teams are often not involved in strategic planning decisions and are brought in after major decisions are made and after much of the costs have been locked in. Even having the information that procurement can provide about supplier choices and costs … could play an important role in keeping costs low in the long-run.

It’s a great article that provides great insight into the real drivers of cost — cultural, control, and consternation (about having too many throats to choke). It also provides some great advice on strategies an organization can use to combat wild price changes in dynamic commodities and some insights on where Henry thinks the challenges in Procurement lie. Check it out.

Listen to BrainNet – Invest your Avoidance Savings to Keep Costs Down

In the recent CPO Executive debate on public sector spend and savings measurement, transcribed in “Cuts from the Centre” and previously referenced in our post on how your Organizational Data is Organizational Data — NOT Department Data, Fredrik Henzler, Partner and MD, of BrainNet, made a great point — while there is no incentive for a provider to offer the same product or service at a 10% discount if they can continue to get what you are paying now, if you offer to split the savings and let the provider invest a portion of the savings in long-term operational and infrastructure improvements, then there is incentive. If the provider can reduce the cost of their product or service, then they have money to invest in new technologies to further improve efficiency and reduce cost, which will keep the provider competitive as time goes on.

Furthermore, if you don’t get greedy and allow your provider to keep a larger margin if, and only if, they invest in operational improvements, then you know that costs will continue to drop over time and you have likely bought yourself years of cost “savings” and will be able to acquire new products and services at a lower price point than your competitors. Not only is it a win-win, but it incentivizes your providers to reach new heights of efficiency and effectiveness. So invest your savings, and just like money deposited in a high-yield savings account, watch your savings grow over time.

Remember the Dangers of Centralized Buying

In an effort to combat the inflation across the board, I’m hearing a number of consulting firms emphasize the need to leverage your spend across the board, which is good advice. However, I’m worried about how some firms might be interpreting this advice. I’m getting signs that some firms, not yet as advanced in Supply Management as they need to be, are interpreting this as a need to “centralize”. While this has been the common historical response when a firm needs to obtain spend leverage and Supply Management for the categories in question are decentralized, it’s usually the wrong one. What needs to happen is the firm needs to move from decentralized buying straight to center-led buying and skip the centralization step and the growing pains that will result.

When you centralize, you lose:

  • local opportunities
    while a national temp labor agency can offer you better rates across the board, sometimes a local agency that is 10% more is actually 40% cheaper because you don’t have any travel expenses for local resources
  • local knowledge
    and sometimes a local buyer has a better understanding of the ups and down of commodity or service pricing in a region than a buyer on the other side of the globe and knows that she can spot buy a better price 80% of the time
  • (some) control over supplier performance
    as a centralized buy will typically be with one or two international suppliers who will not only have a lot more weight and leverage, but distributed production; in comparison, if buys are more local, they are typically with smaller suppliers where the buyer has the dominant position in the relationship and more control over quality and the production schedule

In addition, when you centralize, you can pave the way for organizational conflict as a result of:

  • the divergence of subunit goals
  • conflicts of preference between the central units and remote units
  • the lack of subunit inclusion
  • higher costs of certain purchases on the corporate contract as compared with local costs from a local supplier

However, a center-led purchasing organization will work with each subunit to insure that the best buy is made every time. Sometimes that will be through amalgamation of volume to obtain leverage through a larger contract with an international supplier (where costs are high) and sometimes it will be through the provision of best practices to each unit, which will secure the best rates in their region. You only get leverage where it exists to be found.

Time to Shorten those Payment Cycles

If you want a sustained recovery, it’s time to start shortening those payment cycles. During the recession, the average payment cycle time in many companies shot up due to “cash flow issues”, and it’s already coming back to bite them in the rear end. As SI has said before, this is not the solution to cash flow and any “cost savings” that the business appears to benefit from (by having more cash in the bank that can potentially earn interest on short 60 or 90 day notes) is more than eaten up by the higher costs the suppliers have to charge to make up for the high interest rates they have to pay to obtain working capital.

It’s important to remember that late payments put extraordinary pressure on suppliers, especially small and medium sized suppliers, which often desperately need cash to purchase equipment, raw materials, and, most importantly, meet their payroll. Furthermore, in addition to cash flow problems caused by late payments, many firms incur significantly extra costs for the time and money spent chasing payments and securing interim financing, usually at exorbitantly high rates – which can often exceed 20% compared to your rate of borrowing, which can be as low as 5%.

All these costs do nothing but drive up the supplier’s cost of operation, and effectively, the price they will need to charge to maintain enough profitability to survive. That’s why many prices for components are rising faster than the raw commodity costs. The lack of prompt payments has cut many suppliers to the bone. Extending payment terms doesn’t help with cash flow or “cost savings”. Extending payment terms only drives up the price in the long term while increasing the risk of a major supply disruption as a supplier could go out of business if all its customers take too long to pay.

So instead of extending Days Payable Outstanding, consider looking at other strategies that can lower your cost of operations – such as improving forecast accuracy, balanced just in time (JIT) production, and low cost financing options that are available to you, as a large company, and not your supplier. Better forecasts lead to less missed opportunities and a reduced need to clear inventory at significant markdowns, balanced just in time (JIT) production reduces inventory costs, which is much better than just shifting them to a third party, and financing your purchase at prime or less will cost everyone less in the long run that forcing a supplier to take out short term financing at 20% to 40% per annum.