Category Archives: Cost Reduction

Think Energy Efficiency Investments are Costly? Think Again!

A recent article in Industry Week on “Sustaining a Green Strategy”, which described Dow Chemical’s pursuits to become more energy efficient and further reduce its energy footprint another 25% by 2015, had a very telling number buried in the article. A very significant number. To some, a very shocking number.

Dow has saved 7 Billion with investments into energy efficiency. SEVEN BILLION!

Think about that while also thinking about how many deals you have to negotiate to get that kind of savings in an average Fortune 500. Considering that, on a large direct spend category, 3% is the average savings an organization will find as it negotiates the same hundred-million dollar category again and again, if the average deal size is 100 Million, that’s 2,334 negotiations to get the same savings. (Well, not exactly, as some deals will save 10%, but since other deals will only save 1% due to skyrocketing prices, it’s not far off.)

It’s true that Dow has made 2 Billion in energy efficiency investments to date, but Dow also avoided 9 Billion in energy expenditures from these investments, giving it a net savings of 7 Billion to date — with more savings accruing every day as energy prices continue to rise. And when you consider the constant demands for power from lighting, heating, cooling, and computing that a modern organization is subjected to, it doesn’t take long for an investment to pay off — and it will keep paying off year after year. So make the investment, even if you have to take out a loan to do so. The savings will pay the interest many, many times over.

Procurement and Sales Don’t Have to Trust Each Other …

… but they should focus on TCO or TVM.

Unfortunately, as per a recent Procurement and Sales Survey by Greybeard Advisors, discussed in this recent article over on Supply and Demand Chain Executive on “When Procurement and Sales Collide”, price is still the dominant factor in negotiations. This is problematic. Even though some savings can be found in a price reduction, price can only be reduced so much. A supplier cannot reduce price below cost and stay in business. And price reductions, even if they materialize, are not sustainable in the long run.

As Jim Baehr said, procurement executives need to recognize that as we move into a healthier economy, they need to start doing things differently, and they need to start thinking much more strategically. It’s not just price, it’s quality, it’s sustainability, it’s value-add, it’s inventory, it’s delivery, and a host of other factors that contribute to overall cost and limit organizational profit. So while it’s probably healthy that Procurement and Sales don’t trust each other, since this will keep both sides alert and on their toes, it’s unhealthy that they choose to just focus on price when that energy should go into understanding total cost.

Four Ideas to Make Your Procurement Department More Strategic

It’s a new year, and your Supply Management organization is again being asked to step up its game, which is getting harder and harder to do as there is only so much cost you can squeeze out of the supply chain. So what can you do? You can start by taking a fresh look at the strategic mission of your procurement department and look for ways to be the driver of change and value for your organization. As per our recent posts on Value Focussed Supply and High Definition Sourcing, the value in Next Generation Sourcing savings will come as much from Supply Management’s contribution to profit margins as it will from their contribution to cost reduction as Supply Management is in a unique position to bridge organizational silos and help the organization understand not only the drivers of cost, but the drivers of value and what value is available to be had, for little or no cost, in the supply base.

In an attempt to help your organization get started down the strategic path to Supply Management, BravoSolution has released a white-paper that provides 10 Ideas to Make Your Procurement Department More Strategic that is quite thought provoking. Containing great ideas on how to increase price, take better advantage of volume, and reduce fixed and variable costs, the white-paper is a must read for any Supply Management department struggling with how to improve value when there isn’t much cost left to take out of the equation.

For example, the white paper points out that you need to:

  • learn more about your company’s customers and what is really important to them
    as this will not only allow you to zero in on what they really need, and lower cost, but identify suppliers and products that could provide them with more value and allow them to increase price
  • learn about the markets you aren’t currently serving
    because maybe there is a profitable niche that you could easily serve with your current supply base and minor changes to product designs or pricing models
  • learn about technologies that could reduce your variable costs
    even if the technology is designed to be utilized in production and has to be utilized by your supplier because if it costs 100K and saves 1M a year, it should be a no-brainer
  • teach your organization about where it spends (too much) money
    because it really doesn’t know (and that’s why analysis has to be ubiquitous). It might not know that every department is buying its own toner off-contract at 2x the negotiated contract price. If you’re a large organization buying thousands of cartridges a year (because everyone is print-happy) that’s hundreds of thousands of dollars a year being flushed down the virtual toilet.

So check out these 10 Ideas to Make Your Procurement Department More Strategic. (They’re not vendor platform specific and will be more than worth your time.)

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

If a Deal Is Too Good To Be True, IT IS!

This is just as true in technology and services as it is in products. If you get four bids for a new technology platform and / or (integrated) services package and three are plus or minus 20% and one is 1/3 of the price, I guarantee that lowball bid is too good to be true. And if you did your homework, you’d instantly know it and disqualify it.

You buy a product or service because it’s cheaper to buy than to build or perform it in house. However, that product or service still has a cost to the vendor, in terms of manpower and resources — costs the vendor has to meet in order to deliver you a quality product or service. If the vendor doesn’t cover these costs, and make a fair profit, one of two things is going to happen — the vendor is going to go out of business trying to serve you at an unsustainable level or the vendor is going to deliver a significantly inferior product or service to stay afloat.

I’m reminding you of this because a number of companies have not only been looking for new solutions now that we’re into a slow recovery, but because a number of companies, desperate to reduce costs, have been rebidding everything under the organizational umbrella, including the supply management platform(s) and service contracts. And in doing so, many of them have been getting unbelievably low bids from a handful of vendors who are desperate to win (new) market share — and the companies are seriously considering these bids. These bids are unbelievable for a reason — they’re not real. They’re up front costs, and as soon as you sign on the dotted line, you’re going to be hit with “change fees”, “service costs”, “upgrade fees”, etc. if you want the same level of service being offered by the competition, who are all in the same ballpark at sustainable bids. Or, even worse, the vendor is just going to give you the platform or an initial spending report, and then disappear until renewal time because the cost only covers platform support, not project or customer support. Or, and this is the worst situation of all, the vendor is trying to build a new business (in a new vertical) and thinks it can use you as a marquis customer to attract new customers, who it will overcharge to make up for the loss on you. If it works, you’re in luck, but the vast majority of the time what happens is that either the vendor fails to deliver, because they didn’t understand the true success requirements or they didn’t understand how much it would cost and how long it would take to make you a success, and then shuts down the business. If you’re lucky, they just shut down the vertical and you get to keep using the platform until you can find a new vendor. If you’re, not, the whole vendor goes tits up and you’re left holding the empty bag.

The worst part is that every month, if not every week, I hear of yet another company who signs on the dotted line with one of these vendors offering “unbelievable” deals that “can’t be matched” — and, even worse, the company is one that should know better (because there are success stories that illustrate it understands many of the precepts of good supply management). Especially when it’s so easy-peasy to determine if a bid is reasonable or not.

It’s easy to determine a reasonable range for a (bundled) technology platform (and /) or service. All you have to do is build a should cost model. Let’s say you’re buying a SaaS e-Procurement platform and want regular project management support, best-practice training, and custom integration to your in-house technology platform. Then you know the vendor will have, at least, the following costs:

  • Platform Delivery & Maintenance
  • Account & Project Management Personnel
  • Development Personnel

If the SaaS license will require 1/50th of their data centre resources, then the base overhead to support you will be 1/50th of their data centre and support team costs. If you require about 20 hours a week of account and project management support and training, then you will require half of a senior resource who has expertise in your industry and categories. If the custom integration is expected to take two man years, than you will need the equivalent of two developers on the vendor’s staff dedicated to you.

Now, if the average cost to maintain a small data centre, or rent part of a data centre, that will support 50 similar-sized enterprise clients is 3M, then you can quickly estimate that it will cost the vendor 60K (+- 10K for a margin of error) just to have you on the books, before it lifts a finger. If the senior resource required to support you on your projects is a 120K to 150K resource, then it will cost the vendor 60K to 75K to dedicate this resource to you half of the time. And if the average developer with the necessary skills is going for 70K to 90K, that’s another 140K to 180K that the vendor needs to outlay to support you. Then, there’s the vendor’s cost of sale, which, depending on commissions structures and expenses, is probably in the 15% to 25% range, and the need for the vendor to make a fair profit, say 10% to 15%, to keep investors happy. If you add it all up, you get:

Cost $ Range
Platform Delivery & Maintenance 050K to 070K
Account & Project Management Personnel 060K to 075K
Development Personnel 140K to 180K
Subtotal 250K to 325K
Cost of Sale 040K to 070K
Profit 025K to 050K
Total 315K to 445K

This tells you that any bids you get in and around the 315K to 445K range are reasonable, that if you get any bids that are more than 600K, the vendor either doesn’t understand what you want or is trying to rip you off (up front), and that if you get any bids less than 250K, either the vendor is planning to not support you to the level you need to be supported, the vendor is planning to make it up later with “change fees” and “service fees” when you’re locked in to a long term contract and held captive, or the vendor is looking to make a poster child out of you and take unfair advantage of the relationship (and then leave you holding the empty bag if things go south).

Regardless of why the vendor gave you the unbelievable bid, one thing is clear. If you accept it, you will get screwed.