Category Archives: Cost Reduction

Price is Only ONE Component of Cost

A good reminder of this is Jim Anderson’s recent piece on The Total Cost Approach for Dealing with Unmovable Prices over on The Accidental Negotiator. As Jim notes, the purchase price of an item is not really the true price that we’re going to end up paying for it. There are lots of additional costs, fees, and services that go along with it. Ultimately it’s the total cost of what we’re going to end up paying that really counts, not just the initial purchase price. So if the seller won’t move on unit price, focus the negotiations on another cost component.

As Jim notes, if you’re buying fleet vehicles, negotiate on service costs, warranties, financing, etc. Decent (extended) warranties can easily run you over a thousand per vehicle, and if the vehicle is made well, this is all profit for the manufacturer (as the warranty will expire before something major goes wrong). Here’s an easy few hundred (or more) per vehicle with very little effort. Plus, your average vehicle will need (at least) a few thousand dollars of regular services over the first 60K miles / 100K kilometers, most of which is profit at high hourly service rates. If you’re buying in bulk, you can easily save thousands by negotiating a significantly lower hourly rate. And then financing could run you ten thousand or more per vehicle. Knocking a few percentage points off the rate can save you a small fortune.

If you look at the total cost, it’s often easy to negotiate quite a few percentage points away when you move away from the “fixed price” to the variable total cost components, some of which will be high margin (with lots of negotiating room). Especially since the seller will generally want your business and move where she has wiggle room.

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PPV is a Bad Measure of Procurement Performance

As noted in a recent brief from ChainLink Research, PPV (Purchase Price Variance) is a bad metric for Procurement, especially if your buyers’ performance is being based on it. Not only does this kind of metric encourage behaviour that may lower PPV but create a higher total cost, but it can cost your organization a bundle, and this goes for commodities that usually have low volatility as well as those that have high volatility. Here’s why.

Let’s say you were buying 10,000 barrels of crude oil in 2009 on a monthly basis. The OPEC basket price, which started the year at 40.44 on January 2 and ended the year at 77.16 on December 31, and which reached a low of 38.10 on February 18 and a high of 77.88 on December 1, varied, on average, by $7.20 a month, with a minimum variance of $2.91 in November and a maximum variance of $13.30 in May. If your buyers are being measured on PPV, and they are good at predicting annual pricing trends, chances are they are going to pay as close to $65.04 as possible, as this amount (and any amount between $64.00 and $66.08, to be precise) minimizes the average monthly PPV. (The PPV varies from 0 in July and September to $21.14 in February and averages out to $7.46.)

In this situation, your buyer would spend 7.34 Million dollars trying to minimize PPV, which would cost your organization 467,200. This is what your buyer would pay each month (buying on the day that was closest to the price point target):

Month Price Cost PPV
Jan 46.32 463200 14.82
Feb 43.90 439000 17.24
Mar 50.77 507700 10.37
Apr 52.26 522600 8.88
May 63.71 637100 2.57
Jun 66.08 660800 4.94
Jul 65.04 650400 3.90
Aug 68.04 680400 6.90
Sep 65.12 651200 3.98
Oct 66.81 668100 5.67
Nov 74.95 749500 13.81
Dec 70.64 706400 9.50
AVG 61.14 611367 8.55
SUM   7336400  

But if your buyer was focussed on cost avoidance, your buyer would only spend 6.87 Million dollars trying to minimize cost, saving your organization 467,200. If you ignored PPV, this is what your buyer would pay each month (buying on the day that allowed for the lowest purchase price):

Month Price Cost PPV
Jan 39.29 392900 21.85
Feb 38.10 381000 23.04
Mar 41.79 417900 19.35
Apr 47.15 471500 13.99
May 50.41 504100 10.73
Jun 66.08 660800 4.94
Jul 59.66 596600 1.48
Aug 68.04 680400 6.90
Sep 64.00 640000 2.86
Oct 66.81 668100 5.67
Nov 74.95 749500 13.81
Dec 70.64 706400 9.50
AVG 57.24 572433 11.18
SUM   6869200  

Still think minimization of PPV is a good idea?

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Marketing is a Huge Savings Opportunity

Sourcing Innovation’s recent Illumination on Strategic Spend Visibility noted that best-in-class companies that strategically source their marketing spend save an average of 14.7% on five marketing and spend categories compared with a mere 7.8% savings for all other enterprises (as per a recent Aberdeen Group study) and that, across the board, with good visibility, an average marketing organization can easily find 20% to 25% savings with Procurement’s help (as per a recent Ariba report).

Why? Last year’s report from the Marketing Supply Chain Institute on why you need to “Define Where to Streamline” makes it clear. A surprising 62.9% of survey respondents admitted they had never undertaken a comprehensive audit and analysis of costs and process efficiencies in their marketing supply chain. Almost two thirds of companies have never analyzed their costs! (And yet they wonder how most of their supplier reps can afford to drive Beamers, Benzs, and Jags!) Furthermore, only 10.8% are adopting workflow or collaboration systems to reduce costs, only 11.5% have a back-end marketing platform to optimize resources and process, and only 14.2% admit that their marketing is fragmented.

In other words, Marketing is a savings gold mine. Turn your strategic spend analysis system loose and the savings opportunities you discover will be numerous indeed.

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Even Good Times Call For Lean Supply Chain Strategies

A recent article over on the Harvard Business Review blogs told us that we should “stand by for the same old strategy mistakes”, because you see the same ones over and over again every time a downturn starts to trend up again. Moreover, similar fundamental strategy mistakes are often made by supply chain organizations when the economy starts to improve. As a result, there are lessons to be learned. Three easy ones are:

  • Too many supply chains.Many companies think they should have multiple supply chains — one for commodity electronics, one for custom parts, one for chemicals, etc. — as this will allow for a razor-sharp focus on streamlining operations around a category. The reality is that you should have only one supply chain (from a planning and management perspective), because every (distinct) supply chain costs money to manage and operate. Just like a business loses when it splits its focus (as 20% of operations will end up accounting for 80% of profit), a supply chain loses when it splits its operations.
  • Throttling back on cost reduction.When times improve and profits start to increase, supply chain often starts to think it can ease up on the push for ever lower prices, give suppliers a break, focus on quality, and / or focus on collaborative initiatives that will take cost out in the future. While it is important to focus on (these) other initiatives, you can never cease your cost reduction quest.
  • Pushing too hard for supplier consolidation.While it is true that most companies have too many suppliers in the supplier master, with 20% of active suppliers accounting for 80% of spend, and while it is true that a smaller supply base can enable greater spend leverage, too much consolidation too fast can greatly disrupt your supply chain.

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Don’t Fall for the FUD!

Now that money is trickling back into technology budgets, many vendors are going on the offensive again. As a result, you need to be ready for the emergence of the vendor FUD (Fear, Uncertainty, Doubt) machine that is sure to resurface. We’ve already tackled how you calculate the true TCO/TVM of each product under consideration, thereby helping you to dispel the first piece of FUD you’re sure to hear, which will be along the lines of “we’re the cheapest and have the highest ROI, while our competitor is the most expensive and your ROI will be negative if you go with them“, but once you get past this, any vendor with a decently aggressive sales force will have more FUD loaded up and ready to fire (if they feel they are at a disadvantage). Here are three common pieces of FUD that, to be blunt, don’t mean nothing.

  • Our competitor is being sued (by us).So? Many of the lawsuits in this space are nothing more than desperate attempts by the bigger vendors, who haven’t innovated in years, to literally sue their smaller competitors out of commission with baseless lawsuits that plaintiff hopes will be too costly for the defendant to defend (as the plaintiff will attempt to draw the discovery phase out for years before the case gets inevitably thrown out).
  • Our competitor can’t do Fliggle-Flaggle-Floogle.Many vendors with less competitive or innovative offerings will focus on one or two impressive sounding (but essentially worthless) features that their competitors don’t have and turn up the tech talk dial to eleven in hopes of confusing you into buying their product. Don’t fall for the tech talk. It’s not about the technology, but about the value it can deliver to your organization. And sometimes its best not to buy the technology at all, but to contract with a consultancy or BPO who can maximize its potential (especially if the value curve flattens out quickly, as it does with tactical spend analysis [reference]).
  • You have to go all-in.Many providers will insist that you have to buy the whole suite, complete with licenses for every user in the organization, or you won’t realize the full value available to you. So what? It’s not about how many pennies you can squeeze out of the technology, but about how many pennies you can push down to the bottom line. Let’s say you can buy a solution for Procurement only from a competitor for 50K and that you expect you would drive 500K in savings from the purchase. Now let’s say you can buy their solution for the whole organization for 250K and drive 1.250M in savings. Which is better? The Procurement solution. It has a 10X ROI, compared to the 5X ROI the full organizational solution offers. Furthermore, when you look carefully, you see that the extra 200K only saves you an additional 750K, which is an ROI of only 3.75X. Yes, you want to save that additional 750K, but if you keep looking, you might find another 50K point solution from another vendor that will save you 500K of that 750K, which gives you another 10X ROI (and makes the organizational solution a bad buy since you’d now be spending another 150K to save 250K, which gives you an additional ROI of only 1.67X …. which means that one stumble on the organizational solution path and you would have been better off with the (much) less expensive and (much) lower risk point solutions).

And don’t forget, if the management/ownership team hasn’t changed much, what Tweety Bird has been saying for years still holds true. Don’t get fooled. Once a bad old putty cat, always a bad old putty cat.

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