Category Archives: Cost Reduction

There’s More to Cost than Cost Analysis

While it was exceptionally well written, I was a little disappointed with this article on “uncovering hidden costs” over on SupplyManagement.com.

The article, which made the acute observation that there is no fixed arithmetic formula between the cost of producing the goods and services sold to us and the price charged for them: sellers charge what the market will bear and that to break down a suppliers’ figures, we need to know the proportion of each area of cost that the goods or services are likely to attract, did a great job of describing the different types of analysis one could bring to bear on costs, but a poor job of actually indicating how to reduce the “hidden” costs once found. The advice boiled down to “collaboration is key” which, while correct, doesn’t help you answer the important questions that will arise during the collaboration.

While questions like:

  • Can we give our suppliers access to our contracts to reduce cost?
  • Does our supplier have contracts we could access to cut cost?

are theoretically easy to answer (but not always easy to answer in practice due to the poor state of contract management in many organizations)

questions like:

  • What is the thing made of and what is happening in the market for that material?
  • Where are the cost drivers in these goods or services?
  • How can you buy that material most effectively?

are a little harder to answer.

You need to understand how to perform market intelligence, you need to understand how the goods are assembled (using virtual modelling environments like those offered by Apriori) or the services delivered, and you need to understand what innovative new technologies or processes could be applied to reduce those costs. And that’s more than you’re going to get from a purchase-price, open-book, or total absorption cost analysis. You have to start with a true Total Cost of Ownership and then dive in on each cost.

Share This on Linked In

Use Your Data Analysis System to Analyze Your Green Data and Save Money

As I noted in my recent post on Why You Need Visibility, if you put an energy meter inside a home and show people total usage in real time, a miraculous thing will happen: they will use about 10% less energy. And, more importantly, you can use this behaviour to drive savings, revenue, and innovation in your business. How? Consider these five uses courtesy of Andrew Winston and the Harvard Business Review which give you a green advantage (Five Ways To Use Green Data).

  • Usage Reductions
    If you provide operations with information on resource use, they will be inspired to find ways to cut back.
  • Internal Competition
    Share footprint data across departments, organize a competition, and see the troops rally! Some factory heads would rather miss financial targets than green goals because its just too embarrassing to be at the bottom of the list. (And since every dollar saved goes straight to the bottom line, you might just find yourself more profitable in the current stagflation.)
  • Customer Inquiry Satisfaction
    A great green story can sway customers to your product, and if you are a CPG manufacturer, get you more prime shelf space at Walmart.
  • Initiative Prioritization
    A focus on the value-chain impacts of your operations can help you to quickly zone in on those initiatives that will deliver the biggest results.
  • New Market Opportunities
    When P&G did a study on detergent, they discovered the vast majority of energy use was a result of consumers needing to heat the water to use the detergent. Thus, they invented Tide ColdWater, which generated 2B in revenue in its first year. You could find similar opportunities.

Share This on Linked In

Key Success Factors for Commodity Risk Management

Accenture’s recent white paper on “taking control in the new era or price volatility” listed the following as the four most important success factors for managing commodity risk. At a high level, they’re spot on.

    • Procurement & Finance Alignment
      A risk policy needs to underlie all activities in both departments to insure the risk appetite of the buyer matches the risk appetite of the corporation. The mitigation strategies have to be implemented appropriately. These means that some risks cannot be ignored while others have to be carried.
    • Expertise in Managing Commodity Supply & Price Developments
      When do you buy, how long do you contract for, and how much inventory do you carry?
    • Visibility into Demand Throughout the Supply Chain
      This is the only way to truly measure the impact of raw material fluctuations on the business.
    • Effective Performance Measures

Specifically, measures which link the actual purchase price of a commodity to its market price which allow true savings to be calculated as a percentage savings against expected price and the impact of raw material price fluctuations to be assessed.

Unfortunately, the paper was sparse on implementation details, but here are some tips to get you started:

  • Aligning Procurement & Finance
    The key here is for procurement to lean the language of finance. You can start with Bob’s books on Straight to the Bottom Line and Beat the Odds and Dick’s book on Global Supply Management and Global Supply Chaining.
  • Managing Commodity Supply & Price Developments
    The key here is to stay on top of trends and understand what they mean. Your supply management blogs like Sourcing Innovation, Supply Excellence, and @ Risk will help you out here on a regular basis.
  • Demand Visibility
    Technology will really help out here. Get a good supply chain visibility platform with good forecasting capabilities and you’ll get a handle on how much you need and how long you should be buying for.
  • Performance Measurement
    As the white paper noted, year-over-year savings is not a good measurement. What if raw material prices dropped 20% and you only saved 10% — then you left 10% on the table. That’s not good at all. Similarly, if raw material prices went up 20% above the board and you kept cost increases to 10%, that’s a big, big win. Year-over-Year doesn’t capture that. You should be measuring year-over-year savings as the % change in cost over indexed raw material prices. The calculation is a bit more involved than a simple year-over-year differential, but a much more accurate view into how your supply management organization is truly performing. An example calculation is below given the following raw material costs:

    Raw Material Index Price per Unit Units per Commodity Cost per Commodity
    X $10.01 0.47 $4.70
    Y $7.57 0.34 $2.57
    Z $6.66 1.21 $8.06
    TOTAL $15.33

    If you paid $19.64 per unit, then you paid 128% of indexed raw material cost per unit. If, when you did the calculation last year, you paid 135% of raw material cost, then your year-over-year savings is 7% over indexed raw material cost, which is a 25% improvement (7/28).

Share This on Linked In

The Role of Optimization in Strategic Sourcing – Optimization Results, Spend Applicability and Business Cases

This series discusses the recent report from CAPS Research on “the role of optimization in strategic sourcing”. The primary goal is to highlight, clarify, and, in some cases, correct parts of the report that are important, confusing, or incorrect to insure that you have the best introduction to strategic sourcing decision optimization that one can have.

This chapter overviewed some of the results obtained by numerous companies as a result of optimization and provided a number of cases studies, including a few that included non-cost elements. A few of the examples are worthy of note. They include:

  • the company who used optimization for cost avoidance in an inflationary market and achieved an ROI of 28%
  • the company that saved 120 Million on a 3 Billion spend, a savings of 4%
  • the company that saved 600 Million

The latter two cases are significant as they demonstrate that returns of up to 100 ROI (in extreme case) are possible since a number of providers now offer unlimited usage licenses for (well) under 1 Million a year. Now, professional services could run up the costs by a factor of 10, but it should still be clear that the ROI claims of 20X to 40X that some providers have stated they have achieved (on certain events for certain clients) are possible.

The cases that were described in detail are very illuminating and the following are worth noting:

  • A National Freight Sourcing Event
    A company decided to rebid 2,200 freight lanes, in an event which was opened up to 65 bidders. The company, which expected a 3% to 6% price increase if they stayed with incumbent suppliers, realized a 5% price decrease, a cost avoidance of 8% to 11%.
  • A Film Packaging Event
    The company required over 2,000 different film packaging items across 70 “families” in an event that was opened up to 45 suppliers. The company was able to involve more suppliers while breaking the price down into 25 cost coefficients per material family, demonstrating the power optimization can bring.
  • Product Containers
    Containers for product across 100 locations were needed. A savings of 8 Million was realized.
  • Ocean Freight
    The company utilized 600 ocean shipping lanes and 3 container sizes per lane. Before the event began, the suppliers projected 10% to 15% cost increases. In the end, price increases were only 1%, a 9% to 14% cost avoidance.

Next Part VII: Optimization and Reverse Auctions

Share This on Linked In

The Right Way to Cost Cut

I enjoyed this recent McKinsey Article that noted that companies should start any cost-cutting initiative by thinking through whether they could restructure the business to take advantage of current and projected marketplace trends (for instance, by exiting relatively low-profit or low-growth businesses) or to mitigate threats, such as consolidating competitors. This is much better than the usual practice of cutting equally about everywhere because quick head count reductions often come at a price: missing the opportunities that crises can create to improve business systems or to strengthen parts of an organization selectively.

Also, in some cases, efforts to complete merger integration or to use the new economic situation as a spur to renegotiate supplier or other long-term contracts can yield substantial economies. In the authors’ experience, savings of up to 20 to 35 percent in selling, general, and administrative costs are possible with such measures if companies select the right tactics to support their strategies. The reality is that intelligent cost cutting need not reduce the overall scale of the savings that organizations can achieve. By shifting the focus from organizational structure to current and future strategic needs, it makes for smarter savings, even at companies that have already started down another path.

So don’t be another dumb company. If you have to cut, cut smart.