Category Archives: Cost Reduction

Where Should Procurement Have the Greatest Impact?

Ivalua and Procurement Leaders recently did a study on Purpose-driven Procurement: Entering an Age of Holistic Value that was partially covered over on EPS News that ran a typical, bland, headline on how Procurement’s Value Exceeds Cost Control.

Procurement can add value beyond cost control, and should add value beyond cost control, but what stands out the most in this article, and likely in the Ivalua/Procurement study, was the highlighted figures on areas in which Procurement has made the greatest impact (by % of respondents). Of the fifteen (15) areas presented in which Procurement should be making an impact, only three areas were selected by more than 30% of respondents, and the top 2 were the same old, same old responses of delivering cost savings and cost avoidance which are, in this market, the last two areas Procurement should be delivering value. First of all, times are such that there are, or soon will be no, cost savings in any category. Secondly, it’s not “cost avoidance” it’s “need avoidance“. It’s not just about saving money. In an age where your carbon footprint may soon be more important than your bank account, you don’t want to buy anything you don’t need, and you don’t want to waste anything.

In fact, today, the top ten things that Procurement should be doing are likely the bottom 10 things on the response pyramid, which were ten of the best responses such a survey could have included! Procurement is more than savings, cost avoidance, risk management, and theoretical sustainability (as most organizations won’t let Procurement spend a penny more than necessary to meet a need, even if that penny is to a much more sustainable supplier — there’s a lot more bark in the marketing then there is bite in the implementation; the doctor is aware of many surveys and has had many conversations where, if the buyer could pay 1% to 3% more than the lowest cost, sustainability would be substantially more; the reality is that, at most organizations, it doesn’t matter if the lowest cost is from the dirtiest, most unethical, supplier on the planet — the CFO wants cost reduction, the CEO wants profit, and the buyers were told to meet the targets and make the investors happy, not do the right thing. Hopefully more countries will pass carbon caps, carbon taxes, and sustainability laws because only then will Procurement get to serve the Purpose it wants to serve).

Procurement is the enabler that can transform the organization. And to demonstrate that, let’s review the bottom 10.

  • Supplier Diversity and Inclusion (16%): while you shouldn’t have arbitrary targets (as there is no one magic number that’s the right number), you should always look for diversity that you can include to widen your horizons — you never know where the next big idea, product, or saviour (when your strategic supplier becomes unavailable as the result of an unexpected event) will come from
  • Developing Team Skills and Talent (16%): while the first line to be cut from the budget is always the training budget when it should be the last line to be cut (when the world evolves faster everyday than the day before, and the job you do today will, in some ways, never be the same job in the future), Procurement can maximize the budget you have, find the right partner to improve your skills in a fair exchange (they train you for free if you use their products or services), and even train you on better processes and practices on their own
  • Digitalisation (11%): while this is not a conversation we should be having in 2023 (when Nicholas Negroponte told us all we should get used to Being Digital in 1995), most departments in most organizations are still woefully behind when it comes to technology (and the average employee has more modern apps on their personal smartphone than on their work computer), and that’s where Procurement can help as it needs to digitize to manage its sourcing, procurement, and supply chain and has already been through (part of) that process
  • Improving Cash Flow (11%): Procurement is in the best position to optimize outbound cash flow, balancing payment terms with cost reductions with risk minimization, and can even use that knowledge of cash flow optimization to help Finance select the right terms for short term investments, loans, or even factoring on the organization’s invoices to big, slow, clients
  • Contributing to Revenue Growth (11%): Procurement’s analytics skills that it uses to predict demand can also predict the products/services that are the most popular and the ones that the organization could use to grow revenue by shifting production, marketing, and sales focus to those product lines
  • Improving Product/Service Quality (7%): Procurement can do more than just find new suppliers, they can help with product innovation and service improvement; they can identify suppliers with alternate designs that use alternate, more sustainable, materials that can build a better product and consultants with more experience and expertise to offer a better service
  • Drive Innovation from the Supply Base (6%): Procurement is the perfect partner to drive innovation; it is the first, consistent, and for better or worse, the last department to interact with the supplier, and in order for it to keep the CEO and CFO happy (and get the mythical savings which, after a certain point, don’t exist), it has to develop suppliers to an extent — no reason it can’t be helping you drive innovation
  • Support Mergers and Acquisitions (5%): let’s put it this way, if there’s no synergy in Procurement, there’s no synergy in the companies, and the company being considered should NOT be a target; so at the very least, Procurement should be one of the first sniff tests; it can also determine the synergy potential, the cost avoidance and efficiency potential, the innovation potential from an improved supply base, etc. etc. etc.
  • Demonstrate ROI to the Bottom Line (4%): Procurement NEEDS to be better educating the C-Suite on how its activities hit the bottom line across the board, not just on a few categories it finds savings in
  • Asset Disposal Activities (1%): We need to move towards a circular economy, and that means buying goods that meet as many of the R’s (refuse, reduce, reuse, repair, recondition, refurbish, remanufacture, repurpose, recycle) as possible, which will always include recycling when it’s impossible to get any more value out of the asset, and Procurement, which understands the product best, will understand how best to dispose of it to ensure it is recycled and all of the raw materials reused in the most sustainable method possible

And this is where Procurement should be focussing. Let’s hope Procurement gets there sooner rather than later.

Yes Mid-Markets, 120K is More Than Enough for Source-to-Pay!

the doctor is sure that by now you have certain (mega-)suite vendors whispering in your ear that you really need their full 1 Million+ (annual subscription) S2P solution to maximize efficiency and savings (and that the doctor was crazy*0 when he told you that you should be able to get a sufficient Source-to-Pay solution for 120K a year), which, while possibly true stated that way, you don’t need to spend nearly that much to maximize your ROI.

But how do you maximize ROI without necessarily maximizing savings and/or efficiency? Simple! The same way you optimize profit by optimizing COGS vs. increasing volume. Just like every $1 of savings goes straight to the bottom line vs only $0.10 of revenue, every dollar you don’t spend on a technology solution goes straight to the bottom line vs. only squeezing out an extra 1% on savings.*1

But the best way to see this is to, gasp, do some math! Let’s take three mid-markets at 250M, 500M, and 750M. We’ll use industry averages for COGS (with 33% salaries & contractors; 2% utilities; 5% rental; and 20% amortization/depreciation) and assume 40% external spend. Depending on the industry, external costs can go to 50% or more, but not much in the Mid-Market (MM). We’ll assume an average 5% savings potential and 80% spend addressability over 3 years (as some existing contracts will be long term and not addressable in the short term, and some tail spend will just be too small / one time to ever bother with). We’ll assume that a base solution can achieve 80% of that savings potential, or 4% over three years (if there is sufficient manpower to address all the relevant categories [semi]-strategically).

 

Size 250M 500M 750M
Addressability (80% of 40%) 80M 160M 240M
Savings Potential @ 4% 3.2M 6.4M 9.6M
3 Year Cost 360K 360K 360K
ROI 8.8 17.6 26.4
Savings Potential @ 5% 4M 8M 12M
3 Year Cost 3M 3M 3M
ROI 1.4 2.7 4.0

 

Now, what type of ROI would you like to see if you are a 250M MM? A 1.4X ROI or a 8.8X ROI? the doctor knows what type of ROI he’d like to see! Also, if the mega-suite provider cuts the price in half, it only doubles the ROI to 3.2X. Barely acceptable, and you need the manpower to identify the full savings potential and everything to go perfectly to realize it. (What’s the probability that this will hold true continuously for three [3] years? Zero Percent. 0%)

Unless you have a (very) large category over 10M (where the savings potential on that category is 500K), the reality is that the 80% solution you will get by an average across-the-board solution / self-assembled platform-powered BoB suite will provide you an ROI that far outshines what the oversized, overpriced solutions will do for you as a mid-sized business. (Those suites are only needed for 1B+ enterprises where there are 50M to 100M+ categories where an extra 1% makes a huge difference.)

the doctor loves sourcing optimization, but it typically won’t find that much savings beyond what you can find with good spend analysis on RFP data in a category < 5M. (It might take a few hours of spend analysis, but you will get 80% of the savings with intelligence. If the vendor includes an affordable optimization module (2K/month; likely with model size caps), then you should use it on every category, if just to get a baseline, as you will get a good ROI from the module with continuous use, but if they want 10K/month and you are a 250M business, you likely won’t get enough of a return, especially since most of your categories aren’t that large or complex. Note that if you are a 1B+ multi-national enterprise, the story is the exact opposite. You absolutely need it and in your well managed categories, you won’t identify enough savings without it.)

For most categories, all you need to do in sourcing is 3-5 bids, side by side unit cost and total landed cost (TLC) comparisons, supplier award selection with RFP (spend) analysis, contract cutting to capture the price, configured POs in the eProcurement system to capture the contracted price, and line-item match on the invoice to the PO to make sure you’re paying what you should be. This is two-decade old tech now, but more than sufficient, when properly implemented and enforced, to capture 80% of the “savings” (or cost avoidance) in a category. Procurement savings come more from the proper implementation of a process than from technology that enables that process. What technology does is make it easy to do the process efficiently and effectively because it can guide you through the process, prevent you from missing steps or making mistakes, provide you the insight you need to make the best decisions, and even train you on best practices you aren’t familiar with. And allow you to repeat the process many more times on many more categories in a much shorter timeframe than if you were trying to do it all by hand.

Plus, the technology will allow you to do more with less, so you can minimize the need to expand the Procurement team as the company grows. Remember, good people cost $$$. In fact, a fully burdened high-end resource will cost as much as you pay for the tech, if you are paying the right price. This means that the tech will not only provide you an ROI on measurable cost reductions, but a measurable cost avoidance as you grow as you will not need to add as many people to a Procurement department that will become more efficient over time (as more and more tactical tasks get automated, freeing up the team to focus on value-add tasks). (Remember, tech never replaces the people you need, it just makes them many times more efficient so that you only need one or two high performing individuals for a function vs ten for one that is poorly managed; allowing you to add those ten resources elsewhere to produce more product or grow the business further. However, remember that Procurement does more than one function, so you may still need those 10 people for contract management, supplier development, additional strategic sourcing events, etc. but you won’t need them processing paperwork.)

So don’t overpay for S2P tech. You absolutely need S2P tech, but overpriced tech won’t get you the ROI!

*0 they may be right, I may be crazy … but it just may be a lunatic you’re looking for …

*1 An extra savings of 10% on a maximum savings of 10% leads to a maximum additional savings of 1% overall on a single category. In inflationary times, which we are now back to, you’ll never find more than 10% slack in the TCO of any category. In fact, you’ll do good to find 5%, which means going from average capability to advanced capability will only shave an extra 0.5% off of the total category spend on average.

Don’t think that these inflationary times are going away anytime soon. Supply chains are at their shakiest thanks to both the pandemic and the repercussions thereof, the rapid increase in climate change which has led to a rapid increase in natural disasters, the increased geopolitical destabilization around the globe, and the rebelling workforce, many of whom have gone from living barely above the actual poverty line (relative to where they live) to below it. Now add that to the flat and recessionary economic conditions in most major GDP players, and we won’t be seeing good times ahead for quite a while.

How Do You Find Hidden Costs?

We all know that there is never a fixed arithmetic formula between the cost of producing, and transporting, the goods and services sold to us and the prices charged for them … sellers charge what they can get, and if we don’t do a good job of figuring out the true cost, which can be hard to do, chances are they are building in a hefty margin.

But the margin is only one hidden cost. There’s other hidden costs baked into the COGS by the supplier, some of which even they may not be aware of. But if you want to bring costs down, you have to find them. So where do you look?

Start by investigating each of the main production costs:

  • raw materials — what are your T1 suppliers paying to the T2 suppliers
  • energy — production always requires energy … but there isn’t always one rate
  • labour — if there is temp labour / contract labour involved, is it market rate
  • overhead costs — facilities, financing, etc. — these could be fixed, or they could not … for example, if the supplier has to borrow to fund operations until they get paid, what interest rate are they paying … and how does it compare to your rate? might be cheaper for you to pay them early in exchange for a discount that exceeds your cost of capital

That’s how you them. So what do you do next?

Come up with a plan to address any costs that look high:

  • if material costs are too high, can you buy on behalf of suppliers at a better rate? can you find alternative materials?
  • if the market is deregulated, can you help the supplier identify a better option? are energy requirements so large a supplier would do better off with its own plant? should you invest in it if there are multiple suppliers in the region paying absurdly high energy costs?
  • should you share labour negotiation and management best practices to help your supplier keep labour costs down
  • if suppliers have a high cost of capital, help them out … reduce their cost, reduce yours; maybe you can identify facility upgrades that would save them money

It’s not as easy as it sounds, but it’s not that hard either. Just takes data gathering and analysis.

Right Now, Savings Are Everywhere …

… because you don’t have your costs under control. While there is no such thing as true savings, because finding savings just means that you weren’t spending optimally to begin with, the reality is that you are not spending optimally. Not even in your most strategic categories where you are putting the most of your effort. This is because you are not applying both leading strategic sourcing decision optimization and leading spend analysis to this category across multiple levels on a global category scale. (Even if you own both technologies, chances are you don’t own best of breed in both, and even if you are that one in a thousand company, the doctor has seen the most complex optimization models that are being built by the average company, and they are still elementary compared to what models could, and should, be built.)

So, even if you are given an unrealistic savings target, if it’s 10% or less, it is easy to meet because, until you have applied these two advanced sourcing technologies to every single category, and done so in a three-year time span (as costs always creep back in to a category over time, and that’s why GPOs and niche consultancies find you savings on the same category again and again if sourced three to five years apart), there is overspending everywhere. So, if you can just get your CFO to write the cheque, acquire these technologies, and apply them appropriately, you’re going to find significant savings on the 60% to 80% of your non-tail spend, which hides even higher levels of savings (as we have discussed here on SI in the past).

And then, since the secret to cost control is to source everything, make sure you are buying everything that costs 5 figures or more through an RFX or Auction, and, in many cases, preferably one that is automatically configured and run for you by the platform with little buyer involvement beyond keeping the approved supplier database up to date and verifying the award before the contract or PO is sent to the winning supplier. And if you actually manage to find the majority of savings across your leading spend and tail spend, limiting potential year-over-year cost reductions to 3% in the following year, you’ve still only scratched the surface.

Just because your organization has optimized it’s spend, that doesn’t mean that your strategic / high volume supply base has optimized their spend. This is where supplier development and supplier (relationship) management comes into play. If you help your top x suppliers, where this X constitutes 80% of your strategic spend, and over 50% of your spend, save 10% by optimizing their procurement, you lower your costs on this half of your spend by 10%, and there’s another 5% without doing anything but process improvement. But we always know that savings don’t stop at process improvement, they continue with product improvements that enhance quality, reduce manufacturing costs, and reduce reliance on rare earth metals or non-renewable materials — all of which can be identified with the right innovation.

So, in CFO speak, savings are everywhere, and you should have no problem finding significant savings as long as you acquire, and apply, the right tools for the job. This means if you don’t have appropriate advanced sourcing technologies, you have to go get them. They are worth it.

True Savings Can Only Be Identified through Multi-Factor Optimization

A recent guest post from a vendor-employed guest contributor over on Spend Matters said to “Calculate Your True Savings Using Predictive Analytics”. While the doctor agrees predictive analytics can often give you a good data point as to projected savings, the reality is that it’s not always as accurate as you would like to believe and typically does not capture your best savings opportunities.

Why? Before we discuss the guest post, which did have some good points, we have to note that most predictive analytics algorithms work on trending and statistics on historical or market data, and while this can be highly accurate (95%+) the majority of the time (95%+), because market data is only historical and typically does not include data points on new (not yet introduced or announced innovations), detailed cost breakdowns on consumer / market prices, or operational insights into hidden inefficiencies whose correction can do more than shaving a few points off the top.

Going back to the post, the author states that if you use a Savings Regression Analysis (SRA) model based on multivariate regression of past-realized savings for a given subcategory to compute the savings potential under current market conditions, the target computed will be realistic, achievable, and likely mirror what you will do (despite the savings targets you set).

And this statistically based model will work if it is the same buyer (group) employing the same strategy on the same market base under similar conditions, but what could happen if a new buyer comes in that totally redefines the demand and the market strategy, or the market conditions have suddenly changed from supply shortage to supply surplus, or new production technologies could revolutionize production and trim overhead 20%? In this situation, this type of model will be significantly off.

Now, anything you can do to better predict savings is a positive, because, as the author points out, this allows for

  • better cash flow management (as you will better know your costs)
  • time to market optimization (as you will know the best time to source if you have leeway)
  • goal setting (as you won’t be trying to achieve the impossible)
  • performance management (as you can track against a realistic goal)

But while predictive analytics give a good data point, the best data point is when you use your market intelligence to build good should cost models, use optimization to minimize transportation and incidental storage and sales (and even taxation) costs (when sourcing globally), and use six sigma analysis to see if there is any opportunity to take cost out of a supplier’s overhead production cost. Going into this level of detail may indicate that while the product cost is likely to increase 1% this year (and explains why the predictive software says only 2% savings should be expected after heavy negotiations), an extensive analysis could show that a transportation network redesign could shave 3% and lean process improvements at your supplier could shave 2%, meaning that a cost reduction of up to 7% could be achieved with the right footwork (which is something the predictive model will never tell you). So use the predictive algorithms to establish a baseline, but never, ever stop there.