Category Archives: Guest Author

Getting the Most Out of Cost Reduction

Today’s guest post is from Patrick J. Hogan, a Partner at Paladin Associates, Inc..

A recent article in Paladin Associates’ CheckMate Newsletter entitled “Cost Reduction is NOT a No-Brainer”, generated interest and requests for more information. It made the case that cost reduction programs should be carefully thought out so mistakes and inexperience don’t cause harm. What follows are some common ways that cost reduction programs can be mismanaged, go wrong, and cause real headaches. It is NOT a complete list!

Companies with inadequate spend information really don’t know what they are spending, who is doing the spending, and what suppliers they are spending with. Without such fundamental intelligence, chances are high that resources will be misdirected or wasted, and results will be sub optimized.

Many companies simply need to focus on fundamentals. It is surprising how many companies do not consolidate purchases or buying points, do not require system or product specifications, or do not require suppliers to compete on a regular basis. Many firms simply need to get back to basics.

A common oversight is indirect spending. Companies often focus exclusively on strategic direct materials and ignore indirect spending on telecom, facilities, transportation, office supplies, and so forth. Yet big savings are often available in these areas.

A frequent obstacle to efficient cost savings is lack of buy-in by the organization. It is an unfortunate fact that not everyone in a company is cost-sensitive, or sees cost reductions as being in their interest. In fact, many employees, and even managers, are “empire builders” who are actually more interested in maintaining or growing budgets, organizations, and perceived power. They may talk a good game, but really are not committed to cost-reduction. They may even fear cost reduction. Internal politics and power struggles are very often the chief obstacle to more efficient processes and procurement.

Frequently, the cost-reduction “team” lacks the specific functional expertise to effectively cost-reduce certain functions. Finance or Procurement personnel are generally not the best people to effectively cost reduce Marketing & Sales, Human Relations, Customer Service, Telecom, IT, and many other functions requiring specific product, market, contract, technical or professional functional expertise and judgment. This requires balancing both functional skills and cost awareness. Establishing cross-functional teams with both functional and procurement expertise is one solution.

“Right-sizing” or down-sizing is an area of great risk. Downsizing can improve a company’s health dramatically, or destroy morale and precipitate a “death spiral”. Many of the issues are not intuitive. This topic needs a book in itself, and requires experienced hands to get positive results.

Frankly, overly cozy vendor relationships can get in the way of effective cost-reduction. Suppliers’ sales people work to establish personal relationships and “differentiate” their products for reasons other than price. They are often successful in minimizing competition as a result. But this usually costs the buyer money!! Some favorite sacred cows are sales commissions, legal fees, HR benefits, ad agencies, and printing companies.

On the other hand, not understanding a supplier’s full capabilities can result in overlooked opportunities for savings. A supplier might well have the resources to help reduce costs through process or product changes or simple suggestions, or other approaches not defined in a formal specification or RFP.

An ironic mistake that companies can make in tough times like these is locking into a new “low” contract price, only to find that prices actually drop below that level over time…resulting in overpayment during the contract period. Don’t mortgage the future simply to insure short-term savings.

Many companies have a do-it-ourselves mentality. They do not believe they need help, or they don’t want to pay for consulting help. But nonetheless they are just not getting the total job done. “Not-invented-here” and the “we-already-thought-of-that” syndromes are common themes in many companies. The “fear factor” also plays a role… many employees are concerned about getting credit for cost-savings ideas, or of being blamed for ideas someone else may find. In our increasingly “blaming” society, they are not always being unreasonable either. Many companies have inadvertently set up win-lose scenarios on cost reduction that block the free flow of ideas and participation, and inhibit the use of consulting experts whose savings ideas might expose waste. But all companies have waste, and wise companies want to find it and remove it ASAP. Setting up a win-win environment is key, and getting outside help is smart.

A very common problem for procurement organizations is a lack of appropriate resources. Most companies, even those with large procurement staffs, lack all the skills, the manpower, the funding, and the time to turn over all the rocks required to get the total job done. An ROI analysis would frequently justify more resources. Or, temporary use of consulting resources may be appropriate.

Another common phenomenon is excessive focus on identification of cost reduction opportunities and process development, but inadequate attention on execution and results. Many companies have long lists of opportunities, but short lists of what have actually been accomplished or resulted in tangible savings. In a related vein, savings can erode over time if companies don’t monitor results, update specifications, record engineering changes, housekeep their records, etc. Implementation, follow-through, and measurement are essential in driving for results.

Effective cost reduction is not just about common sense. Like so many other things in life, it requires experience to do it right and avoid costly pitfalls. In tough times like these, with so many “new” managers being pushed into cost-reduction exercises, finding experienced hands to guide the process is critical. Professional consulting help must be considered, particularly with a company with a results-driven focus.

Buying Spend Analysis Systems: Taking a Test Drive

Today’s guest post is from Bernard Gunther of Lexington Analytics.
He can be reached at bgunther <at> lexingtonanalytics <dot> com.

During the course of my work, I am always surprised at the large number of procurement organizations who still perform their analyses by dumping AP data into Excel or Access and developing their own reports. An analyst spends days or weeks each month maintaining this information. Even more troubling are those who have purchased an analysis tool, but still dump the transaction data into spreadsheets and spend hours or days creating their reports. The expensive analytics system they purchased is just serving as a repository for data. I suspect they didn’t take their analytic system for a serious test drive before buying. A test drive is a simple way to know exactly how the system is going to do what you need it to do.

To be useful to a procurement organization, a spend analysis system must be able to:

  1. Load the data.
  2. Transform the data. Make changes to hierarchies and create / modify rules to map the data.
  3. Index in other information to further enhance the data; for example, identifying preferred vendors, vendors with contracts.
  4. Create useful output — not just dump data – such as full reports, ready to send to users.
  5. Update the data with the next month / quarter / year of information.

And, it must be able to do all these things without requiring significant support, either from the vendor or from IT, after the initial training. Most Procurement organizations want to be as self supporting as possible.

To get the most out of your test drive, have the vendor show you, step by step, how their tools work with your data. Before the meeting, create a text file with a reasonable sized segment of data, perhaps a year, in a single table with:

  • Vendor name
  • Cost Center
  • GL Code
  • Date
  • Amount
  • Description
  • Other fields that are interesting to you, such as commodity or preferred vendor.

Select a reasonable size block of data so you understand the performance of the system under the load you expect to have. The goal is to have an interesting segment of data to work with. You want to understand how each step of the process works and delivers, not to build the full system.

After you are convinced that the vendor is capable of performing the essential tasks, you can focus on how the process will work on all your data and fully fleshing out your reports. Arrange a meeting with your vendor (in person or remotely) to have them show you how they do each step of their process with your data.

  1. Load the data into their tool. Is it easy to load new data into the system? World class procurement functions build dozens of different cubes on different segments of their spend data, so this needs to be easy.
  2. Look at the raw data. Can you see your top vendors, cost centers, GL codes?
  3. Have them group some vendors and then look at your data. Can you group vendors as you want them?
  4. Have them create a few nodes in a commodity structure and map some spending. Create some vendor rules, some GL rules and then some more complex rules. Modify a rule and see the results
  5. Have them create a report. Print it out. They modify the report and see it again. Start with a simple report and then do something more complicated (for example, with pivot tables).
  6. Perform a refresh. Add some more transactions to the data. See how all the existing vendor grouping and mapping are applied.

You should be able to do all these steps on your sample data in 2 to 4 hours. Once you’ve done this, you will understand how the system will work for you. If it takes hours to make simple changes in the demo, it will take hours in the final system. If six different people are involved in the demo, you’ll likely need this size team in production. If you can’t see your team doing the work shown in the demo, you’re going to need to rely on the vendor or some third party in the future. In the longer term, you may decide you want to leverage external labor to do the work, but to be able to be independent; you need to understand and be able to perform each part of the work yourself. If you can’t be independent, do you want to be dependent on this third party (vendor or IT group) for every single change you to make?

Spending a day or two test driving different spend analysis options is the easiest way to really know if the system the vendor is proposing will work for you.

Commodity Structures Are Not “One Size Fits All”

Today’s guest post is from Bernard Gunther of Lexington Analytics.
He can be reached at bgunther <at> lexingtonanalytics <dot> com.

Over the last 15 years, I have had hundreds of discussions about commodity structures with CPOs. Invariably, I am asked, “What is the right commodity structure to use?” Or, “Use the UNSPSC structure. It’s an international standard, so it must be the right one.” Or, “You’ve been doing this for years, why haven’t you figured this out by now?”

Once we work with clients for a while they realize that there is no “one size fits all” commodity structure. You can leverage existing structures, but every client has to make some adjustments to any structure based on:

  • What industry they are in (and therefore the products and services they buy),
  • How their business works (how they are organized internally),
  • What vendors they use,
  • How they want to manage your spending, and
  • Past experiences on what works and doesn’t work.

Take the simple cardboard box. Let’s use the example of a 1.2 square-foot, folding box with a removable lid, used largely for the storage of old files. These get used in many different ways at different companies.

The right UNSPSC code for these boxes appears to be: 44111515 “File storage boxes or organizers”. This places this item within the following hierarchy:

  • 44 00 00 00 Office Equipment and Accessories and Supplies
    • 44 11 00 00 Office and desk accessories
      • 44 11 15 00 Organizers and accessories
        • 44 11 15 15 File storage boxes or organizers

The UNSPSC code for an item is useful but, because companies use this box differently, the general classification of the item may also be different as well as its place within the hierarchy

Type of Company Use of Box Top Level Classification
Company with office records (most companies) Storage of files General Office supplies or Records Management supplies
Office supplies company Box is bought from a converting plant and sold to customers Cost of Goods Sold – purchased items
Manufacturer Store parts in the assembly line MRO
Paper company Manufactured for customers Cost of Goods Sold
Records management / warehousing company Sold or provided to customers Cost of Goods Sold – or – Production Parts used in delivery

So even for something as simple as a cardboard box, there is no single commodity structure that is “right” for all companies. You need to think about the structure in terms of what is right for your organization. The last thing you want to hear from users is, “The data jocks in Purchasing have a commodity structure, but it’s just not right.”

Procurement Fundamentals — A Path to Innovation

Today’s guest post is from Bernard Gunther of Lexington Analytics.
He can be reached at bgunther <at> lexingtonanalytics <dot> com.

Every year, I look forward to going to conferences with the hope that I will get a chance to see a great deal of innovation and learn something new. Most years, I am largely disappointed. Is there innovation? Yes. But much of what is being presented relates to operational excellence, operational success or even operational “good-enough.”

Why is this? It’s a lot harder to innovate when you are still struggling to set up standard practices. Procurement systems and processes tend to be a patchwork of different approaches for different spend areas all jumbled together. Many organizations are just catching up to best practices. Let’s take the “101” starting point for any procurement organization, the basic spend analysis of vendor payments — understanding how much you are spending with each of your vendors. Recent surveys indicate that less than half of companies have a system for this. For those companies without a system, they seem to be doing ad hoc dumps of data from their AP system into Excel or a data warehouse with no consistency in the analysis. We all know this is not a best practice in procurement. If companies are not doing the basics well, they have little time to focus on innovation.

It’s not surprising that there are so many presentations about operational successes and so few about innovation at sourcing conferences. Operational success is a key element of a strong function and can deliver significant value, but should it be considered innovation? At a recent conference, I attended a wonderful presentation on Negotiation Fundamentals. One would think that everyone in a purchasing group would be well versed in this and applying the fundamentals regularly. But if you look around procurement organizations, you find that many people are not applying the core disciplines of procurement in effective ways.

Is there support for innovation at organizations? Successful companies are continually investing in innovation and developing new products and processes. These new products rarely just happen and not every new product idea is a success. This means that a procurement group interested in innovation should be doing three things:

1. Look for innovation. Innovation usually comes from new companies but it can also come from unexpected areas. But, in order to recognize it, you’ve got to be open to it. I remember when my grandmother came to visit us one summer from Germany. Like many older people she wasn’t open to trying new things. Her attitude was, “I don’t know that food, so I don’t want to try it,” or, “We have that at home too.” Because she wasn’t open to new things, she didn’t see anything new. She wrongly concluded at the end of her stay that food in America was just like Germany. Are you saying the same thing to innovation?

2. Invest in innovation. Is it 1% of your budget? 10%? Is it 5 projects? Is it 3 new vendors allowed in? Don’t know? If you don’t know, how are you making it happen?

3. Allow for “failure”. A group that is innovating is going to have failures, or “less-than-total” successes. But that’s okay if your environment rewards some risk taking. If not, your people will only attempt things they know will succeed — which is not innovating, it’s following. You need to be able to work on projects and initiatives that aren’t perfect. Success is usually the product of many such small failures. There are far too many projects / programs / implementations that are deemed too big to fail by the owners. Projects promising innovation in a company may get viewed as another procurement initiative ready to fail — over promising and under delivering. This atmosphere is rarely one that fosters innovation.

If you are already innovating — wonderful. But I suspect that most organizations would be delighted if Purchasing were to deliver better operational performance. If your organization is not ready for true innovation, perhaps focusing on operational success is the way to build your organization’s credibility. By demonstrating your ability to add value through the fundamentals, you are setting the stage for future innovation. When you do innovate, you can present it as delivering more of what the organization already values.

Opportunity Analysis: The Challenge is Having Accurate and Usable Spend Information

Today’s guest post is from Bernard Gunther of Lexington Analytics.
He can be reached at bgunther <at> lexingtonanalytics <dot> com.

Sourcing Innovation‘s “Seven Grand Challenges for Supply & Spend Management“, lists the seventh challenge as “Opportunity Analysis”. As a practitioner, I can report that bad procurement data is the biggest obstacle to successful opportunity analysis. By “bad” I mean procurement data that exists when the items are purchased / invoiced is not captured and made available for future analysis. The ongoing data analysis is rarely designed into the procurement process making the analysis hard to do and therefore rarely done.

I find it surprising that half of the large companies I deal with don’t have a formal process for analyzing their AP data. Though they may dump transactions from their AP system into a spreadsheet or a data warehouse, the data is raw and unprocessed and not consistently analyzed or well understood. This is not proper spend analysis, it is flying blind. If the quality of procurement information is so lacking for AP data — the most basic spend data — imagine how bad it is for invoice level data where pricing accuracy can be determined

Accurate and usable procurement information requires source transaction data, ways to enhance that data, and processes to get value from the enhanced source data. The data should be collected and analyzed as part of the regular purchasing process. Data analysis should be designed into the process flows. I will illustrate some of what’s involved to answer the simple question, “Did I pay the right price for an item?”

At a high level, the source data includes:

  1. “Transaction level” information on each purchase that includes: what is purchased, the unit pricing, the amount bought, who bought it, and data to link each transaction to the order, the payment and the contract. The specific data available will vary depending on the commodity. Airline information is different than computers, which is also different than facilities management.
  2. Contract information structured so that each item on every invoice can be priced and stored in a way that links them to transactions.
  3. Payment information which identifies the vendor being paid, who bought the item, which transaction detail links to the payment.

Data Enhancement: Making the raw data meaningful.

  1. Commodity assignment. For an item level cube, the commodity assignment will be more detailed than an AP cube and may be based on the description, the part number, or other attributes of the item.
  2. Pricing context. Each item purchased should link to the contract price, historical pricing, benchmark pricing (internal and external), and other information that puts the unit price paid into context.
  3. Cross item information. Some of the pricing comparisons need to be done across multiple items rather than against a single item. An analysis of the mix of team members on a consulting engagement or a legal matter would be an example.

Data Processing: Converting the meaningful data into actions that save money.

  1. Every month or quarter, the data needs to be collected, enhanced, and analyzed. The analysis should be able to answer such as:
    • Did we pay the contract price?
    • How much of the spending was off-contract?
    • How did the demand shift?
    • How much of the spending was on items that were not intended to be purchased?
    • Which organizations are responsible?
    • How much extra spending did this cause?

    Each company should be able to answer these basic questions in hours, not days or weeks. The data should be in-house and it should not require work from the vendor beyond originally providing the data as part of the invoicing process.

  2. Periodically, the team needs to answer questions like:
    • For a recent price change, what happened to the spending? If we applied the old pricing to the new spending pattern, how much would we have spent? Is this what was expected?
    • Is the mix of items we buy “optimal”? How much could we save by optimizing our demand?
    • How has the market price changed relative to our pricing? Is there enough shift that we should re-bid our spending?
  3. Use the data to generate savings, for example:
    • Request refunds for overcharges
    • Add more items to the contractual pricing terms so we can monitor the pricing moving forward
    • Shift the demand to generate savings
    • Negotiate with the vendor for lower prices

    And, on and on for different ways to leverage the information

This all sounds relatively easy. But it’s not happening today. Let me illustrate from a client example of office supplies. I don’t mean to pick on office supplies vendors, but this is a category with part numbers and contracts so it provides a good starting point for this type of analysis.

The client bought office supplies online through a punch out mechanism from their PO system. The vendor processes the orders, ships the items, and presents invoices for payment. The invoices are approved in the PO system and the vendor is paid per the contract. The contract was written 2 years ago and allowed for fixed (discounted) prices for the top 500 items being bought. When the contract was signed, 250 items were on the list. The new contract offered price reductions on certain items, which the sourcing team projected, would save 12%. Since the contract signing, most prices have been stable, with some exceptions for paper.

As the program was implemented by the client, there were a number of problems with the data:

  • For 20% of the items purchased, the item numbers recorded in the PO system did not match the item numbers in the contract. This was largely a problem of how the PO system recorded the data
  • The client could not state what percentage of the spending was for items with contract prices and what percentage was off-contract. The client needed to ask the vendor for this analysis.
  • The client had agreed to price changes, but did not track those changes and could not calculate the impact of those price changes on overall spending. Again, they had to rely on the vendor to track the pricing and do the analysis.
  • The buyers had shifted their demand, so that of the 250 items in the contract, over 75 were not being bought anymore and of the top 250 items being bought, there was no contractual price for almost 100 of the items. The vendor was waiting for authorization to add 50 new items onto the contract list (with better discounts).

This was all fixable. Fixing it generated incremental savings of 5% and improved the relationship between the client and the supplier. But it didn’t happen until we, the consultants, highlighted the problem and the opportunity.

Generally, we find that procurement data is a mess. And it shouldn’t be. But, this is why it’s a challenge.

Thanks Bernard!