Category Archives: Cost Reduction

Hedge Your Bets

The consensus across the board seems to be that significant price volatility in the commodities and energies markets is here to stay, so you better get used to it. A recent article over on the CPO agenda on “hedging your bets”, which makes a great case for continued price swings of 25% or more, presented 10 strategies for managing the swings and rising prices that every buyer should be aware of. The following are particularly relevant:

  • Learn from Last Time
    Which was a mere three years ago when commodity prices reached unprecedented highs in 2008. Refresh yourself on the impact and mitigating solutions you came up with at the time. You’re going to need them again.
  • Hedge
    Get some expertise from the finance organization and hedge your bets with financial instruments. It might increase the overall cost of the buy a little, but what’s worse: adding 5% to the buy, or taking a 50% wash because you bet wrong? There is so much volatility now across so many categories it’s almost a statistical certainty that the organization is going to get burned. And if the loss could be significant, heeding is a small price to pay.
  • Acquire New Technology
    The supply management suite should contain tools that monitor current pricing trends and illustrate their effects on the company’s balance sheet. It should also contain some risk management or data analysis applications that can provide, in the hands of an expert user, guidance on strategies the organization can use to control and limit the effects of rising prices.
  • Substitute
    Are there other materials that could get the job done? Plastics and glass can be interchangeable in packaging, there are multiple choices for alloys in consumer electronics, and some food stuffs can be made with different recipes. (E.g. cow’s milk vs soy milk vs almond milk vs rice milk)
  • Seek Savings Elsewhere
    If there are no savings in direct, reconsider the organization’s needs for indirect and look for savings in the sacred cows. For example, instead of an hourly rate for legal, look at Alternate Fee Arrangements (AFAs) with fixed fees for well-defined, repeatable, cookie cutter tasks. (Leasing agreements, government filings, and discovery are well understood tasks that should only take a fixed allotment of time that could be negotiated on a fixed-cost basis.) And in marketing, maybe you take control of service spend and the agencies only get paid for creative. (Do you think an agency focussed on creative ad campaigns is negotiating the best rates on printing, production, and air-time?)

Even when prices are rising, there are still ways to reign in costs and reduce spending. You just have to get more creative.

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