Category Archives: Cost Reduction

The Nature of Energy as a Purchased Item

Robert Rudzki, a regular contributor to Sourcing Innovation, recently edited a great two-part series on the nature of energy as a purchased item (Part I and Part II) by Ted Eichenlaub over on the Supply Chain Management Review that should be added to your reading list if energy is a reasonably significant cost of your operations, as the price of energy is only going to increase in years to come.

In these pieces, Ted, who is a senior advisor in the energy practice at Greybeard Advisors, elaborates on the increasing complexity of energy buys in today’s Procurement environment as the commodity cost of energy is only one part of the total cost of energy to the end-user.

Some important points to keep in mind are:

  • Price and Volume
    Energy is expensive and its price is volatile. In order to take advantage of price volatility, the buyer must know what price will achieve the desired cost ledger performance, the volume requirements, and and the nature of the volume.
  • Hedging
    Hedging can be used to reduce price volatility, but it can also increase price volatility if the hedges are not made by an expert.
  • Credit Worthiness
    A supplier may be unwilling to grant a major long-term contract with price that is very likely to below the price it could command in a month or two if it thinks there is a good chance that the buyer might not be around to utilize the full volume of energy that the buyer is committing to.
  • Standardized Contracts
    Most suppliers use standardized contracts and there is little room for negotiation beyond price and volume.
  • Worldwide Sources
    The energy might be produced locally, across state lines, or internationally (in Canada). Depending on where it is produced, and where it is purchased, there may be documentary requirements, energy credits, or other concerns that need to be taken into account.

In addition, there are concerns regarding transportation and delivery, regulation, and responsibility that also need to be understood. For more information, check out the two part series on the nature of energy as a purchased item (Part I and Part II).

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U.S. Small Package Courier Costs Skyrocketing on January 3, 2011

Small businesses and businesses that rely heavily on couriers (for document bundles and demo equipment transport) be warned! On January 3, 2011, both FedEx and UPS are decreasing the divisional factors used to calculate dimensional weight for Ground and Air packages that are 3 cubic feet (5,184 cubic inches) or larger. The factors will decrease from 194 to 166 for shipments within the US and from 166 to 139 for international ground shipments to Canada.

You’re probably thinking what’s the big deal? That’s only a 1.17% change for in-country packages and a 1.19% change for packages to Canada? Right? Well, yes and no. Mathematically, the change is small, but you have to remember that couriers charge based on dimensionalized weight and the price increases approximately linearly with weight. Thus, as per this article on new dimension and weight shipping factors in MultiChannel Merchant (that deserves a hat-tip for being among the first to pick this up) if you have a large parcel with an actual weight of 6 lbs (with a list rate of $29.50) that used to dimensionalize to 14 lbs (with a list rate of $55.90), it would now dimensionalize to 16 lbs (with a list rate of $65.40), which increases your cost by 17%.

In other words, unless you can “grandfather” in the current dimensionalization factor into your renewal agreements, your shipping costs could easily go up by 15% to 20% across the board as a result of that 1.17% change in the dimensionalization factor.

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How Much Can You Really Save If You Switch Suppliers?

I was a little flabbergasted by this recent article over on SupplyManagement.com on how “switching suppliers will save billions” in the UK. While there are often savings to be had if you are willing to switch suppliers, the reality is that the savings, once the total cost is calculated and the total value derived, is never as much as you expect, especially if the product you are buying isn’t a true commodity. And even if it is, there are other considerations. Consider the following categories:

  • Office supplies
    Okay, you can always get a better quote. But remember that delivery charges often aren’t fixed (and will usually increase beyond the average rate of increase by the local delivery company) and the better the deal you get on negotiated SKUs, the more they’ll overcharge you on anything off contract (and, if you’re not watching, charge you even more than what you would pay in the office supply store down the street). The “loss leader” is always designed with your loss in mind.
  • Communications
    Okay, you can always get a cheaper (mobile) plan. But the cheaper the plan, the more you pay on overages, roaming, and long distance (LD). Have an executive with an unpredictable travel schedule? Watch your roaming and LD costs skyrocket! Have an organization where 20% of users don’t fit the basic plan profiles? Watch your overage costs skyrocket! For every penny you save, you’ll lose it somewhere else.
  • Janitorial Services
    You’ll always find someone cheaper. But they won’t necessarily do as thorough a job, and if you’re not careful, they might skip the background check and you might come in some day to replace the backup drive only to realize that the backup drive is gone!
  • Contingent Labour Management (CLM)
    You’ll always get a better quote, but the less a CLM firm gets to fill a position, the less incentive they have to spend the time to find the best person for the job, especially if your competitor is paying them more to fill that same position. And, in the long run, the few hundred you save costs you a few thousand (or tens of thousand) in productivity losses.
  • Custom Manufacturing Services
    You’ll always get a better quote, but what will you sacrifice in quality? And what if they put lead in the paint, melamine in the milk, or bisphenol A in the plastic? Then what?!?
  • Advertising Services
    I’ve no doubt that you can cut any quote in half, but advertising isn’t about cost, it’s about the revenue it helps you generate. Is it really worth hiring a B player at half the cost when the A player is five times as likely to come up with a campaign that helps the organization double sales?

So while you should definitely be willing to change suppliers, don’t rush a decision and be sure to let your current supplier compete in the go-to-market if they have been serving you well. Sometimes all they need to find savings (either by being more aggressive on margin or on innovation and finding more creative ways to serve you at a lower price point) is a little incentive. And remember, it’s not worth switching for 5% that will never materialize unless it’s a multi-million dollar contract. And even then …

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There Are No Hard Choices in Software Spending, Just Hard Heads

A recent Industry Week article on “hard choices for software spending”, quotes John Lovelock of Gartner who says that, if you’re an organization, either you’re viewing IT as a way of making money, saving money or increasing your profitability; or you’re viewing it as an expense to be trimmed. The implication, both of the analyst and the author, is that you fall into two camps, the spenders or the savers, and you have to make a hard choice as to what camp you fall in.

Well, I disagree. There are no hard choices when it comes to software spending, only hard heads. Like Procurement, properly approached and managed, IT investments always increases profits (by lowering costs and/or increasing revenue) — especially in the supply chain. Pick an area. Any area. The right systems will always increase efficiency, transparency, and productivity. And if they impact spending, they will help to contain costs and optimize spending, resulting in savings the first time they are used. And anyone who can’t see beyond the up-front costs to the long term savings has a hard head, especially after all of the successful case studies that have been published by the analysts, research firms, and publications over the last ten years.

Unfortunately, it looks like it’s going to be a while before IT spending reaches the level it should be at and companies replace their antiquated systems and/or acquire systems that they should have had years ago, as Gartner is only projecting total worldwide IT spend in the manufacturing sector to grow by 2.6% this year. That means that while one third of CIOs may go forward with software and hardware upgrades that were deferred due to the recession, as per a study conducted by Robert Half Technology earlier this year, it will likely be a while before the other two thirds of CIOs do the same.

As a result, manufacturers will continue to struggle with increasing complexity, global competition, rapidly changing business environments, and volatile raw material prices for no good reason. And the pressure to reduce costs, improve productivity, and deliver greater customer satisfaction while continue unabated. All because they have a hard head.

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There’s No Such Thing As Savings!

I’ve said it before and I’ll say it again: There’s No Such Thing As Savings. And I’m glad to say that I’m finally not the only one screaming it. As per this recent editorial in the CPO Agenda on “an escape from the tyranny of savings”, the problem with savings — whereby procurement is executed properly and there is early engagement, demand challenge, functional specifications, and diligent supply-market analysis — is that there are none. The more preparation that is done, the narrower is the range of offers from candidate-suppliers. The more radical the procurement solution, the less it fits a standard unit-price-difference calculation.

In other words, when a procurement department is well run, it will generate less of the head-turning savings that CPOs are obsessed with. So there is actually a perverse incentive not to change at all, and to manage spend badly. Because, as I’ve said many times before, savings is just money you shouldn’t have spent in the first place. That’s why “savings” quickly disappear after a company runs all its top spend categories through an open reverse auction for the first time. Once a company is getting market price, there are no more “savings” on the unit price. The only “savings” left are in efficiencies, and once an optimization is run to optimize the network, there are no “savings” left in the buy. The only option left is to go back and reengineer the product to reduce production and/or raw material costs. Then when that’s done there are no “savings” left. Success is then measured by controlling costs and preventing the inevitable rise to previous levels of excess that always happens when a category is put on the back burner and unmonitored. (That’s why “saving” consultancies can come back and revisit a spend category every three to five years and find “savings” when, in reality, there shouldn’t be any if they did the job right the first time and the category was properly monitored at contract renewal time.)

I understand that a Procurement Department still has to track and report its progress against a standard performance metric, but it definitely shouldn’t be savings. In the past I have recommended “cost avoidance” as a possible metric, but the CPO agenda article offers another recommendation which, if properly implemented, might be better. The author suggests using a “Procurement Control Index” which is to be developed by applying the following five criteria against each relevant procurement category:

  1. Is there a policy that describes how staff approach suppliers, what their financial authorities are, and what kinds of goods and services they may buy?
  2. Is there a procurement strategy document that is developed and agreed jointly with the ultimate budget-owner?
  3. Is there compliance with policy and strategy?
  4. Are current contracts and delivery performance actively monitored and managed?
  5. Are there improvement targets for assessing compliance, delivery performance and user satisfaction?

If the appropriate measurements are defined with respect to each question, for example:

  • % of categories with policies
  • % of categories with strategies
  • % of categories where policies are followed
  • % of contracts that are actively monitored
  • % of categories where improvement was seen

and these measurements are combined into a single perfect procurement metric through straight-forward multiplication, then a good measurement of overall procurement performance would be whether or not the PCI increased over time.

Of course, if this is too much, you could always start with Charles’ cost indices over on the Purchasing Certification Blog, but I’d hope the ultimate goal is a more comprehensive metric that applies organization wide.

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