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Whats the biggest single cost for most businesses? Procurement.Purchased products and services

account for more than 60% of the average companys total costs. For steel companies, that number goes

up to 75%; its 90%in the petrochemical industry. Even at service companies, the figure is typically a

hefty 35%. Bringing down procurement costs can have a dramatic effect on the bottom linea 5% cut

can translate into a 30% jump in profits.

Yet few executives have a firm grasp of all the money their companies spend on procurement. They

understand that the purchase price represents only part of the total cost of owning a good or service, but

they dont know precisely the magnitude of the other costs or where they occur. At the multinational steel

producer Usinor, for example, we have found that the hidden procurement costs in one product group

were 230% higher than management had assumed.

To help companies uncover all the costs involved in procurement, weve developed the simple matrix

illustrated below. Based on the familiar activity-based-costing approach, the framework gives managers a

systematic way to identify and organize the full costs of a companys relationships with its varioussuppliers. Using this tool can lead to smarter buying decisionsand a lot of savings.

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Heres how it works. The horizontal axis lays out the steps in the procurement value chain, from initial

acquisition, through possession and use, all the way to elimination or recycling. The vertical axis

represents the three main levels at which costs aggregate. Activities at the supplier level occur any time a

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particular supplier is used. Those at the order level occur every time an order is placed, and those at the

unit level occur for each item within an order. Within each level, we also identify those potential savings

that would produce immediate cash and those that would free up capacity or other resources in the

organizationfor example, reducing the time that employees spend processing a bill. In the boxes of the

matrix, we show examples of the types of costs that might be involved.

Systematically exploring all the costs laid bare in the framework lets you make intelligent decisions about

trade-offs using mathematical optimization models. The analysis can help you determine not only which

suppliers to choose but what share of your business to give to each supplier providing the same product.

Setting up numerous matrices allows you to systematically and comprehensively consider alternative

procurement strategies. Its one thing to know that going with the lowest-cost supplier is not always wise.

This framework will help you understand exactly why.