Achieving Procurement Cost Reduction

The ”Art” of the Cost Reduction

By Will CrockerThe Sublime Group, Inc.

The Backdrop

[email protected] +1 630-253-4880

• What – The Procurement organization has been tasked with achieving a recurring and annual cost reduction in addition to achieving the other goals of ensuring product is available as needed.

• Why – The Procurement organization may have been previously focused on tactical deliver solely and the company is experiencing annual inflationary pricing from the supply base.

• Who – Everyone in the company, Procurement leads, but all organizations have to participate.

• How – Through a rigorous set of tools and processes that can initiate, drive and sustain ongoing value.

What is Cost Reduction?In high level terms, Procurement cost reduction is that which has a material positive (reduction) in the bottom-line of the company’s Income Statement. Areas where these reductions can be achieved include:• Supplier direct purchase price• Shipping & Handling Cost• Purchase Order, Invoice and Accounts Payable Processing• Waste and Shrinkage• Supplier’s Manufacturing Inefficiency• Work In Process• Warranty Recovery• Design for Manufacturability; Design for Usage• Substitute Products• Supply Base Size


Clearly there are more ways to achieve cost reduction than just badgering the supplier for price reduction, BUT, traditionally this is where 80 to 100% of the effort is focused…if at all!

The Cost Management Paradigm


• Eighty percent (80%) of the supplier’s cost is typically locked at the time of negotiation, for the entire life of the contract!

• Little contractual language is typically included to facilitate ongoing price and cost reduction short of some typical language regarding price change resulting from supplier input cost changes.

• Eighty percent (80%) of Procurement’s time is spent trying to leverage the 20% of the ongoing cost that is still potentially leverage-able.

• But the supplier has little or no incentive to help.

The Cost Management Paradigm


• Eighty percent (80%) of the supplier’s cost is typically locked at the time of negotiation, for the entire life of the contract!

Cost

Pre-contract cost change potential Post-contract cost change potential

• Price• Ship & Handle• Manufacturing

Inefficiency

• Price• Ship & Handle• Manufacture Design• Material Content• Supplier Scorecard

The Procurement organization needs to be designed and aligned such that substantive cost reduction can be achieved throughout the commodity, or contract life cycle.

The Management / Leadership Trust Dilemma

Management must embrace and enhance Procurement and Procurement needs to perform, but it takes time and patience to break and rebuild the cycle!


• Procurement has typically been categorized as low performing and unable to achieve cost reduction targets.

• The conundrum is that leadership has traditionally valued Procurement as non-performing and is thus resistant in adding high-potential people and processes.

• BUT, in many cases, contracts have been negotiated outside of Procurement and have not left opportunity for performance, so the cycle continues, or the Procurement employees don’t have a clear understanding on how to identify and negotiate cost levers.

A Focus on ProcurementKey Attributes Traditional Purchasing

Organization(s)World-class Procurement

OrganizationSet High Aspirations

• Periodic, incremental purchase price reductions, hoping to keep up with inflation

• Captures 10-15% initial reduction in Total Cost of Ownership, followed by 3-5% ongoing annual improvements

• Senior leadership views purchasing as core capability and provides visible support and commitment

Fact Based Negotiations

• Disadvantaged vs. suppliers in negotiations who have better facts about the buy

• Total company spend may not be embraced

• Advantaged vs. suppliers; distinctive insights in 3 areas:• Total Cost of Ownership• Supplier economics• Supply market options and opportunities

• Rigorous set of performance metrics used to track progress

Strategic Focus • Process orders and minimize the cost of the purchasing function

• Strategic rather than tactical focus• Emphasis on developing and executing sourcing strategies to

reduce Total Cost of Ownership

OrganizationCapability

• Purchasing viewed as an administrative function: “last to know” about key decisions

• Function has culture of ongoing capability building and continuous improvement

SupplierManagement

• Infrequent bidding with some suppliers, and undemanding “partnerships” with too many

• Builds a world-class supplier network with a few demanding partnerships for goods and services that can truly contribute to competitive advantage

Current Technology

• Technology tools rarely applied: when so, focus on reducing transaction cost and tracking compliance

• Technology tools used to:• Preemptively reshape supply markets to their advantage• Harness technology for better decision making on TCO, supplier economics, and supply markets

• Better integrate suppliers

The key is leveraging the entire Spend Profile throughout the Commodity Life [email protected] +1 630-253-4880

The “Art” of Cost Reduction – Say What You Will Do, and Do What You Say

• Procurement needs to create, manage and over-communicate an annual plan on a regular basis with executive leadership.

• The plan will change during the year, but those changes need to be visible, understood and agreed to by leadership.

• Procurement’s annual plan must be aligned exactly with the internal business customer’s annual plans.

• The plan must include elements of staffing and tools required to accomplish the goal of cost savings.

Communicate, communicate, communicate!


The “Art” of Cost Reduction – Categorizing Savings

• So the burning question always is, what counts?– Hard dollar savings – traditionally thought of as price

reduction– Soft dollar savings – cost avoidance, efficiency

improvements, manpower reductions, etc.• The simple answer is “it should all count” because

we are helping the company be a more cost effective place.

• Unfortunately Profit & Loss statement savings are easy to prove and quick to impact the bottom line.

• But…it all counts!

Make a Plan and Work the Plan!


The “Art” of Cost Reduction – The Savings Plan

• The success of Procurement is the burden of proof, so the easiest way to do this is build a project / cost tracker and glue yourself to internal business finance group.

Work the Plan and Show the Proof!


• This example gives a mixture of hard and soft dollar savings, but can it be argued whether they are all important to the success of the company?

So Where do you Start on a World-Class Savings Journey?

• Robust spend analysis by commodity and supplier– Three year analysis to establish trending and

supplier significance within supply base• Grouping of suppliers by commodity• Establish leverage potential by commodity• Begin to build commodity strategies that support

the direction of the company

Track the flow of money…company-wide!


A Few Examples of Cost Reduction Tactics

• Ask the Supplier for a Cost Reduction!– They likely have been expecting it and planning for it

• Re-open the contract– Based on changed business dynamics– If they agree, they will likely want something in return

• Substitute Product– Great tactic if contract isn’t exclusive or volume specific

• Quit buying certain items– Those that are nice to have but aren’t necessary

• Help them with performance improvement– Shared savings mechanisms

Be creative on savings, the supplier is creative on sales!


So What’s the ”Art?”

• Define all the areas which can be leveraged for cost reduction– Not just price– Categorized between short and long term impact

• Build a detailed savings plan with line item detail– Align the plan with your internal business partners

• Gain approval for your plan with executive management

• Review your plan with executives regularly– Celebrate successes– Communicate roadblocks– Be clear on contingencies and recoveries, if needed.

Build a plan, work the plan, communicate the plan…it’s really organization...not ”art!”


Documents

Achieving Procurement Cost Reduction