Procurement: Take control of costs

Dave HenshallProcess

Dollar and euro money 3d symbols.Now is an excellent time for procurement heads to show their leadership skills and take ownership of the money-saving agenda.

As most major economies emerge from recession, CEOs and business leaders are cautiously planning for the next growth cycle. The winners in this cycle will be the companies that focus on enhancing customer value while eradicating costs that don’t match customer requirements.

For CPOs, I argue that this means managing cost, not just spend. CPOs must link procurement strategies to value. They can do this by acquiring a deeper understanding of and engaging with their organisation’s cost structure, then going on to develop a more strategic approach to managing and reviewing cost.

What are the key steps to achieving this?

Opportunities to manage cost are driven by the business’s core strategy so CPOs must fully understand and influence how their organisation’s cost base supports that delivery. But this is as much about the costs you retain as those you cut. It requires a deeper appreciation of the difference between good costs (those that drive future growth), neutral costs (that support company infrastructure) and bad costs (do neither of the above and are ineffective processes). Assessing these will save money, which can be reinvested in the business.

But how many companies have a formal cost optimisation process? Probably not many, and even fewer have one in which procurement plays a big part.

The brave CPO can capitalise on this lack of formal process by leading the call to develop one in their organisation – and by claiming the lead role.

This involves:

1. Business strategy evaluation

Review the current business strategy to ensure it offers the best solution for meeting customer needs and expectations. Identify customer segments, as well as the services, products, channels and resources they use. By understanding the customer base and the distribution of value or service within it, you can also evaluate the distribution of cost and identify areas for improvement.

A cost-optimisation programme requires high-quality and detailed data to establish a current cost baseline. This should also provide an insight into the decisions that were taken in formulating the current cost structure. The information gathered will enable other key questions to be addressed:

  • Which products and services are valued by our most attractive customers and how effective and efficient are we in delivering them?
  • What percentage of resources is consumed by customer segments of marginal value, and how can we reduce that percentage?
  • Which services should we outsource to more efficient providers?
  • Which product, customer-segment or channel areas should we exit entirely?

2. Detailing the strategy

The next phase is to define what will be included under any cost optimisation programme.  Analyse the gap between the current position and target position. Then define cost targets as well as identify business requirements for achieving them. Remember the programme should be aligned with the business strategy to avoid blindly making across-the-board cuts, which may undermine business objectives.

Cost reduction targets are becoming increasingly aggressive, with many organisations setting them as high as 12 per cent annual cost reduction after inflation. When calculating these, taking a broader perspective helps to ensure setting targets that are acceptable to all stakeholders.

Consider these four viewpoints:

  • Internal view – Look at each business unit and function to identify potential savings opportunities across the company.
  • Competitor view –  By benchmarking against competitors, you can set cost-saving targets to make you more competitive against them.
  • Best-in-class view –  By benchmarking key activities against best-in-class organisations, cost-cutting targets can again be set at a level to overtake them.
  • Investor view –  Most firms attribute positive share price impact to cost reduction efforts. Setting cost targets with financial analyst companies can help determine the cost reduction required to support the firm’s share price, assuming no growth in revenues.

Against these considerations, the list of initiatives that could provide savings include examining best practices, process re-engineering, outsourcing, investment projects, strategic sourcing initiatives and staff cuts. These initiatives must then be prioritised according to criteria such as investment required, potential benefit, difficulty of implementation, risks involved and the urgency and appetite for change and improved efficiency in the organisation.

3. Delivery of the programme

There should be visible, top-level support for the delivery phase. A “can do” mentality across the organisation helps, but it is not enough. Too many change projects fail because of poor governance, inadequate skill sets and political infighting, or plain old “analysis paralysis”. Therefore companies must embrace and support the implementation phase by ensuring they are well resourced and managed by highly skilled people able to drive change.

However, in drawing up this cost management strategy, there is an important additional challenge.

CPOs must secure support for change programmes that enable organisations to drive both “cost down” and “cost out” of the supply chain while simultaneously delivering additional value.

The need to switch from “cost” to “value”, is increasingly recognised by procurement leaders.

While markets everywhere are still in turmoil there is threat and opportunity, so this is exactly the time for CPOs to identify the core processes needed to support company strategies and determine which will be addressed in-house and which should be outsourced to suppliers.

Strategic cost management capability is not an accident. Establishing “supply management as a core competency” (SMCC) will provide the systematic approach most likely to provide sustainable cost leadership. For supply management there are two strategic goals.

The first goal is to become a source for cost leadership. Profitability, margin and earnings per share are at the top of the CEO’s agenda so CPOs must drive home the message how company revenue, cost of sales, operating expenses, working capital and fixed assets can all be directly influenced by procurement.

The challenge for the CPO is to identify the initiatives and priorities that add the most value, assess their teams’ capability in executing these initiatives and develop appropriate metrics to measure effectiveness. This should influence how decisions on selecting cost reduction targets are made (see point two, above).

The CPO must set challenging but realistic targets and select the most appropriate strategy while understanding relevance and contribution to company performance.

In driving cost leadership, procurement leaders can go beyond traditional approaches and employ advanced cost-management techniques to manage their supply markets more efficiently than competitors. They can do this by having a formal outsourcing strategy; collaborating and developing cost-reduction initiatives with suppliers, sharing benefits and risks with them; having tiered sourcing; and revising specifications, processes and reducing complexity to avoid costs.

The second goal for supply managers is to become a source for product and service differentiation. The battle for the customer has never been fiercer and rapid innovation has become a key component for corporate growth. By investing in superior supplier networks and successfully harnessing their resources, assets, capabilities, competences, capital and intellectual property, collaboration becomes a key source of innovation for competitive advantage.

While accessing innovation in supply markets is neither new nor revolutionary, embedding innovation as a process is. This concept of innovation-centred procurement is gaining momentum with procurement leaders. In organisations where it is used, the procurement function is closely aligned with sales and marketing and R&D. Together they use their knowledge of external markets and close relationships with customers and suppliers to search for new opportunities. Having the right suppliers involved early in the innovation cycle can make a huge difference. Furthermore, finding a value proposition that aligns a supplier’s interest to your business to become a customer of choice will become increasingly critical as markets become more dynamic and volatile.

For many organisations, however, the performance gap is still considerable.

Most businesses don’t need convincing that cost management is a wise strategic move, but many still need support in determining both the “what” and the “how”. Without a well managed programme that can respond to competitive conditions and accurately capture and report improvements, businesses may find themselves at a competitive disadvantage.

Those organisations that have successfully established SMCC will be best placed to satisfy the demands of increasingly sophisticated customers, stock markets and regulatory bodies, regardless of volatile economic cycles.

Nuff said …

First published by the CPO Agenda