Procurement Cost Reduction

• Successful procurement cost reduction requires well-defined systems and processes.
• Organizations must establish strong policies, data management, and stakeholder alignment to maximize effectiveness.

Foundational Procurement Elements: Must-Haves

• Spend Data Transparency and Accuracy require understanding spending habits by following the C-COAT principle:
• Complete: Captures all relevant procurement data.
• Consistent: Standardized formatting across records.
• Organized: Categorized by supplier, product, or service.
• Accurate: Free from errors and discrepancies.
• Trustworthy: Reliable for strategic decisions.
• Savings Methodology requires a clear definition of what constitutes a cost saving to track and validate savings effectively.
• Standardized methodology prevents inconsistencies in reporting savings.
• Alignment with finance teams ensures credibility and acceptance of cost reductions.
• Strong Finance Collaboration is crucial for aligning on how savings are recorded, avoiding disputes, and identifying opportunities to optimize budgets collaboratively.
• Cross-Functional Collaboration requires multi-disciplinary involvement like engineering, warehousing, and legal/marketing.

Enhancing Procurement Influence: Nice-to-Haves

• Senior Management Support requires organizations to allow procurement to explore all spend areas.
• Procurement Credibility and Stakeholder Buy-In requires trust across the organization of the procurement function.
• Stakeholders need to be involved early in sourcing decisions.
• Procurement's recommendations must be valued and acted upon.
• Defined Procurement Policies establish clear spending rules for stakeholders.
• Procurement involvement is required at specific spend thresholds.
• There must be guidelines for supplier selection and contracting.
• Compliance with governance and financial controls.
• Early Procurement Involvement requires procurement teams to engage at the start of a project to negotiate better, influence sourcing, and align initiatives with business needs.
• Spend transparency, clear policies, finance alignment, and stakeholder collaboration form the backbone of an effective procurement function.
• Management support, credibility, and timely engagement help procurement teams maximize value, enhance cost control, and drive continuous improvement.

Cost Reduction vs. Cost Avoidance

• Cost reduction actively decreases the cost of existing products, services, or processes.
• Finding ways to do things more efficiently or getting better prices with suppliers is cost reduction
• It is easily measurable and results in direct financial savings.
• Example: Negotiating a new price of $8 per unit from $10 per unit results in a $2 per unit savings.

Common Categories of Cost Reduction:

• Direct procurement items (raw materials, components, ingredients).
• Indirect recurring expenses (logistics, energy, maintenance, and repair operations).
• Like-for-like services (recruitment, temporary labor, facility management).
• For recurring items, cost reduction is calculated by subtracting the new price from the previous price and multiplying by the quantity purchased.
• For non-recurring spend, measuring savings involves comparing negotiated final prices against the initial budget, the lowest of three supplier quotes, or the first supplier proposal.
• Cost avoidance focuses on preventing unnecessary costs from occurring.
• This involves identifying and eliminating waste or optimizing processes,
• Making strategic decisions that minimize expenses.
• Cost avoidance may not be formally recognized as a saving as finance cannot capture it in reporting.
• Example: Negotiating a 10% proposed price increase down to 3% results in a 7% cost avoidance.

Examples of Cost Avoidance Measures:

• Negotiating lower price increases than initially proposed by suppliers.s
• Process optimization to eliminate unnecessary spending
• Standardizing products to avoid redesign or customization costs.
• Cost avoidance remains an essential part of procurement strategy, even if not formally recognized.
• Finance skepticism, lack of direct impact on profitability, and procurement credibility are examples of challenges in recognizing cost avoidance.

Recording Savings: Challenges and Best Practices

Pitfalls to avoid:

• Misreporting cost avoidance as cost reduction.
• Claiming savings without adjusting for volume or timing changes.
• Failing to align with finance teams on savings calculations.
• Ignoring total business impact.
• Recording market-driven price drops as procurement savings.

Best practices:

• Use standardized savings methodologies.
• Maintain transparency with finance and leadership.
• Document all procurement actions.
• Continuously review and refine savings measurement approaches.
• Understanding the differences between cost reduction and cost avoidance ensures accurate measurement and contribution to profitability.

Types of Cost Reduction

• Substituting one purchased item, material, or service for another.
• Changes in source of supply.
• A price reduction from the original supplier.
• A change in the character of the purchase.
• Change in methods of purchasing.
• Consolidate requirements to obtain lower price.
• Reductions resulting from negotiations.
• Simplify, eliminate, modify, or improve a process.
• Introduce or implement a new technology.

Cost Avoidance Types

• Negotiating a purchase price that is lower than the original quoted price.
• Avoiding a future cost increase by delaying or reducing the impact.
• Buildups of inventory in advance of a price increase.
• Establishing long-term contracts with price-protection provisions.
• Changing or eliminating, in some way, a proposed process.
• Purchasing alternative goods or services.
• Generating cost improvement.
• Elimination of a planned purchase.

Total Cost of Ownership (TCO)

• TCO considers hidden costs not immediately visible.
• There are many hidden costs beneath the surface that are not immediately visible, unlike the purchase price.
• TCO gives a complete understanding of the costs with a product or service.
• This ensures not only thinking that the purchase price is the only expense involved
• Analyzing costs beyond the initial purchase adds greater value.
• TCO allows identification and minimizes costs below the waterline, which is important for profitability.

Three Levels of TCO Analysis:

• Upstream costs incurred by suppliers for raw materials, manufacturing, and transport.
• Understanding these costs helps assess the overall impact on business.
• Internal costs scrutinized by companies like Procter & Gamble and Toyota.
• Areas to improve include automation, streamlining workflows, digital transformation, vendor-managed inventory, and standardization.
• Downstream costs impact the customer's experience, and may help maintain relationships.
• TCO ties into sustainability through reducing waste by minimizing packaging, eliminating plastic, and being energy efficient by partnering with renewable energy suppliers.
• Using sustainable materials avoids single plastics and enhances brand reputation.
• Ethical sourcing avoids supply chain risks related to child labor and ensures compliance to avoid losing licenses.
• Additional costs under the waterline are warranty & returns, implementation, temporary labor, tariffs & duties, warehousing, expedited shipping, environmental taxes, tooling & setup costs and order changes/cancellations.
• Factoring in these elements and reducing hidden costs improve sourcing decisions more strategically.
• Inefficiencies in supplier relationships greatly impacts TCO.
• Last-minute design changes, unstable forecasts, frequent order changes, excessive requirements, excessive customization, and late payments are examples of procurement inefficiencies which increase costs.
• Suppliers reflect inefficiencies in their pricing, therefore addressing these inefficiencies leads to cost savings.
• Ask if the business has inefficiencies dealing with suppliers to assess potential risks, and how the situation could be improved.
• Have discussions with suppliers tp identify process improvements.
• Inefficiencies can inflate costs unnecessarily.
• Shifting to a TCO mindset enhances value and drives long-term savings.
• Considering the broader picture improves credibility and ensures positive impact.
• Additional resources may be required for qualifying the business.
• The teams working with the supplier need to establish new communication processes.
• Poor quality can lead to lower quality of service.

Potential risks of changing suppliers

• Uncertainty in production quality, potential defects, waiting time & delays and internal teams being left waiting.
• Internal stakeholders failing to meet their targets, and end-user experience potentially affected.
• Production line stoppages in which a halted production line could cost the company $50,000/hour.
• Exposure increases, issues in compliance or stability potentially arise.
• Reputational damage late to product shipments.
• Customers may turn to competitors, and short-term savings could be outweighed.
• These risks highlight why TCO analysis must go beyond the purchase price, as it could end up more expensive

Functional Trade-Offs and Suboptimization

• Departments may need to suboptimize to achieve an organizational goal.
• Moving supply from a UK supplier to an India supplier introduces increased lead times, less flexibility, higher working capital requirements, and more warehousing space.
• Suboptimization requires mature discussions between department heads to align functional goals.
• A supplier change saves $100,000, but professional should identify all secondary impacts, estimate the costs and compare the total benefit and identify if change makes sense.
• Assess potential business impacts to determine whether cost reductions are one-time or continuous, analyze financial impact, net off additional costs, and make data-driven decisions.
• Teams can drive meaningful cost reductions while maintaining supplier realtionships with proactive decisions.
• Strategic procurement balances cost savings with quality and risk management.
• A mature procurement team moves beyond price negotiations and focuses on total cost, long-term value, and business impact.

Identifying and Leveraging Cost Reduction Opportunities

• It is essential to data collect to start with, from suppliers, business units, finance, or procurement records.
• Conduct a Pareto Analysis (80/20 rule), where 80% of spending is likely concentrated in 20% of categories or suppliers.
• This allows one to identify the largest spend areas to focus on.
• It prioritizes efforts on categories or suppliers with the highest impact on cost reduction.
• Just four key categories might combine to make the cost reduction.
• An opportunity framework considers market and difficulty of the organization.

Flexibility of Price vs. Category Maturity

• It is important to understand how the supplier evaluates by answering questions like
• How many supplier alternatives exist?
• Is there only one supplier that qualifies?
• Are there many potential suppliers in the market?
• The organization must prioritize suppliers who can resist change easily and not consume too many resources.
• To assess price flexibility, a supplier’s profitability has to be analyzed.
• Retailers may operate at 3% net profit, offering little room for price reductions.
• Categories that have never been optimized have the highest optimization for cost reduction.
• Examples of this include a new untouched software service and commodity.

Cost Reduction Initiatives

• Focus on initiatives that are high-impact and easy-to-implement.
• High-impact and easy-to-implement changes should be prioritized over others immediatley.

Potential Cost Reduction Triggers

• No Contract in Place can increase the opportunity for cost reductions.
• Opportunities exist within Contract Renewal when in negotiation mode.
• Untendered Categories have the opportunity for increasing cost reduction.
• Market Prices Falling have more cost reductions.
• Suppliers may offer cost reductions in Acquisitions & Mergers.
• Opportunities occur in New Technology Adoption.
• New companies in the market in Suppliers Relocation can offer lower alternatives for price reduction.