What is the potential for reducing purchase cost?

Purchasing & Working Capital

All procurement managers will have targets and hopefully most of them are being achieved, but if you are the new leader you need to be able to answer some very pointed questions. What is the potential to reduce purchase cost? How long will it take to get to the bottom line? What is the action plan that will be required? What investments will be required to realise this potential? To get the answer right will mean fulfilling the maximum potential of the department’s spend profile.

To get the answer reasonably quickly many companies get external help from specialist consultants. The biggest complaint of many companies that have gone down this route is that it took too long, the benefits promised were not necessarily realisable and it was not always clear that the depth of work done had a real relationship to the eventual value proposition. In addition, it can be hard to replicate the consultants work once they are gone, usually meaning that you will be paying external people for what should be the day job rather than specialist expertise or insight.

Assuming the right skills are available, one of the most important things you can do is build a diagnostic tool from the purchase data in your ERP system. Dependent on the quality of the data you should be able to build a model that differentiates between suppliers, products by commodity type, payment profiles and spend volumes. It is common that ERP data can be missing or out of date. An example is commodity groupings. These were usually built when the ERP system was being implemented, so it can happen that they never change after that. If your spend profile has changed, it is possible that the commodity groups are no longer appropriate. Another example is item codes. There are still many companies who only hold inventory data at product family level. So it can be very difficult for procurement to understand the proper product mix within the family.

Projecting savings in each of the categories will depend on a number of elements. The first will be the numbers of suppliers in the category versus the volume of spend. The higher the number of suppliers, the more likely that saving can be obtained by consolidating spend into deals with one or two suppliers. Next will be the length of time since any deal was negotiated. If a deal was only done a few months ago it is less likely to produce saving versus if the deal was done three years ago. Then there is criticality. The less critical the spend the more likely it is that you will have a choice of suppliers and may be able to substitute various suppliers products. And finally there is the commodity itself. If the group is an openly traded commodity such as metals, grain or wood pulp, it is unlikely that you will have enough power to change market pricing. But at the other end of the spectrum there are categories like transport, office supplies, spare parts, facilities management and security where there may be more genuine opportunities.

Once all this is in place, it will be necessary to have a solid action plan that is rigorously followed, not just by procurement but by the stakeholders who hopefully have input to the plan. The last and probably most important element is having the right level of skilled resources.

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