This post is part of the 33 Ways to Amplify Your Profit Quickly.
To increase profit, besides increasing revenues, you can reduce costs. And, in many industries, procurement costs are often the biggest driver of overall costs. Reducing procurement costs can quickly improve your gross margin.
There are two types of procurement costs, which we will discuss in this post:
Direct purchasing costs;
Indirect purchasing costs.
1. Reduce Your Direct Purchasing Costs
Reducing your purchasing cost will quickly improve your gross margin. Usually, direct purchasing costs are amongst the biggest cost items. Therefore, significant savings can often be achieved -- especially for organizations with a weak supplier management system.
The objectives:
Identify the cost categories with the largest cost-saving potential.
Renegotiate the commercial terms to execute cost savings.
Change suppliers to get better prices.
Steps to execute:
First, you start by reviewing existing spending by suppliers and by category practices.
Gather and consolidate data in a procurement cost database. It could be a simple excel spreadsheet or a massive SQL data file.
Analyze the spending, break it down by category, product, component, supplier, etc. Focus on the key cost categories (e.g., top 20 high spend categories).
Then, you review the existing procurement practices and decision-making processes.
Interviews the buyers and other related key stakeholders (e.g., Procurement Director, Finance Director, the CFO, the CEO).
Map the relevant processes/practices/guidelines, in order to identify the weaknesses and room for improvement.
Check if the existing spending practices comply with the policies. Measure compliance in the key categories.
Afterward, you can identify quick-win opportunities to reduce the direct purchasing cost. Here are some ideas that you can pursue:
Benchmarking: Get external cost benchmark by category. Use them to identify opportunities to reduce spending.
Bundling: Coordinated purchasing across divisions to generate more volume. Get better prices by giving suppliers more volume (e.g., give them a bundling contract for both sugar and flour to get better prices).
Business Unit optimization: Renegotiate prices based on price differences across Business Units or countries (i.e., if one of your Business Units receives the lower price, you can ask for that price for your other Business Units).
Change supplier: Examine if other suppliers can provide cheaper prices.
Demand management: Cutting back volume purchased through proactive planning and behavioral change. For example, an investment bank reminds its analysts not to print all reports to reduce paper and printing costs. Other ways to reduce demand: reduce volume/frequency, adjust specifications, adjust service levels, eliminate unused, etc.
Location optimization: Find price differences across locations (see if possible to buy from the cheaper location), or find a closer supplier to reduce transport costs.
Long-term deal: Get better prices by extending long-term contracts (e.g., set for a 5-year contract to get cheaper prices).
Make or buy: Examine if making the goods/providing the services internally in-house or buying the goods/services externally can be cheaper.
Process optimization: Improving operational interfaces and decision-making processes. For example, introduce tender to obtain multiple quotes as part of the process. Other examples include: enforcing the use of preferred suppliers and using standardized agreements.
Simply Push the Suppliers: Renegotiate prices based on credible threats, benchmarking, and above-average supplier margins. Sometimes suppliers make a lot of margins just because your company doesn’t pay attention.
Standardization and redesign: Change standards and specifications to cut costs while still meeting the need of customers. For example, changing from Class I Hazelnuts to Class II Hazelnuts.
Supplier collaboration: Work with the suppliers to find cost reduction opportunities. For example, by integrating your supply planning with the supplier to drive down the overall supply chain cost.
Supplier management: Review supplier performance. Identify low-performing suppliers. And use the performance to renegotiate the prices.
Use the trend: Renegotiate prices based on input materials price decrease. If the price of cacao gas declines, you can ask for a reduction in the price of chocolate.
Value engineering: Examine value engineering/ product cost reduction options. For example, ask your cake suppliers to tweak their ingredients to give you a cheaper cost.
Once the quick win opportunities are identified, you can size and prioritize the long-term opportunities.
Quantify opportunities and assess the potential impact.
Prioritize opportunities.
Set targets and timelines.
For all categories with high spending, make sure you determine an approach for capturing the potential. If your approach involves supplier negotiation, please don't forget to prepare for supplier negotiations.
Plan for negotiations (what to say to whom by who, when, and how).
Develop supporting material.
Finally, execute the plan.
2. Reduce Your Indirect Purchasing Costs
Indirect purchasing costs are often overlooked due to their varied and smaller size. However, a lot of small cost buckets do add up to a big total cost. And these cost buckets is the one which is usually within your control to a high degree.
The objectives:
Identify the cost categories with the largest cost-saving potential.
Renegotiate the commercial terms to execute cost savings.
Change suppliers to get better prices.
Implement stricter policies to reduce spending.
Enforce compliance with stricter policies.
Steps to execute:
The steps for reducing the Indirect Purchasing Costs are the same as the steps for reducing Direct Purchasing Costs. To avoid repetition, please see the steps outlined above in Section 1.
However, due to the nature of indirect spending, you can often use stricter policies to reduce spending. Hence, there are two additional quick-win opportunities you can explore:
Tighter policies and guidelines: Typical quick win categories are employee travel, meetings, conferences, IT equipment, sponsorship, company cars, etc.
Standard Reduction: Remove the most expensive options from the list of alternatives, e.g., airfares (no business class), cell phones (switch Apple), uniforms (cheaper materials), and agencies (cheaper agencies).
Tips:
As always, focus on the largest categories that make significant impacts.
Don't overfocus on the cheapest price from the cheapest suppliers. One company I know of was trying to save on toilet paper by buying thinner paper. But, as a result, people use more paper, and the overall costs actually went up.
Be careful about the impact of very strict indirect purchasing on the employees' morale. Counting every single penny and cent may harm employee satisfaction and loyalty. Social media is littered with complaints about cheap ass company. Think about your employee value proposition.
To see other ways to improve your profit, check the 33 Ways to Amplify Your Profit Quickly.
Alternatively, to continue exploring winning strategy, click here.
Comments