With some forecasters predicting oil at $250/barrel, many businesses are being forced to impose surcharges, cut capacity and reduce staff to cut cost. In fact recently one headline in the New York Times read "Even Vegas Is Down on Its Luck". So what's your cost management strategy?
Economic downturns are typically accompanied by large inventory buildups and cutbacks in orders that cascade down the supply chain, often having a devastating effect on unprepared suppliers. In such a climate businesses large and small cannot afford to simply stand by and do nothing. A typical response might be that sales are good and costs are bad, followed by a financial crackdown, to limit the damage to the company's market capitalization and the level of shareholder dividend payments? In other words, get back to financial basics.
At Purchasing Practice, we don't believe this is the right solution. We believe in a more strategic approach to cost reduction. Some costs are actually good because they are a vital component that drives current and future growth. Cutting these too far or in the wrong places can have catastrophic impact on a business. It is the role of strategic cost management programs to consider all types of cost: good, neutral and bad. This assessment can then be used to target cost more effectively and reinvest any savings back into the business. By taking a more strategic approach, we believe, businesses can actually create opportunities to outmaneuver competitors who carry on with business as usual or are unable to adapt quickly, except by wielding the axe and cutting staff.
How Purchasing Excellence Helps
We know from previous downturns that procurement plays a key role in any cost reduction initiative. At Purchasing Practice we believe procurement leaders must use this opportunity to not only cut cost but also build sustainable competitive advantage. Following is a checklist of considerations to keep in mind as you look to leverage this opportunity.
Know your business
Procurement staff must understand the company's objectives and what's important to the company in order to gain a better understanding of its strategic imperatives and business drivers. Purchasing must take the lead while creating close alignments and alliances with key stakeholders across the company.
Stakeholders
Procurement must focus on the issues that are most important to the company. It is no use asking stakeholders, '"How can I help you?'" They might not know! Procurement must lead, and, as successful procurement leaders know, one of the biggest mistakes procurement can make is trying to be all things to all people.
By considering how the wants and needs of stakeholders align with what the organization wants and needs from its stakeholders, procurement can examine its relationship with each stakeholder. Procurement can then assess the strategies, processes and capabilities that are needed in order to satisfy these two critical sets of wants and needs.
The battle for talent
In the end, transforming procurement into a competitive advantage depends on winning the battle for talent.
Procurement talent is in short supply across all sectors, and major organizations globally are finding it a significant challenge to recruit and retain highly skilled, experienced procurement staff. This is a critical consideration as your company examines staffing levels. After all, overzealous cutting can be detrimental to employee morale and increase turnover, sending top performers into the hands of competitors and leaving your organization in a weakened position. In addition, with both the shortage of talent and increased internal financial constraints during a downturn, companies cannot depend on hiring to fill the talent gap; instead, businesses have to develop the skill levels of their existing staff.
Suppliers
A prolonged industry downturn is typically accompanied by increased supplier instability. Unfortunately, it is still true to say that many organizations do not know enough about their suppliers. This becomes particularly important in a downturn as supply risk can have an even greater impact on a company's success. Organizations require a proactive and predictive strategy towards supplier risk management to understand the realities of their suppliers, partners and the supply chain as a whole, and to determine the impact on the organization if they cannot fulfill their obligations. So how do you manage the risks of procurement?
Strategies
Manage Your Cost Structure and External Spending
Care must be taken when cutting cost. Too often companies focus on short-term cost reduction, which can result in higher costs over the long term. Common mistakes include:
Strategic Cost Management Strategies in Procurement
Structuring for strategic cost management requires understanding the cost drivers and laying down clear guidelines for how to proceed when first embarking on a cost management program. As you move forward, the task becomes more complex as easy targets are identified and executed and more difficult cost opportunities present themselves.
Typical stages of cost management in procurement are: price drift, price down, cost down, cost out and value add. As companies progress, they move from focusing on reducing cost to removing cost and to adding value, and to be successful they must employ increasingly sophisticated tools and techniques. This includes selecting appropriate supplier relationships and then managing the relationship effectively. Typical tactics may involve simplifying specifications and cutting process waste.
Launch a Strategic Sourcing Initiative
Since the early 1990's, we've heard many examples of the large and sustainable benefits that can accrue when strategic sourcing is applied to attack supply cost.
Strategic sourcing is a collaborative and structured process for dramatically reducing external spending. It is a high-reward, low-risk alternative to traditional cost-reduction initiatives.
Strategic sourcing starts by meticulously defining the requirements for a product or service and continues through the contracting process, followed by ongoing monitoring of the supplier's performance against the defined requirements. By definition, it is very straightforward and commonsense; in practice, it requires skilled leaders to manage the shift in the organization from a traditional procurement organization to a world-class procurement organization.
Strategic sourcing benefits the entire organization by reducing cost, optimizing resources, driving standardization and supporting compliance, while also improving quality, internal processes and lowering total cost. Once realized, savings are sustained through benefits tracking, supplier relationship management and stronger purchasing capabilities.
Manage Inventories
Business downturns are typically accompanied by significant buildup and subsequent write-offs of inventories. Take this opportunity to review materials-planning policies, reduce existing inventories and reexamine prescribed inventory parameters.
Manage Working Capital
Companies striving to improve the way they manage working capital are often handicapped by paper-based, manual invoicing processes that result in lengthy invoice cycle times, which in turn makes it difficult to qualify for and capture early payment discounts. Because these companies allocate so much time and energy to simply processing invoices, they are unable to devote the resources needed to strategically identify and work with suppliers.
Multiple groups, including treasury, finance, AP and procurement, have an impact on an organization's ability to manage working capital effectively, but these groups often work in silos. While each group has its own goals, the entire organization must be aligned to gain maximum working capital efficiencies. For example, managing days payable outstanding and paying suppliers early to capture discounts must be carefully balanced if an organization is to make optimal working capital decisions.
Procurement Excellence
Does excellence matter?
Excellence is no accident. World-class organizations operate and perform very differently than their median peers, reports Hackett. They found that world-class procurement drives 133 percent greater return than typical companies but cuts the cost of procurement by 20 percent. They calculated returns by dividing spend savings (spend reduction attributable to procurement practices) by the total cost of procurement operations. This advantage translates to $3.6 million to the company's bottom line for every $1 million in procurement operations costs.
Leverage the Power of Technology
Many companies have purchase expenditure of up to 60 percent of their overall annual turnover and in some cases even higher. By deploying e-procurement, companies can better manage this spend by creating significant process savings and lowering the absolute cost of the goods and services by ensuring compliance with strategic procurement initiatives.
The benefits:
Delivering these benefits may involve a combination of technologies, such as an e-marketplace for ordering goods and procurement cards for their payment, e-auctions for sourcing initiatives and automated contract management systems, etc.
Achieving the benefits of e-procurement will require the updating of current practices towards best practice. Change management is, therefore, critical to the success of e-procurement.
Drive Compliance and Track Savings
During a downturn, preventing maverick spending and leakage from negotiated contracts becomes even more important. One key performance indicator is whether an organization is on track to achieving their procurement savings initiative goals gained from strategic sourcing and other purchase cost reduction initiatives. The information associated with these initiatives is critical input for annual savings reviews and management reports that communicate savings data to company executives and financial analysts. Unfortunately, most organizations face problems in being able to consistently track the transactions associated with each savings initiative, and in accessing the necessary information for immediate analysis to take required corrective action. A savings tracking solution that integrates into an organization's sourcing infrastructure can deliver the necessary data associated with each initiative to help drive compliance and cut maverick spending.
Conclusion
Company executives and procurement leaders should be proactive in developing strategies for how they might meet the challenges of managing through a downturn.
While smart businesses are prepared to take defensive measures that will limit the short-term damage, best-in-class businesses turn the challenge of a downturn into long-term advantage by building stronger customer and supplier relationships. Best-in-class companies therefore understand that superior performance requires preferential treatment from both customers and suppliers.
On the supply side, this means investing in procurement to win the battle for talent, to develop world-class organizations and business practices, and to deploy technology to support them.
About the Author: David Henshall is president of Purchasing Practice, a niche consultancy specializing in procurement serving local and international organizations to improve their purchasing capability and effectiveness. Henshall has more than 25 years experience working in procurement across a range of corporate sectors. For more information, go to www.purchasingpractice.com.
Economic downturns are typically accompanied by large inventory buildups and cutbacks in orders that cascade down the supply chain, often having a devastating effect on unprepared suppliers. In such a climate businesses large and small cannot afford to simply stand by and do nothing. A typical response might be that sales are good and costs are bad, followed by a financial crackdown, to limit the damage to the company's market capitalization and the level of shareholder dividend payments? In other words, get back to financial basics.
At Purchasing Practice, we don't believe this is the right solution. We believe in a more strategic approach to cost reduction. Some costs are actually good because they are a vital component that drives current and future growth. Cutting these too far or in the wrong places can have catastrophic impact on a business. It is the role of strategic cost management programs to consider all types of cost: good, neutral and bad. This assessment can then be used to target cost more effectively and reinvest any savings back into the business. By taking a more strategic approach, we believe, businesses can actually create opportunities to outmaneuver competitors who carry on with business as usual or are unable to adapt quickly, except by wielding the axe and cutting staff.
How Purchasing Excellence Helps
We know from previous downturns that procurement plays a key role in any cost reduction initiative. At Purchasing Practice we believe procurement leaders must use this opportunity to not only cut cost but also build sustainable competitive advantage. Following is a checklist of considerations to keep in mind as you look to leverage this opportunity.
Know your business
Procurement staff must understand the company's objectives and what's important to the company in order to gain a better understanding of its strategic imperatives and business drivers. Purchasing must take the lead while creating close alignments and alliances with key stakeholders across the company.
Stakeholders
Procurement must focus on the issues that are most important to the company. It is no use asking stakeholders, '"How can I help you?'" They might not know! Procurement must lead, and, as successful procurement leaders know, one of the biggest mistakes procurement can make is trying to be all things to all people.
By considering how the wants and needs of stakeholders align with what the organization wants and needs from its stakeholders, procurement can examine its relationship with each stakeholder. Procurement can then assess the strategies, processes and capabilities that are needed in order to satisfy these two critical sets of wants and needs.
The battle for talent
In the end, transforming procurement into a competitive advantage depends on winning the battle for talent.
Procurement talent is in short supply across all sectors, and major organizations globally are finding it a significant challenge to recruit and retain highly skilled, experienced procurement staff. This is a critical consideration as your company examines staffing levels. After all, overzealous cutting can be detrimental to employee morale and increase turnover, sending top performers into the hands of competitors and leaving your organization in a weakened position. In addition, with both the shortage of talent and increased internal financial constraints during a downturn, companies cannot depend on hiring to fill the talent gap; instead, businesses have to develop the skill levels of their existing staff.
- Invest in Training — One lesson from the 1990s downturn is the threat to staff morale caused by layoffs and redundancies among the remaining employees. This syndrome is often called "survivor guilt," and those survivors are often less productive and preoccupied with the short term. Consequently, their behavior becomes highly risk averse, and innovation is stifled. Surveys have found, however, that companies that increased their training after announcing layoffs were twice as likely to report improved profits and productivity as the firms that did not invest in expanded training. Training and development recognize and value employees, and help survivors move on and respond to the new environment.
- Review the staffing mix — World-class procurement executives build organizations that have a much more strategic staffing mix than typical companies. According to past research from Hackett, world-class procurement executives build organizations with 63 percent fewer clerical staff and 31 percent more professionals. The staffing model plays a key role in enabling world-class procurement organizations to perform very differently than typical companies. World-class procurement organizations spend 20 percent less on operations than peers and have about half of the overall staff.
Suppliers
A prolonged industry downturn is typically accompanied by increased supplier instability. Unfortunately, it is still true to say that many organizations do not know enough about their suppliers. This becomes particularly important in a downturn as supply risk can have an even greater impact on a company's success. Organizations require a proactive and predictive strategy towards supplier risk management to understand the realities of their suppliers, partners and the supply chain as a whole, and to determine the impact on the organization if they cannot fulfill their obligations. So how do you manage the risks of procurement?
- Collaborate for success — In order to benefit from collaboration, it must be managed both effectively and selectively. The wrong approach to collaboration may increase costs instead of cutting them, create confusion instead of clarity and drive suppliers away.Examples of collaboration include joint training and development in such areas as Lean processes, data analysis, common systems and aligned metrics. Cost reduction targets, warranty claim reduction and continuous improvement activities.Collaboration requires sharing information freely and transforming this information into knowledge, and then creating value from that knowledge. The ability to create value from knowledge depends on relationships.
- Supplier Relationship Management — Profitability and efficiency is increasingly being driven by good supplier relationship management, working closely with suppliers to achieve corporate objectives. Managing supplier relationships is vital because it allows companies to create value from their intangible assets. Strong supplier relationships can also help drive innovation as it is often the supplier that can identify opportunities for improving processes or providing new materials.For the buying organization, the purpose of investing time in a relationship with a supplier is to ensure that the supplier always operates at peak performance, or if it hasn't been performing satisfactorily, to instigate improvement measures.Supplier relationships can be categorized depending upon their strategic importance to the organization. This then sets a clear framework by which to determine the appropriate intensity of the relationship and how much time and resource should be committed to managing the relationship. A relationship, for example, could be deliberately kept at a distance but still remain good; this could be because it is deemed that there will be no immediate business benefit from having a closer relationship. This could be the case when the goods or services being supplied are relatively low value, infrequently required and pose very little risk to the organization should the security of that supply ever break down. Moving to the other extreme are the long-term close relationships that may be operated as a partnership. This will often be the case when items are high risk, high value and critical to maintaining the organizations operations. (For more on this, visit the Buying Magician Blog at www.purchasingpractice.com/blog to read "Building the Foundations for Preferential Treatment from your Suppliers.")
- Examine supplier finances — A general economic downturn may put some of your suppliers at risk of financial problems. A review of the financial condition of all key suppliers should be conducted, along with closer monitoring of the financial status of these suppliers through the downturn.
- Renegotiate contracts — A downturn in your business will reduce your requirements for goods or services. Review your volume commitments to suppliers under longer-term agreements, especially take-or-pay type agreements, and be proactive in discussing changing requirements with suppliers. Also, be alert to potential changes in inflation when drawing up contracts.Working with suppliers to mitigate risks and insulate against the negative impact of a downturn helps everyone. Share the pain to survive, get serious discussions moving with critical suppliers to share risks and rewards, reduce cost and improve efficiencies in a downturn as well as to prepare for the next growth phase.
Strategies
Manage Your Cost Structure and External Spending
Care must be taken when cutting cost. Too often companies focus on short-term cost reduction, which can result in higher costs over the long term. Common mistakes include:
- Cutting costs in areas critical to future growth and success
- Eliminating costs without addressing root cause issues, such as inefficient business processes
- Cost cutting decisions based on assumptions rather than fact based data.
Strategic Cost Management Strategies in Procurement
Structuring for strategic cost management requires understanding the cost drivers and laying down clear guidelines for how to proceed when first embarking on a cost management program. As you move forward, the task becomes more complex as easy targets are identified and executed and more difficult cost opportunities present themselves.
Typical stages of cost management in procurement are: price drift, price down, cost down, cost out and value add. As companies progress, they move from focusing on reducing cost to removing cost and to adding value, and to be successful they must employ increasingly sophisticated tools and techniques. This includes selecting appropriate supplier relationships and then managing the relationship effectively. Typical tactics may involve simplifying specifications and cutting process waste.
Launch a Strategic Sourcing Initiative
Since the early 1990's, we've heard many examples of the large and sustainable benefits that can accrue when strategic sourcing is applied to attack supply cost.
Strategic sourcing is a collaborative and structured process for dramatically reducing external spending. It is a high-reward, low-risk alternative to traditional cost-reduction initiatives.
Strategic sourcing starts by meticulously defining the requirements for a product or service and continues through the contracting process, followed by ongoing monitoring of the supplier's performance against the defined requirements. By definition, it is very straightforward and commonsense; in practice, it requires skilled leaders to manage the shift in the organization from a traditional procurement organization to a world-class procurement organization.
Strategic sourcing benefits the entire organization by reducing cost, optimizing resources, driving standardization and supporting compliance, while also improving quality, internal processes and lowering total cost. Once realized, savings are sustained through benefits tracking, supplier relationship management and stronger purchasing capabilities.
Manage Inventories
Business downturns are typically accompanied by significant buildup and subsequent write-offs of inventories. Take this opportunity to review materials-planning policies, reduce existing inventories and reexamine prescribed inventory parameters.
Manage Working Capital
Companies striving to improve the way they manage working capital are often handicapped by paper-based, manual invoicing processes that result in lengthy invoice cycle times, which in turn makes it difficult to qualify for and capture early payment discounts. Because these companies allocate so much time and energy to simply processing invoices, they are unable to devote the resources needed to strategically identify and work with suppliers.
Multiple groups, including treasury, finance, AP and procurement, have an impact on an organization's ability to manage working capital effectively, but these groups often work in silos. While each group has its own goals, the entire organization must be aligned to gain maximum working capital efficiencies. For example, managing days payable outstanding and paying suppliers early to capture discounts must be carefully balanced if an organization is to make optimal working capital decisions.
Procurement Excellence
Does excellence matter?
Excellence is no accident. World-class organizations operate and perform very differently than their median peers, reports Hackett. They found that world-class procurement drives 133 percent greater return than typical companies but cuts the cost of procurement by 20 percent. They calculated returns by dividing spend savings (spend reduction attributable to procurement practices) by the total cost of procurement operations. This advantage translates to $3.6 million to the company's bottom line for every $1 million in procurement operations costs.
Leverage the Power of Technology
Many companies have purchase expenditure of up to 60 percent of their overall annual turnover and in some cases even higher. By deploying e-procurement, companies can better manage this spend by creating significant process savings and lowering the absolute cost of the goods and services by ensuring compliance with strategic procurement initiatives.
The benefits:
- Improved procure to pay processes, resulting in increased compliance with strategic procurement contracts and reduced maverick spending
- Increased spend visibility
- Improved working capital management
- Improved contract management and supplier relationship management, resulting in improved monitoring of the suppliers performance.
Delivering these benefits may involve a combination of technologies, such as an e-marketplace for ordering goods and procurement cards for their payment, e-auctions for sourcing initiatives and automated contract management systems, etc.
Achieving the benefits of e-procurement will require the updating of current practices towards best practice. Change management is, therefore, critical to the success of e-procurement.
Drive Compliance and Track Savings
During a downturn, preventing maverick spending and leakage from negotiated contracts becomes even more important. One key performance indicator is whether an organization is on track to achieving their procurement savings initiative goals gained from strategic sourcing and other purchase cost reduction initiatives. The information associated with these initiatives is critical input for annual savings reviews and management reports that communicate savings data to company executives and financial analysts. Unfortunately, most organizations face problems in being able to consistently track the transactions associated with each savings initiative, and in accessing the necessary information for immediate analysis to take required corrective action. A savings tracking solution that integrates into an organization's sourcing infrastructure can deliver the necessary data associated with each initiative to help drive compliance and cut maverick spending.
Conclusion
Company executives and procurement leaders should be proactive in developing strategies for how they might meet the challenges of managing through a downturn.
While smart businesses are prepared to take defensive measures that will limit the short-term damage, best-in-class businesses turn the challenge of a downturn into long-term advantage by building stronger customer and supplier relationships. Best-in-class companies therefore understand that superior performance requires preferential treatment from both customers and suppliers.
On the supply side, this means investing in procurement to win the battle for talent, to develop world-class organizations and business practices, and to deploy technology to support them.
About the Author: David Henshall is president of Purchasing Practice, a niche consultancy specializing in procurement serving local and international organizations to improve their purchasing capability and effectiveness. Henshall has more than 25 years experience working in procurement across a range of corporate sectors. For more information, go to www.purchasingpractice.com.
