During a normal year, many companies envision improving procurement practices as part of their standard continuous improvement approach. However, the development of pragmatic implementation plans and roadmaps for procurement efforts are often superseded as procurement staff focus on sustaining operations and resolving emergency vendor issues. COVID-19 has led to short-term and long-term transformations for many businesses in all aspects of the value chain including procurement activities. Consequently, there is no better time than now to prepare for and execute changes in procurement strategy to modernize procedures and bring about tangible cost savings.
Below are five tried-and-true procurement strategies that businesses can leverage as they identify the optimal approach to procurement while adapting to the new normal:
Improving Vendor Joint Processes
Procurement staff must work closely with vendors when developing contract structures in order to ensure the desired outcome is properly incentivized. Preparing contracts that are not focused on the appropriate metrics and outcomes can often lead to inadequate results. For example, one of my international mining clients was very disappointed with the underperformance from a newly signed service provider. Upon a deep-dive contract review, we discovered a fundamental misalignment as the vendor was being paid by the number of hours of service performed (an input KPI) rather than by the amount of tons serviced (an output KPI). By collaborating with the vendor and addressing the fundamental misalignment by modifying the contract, my client realized a ~60 percent increase in its tons serviced while reducing contract costs by 40+ percent.
Disaggregating Products and Services
There are often opportunities to disaggregate and remove non-value-add components of a product or service from features that are critical to the value proposition. This occurs when the buyer and seller have different perspectives on the value provided by certain aspects of the product or service offering. To give an example, a publicly-traded healthcare client was looking to reduce costs on a line of generic healthcare items. Through a benchmarking exercise, I identified that a significant portion of the item costs was attributed to our vendor’s marketing and sales support. Consequently, I was able to negotiate a 35 percent cost reduction on my client’s behalf after gaining alignment that the vendor’s marketing and sales support could be managed internally without an impact on product sales. Therefore, it is critical for procurement staff to have a comprehensive understanding of all components of product and service offerings that vendors evaluate when determining product and service prices.
Understanding End-User Needs
At its essence, the core function of a business is to provide a solution to a customer problem through a product or service. While this may sound overly simplistic, there are numerous instances in which organizations can fulfill end-user needs in exactly the same manner at a lower cost via slight changes in product/service specifications. This applies equally to situations in which the end-user is an external customer or an internal stakeholder. A large natural resources client achieved a 30 percent cost reduction by transitioning from a name brand chemical product to a generic with no difference in underlying product performance as validated via technical product trials. An airline was able to reduce a critical food item cost by 5 percent by switching fruit flavors. I also assisted a steel manufacturing company in reducing engineering contractor costs by 15 percent. This cost reduction was achieved by better aligning the fit for purpose between the skill level required for the engineering task and the seniority of the engineer completing the task.
Leveraging Should Cost Models
It is important for procurement teams to understand which high-spend items present the largest opportunities for potential savings. One of the most powerful approaches to gaining an understanding of the underlying costs of an item is to develop a “should cost model.” A should cost model is a bottom-up calculation of how much it “should cost” to manufacture an item or provide a service. A comprehensive should cost model will identify and quantify variable costs (e.g. raw material costs), fixed costs (e.g. labor costs, overhead costs), freight costs, and profit margin that comprise total vendor pricing. Items in which there is a significant variation between the “should cost model” pricing and the current vendor pricing may present immediate opportunities for cost reductions via supplier negotiations. For instance, I achieved a 25 percent cost reduction on the non-fixed costs of a major chemical product on behalf of a public mining and metals company via vendor negotiations. The success of these negotiations was bolstered by a detailed should cost model in combination with benchmark analyses on key raw material, packaging, and freight costs.
Improving Internal Processes and Usage
In addition to collaborating with external vendors to advance procurement outcomes, businesses must also focus on improving internal processes to uncover the full set of procurement opportunities. Often times, procurement outcomes can be improved not only by achieving better pricing from suppliers, but also from optimizing internal product and service usage. For instance, I led an initiative for a VC-backed food client to reduce fruit costs by 15-25 percent across 8 regions while supplying 70 million servings of fruit to its customers annually. Previously, the company lacked a standardized, rigorous, and quantitative menu approach across its 8 regions to minimize costs. As a result, I developed and implemented an optimal fruit rotation for each region which met all nutritional, variety, operational, end-user satisfaction, and packaging requirements. In order to generate the optimal fruit rotation, I built an automated software tool. The simple tool ensures the sustainability of the approach by allowing procurement staff to input new fruit prices monthly which automatically updates the optimal fruit rotation.
Process improvements and cost reductions have increasingly become focal points as companies react to the monumental impact of COVID-19. Organizations are encouraged to identify potential opportunities in which they can implement some or all of the aforementioned five procurement strategies. Completing this opportunity identification exercise will be a valuable initial step in setting up procurement for long-term, sustainable success.
Brad Maltz WG07 is president of Brad Maltz Consulting Inc. and has supported domestic and international clients in generating more than $100 million in annual savings via procurement and strategic sourcing initiatives across multiple industries.