By: Sampathkumar Sudarshan & Carlos Niezen


With the downturn affecting virtually every industry, companies are looking for cash. There's no easier way to generate quick cash without salary cuts, bonus reductions or painful layoffs than to find cost savings in purchasing.


The purchasing of goods and services is one of the largest, if not the largest cost category-for most businesses it represents a significant cost, in some cases exceeding 50% of their total expenses. And the savings can be substantial. In our experience, companies taking a systematic approach can save 5-to-30% of their total costs from purchasing.


The trouble is, in downturns most companies feel caught in a bind. Do they devote their efforts to generating fast money by renegotiating with suppliers? Or do they invest to build the broad purchasing capabilities that will help them come out of the downturn with a stronger competitive position? Too often companies think they need to choose between the two.


Acting under pressure they often take reflexive actions that end up damaging them in the middle to long term. They fail to align their purchasing strategy with their corporate strategy. They grab whatever costs they can for short-term gain (sometimes even driving promising suppliers to the brink of bankruptcy), when slightly more effort would deliver better-and lasting-results.


We've identified an approach that allows companies to build supply management capabilities while also addressing their short-term needs for cash and profits. This stratagem has three key steps.


Sizing the opportunity:


Sizing-and understanding-the opportunity for purchasing gains is the first step in strategic purchasing. How do companies objectively determine how much of their cost saving targets can be delivered by purchasing-and, crucially, link it to strategy?


A company we'll call Food Co. wanted to use its scale to gain competitive advantage in purchasing. As a broad effort to set cost saving targets, Food Co. conducted an "experience curve" analysis aimed at understanding how much its supplier of plastic bottles should be charging, based on the fact that the supplier's costs to produce each bottle should have declined during its years of experience. The exercise was spurred by the fact that the supplier wanted to increase its prices.


For its part, Food Co. also conducted a make vs. buy analysis to determine if it would be more cost effective to produce the bottles itself, and also used broad benchmarking-looking beyond its company and industry for benchmarks-to set savings targets. Thus, Food Co. was not only able to strategically set accurate saving targets for purchasing in a critical category but also turn around supplier negotiations in its favour. Faced with quantitative evidence, its supplier of plastic bottles decided to decrease its prices rather than increase them- and Food Co. saved an annual $7 million.


Finding Quick Hits:


When it comes to generating quick cash, strategic supply leaders typically look inward for places to cut demand. Companies have the most options for cuts in spending for indirect supplies everything from travel to printers. They can quickly impose tighter expense policies and approvals. In tough times, just enforcing compliance can make the cash register ring.


They can put in place stricter approvals for staffing services-and analyse the top 20% in terms of cost with the aim of driving those contracts down between 10 to 20%. They can save on facilities costs by re-negotiating leases with less than three years remaining, trading lower rates for lease extensions. For owned buildings they can apply for property tax reassessments. They can cut back on office support such as janitorial and other facilities staff or re-bid with local contractors. One US bank saved $3.1 million within a year through such means.


 

The next step is to reduce unit prices for indirect supplies. Companies can eliminate off-contract buying, drive down purchase prices with reverse auctions and substitute for lower-cost items like printers. It's always important to balance short-term and long-term considerations. Squeezing quick cash out of an important supplier generally isnt worth it if it will come back to haunt you.


Only after shrinking demand and unit prices for indirect costs should companies take on the bigger challenge of pursuing per-unit cost reductions for direct supplies.


Getting on Firm Footing:


A downturn is the time to consider whether you are sourcing from the right suppliers to support your strategy. Leading companies will pick long-term winners by assessing total cost of ownership, instead of only invoice price. Taking a total cost of ownership approach can help companies rationalise suppliers and also makes it easier to identify opportunities where both suppliers and purchasers can jointly save.


Winning companies also look at how the purchase fits into a bigger scheme of things. For example, because it is charged fines for delayed projects, one construction company takes into account product delivery times. Depending on their business strategy, other companies consider factors like R&D capabilities and ability to innovate, quality of management, industry position and willingness to collaborate across critical fronts.


We find that companies involve purchasing too late in the game in the product development process, and fail to consider the cost impact of their design decisions. Take the case of a cardboard box maker that waited until after it had selected a supplier to call in the purchasing department to negotiate the contract. Had purchasing decisions been considered at the design stage, the company could have considered using two colours instead of three, and a less expensive printing process. Typically, around 60 percent of purchasing costs is committed at the design stage.


To keep the benefits coming, leading companies ensure that there is a clear owner for each key decision, and that decisions are made swiftly, at the right level, and with the right inputs. They install a higher caliber of purchasing talent to track performance. That will help the company keep purchasing costs from creeping up long after the economic turmoil subsides.



Written by Sampathkumar Sudarshan who is a partner with Bain & Company, India and Carlos Niezen who is Bain partner in Mexico City


Originally published in "The Economic Times" dated June 5, 2009