Article

Companies think procurement costs are outside their control—they are not

If there was a time to take another look at procurement savings as a way to reduce costs, free up cash and improve margins, it is now.

Par Sudarshan Sampathkumar, Greg Gerstenhaber and Sumit Nadgir

First published on juin 07, 2013
min


This article originally appeared in the Economic Times Corporate Dossier. The strong headwinds of declining GDP growth and weak industrial output are focusing managements’ thinking once again on the need to improve efficiencies and cut costs. In such a challenging climate, you would expect businesses to have procurement top of mind, as such costs typically amount to as much as 60% of the cost base in most industrial and manufacturing-oriented companies. However, the attention and resources devoted to procurement rarely match the annual outlay it represents. Many firms put more stress on extracting additional savings from conversion costs and manufacturing efficiencies, rather than adequately examining the possibilities of reducing procurement costs, mostly considered as “outside-my-control.” If there was a time to take another look at procurement savings as a way to reduce costs, free up cash and improve margins, it is now. Some firms succeed by implementing a smarter and more comprehensive approach to what they buy. These companies are then better positioned to fund strategic initiatives from savings generated through procurement cost reductions. Let’s look at some of the steps they have undertaken. Look at the mix and consumption of what you buy: Our global experience suggests that procurement functions typically look at the overall cost of procured goods, but not at the mix or consumption. This one-size-fits-all strategy is far from optimal. Consider an electrical component manufacturer in India where an SKU rationalization process, based on actual consumption, revealed that 80% of SKUs only contributed to 8% of sales. By discontinuing and outsourcing many SKUs, the company simplified its complex procurement organization leading to significant savings, reduced material costs and an improved focus on high-value SKUs. Recognize potential of “design-to-procure”: A significant portion of procurement costs get committed when products are designed. Most firms tend to overlook the design aspect while selecting procurement optimization initiatives, as it typically demands significant cross-department alignment. However, involving design and quality control teams in procurement planning can result in significant improvements in the procurement process through initiatives such as standardization, complexity reduction and improved design specifications. Take the case of the procurement team of an Indian manufacturing firm producing steel equipment for the oil and gas sector. The company purchased all its processed commodity metals only from best-quality suppliers. However, when it re-categorized the materials with the help of the design and sales departments, the firm reaped significant savings by using economical and standardized materials in categories where customers did not need expensive material for their equipment orders. Another example is that of a real estate firm which captured over 10% in savings against initial estimates by conducting a standardization and value-engineering drive before issuing drawings for construction. Extend scope of procurement to vendor operations and beyond: Mature procurement and manufacturing processes must encompass the entire supply chain―certainly including suppliers, and possibly the supplier’s supplier. The vendor may not have the expertise, resources and, arguably, the incentives to constantly look for improvements. Supporting suppliers on efforts such as raw material consolidation and working capital funding can result in long-term and mutually beneficial partnerships. Sometimes, a closer look at suppliers’ operations can result in savings. An Indian industrial goods manufacturer buying from large global steel mills faced high wastage, quality issues and bulging inventories. A closer analysis of the steel mills’ processes revealed the buyer’s inability to control material specifications: This was partially due to the supplier’s processes but also because of the buyer’s low bargaining power; both of which resulted in higher costs. To address the problem, the buyer developed relationships—and invested in—smaller steel mills resulting in significant savings through minimized wastage and lesser inventory, as well as lower prices. Apply TCO to address internal inefficiencies: Your own processes can increase the cost of procured goods or make it more expensive for your vendor to supply your company. Examining the total cost of ownership (TCO)—everything from supplier overheads to raw materials to the distribution costs involved in final delivery—can help uncover these costs. One construction company in India found that only 60% of the labour hours it paid workers were productive because of poor coordination. There were three key reasons for the idle paid labour. First, there were no agreed specifications for building materials; second, there were delays in receiving materials; and finally, constant amendments to existing specifications were causing further hold-ups. Or take the example of an international appliance company which had delegated most of its ocean freight decisions to its transportation department—whose primary focus was getting the products through the supply chain on time. When the procurement department got involved, it discovered that the placement of products inside shipping containers left 30% of space unused. Instead of haggling with the shipper to marginally reduce prices, the procurement department worked with other business units to redesign how the product was assembled and packed, lowering consumption of raw materials—and ocean freight costs—by 25%. In today’s trying economic environment, companies need to constantly evolve their procurement strategy. However, Indian companies tend to focus on controlling their supply chain and “insource” rather than outsource. This may not be the right approach. As many vendors become increasingly sophisticated, companies need to constantly re-examine operations to see if they can be outsourced to a lower cost and/or higher capability vendor. Mapping the extended supply chain in conjunction with internal operations can open up opportunities, particularly at the periphery of the organizational supply chain. However, in a survey conducted by Bain more than 70% of global executives said their efforts to reduce procurement costs slipped significantly within a year. Given this finding it would be wise to set up monitoring systems under an accountable Program Management Office. As companies look to beat the downturn, focusing on procurement optimization can be a high-return investment—making the difference between a company able to make strategic investments to secure its future and one that struggles to keep up. Sudarshan Sampathkumar is a partner with Bain & Company in Mumbai and leads the firm’s Performance Improvement practice in India. Greg Gerstenhaber is a partner with Bain in Dallas and a member of the Performance Improvement practice. Sumit Nadgir is a senior manager with Bain in India and a member of the Performance Improvement practice.

This article originally appeared in the Economic Times Corporate Dossier.

The strong headwinds of declining GDP growth and weak industrial output are focusing managements’ thinking once again on the need to improve efficiencies and cut costs.

In such a challenging climate, you would expect businesses to have procurement top of mind, as such costs typically amount to as much as 60% of the cost base in most industrial and manufacturing-oriented companies. However, the attention and resources devoted to procurement rarely match the annual outlay it represents. Many firms put more stress on extracting additional savings from conversion costs and manufacturing efficiencies, rather than adequately examining the possibilities of reducing procurement costs, mostly considered as “outside-my-control.”

If there was a time to take another look at procurement savings as a way to reduce costs, free up cash and improve margins, it is now.

Some firms succeed by implementing a smarter and more comprehensive approach to what they buy. These companies are then better positioned to fund strategic initiatives from savings generated through procurement cost reductions. Let’s look at some of the steps they have undertaken.

Look at the mix and consumption of what you buy: Our global experience suggests that procurement functions typically look at the overall cost of procured goods, but not at the mix or consumption. This one-size-fits-all strategy is far from optimal. Consider an electrical component manufacturer in India where an SKU rationalization process, based on actual consumption, revealed that 80% of SKUs only contributed to 8% of sales. By discontinuing and outsourcing many SKUs, the company simplified its complex procurement organization leading to significant savings, reduced material costs and an improved focus on high-value SKUs.

Recognize potential of “design-to-procure”: A significant portion of procurement costs get committed when products are designed. Most firms tend to overlook the design aspect while selecting procurement optimization initiatives, as it typically demands significant cross-department alignment.

However, involving design and quality control teams in procurement planning can result in significant improvements in the procurement process through initiatives such as standardization, complexity reduction and improved design specifications.

Take the case of the procurement team of an Indian manufacturing firm producing steel equipment for the oil and gas sector. The company purchased all its processed commodity metals only from best-quality suppliers. However, when it re-categorized the materials with the help of the design and sales departments, the firm reaped significant savings by using economical and standardized materials in categories where customers did not need expensive material for their equipment orders.

Another example is that of a real estate firm which captured over 10% in savings against initial estimates by conducting a standardization and value-engineering drive before issuing drawings for construction.

Extend scope of procurement to vendor operations and beyond: Mature procurement and manufacturing processes must encompass the entire supply chain―certainly including suppliers, and possibly the supplier’s supplier. The vendor may not have the expertise, resources and, arguably, the incentives to constantly look for improvements. Supporting suppliers on efforts such as raw material consolidation and working capital funding can result in long-term and mutually beneficial partnerships.

Sometimes, a closer look at suppliers’ operations can result in savings. An Indian industrial goods manufacturer buying from large global steel mills faced high wastage, quality issues and bulging inventories. A closer analysis of the steel mills’ processes revealed the buyer’s inability to control material specifications: This was partially due to the supplier’s processes but also because of the buyer’s low bargaining power; both of which resulted in higher costs. To address the problem, the buyer developed relationships—and invested in—smaller steel mills resulting in significant savings through minimized wastage and lesser inventory, as well as lower prices.

Apply TCO to address internal inefficiencies: Your own processes can increase the cost of procured goods or make it more expensive for your vendor to supply your company. Examining the total cost of ownership (TCO)—everything from supplier overheads to raw materials to the distribution costs involved in final delivery—can help uncover these costs. One construction company in India found that only 60% of the labour hours it paid workers were productive because of poor coordination. There were three key reasons for the idle paid labour. First, there were no agreed specifications for building materials; second, there were delays in receiving materials; and finally, constant amendments to existing specifications were causing further hold-ups.

Or take the example of an international appliance company which had delegated most of its ocean freight decisions to its transportation department—whose primary focus was getting the products through the supply chain on time. When the procurement department got involved, it discovered that the placement of products inside shipping containers left 30% of space unused. Instead of haggling with the shipper to marginally reduce prices, the procurement department worked with other business units to redesign how the product was assembled and packed, lowering consumption of raw materials—and ocean freight costs—by 25%.

In today’s trying economic environment, companies need to constantly evolve their procurement strategy. However, Indian companies tend to focus on controlling their supply chain and “insource” rather than outsource. This may not be the right approach. As many vendors become increasingly sophisticated, companies need to constantly re-examine operations to see if they can be outsourced to a lower cost and/or higher capability vendor. Mapping the extended supply chain in conjunction with internal operations can open up opportunities, particularly at the periphery of the organizational supply chain.

However, in a survey conducted by Bain more than 70% of global executives said their efforts to reduce procurement costs slipped significantly within a year. Given this finding it would be wise to set up monitoring systems under an accountable Program Management Office.

As companies look to beat the downturn, focusing on procurement optimization can be a high-return investment—making the difference between a company able to make strategic investments to secure its future and one that struggles to keep up.

Sudarshan Sampathkumar is a partner with Bain & Company in Mumbai and leads the firm’s Performance Improvement practice in India. Greg Gerstenhaber is a partner with Bain in Dallas and a member of the Performance Improvement practice. Sumit Nadgir is a senior manager with Bain in India and a member of the Performance Improvement practice.