South China Morning Post

Substantial savings possible in purchasing

By Raymond Tsang, Marc Lamure and Carlos Niezen

Published on August 17, 2009
min read


Facing the prospects of slower growth, mainland companies are looking for cash. There is no easier way to generate quick cash without salary cuts, bonus reductions or painful lay-offs than cost savings in purchasing. The purchasing of goods and services is one of the largest cost categories, in some cases exceeding 50 per cent of total expenses. And the savings can be substantial. In our experience, companies taking a systematic approach can save 5 to 30 per cent of their total costs from purchasing. The trouble is in periods of economic turbulence, most companies feel caught in a bind. Do they try to generate fast money by renegotiating with suppliers? Or do they invest to build the broad purchasing capabilities that will help the company come out of the downturn with a stronger competitive position? Acting under pressure, companies 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 (in some instances even driving promising suppliers to the brink of bankruptcy), when slightly more effort would deliver better—and lasting—results. We have identified an approach that allows companies to build supply management capabilities while also addressing their short-term needs for cash and profits. This strategy 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? As a broad effort to set cost-saving targets, a firm we will call FoodCo conducted an "experience curve" analysis aimed at helping it understand how much its supplier of plastic bottles should be charging, based on the fact that the supplier's production costs should have declined during its years of experience. One way companies can capture cost reduction in an experience curve is by constructing a supplier cost sheet which encompasses all components of cost incurred by a supplier to deliver the end product. For its part, FoodCo also conducted a make versus 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. 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. 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 per cent in terms of cost with the aim of driving those contracts down 10 to 20 per cent. They can save on facility costs by renegotiating leases with less than three years remaining, trading lower rates for lease extensions. They can cut back on office support such as janitorial and other facilities staff or re-bid with local contractors. 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. 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. 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 firms consider factors like research and development capabilities and ability to innovate, quality of management, service levels, industry position and willingness to collaborate across critical fronts. Raymond Tsang is a Bain & Co partner based in Shanghai, Marc Lamure is a partner in Beijing and Carlos Niezen is a partner in Mexico City.

Facing the prospects of slower growth, mainland companies are looking for cash. There is no easier way to generate quick cash without salary cuts, bonus reductions or painful lay-offs than cost savings in purchasing.

The purchasing of goods and services is one of the largest cost categories, in some cases exceeding 50 per cent of total expenses. And the savings can be substantial. In our experience, companies taking a systematic approach can save 5 to 30 per cent of their total costs from purchasing.

The trouble is in periods of economic turbulence, most companies feel caught in a bind. Do they try to generate fast money by renegotiating with suppliers? Or do they invest to build the broad purchasing capabilities that will help the company come out of the downturn with a stronger competitive position?

Acting under pressure, companies 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 (in some instances even driving promising suppliers to the brink of bankruptcy), when slightly more effort would deliver better—and lasting—results.

We have identified an approach that allows companies to build supply management capabilities while also addressing their short-term needs for cash and profits. This strategy 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?

As a broad effort to set cost-saving targets, a firm we will call FoodCo conducted an "experience curve" analysis aimed at helping it understand how much its supplier of plastic bottles should be charging, based on the fact that the supplier's production costs should have declined during its years of experience.

One way companies can capture cost reduction in an experience curve is by constructing a supplier cost sheet which encompasses all components of cost incurred by a supplier to deliver the end product.

For its part, FoodCo also conducted a make versus 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.

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. 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 per cent in terms of cost with the aim of driving those contracts down 10 to 20 per cent. They can save on facility costs by renegotiating leases with less than three years remaining, trading lower rates for lease extensions. They can cut back on office support such as janitorial and other facilities staff or re-bid with local contractors.

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.

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. 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 firms consider factors like research and development capabilities and ability to innovate, quality of management, service levels, industry position and willingness to collaborate across critical fronts.

Raymond Tsang is a Bain & Co partner based in Shanghai, Marc Lamure is a partner in Beijing and Carlos Niezen is a partner in Mexico City.