Companies have invested heavily in building strategic-sourcing functions designed to reduce the cost of purchased goods and services, with the intention of making savings and so increasing profit margins. Despite the money invested, which often takes the form of recruiting staff and implementing new technology, it is not uncommon for half or more of the reported savings never to reach the bottom line. Why is this? The short answer is that most category teams lack the ability to mobilise business units to change behaviour and stop leakages (e.g. non-compliance, sales giveaways, customer issues, etc.) that end up cannibalising savings.
Leakages occur for many reasons:
To address these leakages, companies realise that an effective sourcing programme needs to do more than simply negotiate better prices from suppliers. Successful companies have developed the know-how to translate savings into realised earnings before interest and taxes (EBIT).
How have they done this? They focus on raising the level of their sourcing capability, selling the benefits and changing behaviours in known areas of leakage by:
1. Building capability for continuous improvement (not one-time benefits) by:
2. Reducing supply-chain complexity by:
3. Streamlining procurement and aligning sales/procurement metrics by:
4. Proposing a win–win situation for customers by:
Very few companies have successfully realised the savings potential from their sourcing programmes without institutionalising processes like these for driving results that deliver value to the bottom line. Instead, many companies conduct sourcing programmes that identify value and then declare success, making little impact on EBIT.
So, is your strategic-sourcing programme delivering real savings, or just reporting numbers that never seem to impact the bottom line?
- No established savings methodologies: category teams tend to be over-optimistic with their savings projections. They assume that switching to new suppliers can be accomplished quickly, when in reality most of these changes require weeks – or even months – to implement.
- Supply-chain complexity: global sourcing takes advantage of cheaper goods from low-cost countries. However, these cost reductions can be offset quickly if the extended supply chain is difficult to manage and requires added inventory (safety stock), so increasing carrying costs.
- Maverick purchases: satellite offices are often far enough away from the head office to get away with using non-approved suppliers. In such cases, convenience often outdoes savings, and enables employees to rationalise the unchecked use of their suppliers regardless of financial consequences.
- Sales practices: sales departments accustomed to cost-plus selling often show little deference to reduced input costs. Instead, they continue to price jobs at the ‘allowable’ margin rather than at the ‘enhanced’ margin that could be achieved by leveraging the reduced costs won from suppliers.
- Customer requirements: customers may present a barrier by being unwilling to convert to new (but equivalent) products and suppliers, citing time constraints for testing new products and qualifying new suppliers. Often, customers have to be convinced to switch with a lower price, thus eroding a portion of the savings.
To address these leakages, companies realise that an effective sourcing programme needs to do more than simply negotiate better prices from suppliers. Successful companies have developed the know-how to translate savings into realised earnings before interest and taxes (EBIT).
How have they done this? They focus on raising the level of their sourcing capability, selling the benefits and changing behaviours in known areas of leakage by:
1. Building capability for continuous improvement (not one-time benefits) by:
- involving the right people from the beginning, and assembling a team that includes decision-makers
- upgrading the talent level within the team, and improving processes to assess total cost rather than just price, through changing the focus from managing transactions to managing spend categories and suppliers, leading to improved sourcing decisions and more realistic savings forecasts;
- capturing negotiated savings in contracts, rigorously enforcing contractual obligations and effectively managing suppliers to lock in the savings;
- creating Key Performance Indicators (KPIs) and using dashboards to track savings and to facilitate regular communication among stakeholders, so that areas of leakage can be identified and addressed.
2. Reducing supply-chain complexity by:
- optimising end-to-end supply chains by creating natural supply chains and tailoring offerings based on customer segments;
- investigating ‘local’ sourcing as an alternative to global sourcing
- avoiding hard-to-manage supply chains that appear to deliver savings, but actually wash out most, if not all, savings by increasing inventory or introducing unfavourable payment terms.
3. Streamlining procurement and aligning sales/procurement metrics by:
- increasing compliance through eliminating ‘everyone’s can be a buyer’ behavior;
- tailoring sales compensation to reward margin growth.
4. Proposing a win–win situation for customers by:
- passing on a proportion of savings to entice them to buy into new sourcing efficiencies, and offering other incentives in terms of improved service levels and supply reliability.
Very few companies have successfully realised the savings potential from their sourcing programmes without institutionalising processes like these for driving results that deliver value to the bottom line. Instead, many companies conduct sourcing programmes that identify value and then declare success, making little impact on EBIT.
So, is your strategic-sourcing programme delivering real savings, or just reporting numbers that never seem to impact the bottom line?