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Emerging stronger
from the crisis

Reducing costs in Procurement

Politicians and thought leaders have been preaching it for a while: after the pandemic, the economy needs a fresh start. The first virtual World Economic Forum being held under the title “The Great Reset” is an example of this. But the new start can only succeed if companies set out sustainable cost management measures. A tour de force that the future of many companies rests on.

The pictures that went viral around the world were astonishing yet frightening at the same time. Planes parked in hangars or on the tarmac. Freight trains halted at stations. And from a bird’s eye view, the world’s oceans looked in some places like a game of Battleships: row upon row of them, anchored in ports across this planet.

The months of standstill and lockdown have led to some bizarre situations. What can an airline do if it is not allowed to fly? What can a factory do if it cannot produce anything because it is missing parts that it normally sources from all over the world? What can a restaurant do if no guests are allowed to dine?

For many companies, this phase has been an economic disaster. For others, it has meant watching from the sidelines, hoping that their industry will not be impacted next. In either case, it is now as important as ever for companies to streamline their operations and drastically cut costs to protect turnover as well as margins.

Step 1:

Determine and leverage your own position

The pandemic has impacted different industries in different ways. On the one hand, there are industries such as aviation, tourism, and gastronomy, which are suffering extremely from lockdown after lockdown. They depend on cutting costs quickly to survive the current phase reasonably unscathed. To make a ‘fresh start’ and be well equipped for the long-term, they need to implement both immediate measures (see step 2) and a sustainable strategy that must be continuously reviewed.

The winners of the crisis, on the other hand, include tech companies that are profiting from the home office boom, the food delivery trade and, to a certain extent, the automotive industry, which has proven through professional structures that even a difficult market can be mastered during the crisis. The automotive sector came through the crisis relatively well, because supply chains are already very transparent and companies can control not only suppliers but also sub-suppliers. Such professional structures and transparent information help to react quickly and effectively to a changing market situation and to avert possible crises through good risk management.

Similar reasoning applies toward the supply-base of each company, which also includes winners and losers from the current situation, and where the market situation has changed extremely quickly in some industries. While 2020 saw opportunities for reducing supplier prices in many areas for those who could provide a stable demand, the opposite has also been true in some categories in the beginning of 2021. Recent examples include spikes in steel and other raw materials, container freight, and packaging, as parts of the economy rebound, while supply is slow to catch up to previous levels.

Ensuring an agile procurement department is key, acting on opportunities when they arise and protecting the business from increasing costs and supply disruptions when and where demand outweighs supply.

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It is now as important as ever for companies to streamline their operations and drastically cut costs to protect turnover and ensure survival.

„We prepared the current annual reviews strategically and used them to strengthen the partnership with our suppliers. In addition to prices and quality, the main focus was on the further development of our product portfolio and the use of innovative materials. This and the fact that we can offer our partners security despite the crisis ultimately also had a positive impact on cost structures.“

Maryne Lemvik CEO, Skanem AS

Step 2:

Managing demand and implementing immediate measures

Demand structures have changed massively due to the crisis, especially indirectly. Under the current conditions, IT departments in many companies, for example, have had to spend more to ensure their digital infrastructure fully supports working from home. Conversely, travel costs have dropped massively. In marketing, on the other hand, larger in-person events have been cancelled, but the costs for online communication have risen.

In addition to such involuntary changes in operations and the associated costs, the crisis has forced many companies to implement budget cuts and spending freezes across the board to protect the core business. As the economy begins to recover, opening such budgets may seem reasonable, however this risks missing opportunities to stabilize costs at a more competitive level.

Many departments have had to question current practices and demands on suppliers, identifying ways to reduce requirements, volumes, or insource. As an example, budgets for printed sales materials went down in the pandemic, and now this is an excellent opportunity to cement the shift to digital, rather than fall back into old habits.

A company-wide re-evaluation of demand management should take into account the latest shifts in operations and customer behavior, as well as the best current view of the rebound for the company’s market. Based on this, budgets should be re-distributed within the company, with the ambition to stabilize them between historical and lockdown levels.

The decisive factor here is to not leave this solely to the specialist departments such as IT, or the line business. Procurement can help identify concrete potentials for cost reduction and define measures to accomplish that. The best results will be achieved by combining reasonable top-down budget revisions, with a mandate for procurement to facilitate demand management exercises in relevant departments.

Demand & Budget Management

How to avoid unnecessary expenses

Examples

Demand guidelines

  • Introduction or optimization of guidelines demand guidelines for certain materials & services
  • Increase/sensitize cost awareness of employees

4–6 h flights:
Premium Economy instead
of Business Class

Demand control

  • Define or adjust approval processes and thresholds for budgets
  • Verification of expenses by responsible person

Order of big mobile phone
plan has to be approved by
department manager

Operating life

  • Reduction of ordering frequencies
  • Optimization of operating life

Replacement of mobile phones
after 3 instead of 2 years

Elimination

  • Reduction of required amount or cancellation of budget elements
  • Goal: avoid unnecessary operating expenses

Back office: 3 GB
Field service: 5 GB

Examples

Step 3:

Re-evaluate your long-term supply strategy

Once the tactical situation is under control in terms of reallocating budgets, optimizing prices with current suppliers, and ensuring stable supply, it’s time to look ahead at your long-term supply set-up. Disruptions in supply chains such as steel and logistics have shown which suppliers hold firm under pressure and which ones don’t, as well as which suppliers prioritize your business or not.

Many European packaging producers have recently been prioritizing customers buying high-end products, cherry-picking to enhance margins while consumers order increasingly online. Revelations such as these have been painful for many companies and have taken up a lot of energy over the past year. But as supply and demand catch up with each other in various industries over the coming quarters, it’s also time to broaden the perspective and think long-term based on the latest learnings. Procurement should analyze the current situation together with other departments in the company, such as logistics, production, finance and the specialist departments.

The pandemic has made it clear like never before that processes in the company are interlinked and that a stable supply chain is at least as important as cost-effective procurement. In some areas, this will mean spreading supply among more suppliers and countries to lower risks, while in others, spending may need to be consolidated.

After the pandemic, companies cannot simply dust off the plans for 2020 and pick up where they left off. The past year has speeded up several pre-existing mega-trends, such as remote working and sustainability. As a result, the demands on products and suppliers are also changing, which calls for multiple fundamental changes for companies if they want to survive in the future.

As an example, companies should dovetail procurement and product development more closely. The earlier procurement knows which innovations the product development team is planning, the better it can take this into account when looking for a suitable supplier and thus reduce costs. And involving the right suppliers at an early stage of product development can shortcut finding cost-efficient solutions.

This is also a good time for CPOs and CFOs to reflect on the overall strategy, targets, and measurements for the procurement departments. Some of the recent lessons could be built into  steering procurement’s function and potentially the operating model vis-à-vis the business. The case for looking beyond savings and also accounting for total costs, supply chain security, risk exposure, and sustainability is as strong as ever. And ensuring these targets are mirrored in production and supply chain, for example, can help smoothen transitions between suppliers.

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Step 4:

Optimizing costs throughout the supply chain in the long-term

Having set the long-term strategy, now you have to find the actual solutions, changes, and so on. The factors impacting the success of operational procurement are endless, but there are four which should apply to most companies.

Transparency is fundamental

Transparency in the supply chain is currently the most important factor. It allows companies to plan better and possibly even reduce costs they didn’t even know about. Digital data pools make it possible not only to trace the supply chain, but even to control it. Let’s look at one example: a large furniture maker purchases risers from one supplier. Procurement does not simply order them, but has also contracted tier 2 suppliers to supply edges, cardboard, and foils to the risers supplier. Orders are sent by the furniture company to both the tier 1 and tier 2 supplier at the same time.

Total Cost of Ownership (TCO)

is a method of cost calculation that takes into account all the costs incurred during the lifecycle of a product or service. This includes both acquisition cost, running costs such as maintenance and repair, and end-of-life costs. The goal is to identify all relevant and potentially hidden costs in order to take better business decisions.

During the last oil crash, many companies were persuaded by their suppliers that the savings would arrive later and settled for smaller price reductions, even though they could have secured more. This means it’s a good year for granules manufacturers – at the expense of customers.

Suppliers have a tendency to cite rising indices in times of increases, but keep silent when they are falling. Adopting a long-term perspective can balance the situation, as can digging into the specific circumstances of the supplier. Labor costs are sometimes cited as a reason for pushing through price increases. This can look plausible based on country indices, but the supplier’s specific situation may tell a different story, e.g. if they change the skill level of employees or shift their mix of permanent versus temporary workers.  Companies that keep an eye on the relevant data and are willing to dig into their suppliers’ annual accounts and other indicators can achieve a better negotiating position. Because knowledge is power. Digital solutions can help in this regard, such as a common approach for modeling suppliers‘ cost developments, based on raw material developments, energy, labor costs etc.

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Adopting a long-term perspective can balance the situation, as can digging into the specific circumstances of the supplier.

With the help of extensive auctions, we were able to stimulate competition between our suppliers and succeeded in breaking up previous structures. In addition, we were also able to win over new suppliers and integrate them into our portfolio.“ - Michal Svátek Director Global Continuous Improvement, United Initiators

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Be open to new solutions

Since the pandemic began, the downside of low-cost, but possibly long and vulnerable supply chains has made itself painfully clear. A fledgling electronics manufacturer previously sourced a large proportion of its parts from China, which was initially cost-effective. Considering the long supply route, some variability in quality, but primarily the uncertainty of sourcing from only one supplier, the company has since decided on a dual-source solution, with new suppliers in Eastern Europe. This has stabilized the supply chain, put the company in a better negotiating position with other suppliers, and had a positive side effect: not only is the new production currently more cost-effective considering landed cost, but the new supplier also actively plays a part in product development.

 

Introduce new negotiation strategies

When it comes to procurement, the pandemic has once again underscored how important it is to engage in regular exchange with your own suppliers. Provided there is a high degree of transparency, both the winners and losers of the crisis can  significantly improve their cost base and supply security. Procurement should see its own position as a strength. If, for example, retailers can guarantee their suppliers a certain level of demand or even increased sales, this can be mutually beneficial and will definitely be reflected in cost savings.

In addition to classic negotiations, auctions in particular are becoming increasingly important in times of remote working. They were sometimes frowned upon, unpopular or not accepted by suppliers in years gone by. In practice, however, it has been shown that companies that conduct auctions can save a lot of money. They also reduce the amount of time and travel costs spent on negotiations, and shorten the timeline to close a deal. The key is to do the proper preliminary work to ensure that the price is the final variable left to be closed, avoiding any potential counter-sourcing situation further down the line.

Here’s a real-world example: a leading chemical company has achieved total savings of almost 7% through auctions compared to the traditional negotiation method. In other categories, savings can be as high as 40%, always depending on the number and density of suppliers.

 

An extended form of auction is a so-called “Suppliers’ Day”. Instead of negotiating individually with suppliers, a Dutch healthcare company met with its suppliers on one day to explore potential cost savings. The product, which had risen sharply in price due to the pandemic, would have been too expensive in the long run. By negotiating simultaneously, the company wisely created a fair real-time situation in which suppliers had to react quickly in order to compete. This led to considerable savings

Sustainable results through regular follow-up and controlling

Even the best measures need to be reviewed regularly. Companies should frequently monitor and control its activities after implementation. In addition to regular supplier contact, procurement needs to stay close to the line and specialist departments. By following up performance and development activities, as well as re-negotiating, significant added value can be unlocked in the long-term.

Conclusion

The coronavirus pandemic has hit companies hard in some cases, either on top-line, on supply, or both. Whether a company has lost or gained from the crisis, now is exactly the right time to reorganize and optimize cost management. This includes immediate measures as well as long-term strategies. In addition to establishing a stable and cost-effective supply chain, procurement must also anticipate how markets will change in the future and take trends such as digitalization and sustainability into account. This is only possible if the internal arrangements are right, procurement is based on sound analyses, and the best possible use is made of the company’s own position, for example through classic negotiations or auctions. Only those who position themselves correctly now can hold their own in the long-term.

Autoren

Marcus Schwarz

Marcus Schwarz is Managing Director of INVERTO’s Copenhagen office. As an experienced procurement specialist with extensive product and industry experience, he primarily advises clients from the retail and consumer goods industries on cost reduction programs and procurement process optimization.

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Daniel Gilek

Daniel Gilek is a Principal at INVERTO in Stockholm with over a decade of experience in advising Nordic industrial and energy clients in comprehensive transformation and cost reduction programs.

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