Achieving World-Class Cost Optimization

Spend Matters welcomes a guest post from Hani Alexander, Managing Director at Alvarez & Marsal.

In the years since the economic downturn, most companies have pursued quick and easy procurement cost reductions. However, we see many of our clients continue to leave money on the table because transformational change is challenging and imposing. Most organizations know they can reduce costs further, but take shortcuts to implement quick fixes that have little long-term impact. Nevertheless, companies can develop a culture of continuous cost optimization by utilizing a focused organization to plan, execute, and sustain advanced cost-reduction practices.

Even when companies establish a "center-led" strategic sourcing and procurement organization, limitations of effectiveness often arise. These are due to specific issues (like a lack of technical expertise) in the sourcing and procurement organization, limitations (often of negotiation or management expertise) of the business units responsible for contracting goods and services, or a lack of coordination between the two. By combining the knowledge of the sourcing and procurement organization and the insight from the business units, organizations can shift their focus from cost-cutting band-aids to long-term cost structure optimization.

The first step for a company is to establish a new organization focused on driving company-wide cost optimization. This organization must have a senior leader who reports directly to the C-suite, as well as "category teams" to leverage the knowledge and experience of those involved in the daily processes of good and service procurement. Each category team should include a manager, key spenders and support members, transactional members (buyers), and a finance representative to act as an independent "scorekeeper." The team could also include strategic sourcing or procurement staff or other key stakeholders. A large technology company client recently implemented an organizational restructuring focused on global categories, enabling the company to save $200m to $300m per year over the next three years. Without the new organization structure, independent business units would have continued to purchase products and services in an uncoordinated manner, leaving the savings unrealized.

The second step is for the new cost optimization organization and its category teams to plan and execute advanced cost optimization practices. The focus should be on rate (or price) reductions, which impact supplier relationships, and usage (or consumption) reductions, which impact internal stakeholders. Leading organizations address these areas with maximum effectiveness using multiple tools and practices, often in the areas of:

  • Advanced Strategic Sourcing and Category Management Practices such as developing and implementing a formal sourcing strategy.
  • Advanced Supplier Relationship Management (SRM) practices such as implementing cost improvement programs, supplier audits, contract restructurings, and contract compliance reviews. A global company client obtained key stakeholder approval for consolidating critical supplier management functions previously embedded in business units. This reorganization to focused SRM functional groups, enabled the company to use best practices for driving incremental savings with incumbent suppliers not previously realized.
  • Demand and Specification Management such as developing demand forecasts, identifying pooling opportunities, and evaluating and optimizing goods and service specifications.
  • Benchmarking, Market Intelligence and Should-Cost Modeling such as leveraging relevant rate and usage benchmarks and developing should-cost modeling capabilities for key spend categories. An energy company client recently rolled out a should cost modeling tool for hauling that enabled autonomous business units to start benchmarking current costs and drive significant savings through renegotiation with incumbent suppliers.

The final and most critical component is ensuring the savings "stick." Just like how it took you four times of trying a low-carb diet and seeing your ten pound weight loss come grumbling back a month later to realize that it wasn't a "diet" you needed but a "lifestyle change," many cost reduction efforts by organizations never fully come to fruition due to a number of poor practices, controls, and other internal changes. Savings "leakages" are most common in vendor relationships, where inadequate vendor set-up, negligent maintenance of item masters, and too many change orders can erode cost savings. Savings also tend to run away during the procure-to-pay process, often due to insufficient control of purchase requisition and PO approvals and a lack of three-way matching for goods and services. The independent "scorekeeper" is vital to tracking cost savings and reducing the budget line items accordingly, thus preserving the integrity and effectiveness of the program. All of our clients struggle to capture savings and increase operating income. In our experience, the best practice is to reduce relevant budget accounts with the negotiated savings, then track realization with the suppliers and business units. Most of our clients include supplier data sharing requirements in new contracts to enhance the savings tracking process.

By planning, executing, and sustaining advanced cost optimization practices (via a dedicated and focused organization), companies can develop a culture of continuous savings maximization. Organizations willing to invest in establishing world-class cost optimization capabilities, instead of quick fixes, will realize benefits ranging from cost-based competitive advantages to improved gross and operating margins. Plus, no one likes ripping off a band-aid.

-- Hani Alexander, Managing Director, Alvarez & Marsal

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