Continuous Improvement: The Key to Sustained Savings (Part 1)

1. What is a Continuous Improvement program?

A Continuous Improvement (CI) program is a bi-lateral initiative involving the client company and the supplier which aims to realize value beyond rate reduction through initiatives such as product standardization, productivity improvements, waste reduction, right-sizing, etc. These initiatives typically realize savings while simultaneously reducing the supplier's cost to do business with the client company. As a result, the supplier's sustainability and consequently the service levels and quality associated with the category are not compromised. Additionally, these savings improve the overall process and create value for both parties above and beyond what can be achieved through repetitive negotiations.

A formalized CI program is contract-driven and includes a joint team with pre-defined roles and responsibilities, specific targets, and a formalized process. A CI program lays the foundation for a mutually beneficial long-term relationship between two companies and is a proven mechanism for sustained savings realization, risk reduction, and process improvements.

Spend categories that are most conducive to a CI program include MRO, waste management, office supplies, IT hardware, telecom, print, and courier/mail services.

2. The Case for Continuous Improvement

The most common challenge within a procurement organization is the ability to sustain savings through multiple 'out years'. Many organizations are challenged to realize additional savings at the category level beyond initial rate reductions that might have been achieved through negotiations.

The common reaction to this challenge is to squeeze the supplier even more for rate reduction, higher frequency of bids for a particular category (resulting in frequent supplier changes) and reverse auctions or similar tools to try to get additional price reductions. The law of diminishing returns applies to such repetitive negotiation activity. Moreover, while these strategies may temporarily be successful on paper in getting a lower rate for a specific product, it comes at a high cost.

Aggressive rate reduction without a bilateral process and productivity review leads to a common recourse on the part of the supplier. In order to reduce their own costs, the quality of the product and the accompanying service levels show inconsistencies. Frequent supplier changes often result in a continuous state of transition where service levels are compromised and compliance rates drop as buyers often revert to the 'familiar' supplier. The long-term cost of all of these problems is almost invariably higher than the minor rate reductions achieved through frequent negotiations.

The practical solution that aims to realize sustained savings in the long-term while maintaining important supplier relationships as well as guaranteeing service quality is to adopt a 'continuous improvement' approach for specific categories.

In Part 2, I’ll cover how to incorporate this into sourcing as well as some continuous improvement best practices to follow.

Auri Ghatak is a manager in the Strategy and Operations practice of the Hackett Group.

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First Voice

  1. Samir:

    This is very interesting. I am curious to read about how to apply this principle but maybe that’s in Part 2.

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