Quantifying Suppliers’ Contribution to Revenue and Profit: More Than Just Productivity Gains

In the report, Corporate Virtualization – A global study of cost externalization and its implications on profitability, Proxima and FTI Consulting show the P&L impact that comes from increasing external expenditure (i.e., on suppliers) compared with declining labor costs, set in the context of the overall economic environment since 2009. For further background on the study, see our previous coverage below:

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The study suggests that today’s business spends 69.9% of revenues on non-labor cost (compared with 12.5% of revenues on labor). In Proxima’s words, “the externalization of the cost base is a trend that has continued over the last 3 years” with non-labor costs as a percentage of revenue increasing by 6% and labor costs declining by 8%. Overall, the study found that “the increase in revenues and underlying profitability [among the over 1,900 companies surveyed] was made possible not by more employees but a greater use of suppliers.” Specifically, among those organizations considered in the sample, revenues increased by 31%, EBITDA rose by 35%, revenue per employee increased 18%, and the number of employees “rose by only 11%.”

Of course there could be other explanations that led to this trend line, beyond just the externalization of business costs. Productivity, for one, has no doubt contributed to rising EBITDA. Consider the 2013 Q2 revised figures from the US Bureau of Labor Statistics, released in a press release on Sept. 5. According to BLS data on US companies, “manufacturing sector productivity rose 1.9 percent in the second quarter of 2013, as output declined 0.6 percent and hours worked declined 2.4 percent. Productivity increased 3.3 percent in the durable goods … Over the last four quarters, manufacturing productivity increased 1.9 percent, as output increased 1.9 percent and hours were unchanged. Unit labor costs in manufacturing rose 2.3 percent in the second quarter of 2013 and decreased 0.5 percent from the same quarter a year ago.” Two charts from the announcement highlights US output and labor costs in the manufacturing sector, specifically:

Source: BLS (September 2013)

Source: BLS (September 2013)

Source: BLS (September 2013)

Source: BLS (September 2013)

Of course one could argue this data supports Proxima’s claim of the increasing externalization of costs (and the subsequent gains in profit), if you believe that manufacturers are buying more and making less (e.g., assembling fewer parts and buying more components). Yet at the same time, there is no doubt that just as external costs are increasing as a percentage of overall costs inside many organizations compared with direct labor expenditure, so too is productivity improving as well.

Hence, while we should probably dial back Proxima’s findings to account for general productivity improvements in the manufacturing sector (after all, the study eliminates certain services-focused industries from consideration), there are no doubt multiple forces at work that lead to a reduced emphasis on internal labor as the core mechanism for growth and profit. Which of course supports Proxima’s thesis that there is a need to better manage external suppliers. This not only means understanding third-party firms, but also engaging third-party employees in new ways!

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