Cost Reduction Is Not Enough – Defining Procurement and Corporate Value

I’ve been thinking and writing about “procurement value” in the past few weeks, lining up a new briefing paper and webinar that we’ll tell you about soon. (You can put September 25th in the diary for the webinar if you like …)

In researching the topic, I came across this article that I had saved in my files. It is by Jules Goddard of London Business School, academic, businessman and author, and was published on the LBS website in 2014. Re-reading the piece, titled “The Fatal Bias” emphasised both the importance of this discussion, and the importance of the work referred to in the article. That research basically says that a low-cost strategy (in business strategy terms) is in the vast majority of cases not successful or sustainable in the longer term. Here is a quote from Goddard.

“Overall cost leadership is not a viable strategy. This is the key discovery to have come out of the most extensive and thorough study of corporate performance ever conducted. Michael Raynor and Mumtaz Ahmed, both with Deloitte, examined the performance of more than 25,000 US companies over a 40-year period.”

The researchers looked at firms with sustained levels of high returns on assets and searched for linkages to the strategies pursued by these companies.  “The most provocative of their ground-breaking findings challenges Michael Porter’s assumption that overall cost leadership is one of three generically viable competitive strategies. Of the 25,000 companies in Raynor and Ahmed’s sample, only a handful achieved strong and sustained success with this strategy”.

The conclusion is that only very rarely does “cost leadership” as an approach lead to superior profitability. As the researchers say, “it could have turned out that price-based competition was systematically more profitable, or that cost leadership took precedence as a driver of superior performance – but it didn’t.”

Goddard goes on to discuss the findings in some depth, and this is all very much worth reading. He suggests that a cost-cutting approach and too much frugality leads to an “inwardly-focused culture” that leads to organisations which (in the words of Oscar Wilde), “know the cost of everything but the value of nothing”.

He also has words to say about procurement. “Treating suppliers as a cost to be cut rather than a relationship to be nurtured may be counterproductive in the long run. Those who treat their suppliers in this way may find themselves being treated by their own customers in a similar fashion”, he says. We have to know when to add costs in a judicious fashion (which also reminds us of our own paper, “Three Occasions When Procurement Should Spend More”).  A quest for cost leadership too often leads only to value destruction in the long term.

So all of this underpins the idea that procurement must understand how we add value to our organisations above and beyond cost-cutting. There are occasions and spend areas where cost reduction is a valid goal, but there are so many alternative ways in which procurement can help the organisation achieve competitive advantage through different approaches. But the first point is that we must understand in convincing detail what those methods and approaches are, so we can communicate that potential value creation to our senior colleagues. And that’s what we will be looking at in our forthcoming paper and webinar – more on that soon, but in the meantime, Goddard’s article is well worth reading or even re-reading.

First Voice

  1. Trevor Black:

    Refreshing to read someone who actually understands procurement.

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