Last weeks QOTW; should cost reduction be the CPO’s top priority?

The question of the week last week was “should cost reduction be the CPOs top priority?”

As Guy said in our most succinct comment, “whether or not it should be, it often is”.

Tom Lawrence took a differential approach – which is of course absolutely right. Your appropriate strategy as a CPO must depend on your organizational strategy and how your function is positioned at the point in time.

“It depends what stage of maturity the function is at. If historically the function has been performing badly, then there is likely to be a lot of low hanging fruit, and cost reduction may be the priority.  However, a high performing function should be in cost management mode, not cost reduction. And their top priority should not be focusing on the supplier market, but focusing inwardly at the organisation to challenge and change people’s behaviour. Too many stakeholders (often including the Board) need educating about what procurement is there for and what value it can bring. Until they understand this a large effort is required to educate them”.

Market Dojo took perhaps a more basic, but nonetheless pertinent approach to the subject.

“In very simplistic (& capitalistic) terms, a successful company is all about making profit. To make more profit per sale, you either reduce costs or increase prices. Increasing the price may cause the sale to fall apart as you get gazumped by competitors … Therefore reducing costs is the remaining path to keep successful.

If your company sells widgets in the market for £10 each and it costs them £9 to make, you get £1 profit per widget. If you carry out a cost reduction activity and manage to reduce the cost of your widget to £8, a near-as-dammit 10% cost reduction, your profit is £2 per widget sold, a massive 100% increase in profit per widget sold. In order to make £2 profit without the cost reduction, you would have to sell two widgets, in other words DOUBLE your sales volumes. Clearly cost reduction is hugely important.  Yes this is very simplistic and doesn’t account for innovation, market S-curves, upselling, power of a brand, USPs and so on, but if I were a CPO, I would be keeping a very close eye on costs as they will account for greater profit by a factor more than growth of sales.”

My personal view? In most organisations, cost reduction is the procurement function’s “admission ticket” to being taken seriously.  It shouldn’t be – and probably won’t be – the only objective, and it may not always be the most important. But it is probably still important to virtually every organization, and if procurement can’t deliver on that part of their work, then they may not get the chance to do more interesting and ‘strategic’ things for the organization.

Anyway, thanks as always to contributors, and more on this topic as we feature last week’s Spend Matters debate through the rest of this week.

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First Voice

  1. Ian Heptinstall:

    Cost reduction cant last forever. In an organisation which historically had little focus on costs, there are many quick wins that need taking. But, there is a limit to how far costs can be cut. And if we are always going to be measured on it we can be quite innovative on always managing to come up with further savings 😉

    Given there is a limit to how much we can cut cost, is there a limit to how far sales can increase? Possibly, but for most companies their market will be vast relative to current sales. Growing profits sustainably should be what we are about long-term. I would say our long-term primary cost role is about ensuring we purchase at the “right cost”. As Tom says, whether this involves much reduction depends how well we have done in the past. If cost-reduction is our “admission ticket” there is a risk that once we have reduced them the show will be over. Why should our senior team peers think we can do other things if all they have seen us do in the past is reduce costs?

    Many great companies manage to double (at least) their sales year-on-year, with profit growing by orders of magnitude over several years. They dont do this by just reducing their cost base – though it may have a role. In these environments the procurement issues are broader than just cost-focused. Businesses looking to grow have to think more broadly about their supply chain. Cost has to be right for the business strategy, but there will be many other aspects of our supply chain that hold us back.

    If we only focus on the cost element, the others wont happen by themselves, however in many cases if we focus on the most important thing for our business, then often the costs will follow.

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