Increasingly, organisations are placing emphasis on driving cost reduction I and greater value through their I procurement activities. As a result, JLhow often do we hear of departments that have annual year-on-year savings targets of as much as 5 per cent or even 8 per cent across all bought-in expenditure?

Purchasing functions are finding the going harder than ever. We hear more often the comment from procurement professionals that “we’ve generated savings year on year, but the well seems to be drying up” and that “we’re being asked increasingly to commit to ever more stretching targets”.

However, many of the more traditional levers such as concentrating volume with fewer suppliers to obtain bulk purchase benefits and evaluating the best possible price have, in many cases, been exhausted. This is particularly true in the non-strategic purchasing areas such as travel, office supplies, temporary labour and so forth.

What you need to do with suppliers

Purchasing organisations are being forced to look for savings in the complex purchasing categories that are directly strategic to the organisation. These categories may range from Unix servers to highly specialist product components. They often lack a clearly competitive supply market. Even where the supply market is relatively competitive, changing supplier is often not easy.

In many cases, these categories are locked in with an existing supplier, at least in the short term. In such circumstances, a threat to move business is not credible and simple price evaluation is not very useful. The situation may arise for a number of reasons:

• A direct result of high overall costs to switch parts to a different capable supplier. This may, for example, be because of a need to produce new tooling.

• As a consequence of the supplier possessing key proprietary rights that prevent switching to an alternative supply source. In industries such as aerospace and automotive, some buying organisations have outsourced the design of certain components to suppliers. Moving them to an alternative supplier within an existing product life cycle may then not be feasible.
• The supplier may possess the only existing capability for producing the part.

In these circumstances there are a number of ways to move forward. The first is to focus on all elements of the relationship and bring all of its facets into focus through negotiation. This can reveal negotiating leverage where initially none was anticipated.

For example, a major engineering company was locked in with a specific supplier that had the sole global capability to produce a specific complex component to the required standard. The option to develop an alternative supply capability was considered but was expected to take five years to achieve. The existing supplier’s overall quality and delivery performance was rated highly, but there was an urgent need for cost reductions.

The company engaged the supplier with a two-pronged strategy. On the one hand, it stressed future opportunities to win work, across both the locked-in commodity in the longer term and in other more competitive areas in the shorter term. On the other hand, it emphasised the need for cost cuts.

To show its good faith, the customer was willing to agree to a deal on a different commodity that would use capacity in a new plant that the supplier was building. In addition, the company highlighted opportunities for the supplier to play a bigger role in its long-term supply chain objectives. These included the opportunity to move up the chain by assembling modules rather than just making parts.
As a result, the engineering company won a multi-year cost reduction on the locked-in commodity of more than 18 per cent. The point to stress is that although the outcome was discussed as a “partnership” approach, it was the result of hard commercial negotiations and is being managed as such.

The second is to find genuine opportunities for mutually beneficial results. Collaborative cost reduction is a way to generate savings even if there is not a wider relationship by creating genuine win-win cost reductions across both the purchasing and supplying organisations. This approach leverages creative ideas both internally and from the supplier.

The first key to success here is to engage effectively with a supplier. One approach we have seen is to focus on suppliers that have high volume and a history of poor quality and delivery performance that has led to penalty payments being incurred.

Avoiding these in the future gives the supplier an incentive to be involved. In this case, a cross-functional team, led by category purchasing, carried out a “supplier blitz”. The major focus was specifications, which were compared with industry standards and opportunities to reduce specifications were identified to both sides’ advantage.

Negotiations were held to apportion the benefit and agree price changes ahead of attempts to change the specifications.

In our experience, there are often a large of number of pre-existing ideas that the supplier has suggested. However, the purchasing organisation has been unable to implement them as there has been neither cross-functional agreement nor a means to prioritise initiatives. Gaining support of the wider organisation is the second key to success.

External support 

You need to overcome a number of internal roadblocks to win support for these initiatives from outside purchasing:

• The wider organisation may not share the cost-reduction objectives set for purchasing
• they may not be an operational priority. For example, operational functions may veer too far towards risk aversion in terms of both approving new supply choices and in over-specifying the products.

The organisation may operate in “silos”, with considerable cultural and behavioural barriers against co-operation and teamwork between functions. It is, of course, not unknown for operational staff to give the supplier a completely different message from that given by the purchasing professional.

In many cases, the internal roadblocks are harder to overcome than identifying the right way to cut costs.

The first step to winning support is a clearly established joint decision-making approach. The apex to this is an executive level of governance.

All key functional stakeholders need to be represented at a senior level here, in order mat critical decisions made during the sourcing process can be escalated and resolved from the perspective of the organisation as a whole. For example, one industrial organisation that we worked with has set up a global purchasing committee that signs off sourcing and cost-reduction strategies for purchasing categories.

As this shows, a crucial step in the governance approach is to ensure that there is a formal sign-off of negotiating strategies with key cross-functional stakeholders and that any major operational implications are agreed in advance. For example, if a negotiating strategy is likely to result in choosing a new components supplier, getting the agreement of key operational functions may be a crucial step before talks with the relevant suppliers begin.

In the example above, a formal cross-functional body approved the negotiation strategy and parameters, including the least acceptable agreement, in advance of talks. The same body also signed off the likely operational implications at the same time. This had the twin benefit of ensuring that the negotiating team was empowered to make a deal and gave it greater leverage by reinforcing the credibility of the negotiating messages in the face of an entrenched incumbent supplier.

The second stage is to develop cross-functional teams led by a purchasing professional in the role of category leader. This will help to drive the detailed work for each purchasing category.

The leader’s role is both to take charge of developing the strategy and then to drive its full implementation. In leading organisations, this includes the conclusion of negotiations with a selected supplier, the agreement of contracts and bringing the strategy into effect.

Implications for purchasing

The essence of the approach is persuading the whole organisation to support and own the cost-reduction objectives through effective governance and clear category leadership. Once this is done, applying advanced purchasing approaches such as leveraging negotiations across the entire business relationship, collaborative cost reduction and specification rationalisation becomes a much more realistic proposition for the purchaser.

That 8 per cent cost-reduction target may then not be so daunting after all.

Kevin Doran is a principal and Stephen Easton is a manager in the London office of AT Kearney