Six Best Practices in Cost Management

In an increasingly competitive global marketplace, managing spend is an important step to realizing your profit objectives. And more than ever, companies are relying on procurement and supply management functions to deliver the cost savings.

According to a recent PURCHASING poll, the following six practices are common among companies that routinely realize annual cost savings of 3-7% (1):

1. Center-led supply management organization
2. A strategic sourcing process
3. Talented supply management professionals
4. Strict processes for determining real cost savings
5. Executive compensation linked to cost reduction goals

1. Active investment in supply management technology

By consolidating purchases across business units, a center-led purchasing organization can achieve cost savings through volume based discounts. Also, through centralized supply management, firms can gain a better understanding of user requirements across the company and address them more effectively. A successful strategic supply-chain operation needs access to upper management and corporate expertise and the power to influence standards (2). A centralized supply organization structure facilitates the strategic management of corporate wide supply activities and allows a greater level of control over outside spending.

IBM is a good example of what companies can achieve through centralized purchasing. In the past, IBM had 60-70 disconnected procurement organizations around the world and tended to keep its suppliers at arms length. Gene Richter who was brought in from Hewlett Packard to revamp IBM’s purchasing culture replaced its outdated and disorganized purchasing structure with a centralized purchasing organization, created commodity councils to leverage worldwide purchasing, embraced the Internet and saved the company over $5 billion during a five-year period (3). In 1993, IBM had about 4,900 production suppliers. By 1999, about 85% of IBM’s $17.0 billion in production purchases were consolidated with 50 suppliers.

IBM’s investment in supply chain technology has paid off very well. Of the $46 billion that IBM spends on purchases each year (data in year 2001), about $43 billion are conducted electronically. In 2000 alone, the company saved $377 million in costs through its e- procurement program. The reduction was mainly due to a decrease in administrative tasks (4).

IBM’s success speaks for the benefits that companies can reap by successfully implementing supply management technology. However, implementing technology solutions without analyzing the underlying sourcing processes is like trying to paint a house without sanding the walls. A robust sourcing strategy that is aligned to the company’s business needs and a rigorous sourcing process provides direction and structure to a company’s sourcing efforts. According to William Schaefer, vice president of procurement services, IBM global services, “There has to be a strategic view of what a company wants to accomplish, and that gives you a framework from which to evaluate, re-invent, and adopt changes.”

As the strategic role of purchasing and supply chain management becomes evident, so does the need for talented and experienced people to lead supply management operations. In the case of IBM, purchasing driven cost savings and recognition for its supply management practices has come after the recruitment of the two-time PURCHASING medal of excellence award winner Gene Richter. Dave Nelson’s vision and techniques earned John Deere the PURCHASING medal of excellence award in 2001. Nelson established best practices at Deere in supplier development, strategic sourcing and cost management. But one of the most impressive of Deere’s supply chain practices is a tier of programs to recruit and train purchasing and logistics talent. Realizing the impact that talented supply chain personnel can have on an organization’s operations, Deere has decided to cultivate and develop its supply chain talent. Deere had about 80 interns in the supply department and intends to expand that to 130. The program cost $1.25 million in 2000 and direct savings amounted to $15 million. Nelson also established an on-site MBA program at Deere in conjunction with Arizona State University (5).

Companies that have realized the strategic importance of the purchasing function are also beginning to appreciate the need to effectively measure its performance. According to the poll conducted by PURCHASING magazine, companies that consistently achieve cost savings on the supply side of their operations create strict processes and definitions for identifying real cost savings (6). BellSouth, for example, is careful about drawing a distinction between savings that are “budget impacting” and savings that are not. They have established a formal process of review during which the supply manager justifies the cost saving to a review committee comprising CFOs of different business units by showing the company’s starting point, the sourcing process and the resulting budget impacting savings.

For more on cost management, check the student projects and the Director’s publications on the topic under the topic index. The complete article on the 6 best practices in cost management is available in the April 4, 2002 issue of PURCHASING.

References:

(1) Porter, A.M. (2002, April). Spend a liitle, save a lot! Purchasing, 131(6), 23-29.

(2) Moody, P.E. (2001). Strategic purchasing remains an oxymoron. MIT Sloan Management Review, 42(2), 18.

(3) Fitzgerald, K.R. (1999, September). Why IBM wins the medal. Purchasing, 127(4), 19.

(4) Lewis, N. (2001, May). Improving SCM remains a priority. EBN, (1261), 3.

(5) Smock, D.A. (2001, September). Why Deere wins the 2001 Medal of Excellence. Purchasing, 130(17), 15.

(6) Porter, A.M. (2002, April). Spend a liitle, save a lot! Purchasing, 131(6), 23-29.