How can companies generate sustainable cost reductions to remain competitive? And how can the purchasing department actively contribute? Companies ask themselves these questions in economically difficult phases as well as in boom phases. “Value levers“ are often used to generate cost reductions – unfortunately they are often misunderstood and without exploiting their full potential. This article series makes them more tangible and gives examples of how their structured use can generate actual and sustainable cost reductions.
Many different explanations – one important commonality
In the literature, there are different explanations of value levers. For example, they are referred to as such because of the fact that the positive effect on the company´s result is greater than the internal and external costs of the taking the necessary actions.
Another explanation is their significantly greater effect on the company´s result through a relative reduction in costs compared to a relative increase in revenue. Regardless of the explanation, all levers have one thing in common. They offer a methodology to generate savings in a structured way for different categories (sometimes this also means a value increase without a change of cost). At the same time, different perspectives and possible solutions can be used. Thus, a category is dealt with in a multi-dimensional way from a purchasing perspective and not just according to the typical approach of “We invite our current supplier for a yearly appointment and obtain alternative offers from the market for comparison” and the category is considered to be finished for one additional year.
This article looks at the first three levers of the “SCP value levers” in detail and gives practical examples of how sustainable savings can be generated by using them.
Product & Service –
„As much as necessary, as little as possible“
This value lever deals with the physical, chemical and technical properties of a product or material or the scope of a service. For example, in the category „primary packaging material (plastic)“ in the food industry, there are minimum requirements that must be met so that plasticizers cannot be released into the product. At the same time, however, all technical properties that are not necessary and for which the costumer is not willing to pay should not be overfulfilled (“critical to quality”)
One possible procedure for applying this lever is, for example, a “value engineering” workshop with participants form different departments like product design, purchasing, quality assurance and production. The basis for such a workshop is a white sheet of paper with the basic question “Which minimum requirements must this packaging absolutely fulfil?”. The interdisciplinary exchange, in which purchasing is involved at an early stage, thus reduces the risk of higher overall costs or later tensions between purchasing and other departments. In addition, if relations between purchasing and suppliers are good, innovative ideas from the suppliers can be included in the process.
Through this value lever, savings of more than 30% were achieved in the aforementioned category compared to estimates or budgets at earlier planning stages. However, it is important to focus on the most promising materials, products or projects, as a structured analysis with the help of value leverage also involves resources. In industries, where the direction of specifications for an entire series is set at the beginning of a product life cycle, there should be a special focus on this value lever. Changes there are usually only associated with considerable testing and implementation effort, so that additional costs would arise.
Process –
„How do I make my process as fast, effective and efficient as possible?“
Usual goals of this lever are rationalization (e.g., through automation) or the complete elimination of (partial-)procurement processes. It is therefore particularly suitable for articles with low prices per unit (also called “non-critical”) and high article variety (also called “complex”), such as the category “auxiliary and operating materials”. The complexity of a high variety of articles is usually accompanied by complex and thus expensive internal processes, for example master data management, specification management or the relatively more frequent operational processes of (1) order request, (2) order, (3) goods receipt, (4) storing…
The introduction of a purchase order catalogue with approved products enables the process steps “order request” and “order” to merge and thus not only shortens throughput times, but also automates repetitive or manual activities. At the same time, technical and commercial compliance can be controlled via the catalogue. Therefore, IT and accounting usually plays a central role in the processing of this lever, in addition to procurement and the ordering stakeholders. Interfaces between internal ERP systems and the order catalogues must be defined. At the same time, the subsequent invoice verification and processing should also be automated (e.g., “3-way match” or a credit note procedure) so that the automation advantages can be used until the end of the entire process.
The transition from a pure price focus to a cost focus is essential when using the process lever. The target must be to optimize the total costs of ownership / acquisition. A slightly higher price per unit can reduce internal process cost in the procurement processes and thus be more favorable for the purchasing company. But beware: reducing process costs always means removing resources from the process and thus actually no longer producing the corresponding cost! This does not necessarily mean that people have to leave, as long as they are needed and bring added value to the company elsewhere.
Another example form after-sales service would be the dispatch of spare parts by a courier express parcel service provider (CEP) and its commissioning. The request for spare parts often cannot be planned in advance and therefore requires an efficient and cost-effective processing of “ad-hoc” service orders. In the category “CEP”, conditions for different levels of urgency should be contractually agreed on before the actual order. The urgency of the order depends on the individual order. An user-friendly process must ensure that the most attractive supplier from a purchasing and commercial point of view is actually ordered. A regular report on deviations allows to analyze the proportion of “wrongly” ordered suppliers to be reduced continuously. In order to ensure that the process is stable and user-friendly and to avoid possible unintentional non-compliance; purchasing, IT and the ordering department should be involved in defining the process and introducing it in the system landscape.
In addition to the direct process-related savings, additional savings can be generated through the reduction of internal queries and operational troubleshooting. Afterwards the time freed up can be used for more value-adding activities.
Quantity –
„Can quantity effects be achieved through bundling?“
The aim of this lever is to reduce the proportional fixed costs by increasing the quantity, thus reducing the costs per unit. The reduction could also be generated at the supplier and then passed on to the ordering company as a proportional price reduction. An example for the use of this lever is the category “logistics (freight)”. Bundling can be achieved, for example, via different plants, longer periods or different suppliers. Bundling in this context does not necessarily mean the physical bundling of volume flows. Effects can also be achieved if a previously fragmented purchasing structure from different locations is replaced with a lead-buyer structure in which the supplier market is addressed jointly. Potential suppliers are thus more willing to make concessions compared to individual orders since the company´s actual annual demand can be easier estimated.
Bundling via a purchasing alliance together with other companies (usually from other sectors) is the supreme discipline of volume bundling. In addition to the purchasing department, the ordering departments of different locations must be involved to determine whether the purchased services are services that can be bundled. This lever has the maximum savings effects in the case of fragmented purchasing behavior, in which different users use different suppliers for the same demand and are in direct contact with them without the involvement of the purchasing department.
Purchasing as an interdisciplinary task of the entire company
The above-mentioned examples and instruments give an impression of purchasing possibilities to sustainably reduce costs or increase the value contribution of procurement. What they have in common is the necessary cooperation of different functions of the entire company with the procurement departement– the increased effort, however, justifies the generated cost reductions if applied correctly. These examples show once again that good procurement is not only the task of the procurement department; it’s the task of the entire company.
The next part of the article series will be dedicated to the four remaining levers and explain how important it is to choose the right lever for the respective category.