Developing an Effective Cost Reduction Program

HCS Consulting March 2006 Newsletter

Supply Chain Management Review published an article last month that summarized the Aberdeen Group’s benchmarking study of mid-market companies’ purchasing and sourcing practices. The study concluded that ineffective purchasing and sourcing left more than $134 billion of potential cost savings unrealized. That’s a big number and some of it may belong to you. When I talk about cost savings in presentations to CEO’s and Operations Managers, the subject always generates a lively discussion. I have included in this newsletter some actionable ideas that you can use.

How do you develop an effective cost savings program in your company? An important first step is to set goals and objectives for people who contribute to the process. This includes your purchasing folks, but they cannot do it alone. Engineering, manufacturing, traffic, quality, and warehousing are all functions that have a role to play in cost savings. I recommend targeting a specific percentage of total purchases. If you are doing this for the first time, set the bar high – 10 to 15%. You can split the total objective between functions and/or commodities. Most important is having all participants feel they own part of the goal.

Cost reduction should be a continuous improvement program with goals set every year. If you already have a continuous improvement or lean manufacturing program, cost savings can fit in nicely. Many times, I get a question like: “If we save 20% every year, our costs should be zero after 5 years, so how is a sustained effort possible?” The short answer is that things change, prices from suppliers go up, your products change, your customers ask for different products, etc. Big companies in every industry – i.e. G.E., Unilever, Toyota – have this down to a science. Management sets aggressive cost savings targets every year and expects Purchasing and related functions to meet them.

A sustainable cost savings program needs to include three categories of projects:

  1. Some cost savings can be achieved by Purchasing working with suppliers. This kind of savings project would include identifying potential new suppliers, the development of a Request for Proposal, negotiating with suppliers, and awarding of new contracts. If you have not been actively developing alternate suppliers and verifying that your current suppliers are competitive, you may be amazed at the results of this kind of effort – I have had clients reduce costs on a commodity by 25% as a result of an RFP. ACTION STEP: Have your purchasing people select the first 2 commodities that they will target for cost savings, set a goal and time frame (this should be months, not years.)
  2. The second type of cost savings requires a cross-functional effort. A change has to be made to a component or raw material being purchased to achieve a cost savings. Engineering, Quality, and Manufacturing need to be included in the project. There may be testing, sampling, or prototyping as part of the change process. Select commodities and/or items that are high value and important to your end product. The cost savings realized will significantly improve your bottom line. ACTION STEP: Select a purchased item or raw material where you have a good relationship with the supplier. Discuss the possibility of working together to reduce the cost. A supplier would rather work with you to lower cost than have you bidding out the same items which puts his share of the business at risk.
  3. The third type of project is one that is often unnoticed – it is based on recognizing the value of a delay or reduction in a proposed price increase from a current supplier. If Purchasing negotiates a 1% reduction in a proposed increase, that’s 1% avoided now and 1% less in the base the next time around. Calculating the value of delays or reductions in increases will help to highlight the impact for the entire organization and encourage Purchasing to increase effort in this area. Last year I did a newsletter on resisting price increases, in particular those that are announced by a “dear customer” letter. If you are interested in reading that one again, just let me know. ACTION STEP: Set a company policy that states that no price increases will be accepted without a meeting with the supplier making the request.

At Helene Curtis, we went almost a decade without product cost escalation. We were able to more than offset any inflation with cost reductions. Remember, $134 billion, just the rounding error is real money! The Aberdeen Group cited lack of strong procurement processes and inadequate skills and training of personnel as primary causes of this shortfall. These are key topics that I address with my clients. If you would like to learn more, give me a call.

Teaching Purchasing to a Chinese Company– some of you know that I developed and teach a Purchasing course for the Illinois Institute of Technology. This summer I will be delivering 2 lectures on Purchasing “live” via tele-conferencing to employees of a Chinese company. Other faculty members will cover additional logistics and supply chain topics for a total of 24 sessions.

Thank you for reading this newsletter. If you know of someone in your company or in another company that would find it of interest, please forward it to them. For more information regarding purchasing, inventory management, and logistics education, please visit my web site www.hshieldsconsulting.com. If you do not want to receive future newsletters, you may reply and indicate that.

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