Procurement costs can account for up to 40% of an organisations operating expenditure and have been increasing for many years. Most suppliers have contracted price increases linked to either the Consumer Price Index (CPI) or the Retail Price Index, with the impact of inflation this is only set to increase supplier spending.
In the current economic climate, customers are more cost-conscious than ever and are often choosing the lowest-priced provider. To continue to be competitive, organisations must maintain their pricing and many are having to absorb the supplier cost increases which is reducing profit margin and cash flow. This article will explain how this can be avoided and how profit margin can be improved by taking the following approach:
Build a detailed supplier spend analysis
This is a critical first step and will involve extracting 12 months of supplier invoice payment data from the Enterprise Resource Planning (ERP) tool or accounting system and classifying this information by supplier to a defined category hierarchy. Once the spend analysis has been performed, data insights can be established such as identifying the highest spending suppliers, the size of the supplier tail and where there may be opportunities for supplier consolidation. The following chart shows the typical spend profile for a financial services business.
Develop a supplier contracts database
The next stage is to gather the contracts for your suppliers that represent 80% of the spend per category. If you do not have a central contract management process and database in place then this can be a rather labour-intensive exercise but you should start by requesting the contracts from internal users and suppliers. Extract the following key contract information from each contract into a simple Excel or SharePoint database:
Supplier name
Scope
Contract start and end date
Value
Extension options
Termination provisions
Price increase
Review the needs and challenge the wants
In our experience, over 50% of procurement cost reduction savings in services companies originate from effective demand management. If procurement processes are not deeply embedded in the organisation, then requirements will not be challenged and may contain more wants than required or the wrong need which can lead to significant waste. Revisiting these requirements again and establishing the true needs can lead to significant cost reduction opportunities.
Review the specification
Specifications should be reviewed in an open and collaborative way in conjunction with key category stakeholders. To prevent friction between departments it is best that these review sessions are sponsored by the CEO, who should provide a clear explanation for why they are required. Always request evidence to support specification usage in advance of the meeting. For example, if you are reviewing an enterprise software application ask to see details of the number of individual logins and modules used for the past 3 month period and compare this to the total number and type of licenses purchased in the agreement. In many cases, there will be a disconnect and you will be over purchasing.
Implement demand management controls in some categories
It is worth considering putting in place specific demand management control processes in some categories where there is benefit in performing extra due diligence to contain cost and risk, such as software procurement. A review panel can be assembled to understand if existing deployed technology or solutions can be used to fulfil the requirement instead of purchasing a new application. Suppliers are masters at influencing the end users that they need their product, when in fact the end user just needs a solution and an existing application may meet their requirements.
Prioritise focus on highest spending suppliers
With a clear understanding of your specification, forecast expenditure and current contract terms it is time to prepare for your engagement with your suppliers. Prioritise those that are your highest spend and have a price increase due in their contract soon. For some reason organisations are often reluctant in challenging contractual price increases, this is a mistake. Gather as much information as you can about your supplier's current financial position.
Has their revenue or profit increased recently?
How much does your spending contribute to their revenue?
Has your spending increased over the years?
Have you helped them access a new sector?
Try to understand their cost base in more detail and differentiate which elements may have increased due to inflation. Given it is unlikely all their costs have increased, it is unjustified for them to increase the total value of your contract by the index in the contract.
Engage with them at least 1 month ahead of the price increase and set out your reasons for why you reject it. This could be because your spending has increased with them year on year and has significantly contributed to their company's performance. Whilst they may reject your initial request for no price increases it is always best to try to leverage your existing position with the supplier before offering other incentives.
Use non-financial levers first in the negotiation
If you are unable to negotiate a full reduction in the price increase then there are other non-financial leavers that you can consider using. For instance, you can offer to be a reference for the supplier or be quoted as an advocate on their website. Using your brand costs you nothing provided that the supplier is a reputable business. To the supplier such endorsement can be way more valuable to them than the annual price increase in the agreement, for example it could help them win more business.
Consider increasing the scope and/or duration of the contract term
Given the current economic environment, suppliers will also be looking for opportunities to increase revenue and contract commitment in the negotiation. This may be a good opportunity to bundle other products or services into the agreement to reduce the supplier tail in a particular category, but this should only be done where there is a clear cost saving associated with the action and the supplier has the capability to deliver.
Use strategic sourcing where there is a valid business case
The spend review should have identified opportunities for consolidation and strategic sourcing should be considered as the vehicle to achieve this. However, this leaver should only be deployed where there is a clear savings opportunity and return on investment for the time and effort involved. That said, even the mere threat of it can help achieve the negotiation results with an incumbent supplier if their agreement is due for renewal shortly.
Dealing with dominant suppliers
For some suppliers, the threat of competition will do nothing as these suppliers are in such a dominant position that unfortunately, you need them more than they need you. This type of situation requires a very different approach. Having refined your specification, the next leaver is to try to position your organisation as a strategic account. It may sound counterintuitive in a buying process, but in these situations, you need to sell your company as a strategic growth account to obtain discounts or negate the inflationary price increases. Providing details of the company's strategy and growth plans can help in this process but the supplier usually wants something in return such as access to the C-Level executives of your organisation to understand the business strategy in more detail and explore where else they can supply goods or services. Sometimes a commitment to explore or even trial one of their new products will suffice.
Improve procurement governance
Businesses must tread a careful line of remaining agile and entrepreneurial whilst having the appropriate corporate governance in place to satisfy regulators, customers and investors. Putting in place clear procurement policies and processes to ensure that suppliers are engaged and managed correctly is critical for not only cost control but also risk management. Making sure there is clear visibility of contract renewals and a process to follow allows appropriate time to refine specifications and develop negotiation strategies.
How can Swan Procurement help?
Swan Procurement are procurement experts focused on accelerating procurement maturity to optimise costs, manage supplier risks and support business growth. We have more than two decades of experience in helping both private and publicly listed organisations to generate the required value from procurement.
We combine deep specialist knowledge with data insights to deliver a range of services from procurement cost reduction, procurement target operating design to supplier risk reduction. We will work alongside you as your trusted partner to solve your procurement challenges. Please contact us to discuss how we can help.