Procurement Costs Optimization - SiMPL 2023 Keynote
On the occasion of the 13th Supply Chain Innovation Summit in Shanghai - SiMPL 2023 –, I was invited to deliver a keynote focusing on Procurement Costs Optimization.
The summit took place between the 8-9th of June in Shanghai with more than 700 Supply Chain executives attending and representing 355 corporations. An amazing atmosphere of learning and sharing best practices from all sorts of different industries.
As part of my presentation, I wanted to pick a ‘SiMPL’ yet challenging topic that would resonate with procurement professionals attending (and which I’d like to share with you in this article). And then also package it in a way that would capture their attention. Somehow ended up comparing the main challenges of procurement costs management with those of owning a furry friend. After all, dogs are a great way to grab attention – in marketing they’ll boost ad view by 540% in comparison to average ads and social media engagement by 63%! Plus, I have a dog myself so, why not try it out!?
As for the topic of Costs Optimization, why focus on a Total Cost of Ownership (TCO) approach?
According to industry surveys (Gartner), the main challenges today faced in Supply Chain are: Cost Management, Supply Chain Planning and Digital Transformation. We had a plethora of amazing speakers addressing SC Planning and Digital Transformation so I decided to address what would seem like a more ‘conservative’ topic but still of tremendous importance and difficulty. To this day, Cost Cutting / Optimization is still the number 1 strategy to deliver business value within a Procurement / Sourcing department.
But Cost Management is getting more and more challenging. Why is that? With the evolving landscape of Lean Methodologies, a lot of inefficiencies have been eliminated; many corporations have cut costs to the point where if you can any more you’ll be lowering output/productivity; there have been significant savings to date making it harder to reach a higher level of savings; rising costs due to supply chain disruptions caused by events such as the trade war with the US, COVID-19, war in Ukraine, ‘Slowbalization’; thinner margins which can be a cause of all of the above plus the need to remain price competitive.
So what is the most important task of Procurement nowadays?
If you ask the Internet that question, it will tell you that it is to ensure that the right product or service is purchased at the right price. But is that truly what matters most? Buying price?
Let’s set our eyes on the first ‘Paw-curement’ lesson:
If our goal was to procure a dog and we focus on the buying price, we are missing out on a lot of key elements throughout the dog’s lifecycle. Clearly when looking at a certain product or service, there’s a lot more to consider than simply buying price. But if as a Procurement executive you go and ask your buying team what their main goal is, perhaps you will find a very similar answer to the one the Internet gives you – focus on the buying price.
The first challenge we must face is to implement a Procurement & Sourcing culture of looking beyond Purchase Price and into other elements that might influence lifetime costs.
Once you make it clear that we must not focus exclusively on Purchase Price, it then begs the question: what should we focus on then?
The challenge then turns to understanding up to what level of information does the Procurement division have access to. The bigger the spend visibility you have, the easier it is to move up in the complexity of the cost management model utilized. Ideally, we can convince different departments of the importance of tracking KPIs that affect their bottom line as well so as to make better buying decisions that affect their output as well. Let’s look at one example:
A cocoa processor was experiencing leaking o-rings in a chocolate factory leading to an average $1,600 product cost, $27,500 labor cost, and staggering production downtime costs of $596,000 as shown in the table above. It then had to carry out corrective maintenance on average 4 times per week. The cost of new products and maintenance was more than $625,000 per year!
By changing the o-ring to a high-end product manufactured from a material with exceptional thermal and chemical resistance, the company was able to improve the machine’s performance. As a result, the company only had one leaking o-ring per month.
If you look closely, you’ll notice that the price for the new o-rings is 9 TIMES HIGHER. However when you account for the improved performance, lower maintenance cost, lower labor cost and lower downtime cost, you end up saving more than HALF A MILLION USD.
This is a brilliant illustration of the importance of implementing a TCO model that increases the visibility a Procurement Division’s gets to other departments spend so as to make better purchasing decisions which ultimately bring about costs optimization beyond mere price.
Later in the presentation we briefly went over the different components of a TCO calculation:
The primary thing to watch out for when determining a product / service TCO is to account for all costs at present value (after all considering a $10,000 cost in the future will cost you more than that cause you would get a certain return rate if invested elsewhere). As such remember to use the formula above – Present Value = Future Value / (1 – discount rate) to the power of ‘n’, where n is the number of periods considered (e.g. 3 years). You can find many tables online to help you find the optimal discount rate according to multiple other factors.
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But ultimately we find that the hardest challenge lays not in TCO calculation itself, but rather in the necessary corporate culture adjustments necessary to utilize TCO to its fullest. You must firstly convince and shift your buying teams approach on how they see purchasing and how to assess new deals beyong purchasing price. Secondly, you must be able to convince top management on the overall benefits and necessity to increase Procurement’s spend visibility across departments in order to assess the full impact on performance of each new buying decision.
And here’s a doggy twist case study we went over during this presentation to better illustrate the next ‘Paw-curement’ lesson:
“A Production Manager wants to buy a dog for 50 bucks. Purchasing Manager says no, not when we can buy a cat for 30.
Purchasing goes ahead and purchases a cat. After years of field trials, it is decided that the cat cannot perform the function of a dog.
Production says look, we can still get a dog for 50 bucks, and it’s all good.
Purchasing says no, we've already got the cat, and we can retrofit it out to perform the function of a dog for only 45 bucks! That’s still cheaper than the dog!
Purchasing kit the cat out, and with a lot of screaming and shouting, the cat almost passes the tests.
Purchasing decides to lower the standard of the test because it is unfair on the cat, who is feeling belittled because it is expected to pass the dog test.
Purchasing hires a cat specialist for 30 bucks to design a testing process for the cat. Once the testing process is tailored to suit the cat, it passes with flying colors!
Purchasing supplies Production with the upgraded cat. Once in use, production discovers that the cat is not as functional as a dog, and demands a dog.
Purchasing has no money left to purchase a dog after project ‘Cat’ blew out the budget, and Production has no choice but to put up with the cat.”
Lessons Learned: Sometimes, the cheapest option can leave you barking up the wrong tree.
It's the Total Cost of Ownership that determines who's truly the top dog.
Thank you to Major Zeng and 许颖 Mark from Ace Events Limited and to Dr. Francois WANG from EIPM - The European Institute of Purchasing Management HQ for the invite to join this year’s Supply Chain Innovation Summit and to all the Executives who both attended the event and presented their ideas and findings on this exciting function that is Procurement!
Some photos of the event below:
Director of Shanghai-Global procurement services
1yHi Ricardo, you delivered a greate speech! Thank you for share the content online! 😁
Procurement / Sourcing Gardening & Electricals, OBI Group Sourcing | Talent Development, Pitch Bootcamp | TEDx Speaker | THINC Fellow 23-24
1yThank you to all the incredible speakers and attendees I had the chance to listen to and connect with Jun San , Ron He , Jian Li (李健), Xin Jin , Francisco Cadena , Daphne Li , Russell HUANG , Jenny Wang , Lizzy W. , Randy Chen , George Ji , Philip Wang (王千), Dr. Francois WANG , Simon Kong , Elaine Chen , 张松伟 Eric , 叶洁敏 , Qibin Xiong , george chu , Juntian (Ilsa) Dong , Reading Chen , Steve Choong CIA, CFE , Bill Xu and many others 🙏