Savings Strategy Development

A Printer-Friendly Version Of The Online Class Material From

Please note the following reco...
TABLE OF CONTENTS

Lesson
Lesson 1 - Executive View of Purchasing Savings & Savings Definitions
Lesson 2 - Avoidance Defin...
Lesson 1 - Executive View of Purchasing Savings & Savings Definitions
Saving money for our organizations is arguably the #...
Income Statement Examples
We will now look at two examples of income statements. The first income
statement is for a servi...
Now we’ll look at an income statement for a manufacturing company –
specifically, a food manufacturer. Manufacturing incom...
Income Statement Line Item Explanation
If you have begun asking yourself "what does all of this bean counting have to do
w...
Purchasing Impact Exercise
Now that we have examined those areas where Purchasing’s impact can be felt,
it is time to enga...
NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY

Sales

9431000000

Cost of products sold Gross profit -Selling, general, and ad...
In this section of the lesson, we will cover different savings types. Information
about each savings type will be broken d...
Payment Term Savings: Your company receives more favorable payment terms
for products or services purchased this year than...
used in the manufacture of a product and you have determined that aluminum
nuts and bolts can be bought for 10 cents witho...
Fee Waiver Savings: Your company is not charged certain incidental fees that
were paid in the past. Commonly waived fees i...
NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY

Spec. Change Savings =
(OS
Your Answer =
($
Correct Answer =

($

- NS)

x QP

...
any questions, please click on the Ask Charles! button below to ask a question
and get a response from your instructor by ...
Lesson 1 Quiz
NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK

1. Which of the following income statement line items do...
Lesson 2 - Avoidance Definitions & Outlining A Savings Strategy
All of the savings types that we discussed in Lesson 1 are...
requisitioner should be capable of identifying the proper product or service. The
Request Change Avoidance is calculated a...
Inventory Reduction Avoidance: You determine that inventory levels are too high
and decide to reduce the quantity of certa...
Correct Answer =

(

-

)

x$

x

=$

Note that if you must place more orders for items in order to reduce the inventory
l...
Process Improvement Avoidance = $300,000 – ($285,000 + $10,000) = $5,000
If management wanted to know the avoidance over a...
4. Supplier Relationship Opportunities Execution
5. Strategic Sourcing Opportunities Execution
6. Savings Documentation an...
before acting on any of the opportunities.
Actual Annual Savings: These values represent the amount of money you expect
to...
Lesson 2 Quiz
NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK

1. Which of the following is true?
a.) An avoidance is r...
Lesson 3 - Spend Categorization & Analysis
During this lesson, you will be given instructions on how to manipulate
spreads...
the month or months that would represent the most typical months from a
purchasing pattern perspective. If your business i...
Categorizing Purchases
Some purchasing systems require that a commodity or category code be
assigned to each purchase orde...
The UNSPSC
To access the entire UNSPSC hierarchy after you have completed this lesson,
you can visit this website which wa...
40000000
41000000
42000000
43000000
44000000
45000000

Distribution and Conditioning Systems and Equipment
and Components
...
78000000

Transportation and Storage and Mail Services

80000000
81000000

Management and Business Professionals and
Admin...
you gear it to your needs from a purchasing perspective. Create your categories
such that suppliers that offer similar pro...
UNSPSC or you can make up categories on your own.
Go back to your data dump. Sort your spreadsheet by supplier name so tha...
forecast of activity. This could be Finance, who carefully plans cash flow. It could
be Production, who has to arrange for...
headers now have drop down arrows on their right sides. Click on the drop
down arrow in the Category column header. A list...
easier to show savings) which, if challenged by management, could have
embarrassed you.
Figure out the appropriate formula...
Lesson 3 Quiz
NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK

1. Which of the following is the best way to access purc...
Lesson 4 - Quick Hit Opportunities
The third component of a good savings strategy is Quick Hit Opportunity
Execution. Quic...
determining the margins for the products and services that you buy.
Business publications, the Internet, and suppliers’ an...
effort. In other words, Quick Hit Opportunities are those categories for which we
can achieve significant savings relative...
Develop baselines. As previously described, determine your current average
price for the quick hit products and/or service...
You may find that when you start working on pre-qualification criteria, common
elements are found. Pre-qualification crite...
organization. The competitive forces at work ensure that the buyer gets the
lowest price in the market for the required pr...
NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY

This Page Was Loaded Onto Your Screen On 09-10-2008 At 4 : 11 : 54 PM EST
This ...
Price

Bidder ID

Time Of Receipt
09/10/2008 4 : 12 : 58 PM
$8.34
customer
EST
08/4/2008 3 : 56 : 40 PM
$8.35
linda.moisey...
To summarize the process for achieving quick hits:
•
•
•
•
•
•

Find categories that are high impact and low effort
Commun...
Lesson 4 Quiz
NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK

1. It is important to address Quick Hit Opportunities fi...
Lesson 5 - Supplier Relationship Opportunities

The fourth component of a good savings strategy is Supplier Relationship
O...
state and local governments get for the same products, in similar quantities, with
similar service and delivery requiremen...
Value Analysis
Value analysis is the process of evaluating the design of a product or service
(including all components th...
course, this company could take the idea farther by implementing an
eProcurement system and eliminating paper entirely, bu...
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  1. 1. Savings Strategy Development A Printer-Friendly Version Of The Online Class Material From Please note the following recommendations: Use this document only for future reference when finished with the class. It is recommended that you use the online version of this material during the time that you have access to the class. When accessing the class online, you can: Engage in the interactive exercises Send questions to an instructor Take quizzes with immediate feedback Earn your Certificate of Completion by correctly answering at least 28 of the 40 quiz questions This material is protected under copyright law and may not be distributed to any person other than the individual to whom it was delivered by Next Level Purchasing, Inc.
  2. 2. TABLE OF CONTENTS Lesson Lesson 1 - Executive View of Purchasing Savings & Savings Definitions Lesson 2 - Avoidance Definitions & Outlining A Savings Strategy Lesson 3 - Spend Categorization & Analysis Lesson 4 - Quick Hit Opportunities Lesson 5 - Supplier Relationship Opportunities Lesson 6 - The 10 Phase Approach To World Class Sourcing (Part I) Lesson 7 - The 10 Phase Approach To World Class Sourcing (Part II) Lesson 8 - Reporting Savings & Continuous Improvement Page 1 14 22 34 44 55 68 77
  3. 3. Lesson 1 - Executive View of Purchasing Savings & Savings Definitions Saving money for our organizations is arguably the #1 reason that the purchasing profession exists. Sure, we purchasing professionals do an impeccable job of supporting our operations, ensuring that all business transactions are ethical, protecting our organizations from undue risk, and so forth. But it is our contribution to the bottom line through savings that justifies our paycheck. An organization may not be able to measure a return on its investment in human resources for many of its functions. The return on investment in the purchasing function can be measured very easily – we can show that for the money invested in our salaries and benefits, we save (hopefully, a larger amount of) money that goes to our organizations’ profits. Because this type of visibility can result in senior management’s expectations of strong performance, it is critical to develop and execute a strategy that maximizes savings. This course will take you step-by-step through the process of developing and executing a savings strategy. This process is written so that you can apply it to your company, irrespective of the industry. We will begin by discussing an executive view of purchasing savings and will define savings in this lesson. In the next several lessons, we will outline a savings strategy and explain each component of that strategy. Let’s begin by talking about savings from an executive perspective. For executives like CEO’s and CFO’s, the most important result of their businesses’ operations is profit. Simplified, profit is the amount by which revenues (monetary value coming into the company) exceed expenses and taxes (monetary value leaving the company). CEO’s and CFO’s spend their energies trying to maximize profit. Most CEO’s and CFO’s set an annual goal of earning more profit than the organization earned in the previous year. There are two ways of increasing profit: increasing revenues and/or decreasing expenses. As a fellow purchasing professional, you know that we are relied upon primarily to decrease expenses. In other words, we save money. Many purchasing professionals think that because we save money, thus supporting the goal of our executive management to increase profits, that we will be recognized as valuable to the organization. This is not necessarily true. There is an important job of communicating our value to executive management that needs to follow our savings efforts. This communication must be done in a way that is probably different than most of us are used to. CEO’s and CFO’s often come from an accounting background. To communicate effectively to CEO’s and CFO’s, you must speak their language – the language of accounting. We’ll teach you a little portion of the accounting language. Allow us to introduce you to an accounting document called an income statement. Income statements, also called statements of operations, profit and loss statements, P&L’s, etc., essentially show you a monetary value for revenue or sales, monetary values for different categories of expenses and taxes, and the difference between the two. If this difference is a positive value, it is referred to as net income, or profit. If this difference is a negative value, it is referred to as a net loss, or loss. 1
  4. 4. Income Statement Examples We will now look at two examples of income statements. The first income statement is for a service company – specifically, a natural gas and electric utility. This income statement begins with listing revenues and then lists expenses and taxes. Subtracting expenses and taxes from revenues will result in the net income. As you review this income statement, keep in mind that if the revenues were higher without a change to the expenses, the net income would be higher. Likewise, if the expenses were lower without a change to the revenues, net income would be higher. Revenues 10,558,000,000 Electric fuel and energy purchases, net 1,369,000,000 Purchased electric capacity 680,000,000 Purchased gas, net 1,822,000,000 Liquids, pipeline capacity, and other purchases 219,000,000 Restructuring and other acquisition-related costs 105,000,000 Other operations and maintenance 2,938,000,000 Depreciation, depletion, and amortization 1,245,000,000 Other taxes 395,000,000 Interest expense 899,000,000 Subsidiary preferred dividends and distributions of subsidiary trusts 98,000,000 Income taxes 370,000,000 Net income 418,000,000 2
  5. 5. Now we’ll look at an income statement for a manufacturing company – specifically, a food manufacturer. Manufacturing income statements are similar to service income statements, however, manufacturing income statements usually calculate gross profit. Gross profit is simply the difference between the price at which you sell a product and the cost you incurred in buying or making the product. In retail, gross profit is the price paid by the customer minus the price paid by the store for the item purchased. In manufacturing, gross profit is the price paid by the customer minus the cost incurred by the manufacturer. This cost can include not only materials incorporated into the final product but also the internal and outsourced labor involved in converting the raw materials into a finished product. Thus, net income is gross profit less indirect expenses and taxes. When reviewing this income statement, think about how changes to sales, cost of products sold, and expenses can affect the amount of net income – "the bottom line." Sales 9,431,000,000 Cost of products sold 6,093,827,000 Gross profit 3,337,173,000 Selling, general and administrative expenses 1,746,702,000 Interest expense 294,269,000 Other expense, net 45,057,000 Income taxes 444,701,000 Net Income 806,444,000 3
  6. 6. Income Statement Line Item Explanation If you have begun asking yourself "what does all of this bean counting have to do with purchasing?” wonder no more. As we have mentioned earlier, the purchasing function reduces expenses through the savings that we generate. Because financial statements are so near and dear to the hearts of our executive management, it is important to know what part of the income statement is affected by our savings. We will refer to the manufacturer’s income statement to illustrate where purchasing impact is felt. Specifically, we will look at each of these line items: sales; cost of products sold; selling, general, and administrative expenses; interest expense; other expense, net; and income taxes. Sales: While purchasing can help sales figures by ensuring that supplier performance gives our company products or services that meet the marketplace’s cost, delivery, quality, and service demands, it is difficult to quantify the real impact that purchasing has on sales. Therefore, for the purposes of this discussion, we will say that purchasing does not affect this line item on the income statement. Cost of products sold: Because this line item includes the costs of materials and outsourced services involved in producing a finished product, purchasing definitely impacts this line item. However, because this line item includes costs associated with internal labor, purchasing may not be able to have 100% control over the amount of the cost of products. Selling, general, and administrative expenses: This line item includes expenses not considered to be directly allocated to producing the products to be sold. It includes a variety of types of expenses: from office supplies to utilities; from salaries to facility lease payments; and from employee benefits to advertising. Therefore, it is easy to see that purchasing can impact a portion of this expense, but not all of it. Interest expense: This line item covers all expenses related to interest incurred by a company. A company may be financing its purchases of facilities or vehicles or may have taken out loans for operating capital. Interest incurred on those financing activities is captured in this line item. Purchasing generally does not get involved in financing transactions, so we will consider this expense outside of the scope of the purchasing function. Other expense, net: This line item captures all expenses that Generally Accepted Accounting Principles deem unallocable into the foregoing categories. Because the expenses captured in this category are commonly unusual expenses and relatively small compared to the expenses in the aforementioned categories, we will consider them to be outside of Purchasing’s control. Income taxes: Unless someone can show me an example of how purchasing negotiated favorable treatment from the government, this category will be outside of Purchasing’s control also. 4
  7. 7. Purchasing Impact Exercise Now that we have examined those areas where Purchasing’s impact can be felt, it is time to engage in an exercise to demonstrate how our impact affects an income statement. We’ll see how much better purchasing performance improves profits. And, remember, improving profits is commonly the #1 goal of CEO’s and CFO’s. Before beginning this exercise, we must clearly state our assumptions. Here they are: • • • • • Sales will remain constant We’ll consider Purchasing to have the capability of impacting 50% of cost of products sold. The other half will be considered to be comprised of costs associated with internal labor. We’ll consider Purchasing to have the capability of impacting 50% of selling, general, and administrative expenses. The other half will be considered to be comprised of costs associated with salaries, benefits, and the like. We’ll consider Purchasing to have no impact on interest expense or other expense The income tax rate (approximately 35.5%) will stay the same. Thus, if net income before taxes increases as a result of decreased expenses, the amount of taxes paid will increase. Given these assumptions, Purchasing has control over $3,920,264,500 in expenditures. This next exercise will enable you to see the impact on net income when purchasing saves money on the company’s purchases. Simply enter a percentage of savings that the purchasing department can achieve on the total value of expenditures under its control. Then, click on the See Impact button and watch as several of the dollar values in the income statement change. Pay particular attention to the Net income line. Try several different percentages. This exercise clearly demonstrates the fact that when Purchasing saves money, profit increases. When profit increases, our executive management achieves its goal. 5
  8. 8. NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY Sales 9431000000 Cost of products sold Gross profit -Selling, general, and administrative expenses Interest expense 294269000 Other expense, net 45057000 -Income taxes -Net income Enter percent: % Use this exercise to gain a clear understanding of where Purchasing’s impact can be found on financial statements. When communicating the money that Purchasing has saved the company, specify the place on the income statement affected by Purchasing’s performance. Always indicate exactly how net income would have been lower if it weren’t for good purchasing. Remember, CEO’s and CFO’s are often accountants – by using financial statements to communicate Purchasing’s performance, you will be "speaking their language." It is always a good communication technique to position your thoughts in a framework that is embraced by the listener. Savings Definitions OK, so now what is meant by "savings?" Unfortunately, there are no standards in the purchasing profession to dictate exactly what qualifies as savings and what does not. As a result, some purchasing departments have very rigid qualifications for savings while others consider many questionable methods to be valid savings definitions. Because this course is geared towards developing a savings strategy that is embraced by executive management, we will provide recommendations for defining your savings in a manner that CFOs and CEOs will generally consider valid. 6
  9. 9. In this section of the lesson, we will cover different savings types. Information about each savings type will be broken down into four sections: 1. 2. 3. 4. A definition of the savings type The formula for calculating savings An example scenario to which the savings type would apply A calculation of the savings in the example scenario All formulas are algebraic in nature. They calculate a result by performing mathematical operations on variables. Variables are simply values in the formula that change depending on the situation. For example, a formula may be cost = price x quantity. Price and quantity are variables – they will change depending on the situation. All formulas in this section use acronyms as the variables. Each formula will then be followed by the word "Where" and a description of what each variable represents. Therefore, you determine what the proper value of the variable is and then plug that value into the formula. For some savings types, the fourth section will be replaced by an exercise. In the exercise, you will be asked to enter values for some of the variables. When you click on the "Calculate" button, the total savings will be calculated and the correct answer will appear on the screen directly below the values you entered. This will allow you to check your understanding of how the savings types are calculated. Alright. Let’s discuss some savings types… Year-Over-Year Savings: Your company pays a lower price this year for a product or service than it has paid in the past for the identical product or service. Year-Over-Year Savings can be achieved using the same supplier as before or a different supplier. Year-Over-Year Savings = (OP – NP) x QP Where, OP = Old price NP = New price QP = Quantity purchased For example, if you purchased 10,000 ten-packs of Imation CD-R’s for $0.50 each this year and spent $0.60 on the same disks last year, your Year-Over-Year Savings would be calculated as follows: Year-Over-Year Savings = ($0.60 – $0.50) x 10,000 = $1,000 7
  10. 10. Payment Term Savings: Your company receives more favorable payment terms for products or services purchased this year than it has received in the past for the identical products or services or from the same supplier. Note that when your company must pay earlier to receive a discount, your company's cost of money must be factored into the calculation. Payment Term Savings = {(ND – OD) – [(ON – NN) x (CM/365)]} x SP Where, ND = New discount where percentages are written as numbers with two decimal places (e.g., 2% = 0.02) OD = Old discount where percentages are written as numbers with two decimal places (e.g., 2% = 0.02) ON = Old number of days in which payment is due NN = New number of days in which payment is due CM = Annual cost of money (i.e., the interest or other return earned by your company through investing idle cash). This value can be best estimated by your Finance department. SP = Spend on the products and/or services to which the new discount applies For example, if you spend $10,000 with a supplier who has changed your payment terms from Net 30 to 2%/10, Net 30 and your annual cost of money is 6%, your Payment Term Savings would be calculated as follows: Payment Term Savings = {(0.02 – 0.00) – [(30 – 10) x (0.06/365)]} x $10,000 = $167.12 Substitution Savings: Your company pays a lower price this year for a new product or service than it has paid in the past for an old product or service that served the same purpose. Note: If there is a degradation or improvement in quality as a result of the substitution, you must adjust the savings such that it reflects any costs or avoided costs as a result of the change in quality. Substitution Savings = (OP – NP) x QP Where, OP = Price for old product or service NP = Price for new product or service QP = Quantity of new product or service purchased Now, you can calculate Substitution Savings through an exercise. In this scenario, you used to buy for 20 cents each stainless steel nuts and bolts to be 8
  11. 11. used in the manufacture of a product and you have determined that aluminum nuts and bolts can be bought for 10 cents without degrading quality. You will buy 10,000 nuts and bolts and wish to calculate your Substitution Savings. Enter values for OP, NP, and QP on the "Your Answer" line, then click on the Calculate button. Your answer will be calculated and you'll get to compare your answer to the correct answer. NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY Substitution Savings = (OP - NP) x QP Your Answer = ($ -$ ) x =$ Correct Answer = ($ -$ ) x =$ Alternate Condition Savings: Your company pays a lower price for an alternate condition or non-new version (used, repaired, remanufactured, etc.) of a product than it has paid in the past for a brand new version of the same product. If the life cycle of the alternate condition product is shorter than the life cycle of the new version of the product, you must account for the increase in the quantity that you will purchase. Alternate Condition Savings = (NP x NQ) - (AP x AQ) Where, NP = Price paid for the product in new condition NQ = Quantity purchased of the product in new condition AP = Price of the product in alternate condition AQ = Quantity to be purchased of the product in alternate condition For example, let’s suppose you bought 100 new toner cartridges at $20.00 each to satisfy your needs for one year. The next year, you decided to buy remanufactured toner cartridges for $10 each however, because the remanufactured toner cartridges did not last as long, you needed to purchase 150 of them. Your Alternate Condition Savings would be calculated as follows: Alternate Condition Savings = ($20 x 100) – ($10 x 150) = $500 Note: When labor costs are significant in the replacement of end-of-life parts (e.g., a union mechanic replacing an aircraft component), the replacement labor costs should be included in your calculation of Alternate Condition Savings. 9
  12. 12. Fee Waiver Savings: Your company is not charged certain incidental fees that were paid in the past. Commonly waived fees include shipping, set up, and other charges that are in addition to the direct cost of the product or service. Fee Waiver Savings = AF x NT Where, AF = Amount of fee NT = Number of times fee is waived For example, you have previously paid an average of $5 in shipping charges per shipment from a supplier who ships 1,000 boxes per year to you. If the supplier waives shipping charges, your Fee Waiver Savings will be calculated as follows: Fee Waiver Savings = $5 x 1,000 = $5,000 Specification Change Savings: Your company has changed its specification for a product or service such that you will pay a lower price than you have in the past for the product or service. Note: If the idea of modifying the specifications originated in another department and that other department is responsible for reporting cost savings, the purchasing department should not attempt to take credit for the savings. Specification Change Savings = (OS – NS) x QP Where, OS = Price based on old specifications NS = Price based on new specifications QP = Quantity purchased Now, you can calculate Specification Change Savings through an exercise. In this scenario, you paid $10,000 per month for janitorial services that included twice-per-week vacuuming, once-per-day trash removal, and twice-per-month window washing. You now want to change the specification to include window washing only once per month thereby reducing your price to $9,000 per month. You wish to calculate your Specification Change Savings over a 12 month period. Enter values for OS, NS, and QP on the "Your Answer" line, then click on the Calculate button. Your answer will be calculated and you'll get to compare your answer to the correct answer. 10
  13. 13. NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY Spec. Change Savings = (OS Your Answer = ($ Correct Answer = ($ - NS) x QP -$ ) x =$ -$ ) x =$ Resource Reduction Savings: Your company has made a purchase that will eliminate the need for certain employees, facilities, or other resources. Resource Reduction Savings = (DO – DN) + (AR - AC) Where, DO = Annualized direct costs of using the old resources (salaries, benefits, rent, utilities, etc.) DN = Annualized direct costs of a new process to replace the old resources AR = Additional revenue generated as a part of the change AC = Additional costs associated with eliminating the resources For example, your company operates a print shop in a facility that the company owns. This print shop is responsible for printing your company’s brochures. Salaries and benefits for the print shop employees cost your company $350,000 per year. Utilities, materials, supplies, and other overhead cost an additional $150,000 per year. By purchasing its brochures from an outside vendor, your company can have the same brochures printed for $400,000 per year. By outsourcing its printing, the company will lay off all print shop employees, who will be paid $35,000 in severance pay. The company will also sell its printing facility and equipment for $300,000. The Resource Reduction Savings will be calculated as follows: Resource Reduction Savings = ($500,000 – $400,000) + ($300,000 - $35,000) = $365,000 These savings categories are the types of savings most recognized by executive managers as being valid. All savings are based on the premise of paying less than you paid before. Well, what if you didn’t buy the product or service before? Can you still produce financial benefit for your company? Yes! Financial benefits that your actions produce for products or services not previously purchased are called "avoidances." We’ll talk about avoidances in the next lesson. I hope that you’ve enjoyed your first lesson. As you will at the end of each lesson, you now must take the quiz. Click on the Quiz button below to begin. If you have 11
  14. 14. any questions, please click on the Ask Charles! button below to ask a question and get a response from your instructor by email within 24 hours. 12
  15. 15. Lesson 1 Quiz NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK 1. Which of the following income statement line items does Purchasing most commonly affect? a.) sales b.) taxes c.) net income d.) none of the above 2. Buying an item at a lower price than was paid in the previous year is an example of: a.) year-over-year savings b.) payment term savings c.) an avoidance d.) all of the above 3. Substituting a purchased item for a previously purchased, more expensive item: a.) is not a legitimate way of achieving cost savings b.) is a legitimate way of achieving cost savings c.) is an example of an avoidance d.) must be approved by Engineering to be considered a savings 4. If Purchasing is depended upon to generate savings: a.) negotiation cannot be used b.) payment terms should not be a factor in looking for cost saving opportunities c.) avoidances should be the focus d.) it can be beneficial to work with other departments to improve specifications 5. Resource Reduction Savings can be realized when a company: a.) makes a make-or-buy decision b.) negotiates later due dates on its payments c.) continues to purchase a product in the same manner at the same price d.) all of the above 13
  16. 16. Lesson 2 - Avoidance Definitions & Outlining A Savings Strategy All of the savings types that we discussed in Lesson 1 are based on the premise of paying less than you paid before. Well, what if you didn’t buy the product or service before? Can you still produce financial benefit for your company? Yes! Financial benefits that your actions produce for products or services not previously purchased are called "avoidances." But beware…avoidances are not always recognized as legitimate by executive management. Remember, CFOs and CEOs are often accountants and if you cannot show them where your impact is recorded when comparing this year’s income statement to last year’s income statement, they may discount your claims. However, some avoidances clearly result in a better financial picture for your company. We’ll cover five common avoidance types. For each of these types, we’ll discuss common executive manager’s perception of that type. Negotiated Price Avoidance: Your company is seeking to purchase a product or service that it has not purchased in the past. You solicit proposals from suppliers and determine the price offered by the low bidder. After negotiating with one or more suppliers, you agree to purchase the goods or services at a price that is lower than the original low bid. This is the only type of avoidance that is almost universally accepted as legitimate. The Negotiated Price Avoidance is calculated as follows: Negotiated Price Avoidance = (LB – PP) x QP Where, LB = Lowest bid PP = Price paid QP = Quantity purchased For example, if you purchased 1,000 cases of copy paper for $2.50 each and the original low bid was $3.00 each, your Negotiated Price Avoidance would be calculated as follows: Negotiated Price Avoidance = ($3.00 – $2.50) x 1,000 = $500 Be sure to note that the lowest among the original bids is the price used for comparison purposes, no matter which supplier was selected. In other words, you do not compare the final price to the selected supplier’s original bid if the selected supplier did not provide the lowest price in the initial round of bids – you use the lowest of those initial bids as your comparison price. Request Change Avoidance: A requisitioner submits a request to purchase a product or service and the purchasing department persuades the requisitioner to acquire an alternate product or service that is more cost effective. This type of avoidance is not always accepted. Executive managers may feel that the 14
  17. 17. requisitioner should be capable of identifying the proper product or service. The Request Change Avoidance is calculated as follows: Request Change Avoidance = VO - VM Where, VO = Value of original request VM = Value of modified request For example, the Human Resources department requests that 500 procedure manuals be printed and bound in three-ring binders at a cost of $15 each ($7,500 total). The purchasing department persuades HR to have the manuals spiral bound at a cost of $12 each ($6,000 total). The Request Change Avoidance would be calculated as follows: Request Change Avoidance = $7,500 – $6,000 = $1,500 Forgone Purchase Avoidance: A requisitioner submits a request to purchase a product or service and the purchasing department persuades the requisitioner to reduce its quantity or not make the purchase at all. This type of avoidance is not always accepted. Senior managers may feel that the requisitioner should be capable of identifying the proper quantity of product or service. The Forgone Purchase Avoidance is calculated as follows: Forgone Purchase Avoidance = VO - VM Where, VO = Value of original request VM = Value of modified request For example, a requisitioner requests that a mini-van be rented for business travel on August 20 for the one-day rate of $90. The purchasing department has previously rented a mini-van for another department who needed the mini-van from August 14 to August 18. Because the one-week rental fee of $420 was less than the aggregate cost of five individual days, the purchasing department rented the mini-van through August 20. The purchasing department then arranges for the requisitioner to use the mini-van already in the company’s possession, thus avoiding the second rental and its fee. The Forgone Purchase Avoidance would be calculated as follows: Forgone Purchase Avoidance = $90 – $0 = $90 15
  18. 18. Inventory Reduction Avoidance: You determine that inventory levels are too high and decide to reduce the quantity of certain items that are kept in stock without substantially increasing the number of times that you order the items. There are many costs associated with inventory: the cost of money that could have been invested rather than spent on inventory, the costs associated with storage, insurance costs, and so forth. These costs are collectively called "carrying costs." Many companies estimate their annual carrying costs to be 20% to 30% of the value of items in inventory. Your Finance department may have an estimate of the carrying cost percentage that your company uses. This type of avoidance is not always accepted. Senior managers may feel that a small reduction of its total inventory does not necessarily eliminate many of the costs that comprise the carrying costs – they cannot lay off any employees, divest any facilities, etc. It is difficult to prove exactly where a small Inventory Reduction Avoidance would impact the income statement. The Inventory Reduction Avoidance, which is expressed as an annualized value, is calculated as follows: Inventory Reduction Avoidance = (OQ – NQ) x CP x CC Where, OQ = Old average quantity of certain item kept in inventory NQ = New average quantity of certain item kept in inventory CP = Current price of certain item CC = Annual carrying cost percentage expressed as a number with two decimal places (e.g., 25% = 0.25) Now, you can calculate Inventory Reduction Avoidance through an exercise. In this scenario, you purchase motor oil for your fleet of company vehicles for $2 per bottle. You have kept an average of 2,000 bottles of oil in stock in the past, have annual carrying costs of 25%, and now decide to reduce your average stock levels to 500 without placing substantially more orders. You wish to calculate your Inventory Reduction Avoidance. Enter values for OQ, NQ, CP, and CC on the "Your Answer" line, then click on the Calculate button. Your answer will be calculated and you'll get to compare your answer to the correct answer. NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY Inv. Red. Avoidce.= (OQ - NQ) Your Answer = ( - x CP ) 16 x$ x CC x =$
  19. 19. Correct Answer = ( - ) x$ x =$ Note that if you must place more orders for items in order to reduce the inventory levels, you should deduct the costs associated with placing more orders, known as "acquisition costs," from your avoidance. Process Improvement Avoidance: Purchasing professionals are becoming more and more involved in process improvement assignments. Process improvements can generally be defined as changes made in an effort to reduce the time, effort, complexity, human involvement, or cost associated with a certain activity. In many instances, time, effort, complexity, and human involvement can be measured in dollars. Therefore, any reduction in any of these elements will result in a reduction in cost. Unlike the other types of savings and avoidances, the Process Improvement Avoidance is commonly recorded over a period of years. Because it is costly, in terms of time, technology, and human resources, to analyze and improve a process, it may take years of reduced costs to recoup the money spent on improving the process. The act of recouping money spent on process improvements is referred to as achieving return on investment. This type of avoidance is not always accepted. Senior managers may feel that unless a process improvement results directly in layoffs, facility divestitures, etc., no costs are necessarily eliminated. The Process Improvement Avoidance is calculated as follows: Process Improvement Avoidance = CO - (CM + CI) Where, CO = Cost of original process, prorated over a certain time span CM = Cost of modified process, prorated over a certain time span CI = Costs associated with implementing the process improvement For example, your company has just instituted a supplier certification program. In this program, suppliers who have had no defects in their shipments over the past two years will no longer have to have their shipments inspected by your company’s receiving personnel. The parts will go directly into stock. The first supplier who qualifies for this program ships 20,000 individually packaged parts to your company per year. This supplier’s shipments account for 5% of the total shipments that you receive each year. Because inspection work will not be required for this supplier’s shipments, your inspectors’ workload will decrease by 5% per year. The aggregate compensation packages of your inspectors totals $300,000 per year. Theoretically, the annual cost of the modified process would be $285,000 – this accounts for a 5% reduction in work. Your time spent in implementing this program equated to $10,000 in cost. Management is only interested in the first year of avoidance. Therefore, your Process Improvement Avoidance would be calculated as follows: 17
  20. 20. Process Improvement Avoidance = $300,000 – ($285,000 + $10,000) = $5,000 If management wanted to know the avoidance over a three-year period, your Process Improvement Avoidance would be calculated as follows: Process Improvement Avoidance = $900,000 – ($855,000 + $10,000) = $35,000 Avoidances To Avoid As previously mentioned, other than the Negotiated Price Avoidance, the concept of avoidances is often not embraced by senior managers. Even the types of avoidances described in this lesson are often subjective and difficult to prove. However, there are avoidances that are downright despised by senior managers. Here’s one: You purchase $100,000 worth of office products per year and your demand is relatively constant. Your office supply vendor approaches you and indicates that your prices will be raised by 10% across the board. Thus, you can expect your spend for office products to increase to $110,000. After negotiating with your vendor, you are able to persuade them to increase your prices by only 8% rather than 10%. Thus, your spend will be $108,000. Many purchasing professionals will report a $2,000 avoidance. This is not a valid avoidance! What really occurred in the minds of the accountants is that you have incurred an $8,000 price increase. We generally advise you to never report a reduced increase as an avoidance except in cases where you are primarily responsible for managing volatile commodities and the entire market is experiencing even greater inflation as measured by a valid third-party index. It will undermine the integrity of your savings capabilities in the eyes of your senior management. These situations will occur. If you only report your savings and avoidances, you may be challenged and accused of ignoring certain categories where you incur price increases. To have a fully defendable cost savings and avoidance program, it is advisable to record your cost increases as well. Reporting your net savings (savings + avoidances – increases) would be the ideal situation. However, this approach does take a lot of resources and would require you to be familiar with pricing for virtually every line item you buy. Therefore, if you at least record your savings and avoidances, you will be off to an excellent start. 7 Components of a Good Savings Strategy At this point, you have a good understanding of how executives view purchasing savings. Now, we will review the outline for a good savings strategy. Here are the seven components of a good savings strategy: 1. Spend Analysis 2. Target Setting 3. Quick Hit Opportunities Execution 18
  21. 21. 4. Supplier Relationship Opportunities Execution 5. Strategic Sourcing Opportunities Execution 6. Savings Documentation and Reporting 7. Continuous Improvement More detailed descriptions of each of these components are forthcoming in this course, so we don’t expect you to know what each component means at this time. A Microsoft Excel file (http://www.NextLevelPurchasing.com/classes/ssdhandout.xls) accompanies this course in the Downloads section above the Lessons Menu. This file contains spreadsheets of purchasing data. In order to use an example that most of us can relate to, we are using sample data from a fictitious fast food restaurant chain. The Excel file contains several tabs located at the bottom left of your window. Each tab is numbered. Therefore, when we ask you to reference Worksheet x (where "x" is a number), simply click on the tab bearing that number to access the example. After completing this course and before beginning the implementation of your own savings strategy, you create a spreadsheet similar to Worksheet 0 to map out your savings strategy. We’ll call this spreadsheet your "Savings Strategy Outline." Here are explanations of what should be entered in the various columns in the Savings Strategy Outline and when such data should be entered. Target Commencement Dates: These dates represent the dates by which you expect to begin work on the corresponding component of the savings strategy. These dates should be entered into the spreadsheet as soon as you have decided to implement a savings strategy. Actual Commencement Dates: These dates represent the dates on which you actually started work on the corresponding component of the savings strategy. These dates should be entered into the spreadsheet as soon as you start working on the corresponding component of the savings strategy. Target Completion Dates: These dates represent the dates by which you expect to finish work on the corresponding component of the savings strategy. These dates should be entered into the spreadsheet as soon as you have decided to implement a savings strategy. Actual Completion Dates: These dates represent the dates on which you actually finished work on the corresponding component of the savings strategy. These dates should be entered into the spreadsheet as soon as you finish working on the corresponding component of the savings strategy. Target Annual Savings: These values represent the amount of money you estimate saving for each of the opportunity classifications. These values should be filled in immediately after you have completed your spend analysis but 19
  22. 22. before acting on any of the opportunities. Actual Annual Savings: These values represent the amount of money you expect to save or have saved after executing the corresponding opportunity classification. These values should be filled in immediately after signing any contracts for goods and/or services in the corresponding opportunity classification. These values should be updated frequently and finalized at the end of the accounting year to document actual savings. In the next lesson, we will begin going over each of the seven components of a good savings strategy. 20
  23. 23. Lesson 2 Quiz NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK 1. Which of the following is true? a.) An avoidance is realized when you have achieved a cost reduction on a product or service that you did not purchase in the past b.) Avoidances are generally not as easily accepted as savings by executive management c.) A lesser than originally proposed price increase should not be mistaken for an avoidance d.) All of the above 2. A reduction in inventory: a.) is obviously a savings, not an avoidance b.) is not associated with a reduction in carrying costs c.) can result in the avoidance of carrying costs expressed as a percentage of the value of the inventory d.) all of the above 3. Process Improvement Avoidances have a higher probability of being recognized as legitimate if: a.) layoffs are avoided b.) staffing is reduced and facilities are divested c.) facilities are added d.) carrying costs are calculated 4. If a supplier proposes a 12% price increase but, after negotiation, concedes to a 5% increase, you should consider this scenario: a.) a savings b.) an avoidance c.) a price increase d.) breaking even 5. What should you do immediately before implementing a savings strategy? a.) develop a Savings Strategy Outline b.) set target completion dates for each component of the strategy c.) set target dollar values for savings d.) all of the above 21
  24. 24. Lesson 3 - Spend Categorization & Analysis During this lesson, you will be given instructions on how to manipulate spreadsheets containing your company’s purchasing data. However, we recommend trying these exercises using the sample spreadsheets first so that you can compare the results of the exercises that you complete with our versions of the same exercises before you manipulate your own data. While many students taking this class have already taken Microsoft Excel For Purchasing Professionals and, therefore, will know how to apply the Excel techniques used in this class, we have made instructions available for certain Excel techniques that will be required to manipulate the spreadsheets. Where we give instructions on what to do in Excel, we will follow those instructions with the underlined word "(How?)". To open a pop-up box with specific instructions, simply click on "(How?)". This pop-up box will provide the commands that you will need to execute on the sample spreadsheets to complete the exercise. Before beginning work on the spreadsheet, we recommend that you save the Excel file under a second file name. This will enable you to always have the original copy just in case you make changes and wish to save your changes while also preserving the original data. What Do You Buy? The first component of a good savings strategy is spend analysis - assessing exactly what you buy. You probably have some type of computerized records of either purchases or payments for purchases. Perhaps these records exist in your purchasing system or your accounts payable system. You need to extract these records of your purchases into a format that will enable you to analyze them. Unless your organization has invested in one of the feature-rich spend analysis tools on the market, Microsoft Excel is perhaps the most user-friendly tool available when it comes to analyzing data. For the purpose of this class, we’ll assume that Excel will be your software of choice for spend analysis. Unless you already have access to a data warehouse, you must request that your IT department extract your purchasing records from your purchasing or A/P system into Excel. This extraction is simply called a "data dump." It would be optimal if your data dump contained at least one year of purchasing transactions. We recommend that this year be the financial reporting year of your company. The most compelling way to illustrate Purchasing’s value to CFOs and CEOs (who are often accountants), is to examine two year’s financial statements and show exactly how Purchasing made improvements from one year to the next. However, some versions of Excel limit the number of records in a spreadsheet to approximately 65,000. Therefore, it may be necessary for you to accept less than a year’s worth of data. If you must accept less than a year’s worth of data, select 22
  25. 25. the month or months that would represent the most typical months from a purchasing pattern perspective. If your business is cyclical (consistently less or more busy at certain times of the year), you should select months that are neither at the peak nor at the trough of your business cycle. Here are guidelines that you can provide to your IT department when requesting your data dump: One year’s worth of purchasing transactions exported into a Microsoft Excel spreadsheet. The fields that should be included are: • • • • • • • • • Date of transaction Part number (if used) Description of product or service purchased Unit of measure Supplier Category or Commodity (if available) Quantity purchased Unit price Extended price (quantity x price) Other fields are acceptable. You may use this spreadsheet for other analyses, so having things like PO number, receiving information, and other data will not hurt. Open up the Excel file that accompanies this class (http://www.NextLevelPurchasing.com/classes/ssdhandout.xls). Click on Worksheet 1. This is an example of a data dump for our fictitious fast food restaurant. When we have advised certain individuals to consult their IT department for purchasing data, we have met resistance: "We can’t ask I.T. to do THAT!" Believe it or not, extracting information from your system’s database into an Excel spreadsheet is not that difficult. You will not be asking IT to do any customization of your system, create new reports, or anything complex and time consuming. All you need is the data in a spreadsheet where you will do the analysis. Most of the techniques taught in this course are dependent upon having this information, so you cannot develop your savings strategy unless you follow this step. Don’t be shy! 23
  26. 26. Categorizing Purchases Some purchasing systems require that a commodity or category code be assigned to each purchase order or line item. If your data does not have a commodity or category code (we’ll call either of these "categories") associated with each transaction, this section will teach you strategies for categorizing the transactions in your data dump. If your data does have categories associated with each transaction, you will avoid having to do a lot of work. However, this section will still have value to you because you may want to restructure your categories so that they optimally support the development of your savings strategy. Categorizing purchases is a daunting task. How do you look at everything you buy, determine a limited number of relevant categories, and then associate all of your purchases with one of these categories? One strategy is to avoid reinventing the wheel by using a categorization system that already exists. One of the categorization systems that has rapidly gained popularity since the late nineties is the United Nations Standard Products and Services Code – affectionately called the UNSPSC. The UNSPSC is a hierarchical classification of products and services with several levels of classifications. The top level (called a Segment) is associated with a broad category of products or services and each succeeding level is associated with more specific categories. There are over 50 Segments in the UNSPSC. A product or service can be classified at any level, therefore, the UNSPSC offers over 15,000 total unique categories. Each level has a description and a number. Here is an example of finding a category four levels deep within the hierarchy: 10 - Live Plant and Animal Material and Accessories and Supplies 10 – Live Animals 15 – Livestock 01 – Cats Therefore, cats would have a UNSPSC code of 10101501. 24
  27. 27. The UNSPSC To access the entire UNSPSC hierarchy after you have completed this lesson, you can visit this website which was available at the time this class was last revised: http://www.unspsc.org/search.asp. For now, you can review just the Segment values below to get ideas for how your categories can be structured: 10000000 11000000 12000000 13000000 14000000 15000000 20000000 21000000 22000000 23000000 24000000 25000000 26000000 27000000 Live Plant and Animal Material and Accessories and Supplies Mineral and Textile and Inedible Plant and Animal Materials Chemicals including Bio Chemicals and Gas Materials Resin and Rosin and Rubber and Foam and Film and Elastomeric Materials Paper Materials and Products Fuels and Fuel Additives and Lubricants and Anti corrosive Materials Mining Machinery and Accessories Farming and Fishing and Forestry and Wildlife Machinery and Accessories Building and Construction Machinery and Accessories Industrial Manufacturing and Processing Machinery and Accessories Material Handling and Conditioning and Storage Machinery and their Accessories and Supplies Commercial and Military and Private Vehicles and their Accessories and Components Power Generation and Distribution Machinery and Accessories Tools and General Machinery 31000000 Structures and Building and Construction and Manufacturing Components and Supplies Manufacturing Components and Supplies 32000000 Electronic Components and Supplies 39000000 Lighting and Electrical Accessories and Supplies 30000000 25
  28. 28. 40000000 41000000 42000000 43000000 44000000 45000000 Distribution and Conditioning Systems and Equipment and Components Laboratory and Measuring and Observing and Testing Equipment Medical Equipment and Accessories and Supplies Communications and Computer Equipment and Peripherals and Components and Supplies Office Equipment and Accessories and Supplies Printing and Photographic and Audio and Visual Equipment and Supplies 47000000 Defense and Law Enforcement and Security and Safety Equipment and Supplies Cleaning Equipment and Supplies 48000000 Service Industry Machinery and Equipment and Supplies 46000000 50000000 Musical Instruments and Recreational Equipment and Supplies and Accessories Food Beverage and Tobacco Products 51000000 Drugs and Pharmaceutical Products 49000000 53000000 Domestic Appliances and Supplies and Consumer Electronic Products Apparel and Luggage and Personal Care Products 54000000 Timepieces and Jewelry and Gemstone Products 55000000 Published Products 56000000 Furniture and Furnishings 52000000 71000000 Farming and Fishing and Forestry and Wildlife Contracting Services Mining and Oil and Gas Services 72000000 Building and Construction and Maintenance Services 73000000 Industrial Production and Manufacturing Services 76000000 Industrial Cleaning Services 77000000 Environmental Services 70000000 26
  29. 29. 78000000 Transportation and Storage and Mail Services 80000000 81000000 Management and Business Professionals and Administrative Services Research and Science Based Services 82000000 Editorial and Design and Graphic and Fine Art Services 82100000 Advertising 83000000 Public Utilities and Public Sector Related Services 84000000 Financial and Insurance Services 85000000 Healthcare Services 86000000 Education and Training Services 90000000 91000000 Travel and Food and Lodging and Entertainment Services Personal and Domestic Services 93000000 National Defense and Public Order and Security and Safety Services Politics and Civic Affairs Services 94000000 Organizations and Clubs 92000000 Creating Your Own Categorization Scheme The UNSPSC has become popular because many buyers and sellers engaging in eCommerce related transactions have been using it to classify their transactions. The UNSPSC essentially allows both the seller and the buyer to have the same classification system thus making integration of their technologies easier. As more and more companies adopt eProcurement, eMarketplaces, and other technological tools, the UNSPSC will continue to become a preferred, or perhaps even standard, categorization methodology that enables buyers and sellers to transact business electronically with less customization. Despite the eCommerce advantages of the UNSPSC, it also has disadvantages. Like anything that is intended to be "all things to all people," it may be perfect for no one. Your particular situation may require more flexibility than the UNSPSC provides. We recommend adopting the categorization methodology that is perfect for your situation. If that categorization methodology is the UNSPSC, fine. If not, you can create your own. When creating your own categorization scheme, we obviously recommend that 27
  30. 30. you gear it to your needs from a purchasing perspective. Create your categories such that suppliers that offer similar products or services are in the same category. We call this "Think RFP Categorization." In other words, think of all items that could be grouped into a single Request For Proposal and be awarded to a single supplier. When developing your categories based on Think RFP Categorization, you do have to find the right balance between being too specific and not being specific enough. For example, if your company buys computers and computer components, you may think that you need a category for hard drives and a separate category for CD-RW drives. You may be thinking that you could group all of your requirements for various hard drives into a single RFP and award the contract to a single bidder. You may think the same about your requirements for CD-RW drives and prepare a second RFP. However, you may find that most computer peripheral distributors sell both hard drives and CD-RW drives. As such, you could do an RFP that included both hard drives and CD-RW drives and award the contract to a single bidder. Therefore, it would make more sense to have a more general category such as "Computer Components" that included hard drives, CD-RW drives, modems, and other componentry that is available from the same group of suppliers. The opposite situation can also be true – your categories may be too general. A great example is office supplies. Look around your desk right now. Almost anything you see could be considered by someone to be an "office supply." But it does not always make sense to buy all of these things from a single source. For example, copier paper can often be purchased up to 20% less expensively from a paper distributor compared to an office supply vendor. Therefore, it may make sense to have a category for copier paper that is separate from the office supplies category because you would want to do separate RFPs and/or have separate contracts. If you are having difficulty determining which categories to select, a short analysis exercise can help. After you have received your data dump with noncategorized transactions, create a PivotTable so that your supplier names are in each row with the total amount that you spent with each supplier appears to the right of each supplier name. (How?) Next, sort the PivotTable so that it is in descending order with the supplier with the most spend on top and the supplier with the least spend on the bottom. (How?) You can practice creating this PivotTable by using Worksheet 1 in the Sample Excel File (http://www.NextLevelPurchasing.com/classes/ssdhandout.xls). Worksheet 2 shows you a sorted PivotTable. By counting from the supplier with the most spend downward, determine the suppliers who comprise 80% of your spend. We’ll call these suppliers the "80% Supplier Group." Worksheet 3 shows you the same PivotTable with calculations used to determine the suppliers that comprise the 80% Supplier Group. Those suppliers who are in the 80% Supplier Group are highlighted. Now that you have identified the suppliers who comprise 80% of your spend, determine the category of products or services they provide. You can use the 28
  31. 31. UNSPSC or you can make up categories on your own. Go back to your data dump. Sort your spreadsheet by supplier name so that all transactions for a given supplier are grouped together. (How?) Create a new column in your spreadsheet and label it "Category." One-by-one, find each of the suppliers in the 80% Supplier Group and enter the category that you identified for that supplier. Some suppliers may provide more than one category, so pay attention to the descriptions and assign categories that apply to the descriptions. Assigning categories by description should take precedence over assigning categories by supplier. Even though you most likely have most of your categories identified by this point, you probably have not categorized the majority of your transactions. Go through your remaining transactions and assign a category. Is this tedious work? Yes. Will it be worth it? Yes! Only when your purchases are categorized will you be able to effectively identify savings targets. Once you have all of your transactions categorized, create a new PivotTable so that your categories are in each row with the total amount that you spent in each category in the period covered by the spreadsheet appears to the right of each category. Next, sort the PivotTable so that it is in descending order with the category with the most spend on top and the category with the least spend on the bottom. This sorted PivotTable is called your "Spend Profile." Worksheet 4 contains the Spend Profile for our fictitious fast food restaurant. If you have obtained less than a year’s worth of data in your data dump, prorate the data you have so that your Spend Profile approximates one year of purchases. Forecasting Now just because you purchased a certain volume of products and services in those categories you have identified in the past year does not mean that you will purchase the same volume in the next year. You may never purchase those products or services again. You may purchase twice as many products or services. So while a Spend Profile is an excellent foundation for your savings strategy, it must be complemented with a forecast. To fail to complement your Spend Profile when developing a savings strategy would be like driving while looking in the rear view mirror thinking that the road ahead of you will be exactly like the road behind you. Translated to a purchasing situation, if an electronic pager manufacturer expects to enter the cell phone business in the coming year, they will purchase more miniature microphones than they had the previous year. The purchasing manager who used only the Spend Profile as a source for planning information, would be ill prepared to save money on microphone purchases. There are a variety of ways that companies do their forecasting. Some purchasing departments are intimately involved in the forecast. Other purchasing departments don’t even know that other departments are working together on a forecast. To properly develop your savings strategy, you must have access to forecasting information. How you access forecasting information will depend on your particular company. Find out who in your company has possession of a 29
  32. 32. forecast of activity. This could be Finance, who carefully plans cash flow. It could be Production, who has to arrange for an appropriate amount of capacity. It could be Marketing, who is in touch with your company’s client and prospect bases in an effort to estimate sales. Someone in your organization probably has some type of forecast that will enable you to compare projected performance with past performance. This forecast will ensure that any estimated deviations from the Spend Profile are properly prepared for as you implement your savings strategy. If you cannot determine where a formal forecast can be found, at least sit down with your company’s key end users to see how their demand for products and services may differ in the coming year. With a Spend Profile and forecast complete, you now know what you will buy in the coming year. You can now develop a strategy for saving money on those products and services you will buy. You have already seen that the information in your data dump is powerful. With your knowledge of Excel, you can conduct high impact analysis using your data dump. Using PivotTables, we found out how much we spend with certain suppliers and on certain categories of products and services. The next section will allow you to get more powerful information from your data dump. Baselining The simplest explanation of savings is that we pay a lower price in the present than we paid in the past. Therefore, it is mandatory that we know the price that we paid in the past. You cannot calculate savings without first having a "baseline" – a measurement of performance prior to implementing an improvement. While there is no standardization in the purchasing profession for properly determining a baseline, we recommend using the average price for a product or service in the previous accounting year. Again, because we want to demonstrate our value to CFOs and CEOs who are often accountants, it is important that we report our savings in a structure that they will embrace. Using our data dump, we can determine average prices in three steps in Excel: sorting, filtering, and subtotaling. First, sort your data dump by category then description or part number (part number is preferable). (How?) Worksheet 5 shows our data dump sorted by category then description. Next, we will filter our data so that we will see only those products or services in a particular category. Right now, your screen will show all of your transactions. We are going to isolate those transactions in a particular category. Make sure that one cell containing data in your spreadsheet is selected. If using Excel 2003 or earlier: Click on Data to open the Data Menu. Click on Filter to display the Filter submenu. Click on AutoFilter. Notice that the cells containing your column 30
  33. 33. headers now have drop down arrows on their right sides. Click on the drop down arrow in the Category column header. A list containing, among other things, each value in that column appears. By clicking on one of the values, your spreadsheet will show only those records whose category matches the value you selected. This is called filtering. Worksheet 6 shows our data dump filtered such that only records in the Paper Cups Category are shown. End of Excel 2003-specific material If using Excel 2007: Click on the Sort & Filter button in the Editing group within the Home tab to display a menu. Select Filter from the menu. Notice that the cells containing your column headers now have drop down arrows on their right sides. Click on the drop down arrow in the Category column header. A list containing, among other things, each value in that column appears. By unchecking the box next to (Select All) and checking the box for one of the values, your spreadsheet will show only those records whose category matches the value you selected. This is called filtering. Worksheet 6 shows our data dump filtered such that only records in the Paper Cups Category are shown. End of Excel 2007-specific material Now that you have isolated a category of products or services, you can get average prices for each product or service in that category. Simply set your spreadsheet to subtotal your records such that for each change in description or part number the average function is used to add a subtotal to the unit price. (How?)Your spreadsheet will then show you the average price for each product or service that you purchased in the selected category. These average prices will be your baselines. Worksheet 7 is an example of our baselines. Here’s where you have to be careful, though. Notice that you bought the same quantity of 16 ounce cups with each purchase. But that is not true for the 12 and 20 ounce cups. Could this affect your average price baseline? Yes, it could because a “true” average price is calculated by dividing total cost by total quantity. Let’s see how. The following formula will give a true average price paid for every single cup bought by dividing total cost by total quantity. Type it into Cell I40 of Worksheet 7: =((F37*G37)+(F38*G38)+(F39*G39))/(F37+F38+F39) You see a different average price, huh? It’s a good lesson to always carefully scrutinize your data – you could have presented a higher baseline (making it 31
  34. 34. easier to show savings) which, if challenged by management, could have embarrassed you. Figure out the appropriate formula to apply to the 20 ounce cups as well and enter it into Cell I48 to see the true average price. When you have executed your savings strategy and lowered your prices, you will compare your new prices against these old prices then multiply by the quantity purchased in the new year to calculate your savings. After completing all of this analysis, it is now time to prioritize your savings opportunities. We will break our opportunities into three categories: Quick Hit Opportunities, Supplier Relationship Opportunities, and Strategic Sourcing Opportunities. We’ll talk about each briefly now and in more detail in the next few lessons. Quick Hit Opportunities, also called "Easy Wins" and "Low Hanging Fruit" by consultants, are categories of purchases where savings can be achieved easily and rapidly. Supplier Relationship Opportunities are categories of purchases where changing suppliers is not a viable option for realizing savings. Strategic Sourcing Opportunities are categories of purchases that are critical and challenging. Selecting and/or changing suppliers for these opportunities must be done carefully through a diligent process. Setting Targets The second component of a good savings strategy is setting targets or goals. Working towards a goal is simply smart business. How will you know if you are doing a good job unless you have a goal against which to compare your performance? Targets and goals are motivators as well as indicators. You will set goals immediately after analyzing your spend (but not until after this class because you have much to learn). To set goals, you will identify which categories you will address as Quick Hit Opportunities, which categories you will address as Supplier Relationship Opportunities, and which categories you will address as Strategic Sourcing Opportunities. Then, you will estimate a percentage of spend that you expect to save through each of the three opportunity classifications. Multiplying this percentage by the aggregate spend in each opportunity classification will give you your target savings that you will enter on your Savings Strategy Outline. At this point, you are unfamiliar with each of the opportunity classifications, so you will not enter any targets until you are familiar with these. The important part is that you set targets before taking action and executing any of the opportunity classifications. 32
  35. 35. Lesson 3 Quiz NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK 1. Which of the following is the best way to access purchasing transaction data if your organization has not invested in a spend analysis software package? a.) use your system's standard reports b.) dump purchasing data into an Excel spreadsheet c.) ask each of your suppliers to provide reports d.) begin searching for data warehousing services 2. "Think RFP" categorization: a.) is more universal than the UNSPSC b.) does not help to group similar suppliers into a single category c.) is not flexible towards your organization's needs d.) can facilitate a savings strategy better than a standard classification scheme 3. A spend profile: a.) shows you how much you spend in each category of goods and services b.) shows you how much you spend on each purchase c.) shows you how much you spend over budget d.) all of the above 4. A baseline: a.) is a measurement of performance prior to improvements b.) should not be used to judge improvements c.) is applicable to America's favorite pastime, but not the purchasing profession d.) is a snapshot of performance after improvements have been made 5. Targets: a.) are vastly different than goals b.) motivate high achievement c.) A & B d.) none of the above 33
  36. 36. Lesson 4 - Quick Hit Opportunities The third component of a good savings strategy is Quick Hit Opportunity Execution. Quick Hit Opportunities should always be addressed first - before Supplier Relationship Opportunities and Strategic Sourcing Opportunities. Achieving savings through Quick Hit Opportunities delivers rapid results for management and inspires confidence in your savings strategy right at the beginning of your sourcing initiative. Management, purchasing staff, and stakeholders will see that your strategy really works and will be supportive of it. Support is critical because the other two categories of savings opportunities are more challenging and require more collaboration and buy-in throughout the organization. After completing your Quick Hit Opportunities, there is no rule on whether to address Strategic Sourcing Opportunities or Supplier Relationship Opportunities next. You should assess your organization’s situation, culture, available resources, etc. to determine which of these two categories you will address next. So, let’s find our Quick Hit Opportunities. Take a look at your Spend Profile. You will have several categories of purchases sorted in descending order from most spend to least spend. To identify your Quick Hit Opportunities, you must consider both the impact and the effort for each category. Impact First, let’s talk about impact. When evaluating a category, you must consider the impact of reducing prices for goods and services in each category. High impact categories are those categories for which the most potential savings exist. Low impact categories are those categories for which the least potential savings exist. We want to concentrate on those categories that are high impact. Here are some ways of determining whether a category is high impact: • The spending in the category is high. A rule of thumb is that any category whose total spend is 50% or more than the spend in the highest spend category in your Spend Profile is a high impact category. • Prices in the category have not been historically challenged. For various reasons, some categories of our purchases have not gotten very much attention paid to them. You can be sure that suppliers providing these categories have not gone out of their way to give us the best deal. There are probably ample opportunities for savings in these categories. • Profit margins are high in the market. There are various ways of 34
  37. 37. determining the margins for the products and services that you buy. Business publications, the Internet, and suppliers’ annual reports are all sources of information about margins in certain categories. If you find that a particular category has large margins, chances are that you will be able to wrestle a price decrease – there is plenty of room for the supplier to move. Effort Let’s now talk about the second criterion in identifying Quick Hit Opportunities: effort. When evaluating a category, you must consider the level of effort involved to reduce prices for goods and services in each category. High effort categories are those categories where changes to suppliers, purchasing methods, etc. would involve a great deal of preparation time and/or involvement of others. Low effort categories are those categories where changes to suppliers, purchasing methods, etc. would involve little preparation time and/or involvement of others. We want to concentrate on those categories that are low effort. Here are some ways of determining whether a category is low effort: • • • There is little differentiation in the marketplace. Most suppliers provide similar delivery, service, and quality. Customized or detailed specifications are not required. A simple specification, description, or part number is all you need to ensure that suppliers understand your product or service needs. There are few line items involved. After you have assessed the impact and effort for each category, add two columns to your Spend Profile. One column will have the heading "Impact" and the other will have the heading "Effort." For each category, assign an Impact of either "High" or "Low" and assign an Effort of either "High" or "Low". When you are done assigning impacts and efforts, evaluate each category in terms of where it fits in this Quick Hit Opportunity Matrix. Our Quick Hit Opportunities target those categories that are high impact and low 35
  38. 38. effort. In other words, Quick Hit Opportunities are those categories for which we can achieve significant savings relatively quickly and easily. Before finalizing your list of categories that qualify as Quick Hit Opportunities, review your forecast. Find any categories that were purchased during the period for which the Spend Profile was created but will not be purchased in the immediate future. Eliminate these categories from your Quick Hit Opportunities. Worksheet 8 shows our Spend Profile modified to make use of the quick hit criteria. Those categories that meet these criteria are highlighted. Quick Hit Groundwork At this point, you have your Quick Hit Opportunities identified. You are ready to take action and begin realizing savings for your organization. Here is a little groundwork that you should do internally to communicate your targets and nail down your requirements: Advise management of your targets. Sometimes management can be secretive about its plans for the organization. Be sure not to attempt to achieve savings on something that will be phased out as a result of a forthcoming strategic decision by management. Advising management of your targets will give them the opportunity to inform you of any conflicts with their plans. Collaborate with stakeholders. Ensure that any stakeholders, particularly end users, are involved as early as possible and as often as they would like to be. Create an atmosphere that screams "we are going to deliver benefit to our organization together." Make them feel as if they will get credit for something good. A well involved stakeholder can help you succeed. An ignored stakeholder would celebrate if you failed and may even try to facilitate your failure. Even though you will be creating a spirit of collaboration, clearly establish, preferably in writing, the goals of the savings strategy and the roles of each stakeholder. Consider standardization. Standardization is a concept all to itself and will be discussed later in this course. For quick hits, identify any variations of a certain product or service that could be consolidated into one single specification. This type of consolidation could increase your requirements for a certain product or service, thus giving you more buying power, which usually results in lower prices. Acquire current specifications. Make sure that the products or services that you are buying meet the current, as well as future, needs of the organization. Determine quantity, delivery, service, and quality needs. In your collaboration with stakeholders, determine the amount of products or services in the quick hit categories that you will buy over the next one to three years. Determine a schedule or desired lead time for the products or services. Document any service requirements you would have from suppliers of quick hit products or services. Formalize any requirements you may have for passing incoming inspection, warranty, and other quality issues. When you have all of this information, you will be able to determine the suppliers who are capable of meeting your needs, not just offering lower prices. 36
  39. 39. Develop baselines. As previously described, determine your current average price for the quick hit products and/or services. Once you do this, you will be able to determine the amount that you’ve saved by seeking cost reductions for these products and/or services. Now it’s time to take action that results in savings. The tried and true way to achieve savings is to utilize competitive bidding, also referred to as sourcing. Simplified, competitive bidding involves asking several suppliers for their best price and terms with the intention of awarding a contract to the qualified supplier who offers the best overall deal. Suppliers naturally want to offer better pricing than their competitors in an effort to earn the business, so the buying organization can often achieve significant savings. Because most of us are familiar with competitive bidding and sourcing is covered in detail later in this course, we will focus this section on how to make competitive bidding effective and efficient (i.e., fast) when acting upon Quick Hit Opportunities. Key To Effective & Efficient Sourcing The key to effective and efficient sourcing is to identify and avoid bottlenecks while maximizing competitive leverage. We’ll take a look at three bottlenecks that can be avoided with proper strategy. One bottleneck that we have seen organizations run into over and over is qualifying the low bidder. This bottleneck arises when organizations blindly send out requests for proposal to suppliers who reply with bids. The low bidder ends up being a supplier who is unfamiliar to the buying organization. The buying organization then scrambles to determine whether the low bidder is qualified: visiting the supplier’s site, checking references, reviewing financial statements, etc. It becomes difficult to determine if the low bidder is qualified and it is also difficult rejecting the low bid. This process can take an unbelievable amount of time. To avoid this bottleneck, supplier pre-qualification is necessary. You should determine which criteria a supplier needs to meet in order to be considered "qualified" to do business with you. Supplier pre-qualification should be done before a request for proposal is sent to bidders. Only qualified bidders should be given the opportunity to bid on your requirements. This process will force the sellers to sell in order to be considered for the opportunity to bid. It is their job to communicate the advantages of doing business with them. The buyer should not have to work so hard to figure out those advantages. A couple of additional notes on supplier pre-qualification… This is another great opportunity to involve your stakeholders. Determining your supplier selection criteria up front can make the selection process smoother once proposals are received. Waiting until proposals are received to determine selection criteria can result in heated debates among stakeholders, which of course can slow down a quick hit. 37
  40. 40. You may find that when you start working on pre-qualification criteria, common elements are found. Pre-qualification criteria such as positive references, solid financial statements, and good historical performance may be found in prequalification rituals for a variety of categories. When you find these common elements, it can be easy to document a standard pre-qualification procedure that is embraced by present and future stakeholders. Another bottleneck that we have seen is late contract introduction. This bottleneck arises when an organization puts a requirement out to bid. After proposals are received and discussions have taken place with one or more of the preferred suppliers, either the supplier or the buyer gives the other party a contract to review. Several weeks usually pass before the attorney for the receiving party completes his or her review. When the review is complete, the attorney recommends changes that the other party’s attorney must review, then that attorney recommends additional changes, and the revisions go back and forth for months. This process is unacceptable for Quick Hit Opportunities. To avoid this problem, develop a contract template with the assistance of your legal department. A contract template will have all of your company’s standard terms and conditions in it and will leave room for variables such as price, lead time, warranty, and specifications. When preparing an RFP, simply enter all of the variables that apply to your purchase and include the contract template in your RFP. Make sure that the instructions in your RFP communicate that bids must be made based on the requirements outlined in your RFP including all contract terms and conditions. The bidders should treat your contract as they treat your specifications – your terms and conditions are requirements not to be deviated from. This practice commonly results in fewer exceptions to your language and a lot less time spent involving attorneys. Internet Reverse Auctions A final bottleneck is price negotiation. Price negotiation is another process that can add months to competitive bidding. After receiving initial proposals, purchasing professionals are often not convinced that they have suppliers’ best offers on the table. So we persuade bidders to lower their prices. Now, there is nothing necessarily wrong with this approach. Negotiation is a core competency of purchasing professionals and those who are good at negotiation save their companies millions of dollars. But remember the concept of Quick Hit Opportunities – we want to achieve significant savings relatively quickly and easily. For achieving savings in a short amount of time, Internet reverse auctions can be extremely effective. Most of us are familiar with a "traditional" auction - where one individual, group, or selling organization has a product or service to sell and a host of buyers compete with each other to buy that product or service. The competitive forces at work ensure that the seller gets the highest price in the market for the offered product or service. A reverse auction is where one buying organization has a requirement to buy a product or service and a host of sellers compete for the opportunity to sell that product or service to the buying 38
  41. 41. organization. The competitive forces at work ensure that the buyer gets the lowest price in the market for the required product or service. An Internet reverse auction is a reverse auction that is conducted live, in real time, over the Internet, thereby permitting sellers in different locations to simultaneously attempt to outbid each other. Internet reverse auctions have generated billions of dollars in savings and have become embraced by modern purchasing professionals across many industries. When submitting a sealed bid, suppliers usually don’t offer their best price possible. They usually don’t feel the pressure to do so. Why should they minimize their profit margin when the probability exists that they can make more money? Then, when their pricing is challenged by purchasing professionals, they employ a variety of techniques to delay or prevent them from giving the best price possible. So not only is traditional negotiation slow, it may not get to the true lowest price. In an Internet reverse auction, the suppliers see the pricing submitted by their competitors, even though the identity of competitors is kept secret. Suppliers can resubmit bids continually throughout the auction until the time that the auction ends. This process puts maximum pressure on the suppliers to get to their true lowest price quickly. When used in conjunction with pre-qualifying suppliers and positioning your contract template as a requirement, you can generate great savings and conclude the competitive bidding process quickly. Internet reverse auctions overcome the obstacles found in traditional competitive bidding and negotiation – buyers typically can save 5 to 12% more and can award a contract on the same day that proposals are due. These results and speed support the fundamental premises of Quick Hit Opportunities. On the next screen, you will get to participate in a mock Internet reverse auction. On the right side of the screen will be a table displaying a series of bids. You will submit a bid by entering a price in the space to the left of the table, then clicking on the Next button. When you click on the Next button, your bid will be recorded and you will see it in the table with the other bids. The objective is to provide a price that is lower than those that had been previously submitted. Just remember when entering your price to use a format with no dollar signs, no commas, and a decimal point with at least one digit to its left and exactly two digits to its right. An example price would be: 10078.99 And, oh, some students like to bid 0.00, which takes the fun away from the process. So please resist that temptation. If the bids do get that low, please let us know so we can reset the auction. OK. Ready to go? Have fun!!! 39
  42. 42. NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY This Page Was Loaded Onto Your Screen On 09-10-2008 At 4 : 11 : 54 PM EST This auction is for one million widgets. This auction ends at 12:00:00 PM on February 30, 2012. Bidder ID: customer Enter Your Find your bid... Price $8.35 $8.50 $8.90 $8.93 $8.94 $8.96 $8.99 $9.01 $9.02 $9.03 $9.05 $9.94 $9.96 Bidder ID Time Of Receipt 08/4/2008 3 : 56 : 40 PM linda.moisey EST 07/1/2008 10 : 48 : 51 AM jackie.maldonado EST 07/1/2008 8 : 56 : 21 AM rskonier EST 05/30/2008 7 : 33 : 11 PM jnunez EST 05/24/2008 3 : 15 : 25 PM john.rine EST 05/22/2003 5 : 41 : 46 PM john.rine EST 05/17/2003 10 : 54 : 41 AM 02/26/2008 1 : 10 : 1 PM j_ml john.rine EST EST 03/11/2008 9 : 22 : 33 AM cdominick EST 02/26/2008 1 : 7 : 49 PM j_ml EST 02/25/2008 2 : 7 : 57 PM erojas EST 02/22/2003 5 : 6 : 2 PM EST 10/27/2002 9 : 5 : 9 erojas rfisher AM EST 40
  43. 43. Price Bidder ID Time Of Receipt 09/10/2008 4 : 12 : 58 PM $8.34 customer EST 08/4/2008 3 : 56 : 40 PM $8.35 linda.moisey EST 07/1/2008 10 : 48 : 51 AM $8.50 jackie.maldonado EST 07/1/2008 8 : 56 : 21 AM $8.90 rskonier EST 05/30/2008 7 : 33 : 11 PM $8.93 jnunez EST 05/24/2008 3 : 15 : 25 PM $8.94 john.rine EST 05/22/2008 5 : 41 : 46 PM $8.96 john.rine EST 05/17/2008 10 : 54 : 41 $8.99 john.rine AM EST 02/26/2008 1 : 10 : 1 PM $9.01 j_ml EST 03/11/2008 9 : 22 : 33 AM $9.02 cdominick EST 02/26/2008 1 : 7 : 49 PM $9.03 j_ml EST 02/25/2008 2 : 7 : 57 PM $9.05 erojas EST 02/22/2008 5 : 6 : 2 PM $9.94 erojas EST 10/27/2007 9 : 5 : 9 AM $9.96 rfisher EST 10/11/2007 1 : 41 : 53 PM $9.97 michael.smith EST 10/3/2007 7 : 48 : 7 AM $9.98 rskonier EST 10/2/2007 9 : 15 : 30 AM $9.99 rskonier EST 08/29/2008 3 : 42 : 1 PM $10000.00 student101 EST 08/29/2008 8 : 43 : 5 PM $10001.00 student101 EST 08/30/2007 11 : 50 : 36 $10077.00 student102 AM EST 09/10/2007 11 : 17 : 34 $10077.07 customer AM EST 05/8/2008 11 : 59 : 58 AM $10077.08 customer EST 08/30/2007 11 : 37 : 28 $10078.99 student101 AM EST 41
  44. 44. To summarize the process for achieving quick hits: • • • • • • Find categories that are high impact and low effort Communicate your targets and nail down your requirements Prepare for competitive bidding Pre-qualify suppliers Position your contract template as a requirement of bidding Conduct reverse auctions 42
  45. 45. Lesson 4 Quiz NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK 1. It is important to address Quick Hit Opportunities first because: a.) you can gain momentum and confidence by succeeding quickly b.) management will be supportive of your later, more challenging efforts if you show rapid results c.) you can prove your success to stakeholders whose support you will need later d.) all of the above 2. Which attributes characterize Quick Hit Opportunities? a.) high effort and low impact b.) high impact and low effort c.) high impact and low interest d.) low effort and high tension 3. When laying the groundwork for Quick Hit Opportunities, what should you not do? a.) concentrate on keeping your current suppliers b.) advise management of your targets c.) consider standardization d.) collaborate with stakeholders 4. What is likely to happen if you wait too long to introduce a contract? a.) your supplier will sign the contract without review b.) your competitive leverage will be diminished and your supplier's attorney will suggest changes to the contract language c.) the supplier will decline the opportunity to do business with you d.) your attorney will permit the use of the supplier's contract without review 5. Which of the following is a benefit of reverse auctions? a.) they apply a great deal of competitive pressure on suppliers, resulting in a lower price for the buyer b.) they speed the negotiation process c.) they intimidate old fashioned purchasing managers d.) A & B 43
  46. 46. Lesson 5 - Supplier Relationship Opportunities The fourth component of a good savings strategy is Supplier Relationship Opportunity Execution. Unlike Quick Hit Opportunities and Strategic Sourcing Opportunities, Supplier Relationship Opportunities are those categories for which you cannot or do not want to switch suppliers. You do not need to switch suppliers, or even threaten to switch suppliers, to achieve savings. However, it is probable that you will not achieve as high a percentage savings as you would with Quick Hit Opportunities and Strategic Sourcing Opportunities. To determine which categories are Supplier Relationship Opportunities, evaluate each of the categories that you did not select as your Quick Hit Opportunities by asking these questions: • • • Does my organization already have a long-term contract in place with a supplier for this category? Is the supplier for this category the only supplier with the capability of producing this product or providing this service to my organization’s requirements? Has using the incumbent supplier in this category eliminated the problems my organization has had with most of its competitors without creating new problems? If you have answered "yes" to any of these questions, then the category would be appropriately deemed Supplier Relationship Opportunities. As we have stated earlier, you will probably realize the least savings in Supplier Relationship Opportunities, so be sure not to haphazardly consider a category a Supplier Relationship Opportunity rather than a Strategic Sourcing Opportunity. Beware of lame excuses for not switching suppliers. Let’s do an excuse check…be sure that these are not your reasons for not switching suppliers: "We’ve always used that supplier." "We get a good price now." "I don’t have time to think about switching suppliers." All of these are invalid excuses and should not preclude you from considering switching suppliers. You must treat the evaluation of excuses as if the excuse was on trial. The burden of proof for not switching suppliers is on the individuals who object to switching. To be a valid justification for not switching suppliers, your stakeholders need to present evidence. Instead of "we’ve always used Supplier A," a valid justification would state "we have had no late deliveries from Supplier A in the last 3 years. I have a letter from the purchasing director from the company next door that has stated that Supplier A’s only other competitor has only been able to deliver 80% of orders on time." Instead of "we get a good price now," a valid justification would be "I have checked our prices against the publicly released prices that our 44
  47. 47. state and local governments get for the same products, in similar quantities, with similar service and delivery requirements. Our price is already 5% lower. The cost of competitive bidding would not justify the small or non-existent savings we would achieve." Do you see how using evidence is much more compelling? Accept justifications with evidence only – not excuses! There are many techniques for achieving savings by working with existing suppliers. These include: • • • • Standardization Value Analysis Savings Sharing Negotiation We’ll talk about each of these one by one. Standardization Standardization is the process of consolidating the purchases of several similar products or services into the purchase of a single product or service. For example, a hospital may purchase 10,000 16cm tongue depressors per year and 5,000 19cm tongue depressors per year. The purchasing department may learn that no medical justification exists for two sizes and may be able to standardize on a single size. By standardizing, the hospital increases its buying power for the single size and can attain greater volume discounts. Analyze your own spending. Take each Supplier Relationship Opportunity category and create a PivotTable within that category. Find similar goods or services that may be ripe for consolidation. Then, forecast your quantity requirements if you were to consolidate the many varieties into a single variety or, at most, a few varieties. Now, you need to approach the existing supplier (who you have identified as a supplier you cannot replace) seeking cost reductions. However, be careful not to create an atmosphere in which it seems like you are beating the supplier over the head for a discount (even though you are in no uncertain terms seeking lower prices). Make it seem like you have both companies’ interests in mind. Tell the supplier that you have an idea that will help them reduce their inventory and streamline their process of fulfilling your orders. Ask the supplier to collaborate with you on a standardization program that will reduce both companies’ costs. Present your specific ideas and let the supplier know that you would like to increase your volume discount in return for purchasing more of a certain item. In every way possible, try to quantify the financial benefit the supplier will realize as result of collaborating with you on a standardization program. If the supplier is convinced that it will realize savings through standardization, the supplier will be more likely to concede discounts. 45
  48. 48. Value Analysis Value analysis is the process of evaluating the design of a product or service (including all components thereof) and identifying changes to such design that will result in a reduction of the cost to produce the product or provide the service without a substantial loss of functionality. Let’s consider an example of a weightlifting equipment manufacturer. This manufacturer essentially designs its equipment, purchases all components for its equipment, assembles portions of the equipment, then packages and markets the equipment which will have its assembly completed by the consumer. This manufacturer has historically purchased metal plates for use as its barbell weights at an average cost of $1 per pound. By examining each part that went into its equipment, the manufacturer notices that it can purchase sand-filled plastic weights for an average cost of 50 cents per pound from the same supplier. Because the manufacturer’s research has shown that its customers generally have no preference for metal or plastic weights, the manufacturer can keep its selling price the same while reducing its cost which, of course, increases profit. Let’s dissect this example by comparing it against the definition of value analysis. Portion of Definition Action Taken evaluating the design of a product or service (including all components thereof) and The manufacturer looked at all components that went into its weightlifting equipment identifying changes to such design The manufacturer opts to use plastic rather than metal weights that will result in a reduction of the cost to produce the product or provide the service The cost for weights is decreased by 50% without a substantial loss of functionality The consumer still lifts the same amount of weight when using the barbells The use of value analysis is not limited to manufacturers. Service industries are filled with value analysis opportunities. Consider something as simple as a purchase requisition. One company had a purchase requisition that made four copies: one that the originator kept when submitting the requisition, one that the approver kept after signing, one that the purchasing department kept, and one that the purchasing department sent back to the originator to confirm placement of the order. After examining the purpose of each copy, it was found that the approver rarely kept a copy – the originator’s confirmation copy was usually enough of a paper trail for a department. Therefore, the number of copies was reduced to 3 and the cost of the requisitions decreased by nearly 20%. Of 46
  49. 49. course, this company could take the idea farther by implementing an eProcurement system and eliminating paper entirely, but you get the point. When conducting value analysis, always try to determine the financial benefit of each component of the product or service and then compare that benefit against the cost of that component. For example, because most people keep their computers at a low volume, a computer manufacturer may not be able to charge more for a computer with 200-watt speakers, but you can bet that it would cost more to produce the louder speakers. When possible, use value analysis to compare component prices between product lines. A manufacturer of three different lines of tractors found that it was paying similar prices for the horn installed on two of its tractor lines. However, it was paying 6 times as much for the horn installed on the third tractor line. It became obvious that the horn didn’t have 6 times the value – a horn is a horn, it beeps. Therefore, the tractor manufacturer was able to find a horn that was more appropriately priced. Savings Sharing Savings sharing is another way to reduce costs without changing suppliers. In its most basic form, savings sharing works like this: you agree with a supplier to analyze characteristics of the way you do business with them. Each party comes up with suggestions on how to reduce the costs of doing business. For those suggestions upon which both parties agree, the cost savings is calculated and shared equally, usually in the form of lower prices for the buyer. For example, let’s say that an automobile manufacturer has had a contract with a supplier of windshield wipers for many years. Because windshield wipers are somewhat delicate, the contract includes strict requirements for packaging the wipers for shipment. It costs $5 to package a case ($100 worth) of wipers and the packaging cost is absorbed by the wiper supplier. Thus, packaging represents 5% of the price paid by the automobile manufacturer. The wiper supplier suggests that the automobile manufacturer allow the packaging to be comprised of less expensive recycled materials and the two parties will split the savings. By using recycled material, the packaging costs for a case worth of wipers decreases to $3 – a savings of $2. When the savings is shared, each party is entitled to $1 of the $2 worth of savings. Therefore, the wiper supplier reduces the price for a case of wipers to $99. There are countless ways to evaluate shared savings opportunities. The best part is that it is often easy to get suppliers to collaborate with you on shared savings projects. Because the suppliers can improve their bottom line by working with you, they are eager to listen to and identify ideas for savings. Negotiation 47

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