Cost reduction usually refers to cost savings made during a purchasing process, but it is much more than that. It includes savings made through re-negotiation of contract terms and conditions, administrative and operational process improvements, and the intelligent use of data and technology.
This blog post is a recap of cost reduction actions you can take in the short to long term.
These actions require thought, planning, and possible investment in resources. However, they have the potential to pay off much more in the long term!
Here are 11 cost reduction strategies:
Short-term initiatives and quick wins
1. Revisit current contract terms
It’s an acceptable practice to challenge the terms of an existing contract. Any contract not reviewed for more than three years should offer some savings opportunities.
It is likely that some pricing has become uncompetitive and that there is scope for revisiting payment terms. Opening discussions with your suppliers about potential changes to purchasing frequency can lead to volume discounts.
Economic environments change, consumer consumption patterns shift, and technology moves on. Market research and benchmarking provide an opening to discuss pricing with your suppliers.
Wondering how to keep track of payment terms? Learn how Procurement Analytics can provide you with the insights you need.
2. Challenge specifications
The first step is to ask the question – do we really need this product or service? Once that is settled, analyze the extent of the need and, on that basis, review the specifications or design.
Product specifications and packaging are often based on supplier proposals or set with one particular supplier or brand in mind.
Requirements based on expected performance or outcome allow for increased competition by a broader range of suppliers.
3. Eliminate maverick spending
Maverick spending refers to unauthorized purchasing outside agreed contracts. It is also sometimes termed rogue spending or spend leakage.
It can account for a large percentage of all purchases where there is no centralized purchase-to-pay (P2P) procurement process and can be a significant challenge to cost savings initiatives.
Visibility from full spend analysis will highlight this uncontrolled spending and make way for more automated controls.
4. Challenge operational costs
Proper procurement planning helps reduce costs by ensuring the best use of administrative resources. Poor planning leads to expensive emergency procurement actions and high transport costs.
By streamlining internal P2P processes, whether automated or not, you can reduce transactional costs and additional documentation.
5. Review uncompetitive suppliers
The benchmarking process done when reviewing contracts can highlight other similar suppliers in your database that are not competitive.
These suppliers can be approached to reduce their costs in line with the market or failing that, can be removed by moving that spend to more competitive suppliers.
Active management of strategic suppliers and consolidating the total number of suppliers are critical to maximizing procurement savings. Fewer suppliers to manage leads to a more efficient process.
6. Use the data you have
Clean, complete, and timely data is critical for embarking on any savings initiative.
Reliable information on past purchases and supplier performance can highlight opportunities and drive re-negotiation efforts.
Medium- and longer-term initiatives
With short-term wins out of the way, here are some more deliberate strategies that can take more time.
7. Investigate outsourcing
Outsourcing is a strategy through which non-core procurement activities or functions are transferred to specialist external providers.
It is especially suited to indirect procurement categories such as facilities management, security, transportation, and logistics. The cost reduction benefits are:
- Lower costs due to the outsource partner’s economies of scale by aggregating customers’ requirements
- Outsourcing low value/high volume purchases free up expensive internal resources
- Access to global expertise and market knowledge in categories where there is little in-house capacity or experience
- Time-consuming negotiations and contracting are managed by specialists
While outsourcing may be a good cost reduction strategy, it still has its downsides. See how onshoring can be used to increase your sustainability in procurement.
8. Using technology
There are many software solutions that address all or part of the procurement process with the aim of generating savings.
There are opportunities for cost reduction in implementing P2P, spend analysis, and AI in procurement.
Automation aims to reduce costs by cutting down on human intervention in the process of onboarding suppliers, assessing supplier performance, and managing day-to-day operational issues.
9. Implement category management
The main objective of category management is to group and manage each type of expenditure holistically, through the entire procurement lifecycle. Implementing a category management structure requires careful planning.
When in place, this strategy allows procurement to focus their time wisely and not waste resources on repetitive transactional buying. Total spend on a commodity or a service can be leveraged to offer larger volumes or scope to key suppliers.
Category-based analysis can highlight cost avoidance opportunities and potential quick wins.
10. Centralise procurement (or your procurement analytics)
In a decentralized procurement structure, the areas of opportunity for savings are not visible. The chance of duplication of purchases and maverick spending is high even if the global procurement organization is center-led.
Centralizing procurement enables a unified global sourcing strategy. However, implementing a spend analysis tool globally can offer many of the same benefits. A rationalized supplier database leads to increased competition among suppliers and reduced supply costs.
11. Reduce procurement risk
Holistic risk management is a broad strategy often managed at the corporate level. The role of risk management within procurement means ensuring that the correct management controls are in place, especially for ad-hoc and emergency purchases.
The dependence on a sole supplier for a critical item or service is one of the biggest risks in procurement and there should always be a mitigation plan in place.
Part of risk management also means focusing on cost avoidance - which is a type of savings. This can be achieved, for example, by limiting the rate of price increases or obtaining more value from existing contracts.
In the current challenging economic environment, every organization is striving to reduce costs. Key suppliers should be developed as valuable partners working with you to keep costs down.
Cost reduction is still a #1 priority for procurement. As we've shown, there are many ways to go about it.
"Soft Savings" like risk management and cost avoidance don't show up on the balance sheet, and can often be neglected in favor of simple cost savings methods: or "hard savings".
To learn how to prove the value of procurement at the strategic level, read our Ultimate Guide to Procurement Cost Savings. It covers both the hard and soft savings methods and everything in between.
Plus you'll learn how best to communicate those savings to other stakeholders like Finance.