Tuesday, August 23, 2011

Understanding cost drivers as part of improving productivity

Productivity has a huge impact on negotiations as it impacts the amount of time you can spend preparing for the negotiation. The frequency and number of negotiations required also impacts individual negotiations in the same manner. In both procurement and contract functions a frequent question is "how do we provide more value to company?

My opinion is there are two interim steps before you can focus on providing value and both of they provide value on their own. The first is to understand what I call "cost drivers" that add cost or complexity to the work and your productivity and work with the business to change those.
The second step is to focus on improving your functions productivity, as the more productive you are,the more time you have to add value or do better negotiations. You can't add value when you are constantly in crisis mode. Your aren't going to do the best negotiations when you simply don't have the time to effectively manage the process and prepare for the negotiation.

This post focuses on understanding the "cost drivers". .

There are a number of “cost drivers” that affect the amount and complexity of the support required from procurement and contracts group and the cost to the company.“Cost drivers” can broken down into four categories:
1. There are cost drivers that you traditionally have no influence over that directly impact you.
2. There are cost drivers that you should seek to influence where the final decision is made by another function such as your customer.
3. There are cost drivers that are under your control that may be impacted by other functions and influences.
4. Outside influences that neither your group nor the company can control

There are three distinct approaches to managing cost drivers:
1. Drive those that are totally within your function’s control.
2. Champion and seek to influence those activities that are controlled elsewhere but which drive cost and complexity to your function or the company.
3. Champion the use of suppliers and outsourcing to help drive the company’s competitiveness by reduction of time and cost in non-core businesses that provide the ability to focus investments in key competitive areas.

Purchasing and contracting functions usually have no influence in these decisions, but they directly impact the amount and character of the work and the cost to the business.

Quality of forecasts, plans. This affects number of changes, flexibility to be managed.

Number of products, services and variants supported. This affects the total suppliers, and items purchased.

Product and service life cycles. This affects frequency of change of suppliers, changes in products or services purchases, and number of contracts.

Selling model and sales channels. This affects locations to be supported, level of support required.

Nature of the work and the company’s business goals. This affects the approach to buying, the frequency and complexity of negotiations, and amount of contract management required.

Business metrics, measurement approach and measurement periods. This affects many aspects of procurement and contracting and the priorities that get placed on activities.

Ability of the business of customer to define their needs and requirements. This affects productivity, change frequency, complexity of managing the contract.

Stability of the company (payments, credit) This affects supplier interventions, management responses etc..

Purchasing and the contracting function must regularly try to drive or influence these decisions. The final decisions may be made outside of the function or require agreement with another function(s). These decisions directly impact the amount, character, and cost of the work.

Design re-use. Tis affects the number of suppliers and parts supported.

Custom requirements per product / service. This affects the negotiation, inventory, flexibility, cancellations and the entire supply chain.

Standardization across products or services.This affects number of suppliers and products or services supported)

Number of new suppliers introduced for business or technology needs.This affects time required to develop suppliers.

Character of suppliers introduced. This affects the amount of time spent expediting, and managing performance,problems and contract requirements to help manage them.

Type of good or service to be purchased.This affects ability to consolidate or centralize activities, purchases.

Level of “design value added”.This affects level of purchase, number of suppliers, and parts supported.

Level of “service or manufacturing value added”. This affects level of purchase, suppliers, products and services supported.

Level of “internal value added” to the product logistics. This affects numbers of transactions.

Stability of the work force. This affects general productivity of the function.Locations with high personel turn-over have a huge cost.

Warranty and Service offerings. This affects negotiations, management and support costs, number of low volume transactions, number of supplier and parts managed.

Government programs and degree implementation is committed. This affects the required time to support,and manage at supplier/product/service level..

Production or service delivery strategy (single versus multiple locations) This affects numbers of suppliers, inventory, flexibility requirements, landed costs, etc.

Product lead-time offerings versus inventory/fulfillment strategy. This affects the lead-time, flexibility requirements, management of inventory liabilities.

Flexibility commitments to businesses / customers (wew orders, reschedules). This affects the amount of change with the supply base, need for flexibility or management of liabilities.

Degree of risk or obsolescence with materials. This adds additional need to manage the risks, the contract approach, the negotiation of contract terms, etc.

Approach to suppliers (Competitive or Relationship). This affects the purchasing and contracting processes used and the amount of management required.

Organizational Structure. This affects relationships,cross business activity and the ability to do leveraging for the entire company.

Defined roles related to suppliers. This affects the negotiation process, savings, performance, risks etc.)

Willingness to leverage suppliers complete capabilities. This cAN affect the cost, time to market, number of products of services, suppliers, product development times, etc

Existence of top level strategy as to when and how you use suppliers such as strategic relationships, alliances, portfolio, point solutions. This affects supplier relationships, amount of management required, etc.

Amount of cross business & function involvement.This affects degree of internal coordination, influencing efforts.

Amount of “tops down direction and management” provided and degree of leeway given to dispersed operations.This affects key program implementations, numbers of suppliers, flexibility.

Complexity of required terms in dealing with suppliers. This affects complexity and length of negotiations)

Risk strategy with supplier selection (sole or multiple sourcing). This affects numbers of suppliers, risk and amount of performance management required.

Risk strategy in other areas (e.g. how much risk is passed to suppliers?). This affects complexity and length of negotiations and cost of purchases.

Impact on supplier relationships by others (e.g. Accounts Payable). (affects amount of time spent on supplier interventions)

Amount of dependence on other functions for information, support. (Purchasing - Accounts Payable relationship, systems compatibility) (affects transaction and report processing productivity)

Order/Fulfillment Process and tools (affects degree of involvement in transaction portion of business)

Procurement and the contract management function can and should manage these factors, but they may have strong outside influences in the implementation by other groups.

Required operating procedures. This affects tasks performed and degree of checking, controlling and the amount of value added that is provided.

People knowledge and skill sets..This affects overall productivity, cost. management time etc

Availability of standard tools, systems and information..This affects productivity in transactions, supplier management, commodity management, risk management, reporting and data inquiry.

Number/ versions of systems and compatibility of information. This affects investments in software bridges, ability to have needed information for supplier negotiations, commodity management, risk management and reporting.

Number of standard templates tailored to needs, availability of alternative term needed to manage performance and risk and compatibility of templates with current business models and needs. (affects the amount of tailoring or customization required. If templates don’t reflect needs it can also drive more problems that need to be managed).

These are outside influences that affect Purchasing and are traditionally beyond the control of the business and purchasing but still affect the function .Purchasing and the contracting function must aggressively manage the impact to the business.

Character of marketplace (price volatility, material availability. This affects amount of time required to manage purchases, manage changes, manage suppliers, and the frequency of price negotiations, etc.)

Effect of other influences on product or service availability (e.g. Force Majeure). This affects staff required to deal with service or supply interruptions)

In looking at whether a Procurement or Contract group should be outsourced, one of the key questions to ask is whether the outsource supplier will have all these same cost drivers to deal with or whether the company will make the necessary changes to reduce or eliminate them? If all the cost drivers will be passed on the savings will be limited. If they can change them, why not do it first with your own procurement or contracts group. Their seemingly lack of added value may have been driven by you.

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