Wednesday, January 25, 2012

Where Reducing Cost isn’t the Number 1 Priority

While most procurement groups are focused on cost and cost reduction there are a number of situations where cost may not be the primary factor. The simple fact is purchasing spend is an investment by the business or company. Investments are measured based upon the value or return that they provide. Time has an impact on the value or return that will be provided. Many people think of cost as being the rate you pay. It’s the rate times the demand and in many purchases it can be more important to manage the demand.

If you ever worked in new product development in a competitive industry you know that time to market is a key factor in decisions. That’s because of the competitive advantages that you get when you are first to market. You may have a supplier that says they can provide you a product at less cost than someone that already has a product that meets your needs. If using that supplier would push out when your product will be available for market, you probably won’t get much support for using the lower cost supplier.

If you work in the mining or energy sector you know that time to revenue is a key factor in those decisions.The revenue that one day generates from the completed work may far outweigh any cost savings you could generate. If reducing cost will have any negative impact on that schedule you won’t get much support there.

If your business buys and resells other companies products you probably know that the focus is usually not on what the product costs, it’s on what margin are you going to be able to make. If you can’t make the margin you need the cost doesn’t matter.

If you need to hire a supplier on a time and materials basis, you know that the real cost is rate times the demand and the way to keep the cost down is not to focus on the rate as much as making sure that you have experienced people who know what they are doing and aren’t learning at your expense. That keeps the demand for labor hours down so it keeps the cost down. If all you focus on is the rate you may get a lower rate but at much higher end cost.

Time and value the purchase will provide has a huge impact on what to focus on. I remember being called to meet with a Vice President whose business needed to have a building constructed in Hong Kong. He made it very clear that he didn’t want any delays in the procurement and contracting process. He gave me one key fact that highlighted that. Once in operation in the first six-month period they would make more profit than the building would cost. Based on that we fast tracked all of the procurement and negotiations. The focus was on speed, not cost. We didn’t throw unnecessary money at getting it done, but we also didn’t delay things with extended cost negotiations.

If you focus only on the rate and not the demand you lose significant opportunity to reduce the cost. To do that you need to involve the business, understand what their priorities are and work with them as only they can take steps to reduce demand.

In negotiating contracts, one of the things you need to be on the look out for is terms that will drive demand for activities that will add to your cost. I wrote a separate post on that called Managing Demand.

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