How Procurement can still make savings in a world of inflation

Procurement in an inflationary world – the end of “easy” savings

We are in for a sustained period of inflation. The economic balance of supply and demand has shifted for many commodities, materials and transportation, tipping economies into a period of escalating prices.

Procurement professionals have been used to driving year-on-year cost reduction, supported by underlying themes of continuous improvement, driven efficiencies, over-supply of container shipping capacity and cheap labour and, therefore, low-cost manufacturing in Asia. In the future, procurement will not have these “easy” savings. Without any intervention, the baseline will trend upwards, and buyers will not be able to use simple market levers, such as competitive tendering, auctions and leveraged negotiation to make savings.

A strategic approach to procurement is now needed, requiring the use of more complex, and more internally focused levers, such as specification change, process optimisation, value engineering, demand management and supply chain reconfiguration.

There are five steps to take control:

Inflation chart 1

Step 1: Segment the inflationary categories and understand the impact

Not all categories are subject to inflation. As an example, whilst a combination of high oil price and demand is driving huge inflation in the cost of transportation, many categories where cost drivers are not linked to inflationary cost drivers, such as software or labour

Segmenting your supply base by supply market category and annual spend (something that should be a basic default for procurement function) and then by inflationary pressure immediately identifies where focus is required and the consequent strategies.

Step 2: Defend supplier increases – based on cost driver analysis, facts and pain-share!

Procurement functions will currently be dealing with a barrage of supplier price increase demands, some of which will be justified but others will be opportunistic.

Supplier price increases need to be addressed and defended against. Everything is negotiable but the negotiation should be fact-based.

In order to do this, buyers must equip themselves with a cost breakdown of their products and services combined with an assessment of the impact of the underlying cost drivers over time. This will facilitate a fact-based negotiation based on justified cost pass-on from suppliers, rather than a headline number.

Inflation chart 2

Finally, a decision will also be required as to how much cost increase should be accepted. Suppliers will naturally start with an attempt to pass-on the full impact of cost inflation, but what is the pain-share? Do we share the pain equally, based on profit or what we negotiate?

Step 3: Mitigate from deflationary categories and opportunity supply markets

The categories where inflation is not a significant driver should receive immediate focus whilst, in parallel, take advantage of supply markets where, post-lockdown, buyers have market power.

Leverage categories where competition can still be used to drive savings should be addressed using techniques such as tendering, auction, increasing the range of suppliers, negotiation, and spot-purchase.

Whilst there are supply-markets which have been dramatically hit by lockdown. Competition is intense and surviving suppliers will compete intensely for business. By way of example, if you consider that business travel will bounce back in your organisation, right now is a perfect time to negotiate and lock-in hotel rates.

Finally, there may be categories which haven’t traditionally been addressed by procurement and now is the time to leave no stone unturned. Have spend areas such as insurance, audit fees and bank charges really been addressed robustly?

Step 4: Drive step-change savings through a strategic procurement approach

Savings will no longer come from competitive leverage techniques that only impact price. In the new world, savings are going to be driven by reworking specifications to a lower cost, optimising processes and re-engineering lifetime costs and completely reconfiguring supply chains, repositioning supply bases and diversifying risk through domestic sourcing and near-shoring from different regions.

Inflation chart 3

Demand management goes deep into the internal drivers of demand, working out ways to reduce and eliminate. Simple examples range from making sure obsolete mobile lines are not paid for, right through to technical invest-to-save initiatives which reduce energy consumption.

Reworking specifications takes a value analysis and engineering approach to products and services, systematically working through opportunities to optimise materials and processes to lower costs. This provides a perfect catalyst to weave-in ESG objectives, looking to engineer specification change to both lower cost and drive sustainability.

Process optimisation considers every aspect of the value chain in order to identify where efficiencies can be realised or where win-win scenarios with suppliers can be created. We work with clients to take-apart and rebuild each element of the value chain optimising the flow of information, material and money in areas such as forecasting, order quantities, transportation, logistics right down to packaging and returns.

Reconfiguring supply chains to give a lower end-to-end total cost of ownership combined with a risk diversification objective considers where and how to rework the supply base and build an optimum supply chain. We are already seeing an over-riding near-shoring of critical supply categories.

The downside of this approach that cost optimisation is harder and will take longer to implement. The upside is that the impact will be a bigger step-change rather than a smaller incremental impact. The prize is bigger savings, but they are harder to get.

We also believe this is an ideal opportunity to drive the Sustainable Procurement agenda in parallel. The internal levers naturally lend themselves to the delivery of improved ESG outcomes, for example greener specifications, less packaging and reduced CO2 emissions from shorter supply chains.

Step 5: Shift the risk where possible

Finally, procurement leaders should structure commercial arrangements which take into account inflation and protect their organisations from future impacts. They can do this by looking to shift the risk; either back to suppliers, on to customers, using financial instruments to hedge exposure, and by using their own internal processes to manage pricing opportunities, such as stockpiling inventory or spot-buying or switching specifications.

Inflation chart 4

Key points to consider:

  1. We are in for a sustained period of inflation – no more “easy” savings
  2. Savings are still possible but will come from a more strategic approach, using internal levers such as specification change, demand management, supply chain repositioning and process optimisation
  3. Use the opportunity to do more strategic procurement to deliver your organisation’s ESG objectives in parallel.
  4. Don’t roll-over – supplier price increases need to be defended .. and pain-shared!
  5. Find easy savings from other categories – where inflation isn’t a driver and where buyers have the power to take advantage in competitive supply-markets
  6. Shift risk – building in longer-term mitigation strategies

To find out more about how Procura can help your business please contact us.

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