Category Strategies

ADR’s Smart Purchasing Approach

In a recent landmark survey published by the Institute of Supply Management, the number one strategy mentioned for success over the next ten years was reducing the cost of externally purchased goods and services.

That being said, if you relentlessly pursue cost savings, you may suffer an offsetting drop-off in quality or a disruption of your supply. Our company has been advising clients for 20 years in 50 countries and we have found a simple matrix can help you decide what is “smart purchasing” for your company, regardless of its size. When you place each item you purchase on this matrix, it tells you how you should approach your purchasing decisions for that item. In other words, it helps define “smart purchasing” for anything you buy.

Along the bottom axis of the matrix is a measure of the strategic value of an item. How critical is it to your operation or success? How high is the risk if the item is poor quality or the supply chain is disrupted? Along the vertical axis is the cost of the item as a portion of your overall expenses or cost of goods sold. How much do you spend in a year on this item or category? How hard is it to source this item?

This two-by-two matrix gives you one of four basic strategies to follow depending on how you assess any item on your list of purchases.

• Low cost/Low risk items. Examples: office supplies, MRO (maintenance, repair and operating) supplies or factory landscaping. Smart purchasing approach: Automate purchases throughout the enterprise from low-cost vendors, minimize transactions, outsource.
• Low cost/High risk items. Examples: raw materials that are small, but essential components of your product, imports from low-cost country sources, single sourced items. Smart purchasing approach: Stockpile enough inventory and source from multiple vendors to mitigate effects of supply disruptions.
• High cost/Low risk items. Examples: packaging materials, stampings, injection moldings, security services. Smart purchasing approach: Force competition among vendors and lock prices in long-term contracts.
• High cost/High risk items. Examples: Patented technology, software, unique or precious raw materials, significant subsystems that have been outsourced. Smart purchasing approach: Create strategic relationships with vendors. Set up cost-transparent contracts. Consider changes in design or processes that generate cheaper alternatives for the item.

While this system seems remarkably simple it is surprising how many organizations lose business or money when they don’t pay attention to it. Instead, they buy commodities for years from the same vendors who tack on annual price increases while cutting their own costs by carefully managing their own purchases. They are nailed by a power failure at a remote plant or a highway accident carrying their essential supplies. Or they hammer on price until valued suppliers give up and leave them for more profitable customers.

Case in Point

For example, we worked with a tier-one automotive supplier facing rapidly rising costs of raw materials at the same time the company had to meet OEM objectives of continuous improvement and cost reductions of 5% year-on-year. The CEO had already invested significantly in automation, so he didn’t see possibilities for cost reductions from labor productivity. That left him little choice but to focus on raw material costs.

We helped him by identifying materials that were high cost/low risk and finding alternative sources for them, driving the price down through competition. In some cases the raw materials were high cost/high risk because they came from a single source. In those cases we found a few alternative materials at a lower cost that could meet the same specifications. The company had to hire engineering staff to incorporate the new material into the design and test it, but the savings in material more than offset the additional cost of the engineering resources. The result was a net 20% cost reduction in two years. We essentially moved the material from a high-cost/high risk spot on the matrix to high-cost/low risk, where we had more options to manage it.

Consulting Process

As it is engaged by clients ADR uses the matrix process to identify a specific strategy for each category of spend. Our consultants work through a five step process implement the strategy. These steps are—

• data collection
• identifying a baseline
• market test
• sourcing recommendation
• savings implementation

These will lead to significant sustainable savings and increased supplier value at your current or higher quality and service levels.

Tips for Specific Categories

• Steel
• Packaging
• Volatile Commodities