Starting and Operating a Purchasing Cost Savings Program
Robert F. Smith, C.P.M.
Robert F. Smith, C.P.M., Principal, Training Technologies for Business, Inc. Winnetka, IL 60093, Telephone (847) 446-5480, e-mail firstname.lastname@example.org
83rd Annual International Conference Proceedings - 1998
Introduction - Purchasing has the ability to contribute to the financial results of any organization through a cost savings program. The program is an excellent way for Purchasing to gain the confidence of senior management. The paper is presented as a practical way for Purchasing heads to organize and operate a successful cost savings program. It includes goals, structure, necessary definitions, suggestions of where to find savings and how to write meaningful reports.
Defining the Goals of a Cost Savings Program - A successful cost savings program is one that lowers purchase costs without reducing quality below the level required to meet end user needs. The program should ask the question what is the right quality. Often parts and materials are designed with a safety factor in excess of what will be required to perform the needs of the user. Once the minimum quality has been determined, no attempt should be made to compromise it. Delivery should not be compromised by reduced costs. It is important not to make reductions in purchase cost that will result in higher cost of freight, distribution, or after sale service and warranty costs.
Gaining Management Support - Management support is critical for a successful cost savings program. No program can succeed without the funding, resources, and support of senior management. It is important that the Purchasing function be meeting its basic mission - the uninterrupted supply of materials and services meeting the required quality. Until management feels this is happening no cost savings program will have the support necessary for its survival.
The key to a good program is a sound cost savings plan. The plan must support the corporate goals and Purchasing management must have a clear understanding of what they are. Likewise the plan must be known to senior management and have their approval. It must result in savings that make a noticeable difference on cost and profits. Cost must go down or trail the rate of inflation. The cost savings plan must have clearly stated goals that include dollar targets to be saved and a time line of when savings will be accomplished. The goals must be measurable and be able to be verified by the Financial function. Individual savings projects must be assigned to specific individuals.
Cost Reduction Targets - The major areas for cost savings programs include materials purchased for production, packaging, or support operations, labor (both direct and indirect), services that support operations, administration, and support services, Inventory through standardization, simplification, the use of J.I.T., increased payment discounts and negotiated lead times, and positive effects of cash flow.
Identifying Probable Cost Savings Opportunities - Knowing where to look for cost savings can save valuable time and energy. Likely savings candidates will include items that are high dollar expenditures and items that have high volume. Others include long lead time items or those where high dollar inventory commitments are required. Also look at any items that have a high reject rates and those that are chronically in short supply. Parts that require special tooling or those carrying the label "only approved source" are often likely cost savings candidates as is any that have not been actively quoted or negotiated in over a year.
Program Definitions - Having clear agreed upon definitions of exactly what is considered a cost savings is critical to the success of any cost savings program. Any definition used must have the approval of senior management and the Financial Function. A commonly used definition is that the annual cost savings is equal to the old price, minus the new price, times the estimated annual usage. Other Purchasing activities that control, delay or avoid price increases should be recorded separately as cost avoidances. While they are positive actions they are difficult to measure and easy to misunderstand and are better recorded as a separate category.
Who Can Help Find Cost Savings? - The best source of information as to where to look for cost savings is the supply base. Both existing and prospective suppliers have seen their products in a variety of applications and may have already provided cost savings ideas to support their business relationships. The end user of the purchased item or service also often has information that will lead to good cost savings alternatives. Specifiers, such as engineers, and other buyers are excellent sources of cost savings ideas. The distribution and transportation functions often can suggest savings alternatives. Key department personnel in Quality, Field Service and Operations also have insight to cost savings opportunities
Developing a Reporting System - A reporting system must be organized to keep management and other interested parties informed of the results and progress of the cost savings program. Good reports are timely and accurate and usually conservative in stating results. They are informative in briefly explaining how results were achieved. Reports should answer the questions how much, when, who was responsible, and how were results achieved. A successfully developed format included a one page executive summary briefly explaining what had occurred in the previous month and how it compared to expectations, a second section that reported briefly on the status of each open project, and a third section that summarized completed projects completed in the current fiscal year.
Reports should be designed to stimulate buyer commitment and activity. Every buyer should be copied to see their progress and that of their companions. Reports should be available to interested parties in supervision and management. Copies should be made available to any function that will be directly affected by the program. The Financial function should always be included on distribution. The reports should give credit to those who achieved and recognize those who helped.
Stimulating Buyer Involvement - Buyers must be made aware of the importance and amount of management attention that the program will command. Many companies make cost savings a part of the buyer's job description and a part of the performance criteria used to measure the buyers effectiveness during the performance period. Salary increases are often tied to cost savings results. In a few companies cost savings are tied to a performance bonus. In these situations it is important that the goals be measurable, attainable, and equitable.
Summary - Purchasing Cost Savings Programs have become a powerful way to demonstrate to management the ability purchasing has to improve the financial results of a business institution. It is a strong tool to elevate the department and its personnel in the eyes of senior management.