Purchasing Departments or Spend Management functions are a given in most larger organizations.
They are typically charged with:
- Sourcing the suppliers of services and supplies
- Gathering business requirements
- Building quotes and analyzing results
- Negotiating with suppliers
- Awarding businesses
If your organization is serious about attacking your expenses and improving bottom-line profitability, a well-run Purchasing operation is a powerful strategy. Notice I didn’t say great tactic, but strategy.
Managing expenses (capital items, inventory, supplies, and services) is not a one-time event; it's an ongoing business imperative. The Purchasing function is critical to achieving economies of scale, increased efficiency, improved leverage, improved pricing, and greater profitability.
Purchasing’s Unique Role
Purchasing Departments must execute the following eight steps used in the sourcing process for any expense category consistently to be effective:
- Gather business requirements (size, color, dimensions, service level, frequency, etc.)
- Source interested, qualified, and competitive suppliers
- Build a Request for Quote (RFQ), a Request for Proposal (RFP), or a bid
- Manage the quote, proposal, or, bid process with suppliers
- Analyze the results of the process
- Negotiate any final pricing, terms, and/or service levels
- Recommendation to management, category owners
- Award, notification to suppliers, and implementation of results
Successful sourcing activities provide one or more of the following results and benefits
- New or continuous supply of products or services according to needs
- Improved product quality or service levels
- Reduction in new price over current pricing, improved terms
- Elimination of price increases, improved service, and quality levels
Why Companies Overspend on Supplies and Services According to various research groups (Aberdeen and Gartner) organizations typically spend 25% more on supplies and services than necessary if there is no well-run, effective purchasing function guiding those decisions and following the process outlined above.
The reasons periodic cost reduction efforts fail and/or why companies consistently spend 25% too much for supplies and services are the following:
- Lack of executive interest or leadership in expense control
- Lack of dedicated Purchasing staff – expert in eight-step Sourcing Process
- Lack of current price benchmarks for supplies and services purchased
- Organization staff takes shortcuts to the sourcing process
- Inappropriate relationships with certain suppliers
- The organization just ignores pricing for supplies and services, accepting increases as they occur
- Trust that suppliers won't take advantage of them in pricing, terms, and service levels
Purchasing Department – Spend Management Options
For organizations interested in reducing costs, mitigating risk, and increasing profitability, a dedicated Purchasing function is a positive first step. But, there are options to consider in creating, building, or adding that functionality as outlined below.
- Contingency Cost Reduction Firms – Contingent firms tend to be “specialists” in particular categories such as waste, uniforms, utilities, etc. Rarely does one firm have expertise in all expense categories which could top 130 in some industries.
- Fees Charged – Contingency firms typically charge 50% of the savings for the life of the pricing commitment (12 months – 24 months or longer).
- Fee Payment – Fees can be due upon realization of savings (monthly) or at recommendation
- Advantages – If expense challenges are limited to just a few categories, contingency engagements can make sense as they have experts who work on that category regularly and can generate positive results.
- Disadvantages – Usually contingent firms do not have experience in all of your expense categories, meaning you will have to have various strategies-firms to manage all expenses. Sometimes contingent firms get a % of savings from suppliers and as such, try to move you away from your incumbent supplier. Fees of 50% of savings can be quite high compared to other alternatives.
- Comments – Use a reputable firm that can provide references. Be prepared to have regular invoice requests to support cost savings calculations.
- Build Your Own Purchasing Department – Developing your own Purchasing Department signals that you recognize the need to manage expenses effectively on an ongoing basis, which is a positive event.
- Internal Costs – According to ISM (Institute of Supply Chain Managers) the average annual cost for a Purchasing Manager today is $124K. It is impractical to assume one FTE can manage 130 categories annually so, an additional FTE, Sourcing Specialist will also be required at $60K for a grand total of $184K per year in salary + 20% in benefits.
- Costs – Most salaried employees draw a check every two weeks regardless of their results.
- Advantages – Dedicated staff focused on expenses should allow you to attack categories (6 per year or more) and generate a positive ROI from your salary and benefits costs – your savings should exceed your internal costs.
- Disadvantages – Costs internally can be great for smaller organizations. A purchasing FTE will not have the price benchmarks needed when they work a category every one, two, or three years unless they perform a rigorous RFQ. Employees frequently get sidelined from primary tasks to assume other non-Purchasing roles which defeats the original purpose.
- Comments – Building your own Purchasing team is viable if you are prepared to wait 12-18 months for a continuous stream of cost savings flowing to the bottom line. Purchasing FTEs will need to be managed, to network, and participate in ongoing training to have relevant benchmarks to assist the organization but should ultimately provide a 2-3 time ROI on their cost. Transferring existing under-utilized personnel into the sourcing role, while laudable, generally does not provide optimal results.
- Purchasing Consortiums – Buying Groups – Group Purchasing Organizations (GPOs) can provide 10-15% cost savings on narrowly selected items, supplies, and capital equipment.
- Fees Charged – GPOs typically charge an implementation fee or subscription fee to the service, which may include a purchase of stock in the organization to join. Some are free to join, but then take a larger cut in the purchase price for the items you purchase to cover administrative costs. In either event, consortiums will usually take a % of the purchase price to cover administrative costs and profit.
- Suppliers & Selection – GPOs are captive to their suppliers. They will typically have limited suppliers and a selection of items in a number of categories. Services are not usually part of GPOs, but if they are, they will be limited in scope.
- Advantages – GPOs typically do not have minimum purchases and can be quite flexible on spend requirements. GPOs tend to specialize in industries such as dealerships, hospitals, restaurants, etc.
- Disadvantages – Utilizing a GPO will likely require a change of suppliers to utilize their supplier base. Prices are normally fixed and will not be reduced to reflect your greater spend or organization size if warranted. Pricing tends to be the same for all participants or members.
- Comments – GPOs can be a good, convenient, low-cost solution for common or specialty items, but you must keep in mind that their pricing has a built-in revenue share component for the GPO and better net pricing will probably exist outside of the GPO.
- Purchasing or Spend Management Services – Services that provide Purchasing, Spend Management services, have sprung up over the past twenty-five years along with other outsourced business services. Some providers provide services beyond the traditional Purchasing role to include spend analytics, planning, sourcing, purchasing analysis, re-negotiation, implementation, management, and supplier audits as well. Some organizations will utilize these providers as their only Purchasing department while others might use the service to augment their Purchasing staff to provide more bandwidth.
- Fees Charged – Services usually charge a flat monthly fee (similar to a retainer) that is based on locations, the scope of categories to source, and any other tactical or administrative tasks required. Flat monthly fees should be less than the cost of building or running your own Purchasing Department, a common tenet of outsourced services.
- Incentive Fees – For higher-performing services, an incentive fee may also apply once the “guarantee” is achieved. Financial incentives ensure that the service provider is focused on bringing bottom line results as quickly, and effectively as possible and beyond the scope of the minimum guarantee.
- Scope & Suppliers – Some, not all service providers are supplier agnostic which means they will work within your supplier base to reduce costs rather than push wholesale supplier changes. This approach is less disruptive organizationally. Service providers typically have experience across a broad group of expense categories, more so than contingent providers, consortiums, and even internal employees because of their deeper and broader staff experience.
- Advantages – Purchasing service providers are strategic in their overall planning, and tactical in their execution of each category. Costs are generally far less than the cost of internal employees and contingent services, but greater than a less flexible GPO or consortium. Broad expertise in categories, across a broad group of clients provides current reliable benchmarks that GPOs and internal employees do not have, and contingent providers may have, albeit in fewer categories. The last advantage is staff time. Providers need access to invoices and data but then do all of the work behind the scenes leaving staff to concentrate on their primary jobs.
- Disadvantages – Using service providers comes with a monetary commitment of some defined period of time such as 12, 24, or 36 months. While this is a longer commitment than a consortium or contingent provider, it is certainly much less than bringing some on board. Organizations that are not serious about reducing costs long term should opt for a different alternative.
- Comments – Purchasing services that have a small staff and small client base will not have the price benchmarks or experience that a provider with a larger staff will have. Larger teams will also have greater capabilities relative to spend benchmarks, category experience, management, contract tracking, supplier audits, and much more.
- Comparison of Purchasing Service Options - See below for a comparison of alternatives:
Organizations will need to manage the cost of services and supplies for the life of their business. The strategy behind that management can mean the difference between profits and losses for low-margin businesses.
The first question you need to ask is whether the management of services and supplies expenses is worth your time and effort. If 25% of your annual supplies and services expense is worth your time, then the next question is which strategy do you pursue?
- Purchasing Service Provider
- Contingent Services Provider
- Purchasing Consortium
- Building Your Own Purchasing Department
There are many options for reducing costs and improving profitability with Purchasing options defined above. Research says (Aberdeen Group) most organizations overspend by 25% without trained Purchasing resources... our experience bears out that metric.
Lastly, how aggressive you are in terms of timing and the savings results you need should dictate which option you ultimately select. Decentralized Purchasing environments (untrained staff sourcing periodically) are not an efficient use of time and can result in over-spending by 25%. Pursuing one of the four options above is certainly better than doing nothing and will at a minimum reduce costs and contribute to your bottom line. Good luck in your efforts!
Doug Austin is the founder and CEO of StrategicSource, Inc. and ExpenseEdge, the leading provider of Spend Management Services (strategy, spend mapping, sourcing, process improvement, and audits) for the automotive, manufacturing, hospitality, professional services, education industries, and more. Doug is a Veteran of the U.S. Marine Corps, a graduate of the University of St. Thomas, and a speaker at various conferences, 20 Groups. seminars, and webinars. Doug has acquired over 45 years of line, staff trainer, speaker, consultant, and business owner.