Under-pressure procurement functions often stick to just the top one-third of the purchase ledger to generate cost savings, leaving the bottom two-thirds untapped. The result: significant potential for cost reduction, with no clear route to achieving it.
So how can FDs and the finance function get involved? How can they work with purchasing to identify savings? What kinds of savings are possible and how can they best be achieved?
Talk to FDs – and procurement functions – and some clear messages quickly emerge.
To begin with, purchasing functions must first accept there’s a case to answer. Many buyers focus their attention on negotiating new contracts with suppliers, supplemented by periodic ‘category reviews’ of major spend items. And if the potential savings tied up in the lower reaches of the purchase ledger are to be tapped, that needs to change.
“All too frequently, purchasers either think the bottom two-thirds are inconsequential, or that they’re already achieving best-value pricing,” says Graeme McKinnon, commercial director at Expense Reduction Analysts. “They couldn’t be more wrong.”
One example is at Moorfields Eye Hospital in London, where contracts officer Aitor Cisneros wanted to be sure that the hospital was getting the best possible deal on the water coolers they bought in – an essential spend.
With 43 coolers in and around the hospital and its outreach clinics, each typically costing £6 to refill with a 19-litre bottle of water, the annual cost of around £1,000 per cooler quickly mounted. There were operational costs, too. “We were tied to having lorry deliveries of water cooler bottles every two weeks,” says Cisneros. “We had to find space to store the bottles and the empties were an eyesore.”
The solution: mains-fed water coolers, each equipped with carbon block filters and ultraviolet lamps to filter out and kill any mains-borne contaminants.
A cool saving
The impact on cost? Instead of paying £6 or so for 19 litres of water, the hospital pays about two pence. A ‘sleep mode’ incorporated in each cooler also reduces the hospital’s energy consumption.
“We only have one bottle-fed cooler left in the hospital,” says Cisneros. “Where you’ve got about 30 regular users of one cooler, it definitely amounts to a huge cost difference if you switch to mains-fed coolers.”
The figures speak for themselves. A thorough procurement review can yield an average saving of between 5% and 10% of its cash spend, research suggests – equivalent to a 20% boost in profit for the average FTSE-350 business. And it’s in the bottom two-thirds of the purchase ledger where the potential is greatest. There are more suppliers and more ‘maverick buying’, but because it’s been so neglected, there’s so much more potential.
“Once you start diving into the detail, there are invariably savings to be made,” agrees Julian Seidman, client finance director at FD Solutions, a provider of part-time FD. “On their own, they might not be significant, but are often easily made and quickly add up to a big number.”
Precisely how those savings will be made is down to individual situations and once focused on the task, buyers will be quick to spot opportunities.
In some cases, reopening price negotiations will be the answer. In others, it will be a policy decision: does everyone with a business-provided mobile phone or Blackberry actually need that provision, for instance?
Make cost awareness a sustainable discipline
Once you’ve nailed the savings down, how do you make them last?
The first step that FDs must take to instil sustainable cost control throughout their organisation is to put in place a well-structured framework that is centrally managed, but has representation in every function or department and a method of measurement everyone can understand and access.
Group finance is a good place for this to be managed, but, increasingly, centrally-led procurement functions are playing a fundamental role in such strategies with the chief procurement officer or purchasing director assuming ultimate responsibility. They are, in effect, the rising star of the corporate world and close relations between procurement and finance is a recipe for sustainable savings.
The CFO of the pharma division at Swiss-based pharmaceutical giant Novartis, Jonathan Peacock, is an example of a CFO who understands why this makes sense. “It’s really the partnership of the CFO and the head of procurement that we found to be quite powerful,” he says.
And it’s something Peacock puts his full weight behind to ensure the rest of the business is also bought into the vision.
“For a sourcing organisation to be successful, it has to be integrated into the business,” he explains. “I try to act as a support in ensuring we get that integration.”
This is often easier said than done because, traditionally, procurement staff have been seen as junior partners in the average business and treated as ‘PO pushers’ who are only to be brought in after deals have been done. While this has changed significantly in recent years, there remain huge differences in the maturity levels between companies and industries.
Blackspots include areas of traditional power within an organisation such as marketing, legal and those departments that are seen as the lifeblood of the company. For example, the research and development people would hold all the cards in pharmaceuticals and high-technology industries and only with full board support – in particular, the CFO – will procurement be able to successfully tackle these problem areas.
But even with a centralised procurement function that enjoys full board support, sustaining savings into the long term can be a difficult nut to crack – a particular bugbear of Neil Deverill, who has served as global chief procurement officer at Anglo Americas and Royal Philips.
“It is easier to observe lasting change when there are systems in place that prevent recourse to alternative or prior practice,” he says. “Of course, standardisation will bring about common systems, processes and cost efficiencies, but I still detect hostility and resentment to new practices, even when they’ve been in place for five years or more.”
Key, therefore, to instilling long-term cost control and margin improvement is to embed processes by which the entire organisation must work to. And these processes must be developed and managed centrally.
Successful demand management is a good example of a strategic process which can have immediate and material impact on external expenditure and the bottom line. By managing the behaviour of staff rather than telling them what suppliers to use, or demanding 10% budget cuts, huge benefits can be realised without damaging productivity.
A good example is travel management. Do six people really have to attend a meeting in New York? Can it be held in Europe? Can it be combined with other meetings planned for later in the year? Can it be conducted by video conference instead?
These might seem like obvious points, but there are a frightening number of companies that don’t have robust policies in place to manage even this level of behaviour.
There are also a multitude of technology solutions that can help. The adoption of e-procurement systems, linked to pre-approved catalogues provided by suppliers, means that only approved vendors are used, that price can be centrally managed and external spend accurately tracked.
Spend analysis allows corporate-wide expenditure to be analysed down to the line-item level, meaning that inefficiencies can be ironed out relatively easily.
It is not uncommon for departments in the same organisation to be buying exactly the same product from the same supplier at wildly different rates, for example.
Also important to the process is to conduct regular measurement, with relevant key performance indicators of success, such as annual savings as a percentage of sales, visible improvements in margin at the profit and loss level.
It’s one thing driving savings, quite another making sure it falls to the bottom line and doesn’t get absorbed by the business unit. This includes year-on-year productivity improvements.
But, as Deverill notes, not all FDs see the potential that such strategies and processes hold. FDs “are good at getting cuts, but for the most part they are blind to the other side.”
David Rae is editorial director of Procurement Leaders magazine
Malcolm Wheatley is a journalist
For more ideas on making sustainable savings, read our Financial Director Guide: The Cost Control Checklist, published alongside this issue. Download a full PDF by clicking here.
Forge a strong relationship with procurement
As director of finance for Great Ormond Street Hospital Children’s Charity, I’m responsible for ensuring our £15m annual budget is managed efficiently and focused on achieving charitable objectives. Our charity does not have an in-house procurement specialist, so we rely on the skills and talents of our staff to negotiate the best deals with suppliers.
Each department has its own procurement procedures tailored to their needs, competitive tendering taking place within a framework agreed with finance.
Our activities, including campaigns, developing corporate partnerships, major gifts, community fundraising, legacies and special events, are well diversified and this decentralised approach to fiscal responsibility works well for us.
A collaborative approach to good procurement practice engenders a sense of responsibility at the departmental level. Each departmental director ensures that local procedures are adhered to and encourages their staff to challenge all costs, irrespective of origin.
Andrew Hibbert is director of finance, information technology, operations and human resources for Great Ormond Street Hospital Children’s Charity.
Three areas where strong collaboration is crucial to both procurement and the business are reporting savings, business perspective and data provision.
Nothing rankles like puffed-up ‘savings’ that never seem to flow through to a thumping end of year surplus and I strongly believe in ‘one set of authentic numbers produced by finance’ – that means procurement too.
Savings claimed must tie in to these recognisable figures. Procurement must be crystal clear on one question: what are savings measured against?
One saving against a probable overspend could be a triumph for the buying department, but might show as minor favourable variance against budget. Finance should work with procurement to ensure it gets fair credit and credibility.
Beating suppliers up on payment terms to the point they have cashflow problems and can’t supply is clearly counterproductive.
If procurement operates in isolation, this can happen: I’ve seen procurement brought in at the eleventh hour to shave another 20% and impose a plethora of conditions.
Finance is well placed to keep the buying department in the know – ensuring this never happens.
Carolyn Bresh is co-founder of Everymind, a consultancy to finance functions. She was previously group financial controller at Reuters