Over the past several decades, companies have used all three approaches -  reducing payroll, overheads and supplies - with a varying degree of success. Many organizations have introduced higher productivity initiatives, trading higher pay for the elimination of non productive activities and improved working methods. More recently, the emphasis has moved to outsourcing non-critical activities. While it is true that many more such opportunities exist, it has to be said that they are  becoming increasingly difficult to implement as all of the easy options have been taken.

Similarly, many organizations have reduced their overheads by rationalizing their manufacturing and office facilities, often accompanied by relocation to lower cost areas. Further cost reduction is achieved by drastically cutting back on other "optional" activities such as training, travel and advertising. Whilst this latter approach will reduce cost in the short term, it can have serious implications for the longer term.

For most organizations, the proportion of turnover or revenue spent on purchased goods and services (supplies) required to run the business is between 30% (for service industries) and 65% (for manufacturing).

Reducing the amount spent on purchased goods and services seems an obvious move because it is the largest element and any cost reductions should flow straight through to the bottom line.  While the theory is certainly correct, serious problems have arisen from the manner in which it has been achieved. Many buying organizations believe that it is just a matter of going out and “beating up” on the suppliers to reduce prices. Whilst initially this will have a positive result, in the long term it has the potential to severely damage the market and, in turn, the buying organization’s ability to sustain the low prices.

A typical breakdown of  a supplier’s price shows a profit of 10% maximum, overheads at 20% and the balance being costs made up of manpower, materials, machines and facilities. A crude approach to “reduce price” invites a supplier to yield a portion of profit in order to obtain business. The supplier may or may not choose to do this but in any case, for the buyer, the number is not large.

The supplier could also decide to reduce the proportion of overheads for a particular customer but it should be remembered that this must then be recovered from  other customers. None of this tackles the area of highest potential, namely the supplier's costs, some of which may be created by unnecessary demands of the customer.

Strategic Purchasing is about extracting the best possible deals from suppliers, often by working in a co-operative manner to reduce their inherent costs. It is this area that has been neglected even by those organizations that have decided to increase emphasis on Purchasing as a means of maintaining or increasing corporate profit.

What should senior financial managers do? Invest time and energy in setting up an effective Purchasing operation that plans for the long term while at the same time gains benefit from properly considered short term action.