During our travels around Asia, we hear Procurement team members talking proudly about the cost savings  they have achieved. When we delve below the surface of these however, we find few have really identified how that impact relates directly to either the top or the bottom line of the organization. Is this the experience in your organization? Are the so-called savings questionable?

Why is this an issue for organizations today? We are witnessing some quite dramatic changes in supply markets with sellers being able to move prices  aggressively higher and in some cases, putting their products on allocation.

This puts considerable and rapid cost pressures into companies with CFO's being hard pressed to manage costs and preserve margins. "Cost savings" that are often quoted fail to stack-up. Few CEO's are impressed by news of a major increase in raw material costs and the Purchasing team claiming "savings" by limiting a raw material cost increase to 15%.

We have seen a small but growing number of cases where the organization sees Cost and Savings differently. In these organizations, Purchasing plays a proactive and connected role in the Budget Planning process. The focus is not just on Cost Savings but on Cost Out.

Let's try and define the difference between Cost Out and Cost Savings and then make a case for why companies should become more interested in talking about Cost Out as a measure rather than focusing on Cost Savings.

Today's enemy of competitive success is waste. Not only waste inside your organization but up and down the whole business supply chain. Waste is not just cost, it can be quality, technology, time, resource or duplication.

The Business Supply Chain extends from the customer's customer, through the enterprise, to the supplier's supplier.  Waste in this extended process is often the result of cost-in without the corresponding value-out.  

Here are some examples:

• It may be the need to provide supplementary delivery for goods that are short-supplied due to poor sales forecasting, production breakdowns, supply allocations.

• A customer's late changing forecast results in less than optimum shipping of product inviting supply chain inventory.

• The engineer's detailed specification may require the supplier to change their manufacturing set-up unnecessarily.

• The Supplier's supplier refuses to supply a fundamental raw material causing the supplier to call force-majeur and the factory to close.

• The sales person selling and committing the company to something that is non-deliverable without specialized effort and cost.

• Poor communications between internal "functions" or businesses cause work and waste.

What has this to do with Purchasing? Well, often the Purchasing specialist is involved with managing the consequences of these decisions made by others. They then work with the external supply market trying to optimize around a decision already made without the opportunity to see the whole.

Examples of this include the following:

• Buying a major piece of rotating equipment focusing on lowest capital cost but incurring ongoing maintenance costs. Quoting a saving of 10% off  the price is swamped by the impact of major refurbishment costs within 5 years.

• Specifying so that the equipment being bought is non-standard, inviting
self-generated monopoly supply situations with subsequent cost disadvantage

What if the Business as a whole could be aligned across the Business Supply Chain and what if there was a corporate focus on Value Creation? Value is created when the benefit is greater than the cost. Value creation seeks to locate cost and waste and then work to remove costs and waste where the Value equation does not compute.

This leads organisations to locate areas where Cost not leading to Value Creation provides opportunities for Cost-out. Cost removed in this way tends to be removed permanently from the business. It tends to add to the enterprise's competitiveness and from our own observation and experience, success builds upon success.

Purchasing, when involved in a Cost Out and Value Creation organization,  quickly learns to seize opportunities through focusing on the objective of a truly Business Procurement Process.

Such a process has 2 complimentary objectives.

1. Releasing the latent value which can be released "simply" by changing the way we do things. This may involve changing the specification or business processes. It involves internal re-alignment.

2. Releasing the latent value in the supply market.
This usually involves the first stage AND an additional stage involving interaction with the supply market, often in different ways to those usually practised.

Here are some examples:

• Motorola found that, the best possible supply chain with minimal waste was an average of 60% less costly than their actual supply chain. This finding has been crucial towards Motorola maintaining its competitive position.  They are consciously working to take out this cost with their selected suppliers in joint Cost-out programmes. This has improved their speed to market, removed mountains of waste and found new levels of Value Creation.

Contrast this with a different scenario from a less successful competitor.

• Over the past few years they have been proud of their procurement leverage with major savings successes being reported to senior management. This company is suddenly finding price increases for their major raw materials jumping at alarming rates: +15% one week followed a week later with further requests for +10%. The pressures are coming from further up the supply chain. With marketing seeming unable to bring forward product price increases, serious implications for profit reduction are being relayed to shareholders...share prices are heading south. They admit that when times were good, talk about focusing on Cost Out across the Business Supply Chain fell on deaf ears. They may survive!

• Yet another company made some major inroads with their approach to Purchasing  focused on Total Cost of Ownership and buying decisions made with respect to asset life and asset operability. While these were great steps forward, the assumption was that the internal maintenance costs would go down. However Maintenance was a different budget centre and had no intentions of reducing its capability. This disconnection between Purchasing and Maintenance resulted in resource duplication and subsequent waste creation.

If this message is so powerful and logical, why are more companies not embracing it as a fundamental Business Value. Why are more companies not extolling VALUE CREATION and COST OUT as fundamentals for a successful competitive business?

Well, the reasons are many. It seems that as a company develops, it also develops a Corporate mentality rather than retaining its entrepreneurial spirit.  Functions and Departments develop, each with their own particular focus, culture and agenda.  To take something away is not easy (just try it on your children!) without there being a clear WIIFM (What's In It For Me?). Thus  Change Management runs into many barriers. The longer the company is around, the more solid become the silos and barriers to change ("That's not the way we do things around here", " We tried it before and it did not work", "That's not my area of concern.")

So,  what should a company do?  Should it ignore the current price increase trends, continue to focus purchasing measurement on Cost Savings, and maintain the status quo?  Can it afford to stay the same?  Of course, one can ignore reality. Perhaps price increases will pass you by...Perhaps your product prices can increase faster than your costs.

An alternative is to start today to understand the real difference between Cost Savings and Cost Out/Value Creation and the impact on your own organisation.  A holistic Opportunity Analysis can often quickly scope the size of the prize and the height of the barriers to change.  

The benefits from your newly aligned Business Supply Chain will provide improved speed, lowered real cost, increased value and improved competitive advantage through smarter decision making.

How much improvement is only limited by your imagination and your commitment.