Three Cost-Optimization Strategies for Procurement Leaders
In a recent Gartner survey, 70% of sourcing and procurement respondents said their primary tactic for generating business value is enhancing supplier collaboration. This statistic contrasts significantly with historical cost-reduction tactics. The alternative is to focus on cost optimization. In this blog post, we elaborate on three cost optimization strategies Gartner recommends and discuss four ways these strategic goals can be translated into reality.
What is cost optimization, and why is it important?
There’s a vast difference between cost cutting and cost optimization. Historically, procurement leaders have focused on driving costs down (cost reduction). This well-intentioned focus can, however, lead to terse supplier relationships, restricting suppliers’ abilities to deliver the best service. As anyone focusing on quality rather than quantity and, as Gartner says in their Supply Chain Cost Optimization Playbook for Sourcing and Procurement Leaders, “The best suppliers are often not the cheapest.”
Instead, any long-term focus should shift to cost optimization, defined as “a business-focused, continuous discipline to drive spending and cost reduction while maximizing business value,” according to Gartner.
“The best suppliers are often not the cheapest. A short-term focus on cost savings will result in companies inadvertently getting rid of their most capable suppliers, which can impair agility, compromise service performance and affect future growth potential.” - Gartner
Challenges procurement face
One of the most significant challenges facing procurement and sourcing leaders and their teams is that a short-term focus on cost reduction may not be the most effective strategy in the long term. After a while, there are simply no further savings to be had, making this strategy ineffective at best and damaging at worst. A long-term insistence on cost-reduction won’t just harm supplier relationships; it can cause irreparable damage to business operations if alternative, cheaper suppliers are found lacking.
A cost-reduction obsession may also reduce the procurement function’s ability to place nicely with others. Unsurprisingly, procurement teams tend to have operated in organizational silos in the past.
Forward-looking procurement leaders realize, however, that we have left the era of cost-reduction for the sake of short-term savings. Instead, focusing on mutually-beneficial cost-optimization strategies requires short-, medium- and long-term thinking. Seeing the bigger picture and building the infrastructure and capabilities to support this long-term vision has the potential to benefit all parties in time. Deeper collaborative relationships have the potential to generate more business value in the long run.
3 cost-optimization strategies to use
Gartner’s Framework for Supply Chain Cost Optimization recommends that savvy procurement and sourcing leaders consider the following three key strategies.
- Firstly, starting with the short-term goal of operating better by reducing waste to improve total unit cost.
- Secondly, in the midterm, it makes sense to reconfigure how organizations function to reduce structural costs and operating losses.
- And thirdly, a longer-term plan should transform the business by investing in changes to improve overall cost-effectiveness.
Translating these strategic goals into reality
While these strategies make sense, the art of strategic delivery lies in its execution. These four tactical recommendations – supplier collaboration, better pricing negotiation ability, improved compliance due to easier contractual processes, and digital technologies – go some way towards translating cost-optimization strategies into reality.
- Supplier collaboration
Procurement and sourcing leaders focused on long-term value know that collaboration is critical. Gartner says, “rather than taking an old-school approach of beating suppliers for a price reduction, many companies are now focusing on collaborating with suppliers to identify opportunities.”
But effective collaboration doesn’t begin and end with suppliers, as you’ll discover in this report.
“Driving cost optimization across the enterprise will require procurement leaders to re-evaluate how it impacts internal stakeholders, suppliers, and external parties.”
In the case of effective rebate management, disconnected relationships can harm all parties’ abilities to deliver value. This doesn’t just apply to external supply chain relationships, however. Internal relationships between procurement, sales, support, marketing, and legal functions are almost as essential to get right.
Conflict arises most often when information varies between parties’ systems and tools. Each party thinks they’re seeing the truth – however, they are only seeing one version of the truth. The alternative is to use a single system to manage every stage of the supplier collaboration process: From initial contract negotiation and documentation to ongoing incentivization.
- Negotiate better pricing conditions
Any organization that leverages rebates as part of its sales incentives understands that getting the best deals and the best performance requires a subtle balance of price, volume, and performance. It’s hardly surprising, therefore, that Gartner recommends structuring agreements with mutually-beneficial outcomes in mind. The challenge is to find the right balance.
“When contracting with strategic suppliers, it is important to structure agreements with mutually beneficial outcomes. Critical links between price, business volume and evaluation of supplier performance will not only motivate improvements in service levels, but also foster opportunities for suppliers to consider proactive opportunities for cost savings and efficiencies.” - Gartner
Effective cost optimization requires good negotiation, certainly, but negotiation cannot exist in isolation.
- Improve compliance with contract processes
Collaboration is far more likely to be more successful when supplier relationships are established based on trust. Similarly, trust requires openness. The days of highly secretive contracts pored over endlessly and locked away in drawers are over. The alternative, open negotiations with all relevant parties, which become safely-stored, cloud-based contracts, improve honesty. This, in turn, enhances trust, which improves relationships and ensures negotiation is done in good faith.
That’s all great in theory. However, contracts are only useful if they’re conducted regularly. Sadly, the complexity involved in negotiating contracts for a long-tail of suppliers means that they are rarely done effectively at scale. To make contract negotiation and contract compliance more efficient, it’s worth considering the use of digital technologies.
“Companies often have a different approach to signing contractual agreements with suppliers. Some will only sign agreements with a select number of suppliers to reduce procurement’s complexity, while others will have supplier agreements with most of the supply base. Regardless of this, companies should reassess how they leverage supplier agreements to their advantage.” - Gartner
- Deploy digital technologies
A significant challenge to effective cost optimization lies in the very manual nature of a lot of procurement work. Gartner says, “Procurement continues to run many activities manually. It uses traditional technology to aggregate and clean data from separate systems to analyze spend. It also runs sourcing events using spreadsheets, often spending hours each week processing POs and reconciling invoices for the business.”
The alternative, leveraging digital technologies like rebate management software and other automation tools, put the power of scale firmly in the hands of procurement leaders and their teams. The Gartner Supply Chain Cost Optimization Playbook for Sourcing and Procurement Leaders says the following:
“By deploying digital procurement technologies, companies can reap a host of benefits, including increased visibility into spend, faster execution and the ability to automate tactical work.”
At Enable, we agree. We’ve seen thousands of customers turn to automation to improve how they manage rebates. It’s remarkably easy to get started with automation once the decision has been made to stop doing things the way they’ve always been done, but it’s not always easy to take the first step. Just like leveraging alternative, long-term cost-optimization strategies isn’t always an easy decision to make.
We’re not the only ones who know it’s worth it. That’s why we’ll conclude with this quote from the playbook.
“Optimizing costs across the enterprise requires an expansion of scope and mindset beyond functional silos and financial reporting conventions to make conscious trade-offs in the configuration and operation of supply chain networks.” - Gartner, Supply Chain Cost Optimization Playbook for Sourcing and Procurement Leaders
Find out more
The points we have covered in this article are just the tip of the iceberg. For a more in-depth look at cost optimization, it’s worth reading the playbook in full.
Download the Gartner Supply Chain Cost Optimization Playbook for Sourcing and Procurement Leaders to discover:
• Tactics to help you negotiate better pricing conditions and leverage supplier agreements for a competitive advantage.
• Strategies to identify cost optimization opportunities with your supply base
• How to deploy digital technologies to automate and optimize manual procurement processes.