Why is cost reduction important?
It really makes me quite irritated.
There’s a corner of the Procurement world that thinks that delivering cost reduction is “old school” procurement, and that this activity should be sacrificed on the altar of enlightenment. It’s a grubby practice that only junior practitioners would trouble themselves with.
Some have sneered and derided those that practice this discipline, often resulting in newcomers to Procurement thinking that cost reduction is a “dirty” term!
My position on this topic is crystal clear. Cost / price reduction and spend management is vital for businesses who spend a significant chunk of their revenues with 3rd parties, especially the likes of manufacturing companies.
But I also know that Procurement offers way more value to a business than cost reduction alone. There’s also risk management, supplier performance management, innovation, compliance, sustainability and more.
The plain truth is that, for a majority of businesses, cost reduction will continue to be the primary metric on which Procurement performance is measured, like it or not.
Unlike other metrics such as supplier innovation, it’s pretty straightforward to measure. Plus, cost reduction has a direct impact on the bottom line, either giving a direct boost to profitability, or allowing the business to pass on price reductions to their customers to secure a higher market share. So, this is fairly fundamental to business health, correct?
Many people mix cost reduction with price reduction. They aren’t the same, although they’re often used interchangeably.
Cost reduction, in its strictest definition, involves the removal of unnecessary cost from the product or service, often with buyer and supplier working in collaboration to achieve mutual benefit. This approach attacks the costs of the product or service, leaving supplier margin unchanged, using techniques such as value engineering / analysis.
Price reduction on the other hand focuses on the price of the product/service. Going to market with a competitive tender / RFP or an e-auction uses the superior leverage of the buyer to drive prices down through the effects of competition. This is where the suppliers’ margin can be squeezed.
Both approaches have their place in the toolkit of the Procurement professional. Knowing when to use each approach for maximum benefit is key.
More on this topic in a future blog.
