Highly Effective Cost Leverage

It's nowhere easier to make savings than in purchasing. Going about it strategically, costs can be lowered by up to 20 percent. But only very few medium-sized businesses use this chance.

By Eli Hamacher

That was something Thomas Schmuck had not expected. Never before had the costs of Software AG been analyzed by external consultants. "At first, I was skeptical whether such a project would pay at all", says the head of purchasing at the software specialist. He could only be convinced when the consultants promised not only to provide the analysis but also accompany its implementation. And 18 months later, it was fact: The target was even exceeded in the specified time. The purchasing volume of € 100 million was supposed to be reduced by 15 percent. In the end, it was more than 17 percent.

To achieve this, the purchasing department of Software AG was massively restructured. It used to be that the country organizations were responsible for procurement. Today, it's in the headquarters' responsibility. "In many countries, the same articles were purchased but at different prices", says Schmuck. Software AG now bundles the volumes. One consequence: The number of suppliers was significantly reduced; for IT products alone by one third. Thanks to larger order volumes, the purchasing staff is thus able to negotiate better prices. Reduced from 200 to 20 was the list of subcontractors helping out at short notice in case of bottlenecks.

At the same time, a new system of ratios was introduced to make it easier to detect irregularities – for example by an analysis of marketing expenditures in relation to sales. "That's why many long cherished customs also ended up on a delete list", says Schmuck. Thus, a few customer events were entirely phased out or streamlined. The financial crisis had been good for purchasing in many respects. "Today, procurement orders are checked much more critically than in the past" – as stated in a study by the Munich-based purchasing consultancy Araia Consulting. The economic crisis helped make the company's employees aware of the subject of purchasing cost, says Thomas Staudenmayer, Managing Director of Araia Consulting. Figures from the study prove that purchasing can be a huge cost driver: According to the study, a simplified design alone can reduce procurement costs by ten percent. Reducing the number of variants of supplier products would provide savings of more than seven percent.

"Purchasing is the most valuable cost leverage because there is no other way of realizing savings faster", Gerd Kerkhoff also says, the Managing Director of Kerkhoff Consulting. And if the purchasing department is efficiently structured, producing companies could save between eight and twelve percent; service providers even up to 20 percent.

But especially medium-sized companies are often unable to efficiently set up their purchasing. "The smaller the company, the worse its purchasing", says Thorsten Makowski, Managing Director of the Berlin-based purchasing consultancy Valueneer. Frequently, for example, tender invitations would be used either not at all or only rarely, and thus one of the most important cost reduction levers would remain unutilized. Yet, even small medium-sized businesses could make savings with relatively simple means and without any additional personnel. This is shown by the example of Berliner Seilfabrik which, in the middle of last year, called in the consultancy Expense Reduction Analysts. Berliner Seilfabrik is producer of individualized playground landscapes with sales of € 12 million annually. The consultants expected the greatest savings potential in transport, in logistics, in packaging and in printing catalogs and letterhead paper. Accordingly, they scrutinized these cost pools in particular. "We then invited much more tenders than before and also replaced several suppliers", says owner Karl Köhler. All in all, the rope factory is now saving € 130,000 per year. After all, that's 30 percent in the corresponding cost categories.

When savings objectives are not reached or savings plans are not even prepared, it's frequently due to bad internal communications between the purchasing department and technical departments. "But purchasing and technical departments must collaborate already very early on in new tender procedures", says the purchasing expert Kerkhoff. In particular, to be able to talk at eye level, buyers should have a basic understanding of the goods to be procured and purchased. This would also help in negotiations with suppliers. According to the study by the Munich-based purchasing consultancy Araia, the chance is hardly ever used to talk on an equal level with suppliers and thus make them a partner. And that although nobody knows the products better than the supplier itself. This know-how could be used for one's own competitive advantage – through supplier workshops, for example. The supplier will also profit because it can present itself as a strategic partner and advertise for innovations.

The agricultural machinery producer Claas also realized this already and is working closely together with its suppliers. "For all products, we provided a breakdown of the individual major price components so that we could say exactly what costs how much and why, and also what are the most important cost drivers", says Josip Tomasevic, head of corporate purchasing at Claas. Now, negotiations are not only about prices but also about how products can be made more economical – without any cutbacks in quality. Tomasevic: "The more know-how we bring in, the more constructive our talks." Like at Software AG, Claas also drastically reduced the number of suppliers for production materials – from 1350 down to 966. All in all, an amount in a double digit range of millions of euros has been saved; at least five percent of the total purchase volume.

The next challenge is looming already. Because past economic cycles have shown that cost discipline will be fast forgotten in the upturn phase of the economy. "We can increasingly see the bad habit of purchases being sometimes made haphazardly and while bypassing controlled processes", says Staudenmayer. Maverick buying – wild purchasing, as the experts call it. "That's a first rate profit killer."