ARTICLE: OPTIMISING EXTERNAL COSTS – SAVINGS THAT LAST

We cover:

• A 4 tier model for categorising your supplier base
• How to structure your supplier base to best deliver value
• How to optimise individual suppliers throughout the lifecycle

If you are looking to drive lasting savings from your suppliers, read on…

Our 3 stage Structured External Cost Optimisation process starts by ensuring the supplier landscape is correct and only then drills down into further savings within each supplier. That way the savings you identify will be built into a structure in which they stick. You can realise short term savings by jumping straight to Stage 3, but unless you get the shape of the supplier base correct, any savings will diminish over time as the structural inefficiencies drive cost back up.

STAGE 1: BUILD A SUPPLIER PROFILE TO UNDERSTAND THE FOOTPRINT OF YOUR SUPPLIER BASE

In some sectors, supplier classification is to a greater or lesser extent prescribed, for example the Critical Third Party regime in UK Financial Services. However, in industries where that isn’t the case it is still important to categorise your suppliers in order to understand the risks and opportunities they present. Only by doing this can we better balance them in Stage 2. There are many characteristics you could use to group suppliers, so to cut through the noise, place them into one of four tiers based on how they rank against three criteria:

• Criticality
• How widely they’re used across the organisation
• Ability to substitute

Building a supplier profile should be done as efficiently as possible. The goal is simply to differentiate between suppliers in a way that is meaningful and enables us to release value in the later stages of our optimisation.  

Once you understand your current supplier landscape and the role each of your suppliers is playing in it, then you can consider where you can contract differently to deliver value more effectively. We look at that in the next stage.

STAGE 2: OPTIMISE YOUR SUPPLIER FOOTPRINT

When deciding how best to structure your supplier landscape, you need to strike the right balance between a fragmented supplier base – with many small suppliers, delivering overlapping services – and an overly consolidated base, where a small number of suppliers have too much power or control. A simple way to approach this is to look at the output of Stage 1 from a services angle rather than the suppliers: services which are complex, or have long lead times, may lend themselves to a smaller number of larger suppliers; commoditised services could be appropriate candidates for more fragmented bases that give you a choice of suppliers. When considering how far to consolidate the suppliers delivering any particular service, keep in mind the following:

• Overhead – overseeing a supply chain takes effort for all but your base suppliers. If your number of core and strategic suppliers is too large it will lead to an unnecessarily high overhead.
• Retaining commercial tension – is it possible to dual source?
• Risk management – are you leaning too much on any one supplier? Do you have visibility / control of any sub-contractors?
• The balance between strategic partnerships and agile new entrants – will your chosen suppliers still enable you to access innovation?
• Differentiating your business from others in your industry – be clear on what will you will compete on if many are outsourcing to the same players

Your goal is to maximise the benefits that come from either scale or flexibility while balancing risk and supply chain complexity  

STAGE 3: OPTIMISE INDIVIDUAL SUPPLIERS

When deciding how best to structure your supplier landscape, you need to strike the right balance between a fragmented supplier base – with many small suppliers, delivering overlapping services – and an overly consolidated base, where a small number of suppliers have too much power or control. Opportunities exist to optimise costs at every stage of the supplier lifecycle. We break down the supplier lifecycle below and highlight some concrete actions you can take to drive value from suppliers at each stage.

We have focused primarily on financial value, but you will see wider non-financial benefits as well: SUPPLIER SELECTION Total Cost of Ownership (TCO) Analysis: Conduct a TCO analysis to identify suppliers who offer the best overall value, including factors such as maintenance, operation, and disposal costs, rather than just focusing on the initial purchase price. Competitive Bidding: Use competitive bidding processes, such as e-auctions, to ensure you receive the best value for money while encouraging suppliers to offer their most competitive terms. Volume Based Pricing: Leverage the collective buying power of your organisation to negotiate volume based pricing with suppliers to reduce unit costs.  

Clear Communication of Expectations: Clearly communicate your expectations, performance metrics, and compliance requirements during the on boarding process to ensure alignment from the start.

Performance Based Contracts: Structure contracts with performance-based incentives that reward suppliers for meeting or exceeding specific cost-saving targets, ensuring alignment with your financial goals.

Streamlined Processes: Streamline your on boarding process to reduce administrative costs and time-to-market, enabling quicker realisation of benefits from supplier relationships.

Training: Provide training and support to suppliers on your processes, quality standards, and compliance requirements to enhance their performance and reduce errors.

Early Payment Discounts: Negotiate early payment discounts to improve cash flow management and reduce costs. Paying invoices early in exchange for a discount can provide significant financial savings.

Drive Innovation: Establish collaborative innovation programs, where both parties share the financial benefits from implemented innovations. This can include joint research and development projects, co-creation workshops, and regular innovation reviews to continuously improve products and processes.

Monitor Performance: By regularly evaluating suppliers on key metrics such as cost, quality, and delivery performance, you can identify areas for improvement, negotiate better terms mid contract, and make informed decisions about supplier retention or replacement.

Volume Rebates: Implement volume rebate programs where suppliers offer rebates based on the volume of purchases over a specified period, effectively reducing overall procurement costs.

Joint Cost Saving Initiatives: Partner with suppliers on cost-saving initiatives, such as process improvements or waste reduction programs, sharing the financial benefits realized from these efforts.

Market Intelligence: Leverage suppliers for market intelligence to gain insights into industry trends, competitor strategies, and emerging opportunities.

Mid Contract Re-negotiation: Conduct regular reviews to identify potential opportunities for re-negotiation. These may include significant increases in spend with a supplier; scheduled time-based reviews (e.g., annual reviews); or changes in market conditions (e.g. emerging suppliers, market consolidation, or technological advancements).

Clear Exit Procedures: Establish clear exit procedures, including detailed transition plans, timelines, and contingency plans to minimize disruptions and associated costs.

Avoid Penalties: Ensure compliance with contract terms to avoid penalties and fees associated with early termination or non-performance during the exit phase.

Knowledge Transfer: Ensure knowledge transfer to retain critical supplier knowledge and ensure continuity with new suppliers. You can also use insights gained from the off-boarding process to negotiate better terms and conditions with new suppliers.

Strategic Timing of Exit: Schedule the exit to align with financial cycles, such as avoiding annual payment deadlines, to minimise costs. By timing the transition, you can reduce unnecessary expenditures, such as prorated payments or overlapping service fees.

CONCLUSION

If you want to get lasting savings on your external costs, focus on making structural changes. By following the process described in this article, you will understand your existing supplier base more accurately and be able to realise savings across the supplier lifecycle, not just at the point of contract award. If you are looking at supplier costs as part of a wider cost optimisation, we recommend sharing your internal conversations with suppliers early in the process. This will lay the groundwork for a productive discussion when you get to Stage 3 and want to talk to them about rates. They will understand the broader context and you may be surprised how willing they are to work with you. Above all, by taking a broader cost optimisation approach rather than simply pressing suppliers to cut costs, you will release recurring value for your organisation and ensure costs do not simply creep back up.