United States

Executives share positive economic message and best practices at CFO Club

ARTICLE

In some recent CFO Club meetings, representatives from GE Capital, Prime Advantage and Provident Spend Management addressed the impact that a volatile economy, material procurement and other cost drivers may be having on your business. Following are highlights of their remarks.

On track for a sustainable recovery

Overall, the United States’ economy is expecting moderate growth due to a number of factors, according to GE Capital. Driven by labor conditions, an aggressive federal policy has kept interest rates low. Inflation is contained for the time being at around 2 percent and markets are less reactive to the latest Euro-zone challenges. There are fewer negative equity drivers as the economy experiences an historic run.

  • Consumption is up for 12 consecutive quarters. The key to the GDP is economic consumption and it represents more than 70 percent of the US GDP. Notably, it is higher now than in the same quarter in 2006. Government spending is down from 2006 as well.
  • The U.S. labor market is healing (gradually); unemployment is declining (slowly). The country is still three million job openings short of the 2008 level. But part-time and low-wage jobs make up much of the new jobs being created. Yet more than two million people are leaving their jobs to move on to other opportunities that did not exist until recently. Trade, transportation and utilities as well as business and health care are leading job-opening industries.
  • Spending is up, saving is down. In last year’s fourth quarter, there was a spike in restaurant spending compared to the year before. This may be indicative of the optimism businesses are feeling. Savings rates are dropping, due perhaps to confidence in the economy that is translating into more spending.
  • Auto and retail sales are picking up. The average age of a U.S. car is just under eleven years. Despite a pickup in car sales, owners are holding onto their cars longer than usual. Retail furniture sales are up as well. Notably, gasoline and food prices are settling into a range.
  • Individual income tax receipts are rising. But that indicates that more money is being earned.
  • U.S. labor competitiveness is growing. Doing business in China is becoming more expensive. Execution, shipping and labor costs are bringing operations back to the U.S.
  • Residential mortgages still with us. Yet in housing, a favorable price momentum is setting in; a more favorable balance is emerging between the number of existing housing units and the number of households. Housing prices are rising, however, and in some areas are out-pacing inflation.

GPOs and supply chain management

While there are various names for group purchasing organizations (GPOs) – such as a purchasing alliance or an aggregation group – in the end they are created for the same reasons: to drive costs down for their members and increase volume for suppliers. According to Prime Advantage, up to 15 percent of Fortune 1000 companies utilize GPOs and 85 percent of them see savings of 10 percent or more.

GPOs can help mitigate supply chain risk by only engaging in approved, endorsed suppliers. For members that have limited in-house procurement resources, outsourcing the management of some contracts to GPOs can save time and effort.

There are three GPO models:

  • Vertical market GPOs focus on one industry sector
  • Horizontal market GPOs span across industry sectors
  • Master buyer GPOs are made up of a single large buying organization with several smaller companies leveraging the organization’s contract with suppliers

There are also different ways GPOs engage with suppliers:

  • Committed spend – The GPO negotiates pricing and members must comment to spending a certain amount through the contract. Members can realize greater savings but there are a limited number of vendor categories available.
  • Non-committed spend – The GPO negotiates rebates and discounts; members participate at will. The approach offers less savings but a great number of vendor categories.

Some GPOs are using revenue models, moving away from large up-front fees (which can run into six figures) and eschewing annual fees. In this model, the GPO’s revenue comes from suppliers who pay administration fees on transactions.

The most popular contracts involve suppliers of office products (with an average savings of 17 percent); pharmacy benefits (9 percent); multi-function devices and copiers (15 percent) and relocation services (18 percent).

Using strategic sourcing to improve margins

According to Provident Spend Management, manufacturing organizations spend three-to-five times more on suppliers than labor. In other words, about two-thirds of their revenue is spent on non-labor costs. This may not be news, and it’s even more remarkable when the potential savings are considered: On average, one dollar of cost reduction in procurement of raw material or packaging – the largest concentration of expenditures – is the equivalent of five to seven dollars of new revenue.

But if companies don’t invest in the right talent, processes or resources, they can’t expect to realize these savings.

In direct materials, there are a number of areas where procurement has an impact on profitability and margins, including cost controls, purchasing strategies, systems/processes/tools, people and packaging optimization.

Management, however, may not have high enough expectations of procurement and how it can help increase profitability and improve margins.

Data availability is the foundation to procurement. A company’s procurement department must have easy and quick access to detailed data, especially regarding strategic sourcing. Otherwise pricing, service options and other issues will be based on assumptions and will not provide opportunities for the most advantageous savings.

In a recent study on strategic sourcing for mid-size enterprises, it was found that strategic sourcing methods were applied to only one-third of spending when they could apply these methods to as much as 60-75 percent. This is due in part to the reliance on incomplete data or the exclusion of key stakeholders in procurement planning. The result is a collective loss of $134 billion in lost savings on an annual basis.

Strategic sourcing is a fairly in-depth, multi-source process. It begins with data gathering, sitting down with key stakeholders such as sales, marketing or product development to understand priorities and align with corporate objectives; a strategic strategy that evaluates and solicits bids from suppliers; and performance tracking to ensure the company is truly getting the savings that suppliers agreed to in negotiations.

Processes for strategic sourcing will vary depending on spending category complexity, savings opportunities, the diversity of the supplier mix within a category, and company priorities, among other criteria.

In the end, it’s all about market management and protecting your margins. Taking full advantage of volume, centralizing procurement where appropriate, engaging in fact-based negotiations with suppliers, and ensuring business needs drive purchasing decisions.

Procurement can literally involve every aspect of a business, so here are a few things to keep in mind:

  • Review supplier relationships and contracts. Meet with your procurement personnel on a regular basis.
  • Cultivate a culture of continuous savings and “cost take outs.” Cost reduction efforts must be continuous, not periodic.
  • Beware of sacred vendor relationships. Make sure you stay honest and objective with your evaluation of suppliers.
  • Recognize that it can’t all be done at once. Even bad long-term contracts can be addressed; you just need to prioritize your goals.
  • Pursue cost savings during times of profitability. It’s better to implement savings strategies when things are going well than desperately seeking savings when income is low.

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Steve Menaker 
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