Hard times calls for hard cash

State of Flux

The credit crisis is affecting organisations from those in the Dow Jones to those run by Mr and Mrs Jones and is driving a need for tighter controls on cash. Improved management of third party spend with suppliers offers organisations a quick way to release cash into the business and reduce risk.

In these times of recession or near recession, organisations are beginning to grasp the effects of the credit crisis. Some are struggling to grow their top line sales, some have suppliers or customers that may go out of business and some need cash - quickly.

The management of third party spend/supplier base is an area that has been largely ignored or considered an administrative task, however the mantra ‘that every dollar or pound saved goes directly to the bottom line’ warrants more focus. Research organisation the Aberdeen Group estimate that for a ‘typical enterprise’, £1 saved has the same impact of £5 in revenue in terms of contribution to the bottom line. Using this same ratio, £1,000,000 in cost savings would be the same as signing a new £5,000,000 client.

To complicate matters further, globalisation trends such as outsourcing or low cost country sourcing have led to increasing complexity of supply chains.  It is now even harder to track and manage organisational spend and business continuity risks within the supply chain.   

If you’re a business owner or executive it’s the right time to ask yourself some searching questions. Questions like; do you have visibility of third party/supplier spend? How many suppliers do you have? Which of these suppliers are critical and which pose a risk to your business? Which suppliers constitute the majority of your spend? Do you actively manage them? Do contracts exist and what are each parties obligations under these?

Being unable to answer any of the above questions highlights potential areas of opportunity for supply chain improvement and ultimately cash flow improvement. It is time to call on a sometimes forgotten part of the organisation to scrutinise the cost base and use modern buying techniques to deliver quick savings.

Organisational spend with third party suppliers is typically a large part of the cost base, depending on the industry the numbers will differ but usually a minimum of 40% of total spend relates to third party suppliers. This makes it a key area to focus on for operational effectiveness, operational cost and business continuity risk and should be well managed. For a lot of organisations this is not always the case, according to a study by Accenture, 50% of an organisations third party savings is lost through poor supplier management. A recent State of Flux study supports these findings, further highlighting that most Fortune 500/FTSE 100 organisations don’t actively track the risk within their respective supply chains.

A procurement function has a lot to add in the ‘quest for cash’; the many capabilities range from inputting into the budgeting process and cash-flow forecasting, strategic outsourcing or in-sourcing of the supply chain, to more traditional tactical initiatives such as cost out programmes using eAuctions and other buying techniques. Benchmarking organisation Hackett says that organisations with world-class procurement functions show dramatically improved effectiveness over typical organisations, operating with 46% fewer suppliers, leaving more time and scope to actively manage them.

Run correctly, a procurement function brings considerable value to an organisations cash management, such as a structured and auditable buying process, visibility to the risks within the supply chain, information on spend and contracts with third parties, market insight and knowledge, internal controls over spending and the supply base, contractual and relationship management of strategic suppliers (which in turn leads to better access to innovation and speed to market of new products or services), supplier financing, potential business improvements and cost saving initiatives. Incorporating all the above gives the organisation tighter controls on cash, coupled with this, the better visibility provided by procurement reduces the risk of supply chain disruptions.

One of the greatest challenges the procurement function faces in being able to deliver value, is being seen as a strategic function that is aligned at an executive level to the organisations strategy. Traditionally, procurement functions have not adequately marketed their value internally, especially to other business units. This has resulted in negative views such as ‘holding up the decision process’ or being ‘only focused on price’ to such a point that some departments, (for example legal, marketing and IT) are often not involving procurement in the early stages of the buying process.

Early engagement can positively influence the savings and value that can be delivered by the procurement function as they are able to contribute to the organisations objectives rather than react to a demand from the business. A recent example of this was seen with a global bank whose IT department had decided what type of desktop PC’s their staff should have, the support service to be provided to them and the frequency of the moves and changes their staff could have, before handing the project to procurement.

By doing this, the IT team left procurement with just price as a negotiation point. Early involvement would have allowed them to provide a commercial challenge to the specification and volumes when the business requirements were being set resulting in a change to the final solution and an overall cost reduction.

In this market, the value of a good procurement function cannot be ignored, typical hard cash savings delivered by procurements early involvement in a cost out or strategic sourcing initiative range between 10% and 40%. Multiply this across your cost base and you have a compelling business case for action.

Organisations will not avoid the impact of the credit crunch, but through proper planning and use of the procurement function, they will be able to drive costs savings and control risks to minimise the effects. This management of cash and risk will enable them to look to the future with a stronger, consolidated, better managed cost base and more robust internal controls.

Alan Day

Parts of this article have been reprinted in the Age article and New Zealand Herald article 'Tips to weather the storm'