How to Avoid Three Profit Robbing Procurement Mistakes

Don't step over dollars to save pennies, says a management expert. April 15, 2006

David Hayden is a procurement fulfillment specialist with an MBA in Technology Management. Visit CNC/CAD/CAM Resources for the Home and Small Shop.

When I think about manufacturing in the United States, I think of Shakespeare. A great line from Hamlet reads, “O Gertrude, Gertrude, When sorrows come, they come not single spies But in battalions.” Manufacturing is in the fight of its life in this country. We are besieged with high quality, low cost imports as more and more manufacturing moves offshore. Manufacturers that remain in the US are required to improve quality and delivery while lowering prices. So we push our suppliers, negotiate deals, consolidate jobs, and trim staff and budgets. There is one hidden pool of savings out there, however, that many of us are missing - an efficient procurement process.

We have all heard about the 80/20 rule. 20% of something is responsible for 80% of the result. Sometimes it is encouraged to separate the vital 20% from the trivial 80%. It is a very useful tool for decision making and problem solving. But there is another principle that, when not managed properly, will quietly rob profits from your company. That is the 10/90 principle. Basically, indirect goods represent 10% of a company's expenses, yet procuring these goods typically consumes 90% of the purchasing resources.

Like Shakespeare's, our tragic comedy unfolds before our eyes. Think of all the effort we put into procuring indirect goods. We deal with vendors, shop price, and look for low cost alternatives, yet at the end of the day, if we manage to save 20%, our total savings is a paltry 2% of our total spend. All that time and effort managing pennies is stolen from managing the big spend.

There are three fundamental procurement process errors that companies should avoid:

1) Inappropriate substitution. A purchasing agent gets a request for a specific item, but when searching for a good source, is faced with lower priced substitutions. Purchasing people are often not experts in the products they buy. They know how to find sources and negotiate price, but not necessarily why a specific item was requested. Or, the person making the request may be ordering the same thing that has always been ordered because that is the way it was done before. It is possible that the lower priced substitution is a superior product. What’s an overworked purchasing agent to do?

2) Overwhelming company resources by shopping incidentals by price only. Purchasing agents and managers are continually faced with the problem of stepping over dollars to save pennies. In the midst of a very busy day trying to negotiate tons of steel or thousands of widgets, doesn’t someone usually ask them to find a lower price on perishable tooling or toner cartridges? In the middle of sourcing thousands or millions of dollars of raw goods, they have to stop and save a couple bucks on items that, over the course of a year, might save a couple of hundred dollars.

3) Spreading procurement over too many vendors. Purchasing from friends and/or supporting a large number of secondary/tertiary vendors for price alone drives prices up and erodes your bottom line. Every requisition written has to be processed. First, it must be emailed, faxed, mailed or phoned in. Once the goods arrive, the shipper needs to be matched with the purchase order and a check must be cut. The check must be mailed and eventually processed when deposited by the bank. With a little process mapping, the cost of processing an order can be determined.

The errors above are ingrained in the procurement systems of even the most efficient companies. Though there will always be inefficiencies, with some study, meaningful policies, training and discipline, these profit robbing practices can be greatly reduced and quickly reflected on the bottom line. Here is what you need to do:

1) Map out your current procurement process from start to finish. Your task is to identify the following:

a. What initiates a purchase? Is there a Kan-Ban, Hi-Lo or other system that initiates the request? Are there any labor or software licensing fees associated with this system? Does the system automatically issue purchase orders to vendors? If so, who is monitoring the system to make sure the Hi-Lo quantities are appropriate for current production levels?

b. What does it cost to initiate the request? If a person is monitoring the system, what is their total compensation and how much of their time is consumed initiating the request?

c. Is a vendor managing the inventory? If so, insist on a financial breakdown so you know how much of the price is related to the product and how much is related to the service provided. This is often buried in the markup on the individual items.

d. Are your inventory levels of indirect goods appropriate for current production? What is the cost of maintaining that inventory? What is the cost of lost production in penalties, overtime, expedited shipping, delayed payments, machine downtime, reputation and so on associated with running out of critical tooling or other supplies? How often are these expenses incurred due to inadequate procurement processes?

e. What is the process for issuing purchase orders? How many people have to touch the order? How much time do they spend per order? What does it mean in terms of dollars?

f. How are purchase orders delivered to the vendor? Do you use fax, phone, email, US mail or shipping services? What are the labor and direct costs associated with purchase order delivery?

2) Use the same process mapping for receiving the items and for processing payments. The net result is that you will be able to determine just how much it costs to procure any given item. You will become aware that when a well meaning price shopper saves $20 on some tooling, he generates $80-$200 worth of paperwork.

3) Evaluate and consolidate your vendors. You may be amazed by the large number of vendors you use to keep the wheels of industry turning. Much of what is purchased from the secondary or tertiary vendors could easily be purchased from a primary vendor, but someone did not want to pay the higher price charged by the primary vendor. Again, the small savings in price actually robs the bottom line of much needed black ink.

4) Evaluate the company policies and reward systems. Is the company rewarding profit robbing behavior by measuring success based on line item savings? Develop reward systems based on bottom line savings. Measure success by aggregate yearly or quarterly savings. Now that you know how much the procurement costs for PO and payment processing, you can measure true savings.

5) Before rushing out to reduce head count, explore where the company can benefit from bright, well meaning people. Continually train and educate everyone involved in the procurement process. Involve them in process mapping so they also get a strong sense of the counterproductive practice of over shopping price. As they become process oriented, they will be valuable assets to focus on other process improvement projects. They will be far more cooperative if they know it is not about cutting their jobs.

6) Find broad spectrum vendors that can provide a wide variety of products. When you find vendors that can supply the bulk of your supplies from a single source, you are on your way to measurable, significant, bottom line savings. This is what I help companies do. Trust me - it can be done and the results are real.

7) Pay your vendors promptly. They can often pass additional savings on to you if they do not have to budget for the cost of their money or collection activities. The broad spectrum vendor may entertain monthly invoicing. Rather than having to process scores of invoices, you only have to process one, and write one check.

8) Measure your vendors by the extent to which they support your efforts to streamline the procurement process. Look at the aggregate across the full range of items purchased from the vendor. In total, what are your accumulated savings?

9) Don’t step over dollars to save pennies. Undoubtedly, you will see that some line items purchased from a broad spectrum vendor will be higher. Remember, a little higher does not mean ripped off. If you are still getting the item at a competitive price, you are miles ahead of the game. Don’t punish your vendor or rob your bottom line by “cherry picking” each item.

My friends, we can not stop the battalions, but we can fortify our position. We can think smart, simplify our supply and improve our bottom line.

David Hayden is a procurement fulfillment specialist with an MBA in Technology Management. Most recently, he opened the mid-Atlantic office for EssentiaLink, a supply chain fulfillment provider. He has authored and self-published the popular 7 Easy Steps to CNC Programming and 7 Easy Steps to BobCAD/CAM books. Visit CNC/CAD/CAM Resources for the Home and Small Shop.