Procurement cannot avoid cost reduction. A chief procurement officer said it well, 70% of procurement performance is reflected in procurement cost reduction. Supplier quality, delivery time, service, etc. are certainly important, but if the cost target is out of control, the value of other targets will be greatly reduced. Therefore, whether it is my book or training, the core is cost reduction, but it is not a simple negotiation price reduction – you know, I rarely mention negotiation, but to seek better solutions within the supply chain. In summary, there are three steps to reduce supply chain costs:

The first step is to lower the price through negotiation . Relatively speaking, this is what procurement is most familiar with and is best at. How much can price negotiation affect the product cost? In a mature procurement environment, such as when the supply market is fully competitive and the bidding process is standardized, it is about 10%, because the normal profit of suppliers is also around 10%. Some extreme cases are excluded, such as electronic products such as semiconductor chips that drop in price very quickly, or some products that are seriously oversupplied, such as steel in the past two years – these products must follow the market. The ultimate price negotiation is to make the supplier earn nothing or even lose money, but these cannot last long. Therefore, the product cost that price negotiation can really affect is limited.

In some companies with extensive management, suppliers may also make huge profits. For example, in rapidly developing emerging enterprises, the procurement system is not perfect, supply guarantee has always been the top priority, and cost pressure is relatively small; or in some “aristocratic” enterprises, there are no procurement cost reduction indicators, the procurement and bidding process is not sound, and the competition among suppliers is insufficient. In these cases, through price negotiations to “sweep away floating profits”, the one-time cost reduction will still be considerable. But for most companies, after rounds of price negotiations, the potential for “sweeping away floating profits” has been basically exhausted, and 80% of what you get is already the best price.

Furthermore, although the negotiated price reduction can affect the product cost by about 10%, the actual cost reduction you can get in the end is not much: inflation will always transfer some of it to the purchaser; “the world is bustling, all for profit”, suppliers must always maintain a certain normal profit. Purchasing can eliminate some suppliers and increase the business volume of other suppliers in exchange for more cost reduction; or use both soft and hard tactics, whether it is the kingly way or the tyrannical way, just relying on the words of the purchasing department, it is estimated that it is very good to reduce the price by three or two points every year (not counting the price reduction brought by the one-time large-scale integration of suppliers, the experience value in North America is 9%). Then more cost reduction potential must be tapped from other places.

This requires us to move to the second step of cost reduction, that is, to reduce production costs through lean production and to reduce transaction costs through e-commerce . For the improvement of the supplier’s production process, on the one hand, it is to shorten the production time, thereby reducing labor and equipment costs; on the other hand, it is to control or eliminate variable factors to improve the yield and reduce waste. Lean production, Six Sigma, etc. are all powerful tools for improving production processes. But in general, their results are not as great as imagined, and I believe that many friends who have implemented them will agree. The reason for this, in addition to the formalism of tools for tools, is that the production process only accounts for about 10% of the entire delivery cycle, while 90% of the time is spent on things that do not add value, such as going through the process, doing approvals, preparing documents, etc., that is, the transaction process. Compared with the production process, the transaction process covers a wider range and is more difficult to improve fundamentally, but e-commerce can be used to improve efficiency.

During the entire transaction process, most tasks are carried out around purchase requisitions, purchase orders and delivery orders. Most of these tasks can be automated and done by the system. However, in companies with low IT application levels, these tasks are still mainly done manually, which has become a resource black hole for the company and suppliers. For example, there is a company with a market value of tens of millions dollars. The company is very young, its IT application is quite basic, and ERP has not yet been fully implemented. Order processing is all manual, and there are about 80 purchasers alone; while similar companies with higher IT application levels only need about half of the purchasers. For this item alone, the company spends several million dsllord more on labor costs each year. This is the case for the purchaser, and the supplier is no exception. If the purchaser does it manually, the supplier will have to deal with it manually. With the continuous increase in domestic labor costs, these transaction costs are becoming more and more difficult to ignore. In addition, from the purchaser to the supplier, most of the team’s energy is spent on these low-value-added chores that can be done by the system, and less time is spent on high-value-added tasks such as managing demand and straightening out relationships. The opportunity cost is also high, resulting in higher inventory, more rush work and more waste. “The wool comes from the sheep”, these costs will eventually be reflected in the supplier’s price.

If negotiating cost reduction mainly depends on talking, then promoting lean production and implementing e-commerce require more cross-functional collaboration: without the support of quality engineers and designers, it is unrealistic to improve the supplier’s production process; without the IT department and the finance department, e-commerce is out of the question. Therefore, to step onto the second step of cost reduction, procurement personnel need to have higher leadership capabilities to drive cross-departmental collaboration. In terms of cost reduction potential, this stage roughly affects 20% of product costs. Why is it 20%? You will know after looking at the third step of cost reduction.

Value Engineering / Value Analysis (VA/VE) is the third step in reducing supply chain costs and also the biggest potential for cost reduction, because 70 to 80 percent of product costs depend on design, such as material selection, technical specifications, tolerance accuracy, etc., which determine the cost of the product. Reducing costs through optimizing design is especially important for strong suppliers. Because such suppliers have advantages in technology or scale, it is very difficult to negotiate price reductions, and they can only reduce costs more through optimizing design.

It is not difficult to understand the concept of reducing costs by optimizing the design. For example, in order to achieve the target cost of the design or the annual cost reduction target of the procurement, suppliers often propose design optimization suggestions, such as changing the continuous welding of the aluminum chassis to spot welding (friends familiar with aluminum processing know that aluminum welding is difficult to operate and is prone to defective products. Using spot welding can improve the yield of the product). This is a good idea, but designers may not agree because it affects the appearance of the chassis. Cost is certainly important, but after the design is completed, it mainly becomes the task of procurement. Due to risk aversion and departmental interests, technicians are often reluctant to optimize the design, which has become one of the fundamental reasons why design optimization and cost reduction are difficult to implement.

What should we do? You may say that procurement must have a good relationship with design. Yes, all business activities are interpersonal relationships, whether inside or outside the company. However, in large companies, once it comes to departmental collaboration, the power of personal relationships is limited, and nothing can last long if it relies on relationships. As a procurement manager, you have a good relationship with some key designers, and they help you optimize the design to reduce costs. It is okay once or twice, but it is a problem if it happens too many times, because their main task is not to reduce costs; they have other more important tasks, such as developing new products and solving customers’ quality problems. They understand the importance of optimizing design to reduce costs, but sorry, their main task is not to do these. To solve this problem, we must start with performance appraisal and put the cost reduction target into the KPI of designers, for example, 40% of the annual cost reduction belongs to design, 30% to quality, and 30% to procurement. However, performance appraisal alone is not enough. Procurement must play a leadership role, integrate the power within the company, and work with suppliers to promote process improvement and design optimization to reduce costs.

The process of crossing the three steps of cost reduction is a process of cross-departmental and cross-company collaboration. Procurement plays a leadership role, and its role is crucial, which is determined by its window position between the company and the supplier. However, in reality, “purchase management” is busy with miscellaneous tasks and neglects management. Leadership is even more inadequate, and there is no energy or ability to rise to the second and third steps of cost reduction. Since it is impossible to drive other departments to influence those larger cost structures from the perspective of production/transaction processes and design, in order to achieve the goal of cost reduction, purchase can only fight hard in price negotiations and play the game of profit transfer. From the original win-win situation, it is later discussed that the purchaser wins and the supplier loses, until the final lose-lose situation (the supplier does not make money, breaks the jar, and has continuous quality and delivery problems, which eventually affect the purchaser). Even if purchase seems to have achieved cost reduction, it is actually negative for the company’s total value.