Suppliers are easy to talk about, but money is not easy to talk about. But no one can afford not to talk about costs, and as one chief procurement officer in North America put it, 70% of procurement performance comes from costs. Here we will talk about three main types of cost indicators, including procurement cost reduction, cost avoidance and procurement rebates.

Let’s first look at procurement cost reduction. It is said to be a cost reduction, but in fact, it is more often a price reduction. The common annual price reduction index is calculated in the form of purchase price difference, that is, the PPV that is familiar to foreign-funded enterprises. The purchase price difference is very simple: the original 100 dollar per piece, now 95 dollar, saving 5 dollar, is a 5% price reduction. However, in practice, statistics are much more complex and difficult.

The most difficult thing is how to set the benchmark price. If you use the actual purchase price in the past, when should you use the price? Is it the price of the last purchase, or the average price over the past period? What about new products that don’t have a history of purchase? If it is the market price, which and when is the market price? If it is a global purchase, which region will be used?

In the past few years, CAPS Research has held several rounds of roundtable meetings around the world, and most of the participants are chief procurement officers, vice presidents, and directors of Fortune 500 companies, and the topic of discussion is not how to save money, but how to count it. It’s also a reflection of the challenges of big business: it’s not easy to do a good job, but it’s even harder to prove it’s a good job. Many bureaucratic mechanisms in terms of procurement systems, processes, policies, etc., are built around ‘proving well done’, that is, performance statistics. There is no perfect statistical method, the key is that the statistical caliber must be consistent in order to be comparable.

The three major cost indicators of procurement

It’s an indicator, and it has the potential to be manipulated. In terms of annual cost reduction, it is common to turn a blind eye to the supplier’s initial quotation. As an old colleague of mine complained before, others buy things for 100 dollar for 120 dollar, and then reduce the price by 5 points every year, and get a bonus every year; He slashed it to 96 dollar with one knife, and the price reduction in the following year became a problem. It’s not hard to understand why these are all side effects of performance appraisals. For professionals, we still have to do the right thing, and you and I both know what is the right thing.

In addition to the annual price reduction, there is also cost avoidance for procurement cost reduction: although the company’s purchase price has not fallen, it has not risen, while the market price has increased by 5% in the same period. From the perspective of financial statistics, this is not a cost saving, but you know, it is also important for the business. We have made ourselves a big customer of suppliers, and one of our major goals is that when there is a shortage in the industry, we are not the first batch of customers who are inflated and short-fed. This gives us more leeway to allow competitors to take the lead in reducing gross margins due to rising procurement costs; Or take the lead in raising prices and let more customers come to us.

If procurement cost reduction is an ‘offensive’, cost avoidance is a ‘defensive’, which is not a credit or hard work. The challenge is that statistics are more difficult and more difficult to quantify objectively.

For example, it is difficult for the market price to be equal to the specific product, unless we are buying bulk raw materials or something, and have our own price index. Even for standard products, the vast majority of purchases have customized ingredients, which are difficult to directly link to those market price indexes, not to mention those products that we design and let suppliers customize according to the drawings.

Another example is that the supplier wants to increase the price by 10%, and the procurement is cut to 4%, which means that the cost is avoided by 6%? The supplier of the new product quoted 100 dollar, and the purchase was cut to 80 dollar, which means that the cost of 20 dollar was avoided? There is an element of numbers games in this, which can easily fuel the game. Suppliers are well aware of this, and they also take advantage of this sky-high asking price to ‘cooperate’ with procurement to do a good job. That’s why finance departments tend to be less interested in cost aversion.

Purchase rebate refers to a certain percentage of discount given by the supplier to the purchaser when the purchase amount exceeds a certain amount. For both buyers and sellers, this clause gives everyone an incentive to increase the amount of purchases. The more business you do, the more rebates you make; If the business is less, the rebate will be less, which is easy for both parties to accept, especially when the business fluctuates greatly and the purchase volume is difficult to predict. As a purchaser, don’t limit yourself to the existing purchase volume, and include rebate clauses in the contract as much as possible.

Finally, let’s talk about the payment terms. This is actually part of the procurement cost indicator.

This includes billing terms and early payment discounts. The account period refers to how long it takes to pay after the arrival of the goods, and it is also a portrayal of the contrast between supply and demand. For example, in the home appliance industry, some companies are 3+6: three months of payment, and the payment is not cash, it is a 6-month acceptance bill, in fact, it is a total of 9 months of account period. In industries with weak bargaining power, such as the catering industry, the industry concentration is low, and there are fewer enterprises that can affect the supply-side market, and the account period is relatively short, and even cash transactions.

The payment period is long and generally required by finance. Don’t you know that the scale of suppliers is generally smaller, the cost of capital is higher, and the wool is out of the sheep, and in the end we still have to pay and pay a higher purchase price? Of course, finance is arguably the most knowledgeable thing in a business. So why do you still do this stupid thing? There are two reasons for this. First, the company’s cash flow is really difficult and it has to do so; Second, competitors are extending the account period, and we don’t suffer losses by doing so.

Some companies are quite large and have exceptionally adequate cash flow (listed companies, which can be seen in public financial statements), but the account period for suppliers is still 9 months. When asked why, the answer is because competitors are doing it. It is said that competition makes people good, but in fact, many times, large enterprises are competing to do more evil than others. Competitors are doing stupid things, and that doesn’t justify us doing stupid things. If you have a short account period, the supplier will of course know that you become a customer that the supplier is more willing to do business with, and the quotation and service they give you will also be reflected, and high-quality resources will also be inclined to you.

A significant number of companies doing this are industry giants. With the scale of procurement, these giants got the price they wanted, which is, of course, the lowest price in the industry; I also got the desired account period, of course, the longest account period in the industry, but I just couldn’t get the delivery and service I wanted.

For example, when it comes to the peak season, or when there is a shortage of capacity in the supply-side market, several industry giants have complained about procurement, saying that suppliers do not support them enough. Is there anything unusual about this? With your pricing strategy and commercial terms, you’ve ‘succeeded’ in making yourself a low-profit customer for your supplier: if you’re a supplier, is the last bit of capacity for a high-profit customer and a 5% profit, or for a low-profit customer and a 2% profit? Is it a good customer with a 30-day billing period, or a low-quality customer with a 270-day billing period?

The advance payment discount in the payment terms is a certain discount to be paid to the purchaser if the supplier wants to get paid in advance. For example, if the goods are paid within 10 days, the purchaser will be given a 2% discount; 20 days payment on delivery, 1% discount to the purchaser, etc. When the enterprise has sufficient cash, it pays the supplier in advance and gets the discount, which also improves the efficiency of capital operation. This is also good for suppliers: suppliers are generally smaller, have high financing costs, give purchasers appropriate discounts, and tend to have lower interest rates than borrowing from banks (which may be the prototype of supply chain finance).

This is followed by the time value of money: $100 today is not the same as $100 three years from now. Suppliers need to calculate this account, and the purchasing staff must also be able to calculate it. This will help with better communication between procurement and finance. For example, in North America, when some suppliers are tight on cash flow, they will take the initiative to apply for early payment and give a certain discount. Purchasers evaluate whether the payment discount proposed by the supplier is appropriate based on the opportunity cost of cash.

Incidentally, in the supply chain, the time value of money is still used in many places. For example, in the decision of self-made or outsourced, self-made needs to build factories and buy equipment, and these fixed assets need to be depreciated for many years, and we need to calculate the net present value to compare with the outsourcing strategy. When I went to Silicon Valley for an interview, one of the questions was the time value of money. This is because the old owner is pushing for an asset-light strategy, which requires a purchasing manager to fully measure the total cost of both self-made and outsourced.