Special 3-Part Series: Supplier Cost Management Best Practices

Part 2: Re-examining Some Old Beliefs and Common Misconceptions

As a leading cost consultancy, we often work with clients who, before our involvement, were approaching the optimization of their supplier relationships and contracts with dated notions and methodology.  Additionally, even when we see clients pursuing best practices in purchasing and procurement, they are often still leaving between 10% and 30% on the table. How is this possible? It’s a combination of factors. And while no two organizations are alike, they often share one or more of the following characteristics:

  1. Not following true “best-in-class” practices in purchasing/procurement.
  2. Allowing old ideas and misconceptions to interfere with the optimal strategy/approach.
  3. Reluctance to enlist external resources to supplement a strategic cost management program.

In part one of our series, we discussed some of the best practice tips that can be employed to help organizations improve their supplier cost management practices and move further along the curve from “good” to “exceptional”.

In part two, we’ll re-visit some old notions and common misconceptions that can also result in organizations leaving money on the table.

Is it business as usual?

While many organizations do indeed have their act together in the area of centralized purchasing and procurement, we are quite often surprised by the “business as usual” purchasing mindset that many organizations still cling to. See if you recognize any of these old notions in your team’s approach to supplier management:

Suppliers give similar pricing to similar customers. Actually, it’s often the opposite. We routinely see pricing discrepancies of up to 30% between clients with the same supplier(s), similar volumes and product/service requirements. This is often attributed to local and regional market variations, the supplier’s business strategy, regional market share, and profitability targets, business unit pricing policies and how your local sales rep (and management) are compensated.

We do quite a bit of work in the primary care space and over the past several years we have observed that while a large national healthcare products distributor had a stated policy of extending low margin prices to these clinics that in fact, the actual contract pricing varied between 10% and 15% between similarly sized “peer” clients.

Your expertise in purchasing in one cost category will produce similar results in another. We often see clients take a generalized approach where purchasing/procurement is responsible for managing multiple categories simultaneously. This is understandable when clients first move toward a centralized purchasing model and they begin to build out their purchasing team while attempting to make the best use of limited resources. However, because each industry has its own market dynamics, cost drivers, business models, and competitive landscape, it is critical to develop an in-depth understanding of your suppliers’ markets to achieve the optimum results. In order to develop that level of industry expertise, it is just not practical to expect that someone is an expert in more than one (or two similar) supplier industries. A generalized approach will often get you generalized results.

National pricing agreements (and/or GPO pricing) offer better deals than local or regional agreements with the same supplier.  Actually, we often find that local or client specific contracts can produce superior results. One of our large healthcare clients asked us to review their medical supplies contract which was connected to a very large group purchasing organization. When we reviewed the contracts and pricing, we determined that in fact, the client could be doing much better with a customized agreement. The result? A 13% improvement.

Supplier loyalty translates to best price and service. Frequently we will observe that organizations tend to focus almost exclusively on high-priority projects to the exclusion of other projects. This prioritization can sometimes lead to a false sense of security that a loyal relationship is serving them well, and is best left undisturbed. This is often reinforced by the supplier rep, broker or agent who has worked hard to develop a close relationship with the key stakeholder in the organization who then resists disturbing the relationship. Sometimes this can also manifest itself thru simple gestures like tickets to an event or support for the client’s annual fundraiser. We almost invariably see clients leaving meaningful dollars on the table if they don’t perform a regular, formal full-market review of all their suppliers, regardless of the length of the relationship and how high up that goes in the client organization. And if the supplier sits on your board? Time to re-examine the relationship to ensure that there is no conflict of interest at stake.

Volume will get you the best deal. As we’ve discussed previously, purchasing volume is only one of many factors that determine the ultimate price. Organizations often omit key service and/or quality criteria in their analysis. Are there specific requirements for product use or selection? When was the last time you re-visited your requirements with the supplier? Are there changes that you can make that will lower the cost to serve you as a customer or that will help the supplier realize greater efficiencies?

Three (3) bids will get you to the best price. It is true that in general, it is a best practice when going to market to source at least 3 qualified bids. However, it is access to current broad market benchmark data and in-depth knowledge of the supplier’s industry that will contribute more to driving the greatest value for your organization than simply positioning 3 vendors against each other. And, as discussed previously, understanding the cost drivers of your suppliers and prioritizing your requirements whenever possible to align with the supplier’s efficiencies can offer additional ways to reduce costs.

You’re asking the right questions in your RFPs. Possessing access to inside industry knowledge is the key to asking the right questions. We often see the same regurgitated RFP templates used for bid requests across multiple expense categories. RFPs should be custom tailored to each individual expense review and for each client and with the knowledge of the particular supplier market (terminology, business/service models, etc.). This takes time and “industry insider” knowledge, but the effort is well worth it.

We recently performed a review of a client’s security services where the client was not happy with the incumbent security firm. They were experiencing a high degree of turnover which had become disruptive to their clinic operations and a distraction to management. In capturing their requirements, we learned that they had previously specified that the guard shifts in most of their locations needed to be part-time. What they did not realize was that security guards will look for supplemental work when they aren’t provided with a full 8-hour shift and that the higher quality guards all gravitated to full-time shift work. This was contributing to a higher turnover rate as well as a lower overall quality of guard personnel. By reconfiguring the RFP and the client’s requirements, other larger national and regional firms were then willing to participate in the process and the client was able to source a better firm while reducing their cost.

Group purchasing will lower your costs. Group purchasing through a GPO can lower your costs, but often this is only part of what is actually possible due to the way GPOs are structured. Cost reduction can typically be improved — in some cases by 10 to 20% — by taking a customized approach.

Recently we performed a reference lab review for a large healthcare clinic client. The supplier had already committed to providing consistent pricing to all customers through a commonly used GPO program. However, by working with the supplier and by introducing concepts applied in other similar projects elsewhere in the country, we were able to create a different pricing model for that particular client that lowered their unit costs by 42%.

Lower price means lower quality and service. Many factors comprise the total cost of ownership, including the quality of the product/service, service delivery and the underlying business process with the supplier. Also, the increasing role of technology could lead to a lower cost structure, and how well a supplier is managing its own supply chain may translate to more competitive pricing without sacrificing quality or service.

A few years ago, we ran a purchased garments and uniforms review for a large healthcare client. To assist patients in recognizing clinic staff the client provided a wide array of branded apparel for employees. Because the client had grown with the supplier over a long period of time, the process of ordering, fitting and managing returns had become time-consuming and expensive and it required a .5 FTE just to manage the process. Because of our familiarity with other national suppliers in this industry, we were able to introduce several qualified suppliers that could better meet the client’s needs. The result? A customized order portal and a fully automated order to delivery (and returns) process that freed up the .5 FTE for other higher value tasks while saving the client 25% over their previous cost.

The lowest price is the lowest cost. Again, one must look at the complete picture to understand the total cost of ownership. A supplier may offer a lower price, but are they transferring responsibilities to the buyer in the process? Adding service/delivery fees for small orders? Substituting an item with an item that is not exactly like-for-like? Often reviewing the contract and the invoices will uncover some of these ancillary costs but not always. Sometimes you have to dig pretty deep and also be aware of what the industry pricing and contracting practices are in each category.

These are a few common misconceptions that many organizations share, which unfortunately lead to “leakage” — dollars left on the table that could be put to better use.

Adjust your lens. As you can see, by re-visiting old assumptions and practices, new opportunities to reduce and manage indirect costs can often present themselves. Combining best-in-class practices with a more strategically focused approach and deeper understanding of your supplier’s industries will help you make the journey towards employing best-in-class purchasing and procurement methodologies to realize the cost improvements that you seek.