Special 3-Part Series: Supplier Cost Management Best Practices

You’ve been a successful senior leader of a large healthcare organization for some time now. You’ve run a tight ship. When possible, you’ve cut costs. But now circumstances dictate that you must find an additional 5%, 10%, or even 20% in non-labor related (indirect) cost reductions. You just don’t see how it can be done.

You’ve looked at ways to control cost: reduced/eliminated overhead, controlled spend, aligned with a group purchasing model which can help you increase your buying power and gain access to better contracts and discounts than you could negotiate on your own. But is that enough? Could you do more? Chances are, you have a few areas within your category management where you’d like to decrease cost and perhaps a few areas that lie outside of purchasing’s scope of responsibility as well, but you don’t have the time or resources to make it happen.

And despite your best team’s best efforts, you can almost always find 15% to 20% of spending that hasn’t been managed as closely as it should. You are not alone.

Over the past 27 years, we have worked with numerous organizations in this situation—including healthcare organizations, non-profits, manufacturing companies, financial institutions, professional-services firms, and higher-ed institutions. Our experience shows that non-labor related cost-reduction opportunities follow similar patterns virtually everywhere. The lessons we’ve gleaned may not solve your entire problem, but they may offer you a fresh perspective.

What is a dollar saved really worth to your organization? Every organization is a bit different, but on average, most non-profit hospitals and primary care clinics generate an operating margin of -1% to +2%.

Clearly, every dollar added to the bottom line of an organization with a low single-digit margin is meaningful.

Using a 1% operating margin as an example, if non-labor costs are 20% of the organization’s operating budget, a 5% decrease in these indirect expenses would equate to doubling the organization’s revenues. Very few organizations have the opportunity to even contemplate that type of growth which is why taking a fresh look at best in class cost management can be an effective way to achieve the desired result.

This is not to say that you can cost cut yourself to greatness. We live in a time when business models age faster than the latest iPhone, and senior leaders understand that focusing on operational efficiency alone is not enough to succeed. However, when it comes to funding new growth initiatives or unbudgeted projects, revisiting your cost management practices can often represent an opportunity to generate some of those valuable funds.

So, where to start? If you are the CEO or report directly to the CEO perhaps you are in a position to advocate a change in strategy or a wholesale shift in reconfiguring services or department structures or process. For most organizations, these are daunting choices and they come with far-reaching implications.

Ready to call a meeting with your head of purchasing or procurement to discuss this initiative? Perhaps you should ask yourself the following questions first:

• Is your purchasing team “best in class”? By what measure?
• Do they have the additional capacity required to execute this initiative in a reasonable timeframe (months vs. years)?
• Do they have the supplier expertise required in every expense category?
• Are you dismissing any areas of potential opportunity out of hand due to political or other limiting reasons? Is this consistent with your fiduciary responsibility?
• Are you really taking a fresh look or just recycling old ideas?
• Are your RFP’s asking the right questions?
• What supplier industry benchmarks will you be using?
• Do you have adequate processes in place to track supplier compliance? Internal compliance?
• How will you measure success?

Case in point: we recently completed an engagement with a large healthcare clinic with multiple locations that had their own internal procurement team. At first, they were very skeptical that we would be able to add any value beyond what they were already doing. And in fact, we did validate that they were doing a great job in 5 of the expense categories that they managed. However, in the other 6 categories we reviewed, we were able to identify incremental opportunities to reduce cost. The result? The client is saving in excess of $600k annually.

Besides generating incremental cash flow beyond what’s possible with existing internal resources, some additional benefits of engaging with an outside cost management firm with deep industry insights can be:

Improved Visibility and Transparency
Often outside firms can offer insight to help senior management understand where transparency is most important which provides senior management with the ability to make a better-quality buying decision. Transparency can often identify and break down silos that often increase cost and impede efficiencies while exposing flawed assumptions and old ways of doing things.

External Benchmarks
Yes, benchmarks matter. External benchmarks on some measures may be difficult to get, but they can enable management to compare their organization’s performance against their peers as well as across industries and geographies. Internal benchmarks are certainly easier to access and can often provide helpful insights, but they don’t always represent the extent of what is possible to achieve. As a result, organizations often settle for far less than what is actually possible.

By partnering with a third-party cost management firm an organization can either determine that opportunity exists to lower their indirect cost, or they can obtain a valuable independent validation that their indirect costs are at or near market benchmarks. The former drives cash flow, which is always desirable, and the latter can often be an opportunity for the senior leadership team to demonstrate to their board and other key stakeholders that they are exercising strong financial stewardship on the G&A side of the operation.

Improved Contract Negotiation and Contract Management Processes
Firms that manage a large volume of projects across multiple supplier categories can often provide insights into a wider variety of negotiation strategies and tactics. These tools and insights can provide greater leverage with a client’s supplier base while facilitating improved standardization of how contracts are negotiated, managed and renewed with less risk/financial exposure, etc.

Market Trend Analysis
Provides the client with the ability to more closely track the market and identify opportunities to adjust/optimize when there are material changes in market conditions.

Savings Leakage Identification/Tracking
Drives increased compliance/adoption of the new solution to optimize savings.

Improved Internal Accountability
Improves spend control.  Allows the client to reward employees who are managing expenses well.

Improved Purchasing/Supplier Compliance
Greater visibility of each expense category tends to drive improved compliance.

Identification of Additional Savings Opportunities
Engaging a third party with deep category expertise can provide broader insights and help spread understanding of operational cost optimization across more operating expense categories.

Knowledge Transfer
Provides deeper industry insights on how to manage each expense category. Can also offer opportunities for employee/organizational development/learning which leads to a culture of operations expense management and improved skill sets (increases employee value).

Depending on management’s priorities and where cost management sits on that list will determine how each of the above benefits will be valued. In our experience, most organizations find that they can enhance their cost management capabilities through knowledge transfer across several of these disciplines by engaging an external partner to assist them with this initiative.

Drive for Internal Alignment
Few would dispute that the support of top executives is required for cost-management efforts to succeed. Involved CEOs and CFOs, in particular, can help mediate the inherently political nature of such exercises and provide critical energy and motivation while ensuring executive alignment and accountability throughout the organization. Yet in our experience, the involvement of the senior leadership team is not sufficient in and of itself — especially in larger more complex organizations when other strategic initiatives are competing for their attention. You’ll need a process that leverages their executive sponsorship without bogging them down.  Functional key stakeholders must also be involved in the process particularly when it comes to validating requirements, leading change management across departments and supporting a successful transition for any new solutions that may be implemented.

Clearly Articulate the Link Between Cost Management and Strategy
The strategy must lead to cost-cutting efforts, not vice versa. The goal cannot be merely to meet a bottom-line target. Clients who committed to a targeted approach supported by regular reporting on results with greater transparency and monitored industry trends and compliance were the most likely to sustain the results over time.

With such insights, management will also be able to deliver a consistent message on how indirect cost management would make an organization stronger—a message reducing short-term resistance and even inspiring the organization to support the effort. Moreover, once these practices are baked into the organization’s standard operating practices, ongoing cost management will become a more enduring part of the organization’s strategy for long-term health.

Treat Cost Management as an Ongoing Exercise
Most organizations treat cost management as a one-off exercise driven by the need to manage short-term profit/budget targets—and some of these exercises do succeed in the short term because of constant pressure from the CEO or CFO. Yet such hasty cost-cutting activity typically goes into reverse once the pressure is removed and rarely results in sustainable changes in cost structure. In our experience, the reason is that one-off exercises don’t require internal capability building or meaningful improvements in purchasing processes/methodologies.

In pursuing a more strategic approach and utilizing external resources, organizations can enhance their cost management processes and capabilities which will help them close gaps and drive sustainable results over the long term. Cost-management programs need to be scoped as two- to three-year initiatives rather than as immediate-term efforts with one-year horizons. Rethinking common practices in cost management should help to realize this goal.

While there’s no single silver bullet to ensure that cost-management programs will stick, organizations can improve their chances by revisiting old assumptions and taking a more strategic approach. Fostering stronger executive alignment with greater accountability, visibility and transparency and engaging external resources where appropriate while treating cost management as an ongoing exercise will provide the right prescription for sustainable success.