Five steps to achieve value for money
By Haytham Etemad
Managing director (ArcBlue Egypt Office)
Achieving value for money is one of the main objectives for effective procurement practice but it is always difficult to achieve this value for money in all procurement activities in the following article we will be discussing how to achieve value for money in five steps
- Cost reduction strategy
financial goals of the company are profitability, return on capital invested, liquidity, and so on; cost reduction will be a cornerstone to support these goals specially if business strategies are based on cost leadership. In public sector cost reduction will support services provision and efficiency targets
Basically Cost reduction strategies are knowing what the costs really are and then looking at how to reduce them. So effective cost analysis must be applied in order to identify and eliminate waste and re-negotiate prices if needed
Effective supply chain management may secure cost reductions through measures such as the following.
- Process engineering or re-engineering, to streamline and integrate processes, eliminating unnecessary activities and process inefficiencies
- Organisational restructuring to minimise labour and overhead costs and maximise process efficiencies (less duplication of effort, fewer managerial and co-ordinatory mechanisms, and so on.
- Outsourcing or off-shoring non-core competencies to obtain value at less cost and internal resources can be more efficiently focused also the organisation can dispose assets to generate cash to enhance liquidity.
- Applying ICT and automation technologies to streamline processes and to increase productivity and reduce labour costs
- Finally and most importantly Developing supplier relationships for cost and price advantages by developing collaboration to encourage mutual cost reduction, reduce sourcing and transaction costs, and so on
- Reducing inventory costs and administration
Modern thinking suggests that ‘inventory is evil’ for 2 reasons ; first, an organisation holds stock that reduces the amount of cash available as money have been paid to acquire or manufacture the stock, and will not be recovered until the stock is sold. Secondly, stock is a sign for inefficient work practices; if there were no buffer stock to fall back on we would have to remedy such inefficiencies, but with stock in hand we can afford to overlook them. No organisation would adopt this thinking to the point of holding no stock at all. But it is obvious that minimising stock will help in achieving operational efficiency, provided that our customers will be disappoint due to lack of stock.
Applying Just In Time (JIT) concept buyers can minimise the levels of stock needed by working closely with suppliers; they do not deliver the ordered goods until the moment that the buying organisation actually needs it. This requires very close coordination with suppliers, who must be continually updated on production schedules.
Also, buyers can apply consignment stocking techniques which.means that suppliers provide a buyer with stock, on the buyer’s premises, but without charging for it in advance. Instead, the buyer pays for the stock only as he uses it. This protects the buyer’s cashflow, while at the same time he benefits from having stock on hand at the supplier’s expense.
Supplier Managed Inventory is another technique the buyers can utilise to avoid holding and administrative costs. It is similar to consignment stocking but in this case the stock is held at supplier’s premises so the supplier covers stock holding costs and administrative costs and when the buying organisation needs this stock, the supplier delivers immediately.
- Collaboration on cost reduction
Another area where suppliers can help the buyer in achieving value for money is a joint initiative to reduce costs. let’s take an example to illustrate
An increase in external spending by manufacturers means that the price paid by the consumer is largely made up of costs charged by suppliers to the manufacturer: the manufacturer himself adds relatively little value. in order to achieve competitive prices, such companies must focus on their costs. So it is vital for purchasing to contribute in reducing costs right along the supply chain, while maintaining and improving quality.
Procurement team will be required to increase the level of trust between the company and their suppliers which will facilitate using open book costing. When trust is built the suppliers will be ready to talk frankly about their cost structures and several benefits will be gained such as:
- cost-based pricing enables the buyer to get to know the supplier’s operations and processes
- it enables joint identification of areas for cost reduction and added value;
- cost based pricing reassures buyers that they are receiving value for money
cost transparency is even more radical approach as it is considered as two-way sharing of cost information on activities in which buyer and supplier have a common interest. This is more suited to a strategic partnership relationship with appropriate confidentiality protection.
I used to put a sign in my office saying “We provide 3 types of services – HIGH QUALITY, QUICK, CHEAP – select two” There is always a trade-off between cost objectives, quality, and delivery objectives.
This has led to the recognition that cost/price and ‘value’ are not the same thing. ‘Value for money’ has been defined as ‘the optimum combination of whole life cost and the quality necessary to meet the customer’s requirement’. It is an important strategic objective, particularly in the public and non-profit sector; there are number of purchasing techniques that buyers can use to obtain value for money such as .
- The use of value engineering of new products and value analysis to eliminate non-essential features.
- Adopting whole life costing methodologies, rather than focusing on purchase price.
- Consolidation of requirements to facilitate negotiation of contracts and prices
- Encouraging standardisation to reduce costs of spares and maintenance
- Using proactive sourcing techniques such as challenging preferred supplier to ensure competitive value, and including in contracts a provision for year-on-year price reductions and so on…
- Using e-procurement for process efficiencies
- Global purchasing (to take advantage of low-cost country production)
- Payment and warranty terms
In relation to payment, a buyer in collaboration with finance team must honour the due date term in any contract. But that does not prevent him from negotiating hard for extended payment terms (90 days credit rather than 60) If payment is delayed by 30 days, the money will be earning interest on deposit, or reducing the overdraft interest. So this is much better than having the money in the supplier’s account. But If the buyer on purpose delays payment beyond the due date, it will have a damaging effect on supplier relations. So we need to be carful with payment due date.
Sometimes if the buying organisation has extra cash resources buyers can use it shorten payment period that may help in getting better pricing arrangement for example you can ask the supplier to provide extra discount for early payment taking into consideration the interest rate earned if the money stayed at the bank compared to the discount percentage by this way you will get better value for money and enhanced relationship with the supplier.
Warranty terms are another area, often overlooked, where added value can be leveraged. Buyers should look out for opportunities to include warranty terms in supply contracts. As We run a risk of disruption to operations, or having to compensate a disappointed customer, in the event of product failure. If such failure can be traced to an input purchased from a supplier, it is entirely appropriate that the supplier should bear the cost. A warranty term is one that places an obligation on the supplier in such circumstances to compensate the buyer in whole or in part.
Finally, value for money is a huge topic that we cannot conclude in one article and we will be discussing some techniques mentioned in this article to achieve value for money in later articles to get better understanding of this hot topic
CIPS Study materials
Purchasing & Supply Chain Management (Lyson & frington).