When looking at the two kinds of spend, i.e., direct (inventory) versus indirect (expense or overhead purchases), it has been found that the indirect purchases take much more time. But, you can still use fundamental processes to hone in on opportunities to reduce the indirect costs.
Defining Cost Reduction and Cost Cutting
Before we go any further, let’s clear up the terms ‘cost reduction’ and ‘cost cutting.’
‘Cost Cutting’ is eliminating an expenditure without regards to the consequences or effects when doing so.
‘Cost Reduction’ is the reduction in the prices paid for products or services yet maintaining quality, delivery and service.
The result is that the departments should be able continue to operate as needed without interruption while reducing the costs the company shells out.
So how does a company go about reducing costs in a controlled fashion?
Managing MRO Spend
Management of the ‘indirect spend’ process is important for a couple of reasons. First, there are specific contractual elements that must be in place when making agreements (or sending out purchase orders). Second, there is a large amount of efficiency gained having one department with skilled professionals complete these tasks. To do so means to organize, control and optimize these expenditures.
Organization
The first step in managing indirect purchases is creating the environment that enables control over the spend for the company. Typically, only one department, staffed by procurement professionals, is assigned this responsibility.
Control
The control of the purchases is necessary due to the complexity of contract law. The firm must complete the purchase order (contract) process with suppliers. This means defining all products or services, terms and conditions, and agreeing on price and delivery. These purchase orders (or contracts), if greater than $500, must be in writing, i.e., there must be a written offer and acceptance of the purchase order by the company and the supplier.
Next, communication must be managed. Imagine five (5) different people, at one company, contacting multiple individuals at a single packaging supplier to order and/or inquire about open orders, availability, or technical specifications. There can be and usually is a lot of confusion, not to mention inefficiency, at both companies when this happens.
Spend Optimization
Basically, in cases where the product or service is not sole sourced, there are two steps that work towards achieving spend optimization, i.e., competitively bidding products and/or leveraging the spend. But, what kind of cost reductions are possible when making these indirect purchases?
MRO cost reductions are typically ‘estimated’ as a function of the total overhead spend. For example, if a company had an ‘indirect’ or overhead spend of $12 million, and by professionally managing these purchases, they could expect to save approximately $120,000 with just a one (1) {2bf209ca88e06deac55c1059e09d0cd2131e4e9f2199a59c5512cbe0c4dd3869} reduction of the spend on the items that make up these indirect costs.
The Bottom Line
The company typically spends more time on indirect expense purchases than it does on direct purchases. But there are savings to be had and it can be substantial. To reduce costs, when purchasing products and services, it is necessary to manage, organize and control this process to achieve ‘spend optimization.’ Finally, the company gains capability and proficiency by assigning this responsibility to a group of professionals in a single department.
Related Topics
Understanding Category Management Process. The category management process is the careful and deliberate segmentation of products and services into different categories. The segmentation makes it easier to understand, source, and manage the products and services with suppliers. For more on this topic, please follow this link.
Reducing MRO Costs. A company with a revenue stream in the millions, can save hundreds of thousands of dollars each year in this area by applying fundamental purchasing procedures. For more on this topic, please follow this link For more on this topic, please follow this link.
Manufacturing and Supply Chain Services
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