How to calculate procurement cost control and how to leverage it?

Procurement cost control is highly strategic for companies. It has an impact on economic issues as well as customer satisfaction and brand image. Procurement cost control relies on efficient supply chain management to enable companies to meet customer demand at all times, while promoting profitability and sustainability. This is the reason why it is important for procurement and logistics departments to calculate and then optimise procurement cost control.

Procurement cost control, a strategic issue

“Procurement” in companies refers to the purchasing of goods and services for several possible purposes. These may be products directly intended for resale, materials required for the manufacture of end products or goods intended for storage. Procurement is a key part of the supply chain.

As Graham Stevens, then senior consultant with the services network Peat Marwick McLintock (now KPMG), wrote in his article "Integrating the Supply Chain": "The objective of supply chain management is to synchronise customer requirements with the flow of materials from suppliers so that you can balance what are often seen as conflicting objectives, namely high customer service, low stock management and low unit cost." This text, published in 1989, is still used as a reference for today’s procurement and logistics departments.

Procurement cost control therefore consists of synchronising the various logistics flows and optimising resources as efficiently as possible as part of cost reduction strategies. As such, procurement teams need to focus on these five main components to improve their performance:

· The planning and management of requests from customers;

· Sourcing, i.e. the selection of suppliers and service providers, which covers all the goods and services that a company may purchase;

· Manufacturing, i.e. the receipt of materials and/or goods needed to produce end products;

· Delivery and logistics, which covers coordinating orders and then scheduling deliveries;

· Returns, i.e. the company taking back products returned by customers for various reasons.

How is procurement cost control calculated?

To calculate procurement cost control, companies need to factor in three key elements, whether these are variable costs or capital costs. These indicators are: The cost of placing an order, the cost of holding stock, and the cost of any shortages.

The cost of placing orders

This indicator includes all expenses related to placing orders, such as:

· Administrative and logistical follow-up;

· Transport;

· Receiving and handling;

· IT equipment and software;

· Costs of staff involved in the process;

· Etc.

The cost of holding stock

This covers all costs associated with holding stock, whether they are direct or indirect, including:

· Insurance;

· Surveillance and protection;

· Rental and maintenance of premises;

· Facility depreciation;

· Administrative costs;

· Heating;

· Equipment;

· Etc.

The cost of shortages

In addition to these preliminary costs, there is, of course, the cost of any possible stockouts if there is a delay in delivery or an error in supply forecasts. These costs usually come from lost orders, subcontracting, idle labour, etc.

Adding up the costs of placing orders, stock holding costs and shortage costs over a year gives a company the annual cost for their supply management. This means it is vital for companies to have perfect command of these processes, so that they can optimise them.

How is procurement cost control optimised?

Once they have calculated the above, companies can optimise the various components of their procurement process both in terms of stock management and orders. Logistics departments can use tried and tested processes (or new ones) and technological tools to optimise procurement cost control, and possibly reduce costs from inefficient practices.

Laying the groundwork

First of all, they need to choose the optimal supply management model (forecasting method, Kanban method, just-in-time method, calendar method, etc.) as well as the necessary computer systems and automation software.

Once they have this foundation under control, they can activate various optimisation levers for procurement cost control:

· Avoiding over-stocking;

· Anticipating shortages;

· Optimising storage space;

· Reducing dormant stocks;

· Etc.

Managing and improving performance in these aspects can include the implementation of new strategies, such as data management for spending, raw materials, inventory management, and maybe even creating models for possible economies of scale for a given product or service.

The procurement function is responsible for the cost of placing orders. In this respect, there are two main optimisation levers centred on the total cost of ownership: rationalising the supplier portfolio and digitalising transactions. These features can help reduce procurement costs, or help the company optimise its procurement process and make optimal use of its budget.

Rationalising the supplier portfolio

Procurement professionals and other buyers can start by rationalising their supplier portfolio. This results in double savings on both supplier management costs and ordering costs.

This rationalisation may also help reduce the number of orders, as well as the number of deliveries and the greenhouse gas emissions they produce.

Last but not least, an approach like this helps develop strategic partnerships with approved suppliers or distributors; in other words, it improves contract management.

Digitalising transactions

It is also in the buyers’ interest to make their company’s Procure-to-Pay process paperless (this goes from product access and orders to payment), i.e. through procurement software. In addition to reducing administrative costs, this lever has many other benefits. It speeds up the transactional process, reduces the number of errors and lowers the company’s environmental impact.

As you can see, calculating the procurement cost control means you can identify and activate the appropriate optimisation levers, both on the logistics and procurement front. This is something which can only be achieved based on close collaboration between the company’s departments combined with the digital transformation of the procurement processes. Procurement cost control is always about profitability and value creation, and therefore company sustainability.