Cost Leadership within the Procurement Function: Building Capabilities focusing on Category Management, PMT, and Organization & Roles to enhance the company strategy.
Table of Contents
Cost leadership as a company strategy.
Cost leadership is a strategic approach where a company aims to become the lowest-cost producer in its industry. By achieving and maintaining lower operational costs than competitors, the company can offer products or services at lower prices, thereby gaining a competitive edge. This strategy focuses on efficiency, economies of scale, rigorous cost control, and cost minimization in areas such as production, logistics, and procurement.
Key Components of Cost Leadership
Economies of Scale:
- Producing large volumes to reduce per-unit costs.
Operational Efficiency:
- Streamlining processes to eliminate waste and improve productivity.
Cost Control:
- Tight management of expenses in all areas of the business.
Procurement Strategies:
- Sourcing materials at lower costs through bulk buying and strategic supplier relationships.
Technology and Innovation:
- Implementing advanced technologies to enhance efficiency and reduce costs.
Leadership within the Procurement Function
An effective procurement function often forms the backbone of successful companies. For optimal efficiency, this function requires a solid strategy and strong leadership. Let’s delve into the three critical perspectives concerning building capability within procurement:
- Category Management: To achieve the maximum return from suppliers, companies should adopt category management. By segmenting purchases based on similar products or services, businesses can craft procurement strategies tailored for each category, leading to a better negotiation position and cost-effectiveness.
- PMT (Processes, Methods, and Tools): Standardized and optimized processes are crucial for the smooth operation of the procurement function. Beyond standard processes, companies should also implement effective methods and workflows allowing flexibility in addressing shifting market conditions and supplier dynamics.
- Organization and Roles: Clarity in roles and responsibilities is paramount to ensure that all members within the procurement function are engaged in the right tasks, optimizing the overall performance of the operation.
In order to achieve leadership within the procurement function, every procurement strategy should be rooted in the company’s overarching strategy. By linking these two strategies, it ensures that the procurement function supports the company’s goals and vision. In terms of measuring success, KPIs (Key Performance Indicators) play a central role in objectively evaluating the performance of the procurement function.
An essential aspect of a business strategy is ensuring compliance with laws, mandates, and the company’s policies. By crafting a robust procurement strategy, not only can companies ensure compliance but also ascertain that the offerings and values presented to their customers are reinforced by the supplier base formed.
Strategic objectives provide guidance for all business functions. One such objective, Cost Leadership, exemplifies how company-wide goals can significantly impact the various perspectives within the procurement function.
- Category Management: When a company targets Cost Leadership, this not only defines its position in the market but also provides direction to the procurement function. Cost-awareness becomes paramount. This perspective requires a revision of category strategies to ensure alignment. For example, if a business’s unique selling point (USP) is offering high-quality products at competitive prices, the procurement category strategy must focus on sourcing suppliers that can provide the best quality materials without compromising cost. Therefore, the sourcing strategy for each procurement category needs to be tailored towards achieving cost leadership, especially in a competitive market.
- PMT (Processes, Methods, and Workflows): With the overarching goal of cost leadership, the tools and processes employed by the procurement function must reflect this priority. The introduction of strategic negotiation tools, like the Procurement e-Auction, can be pivotal. e-Auction, in particular, has the potential to tap into the supplier market to identify cost leadership opportunities, ensuring the company’s purchasing power is maximized without sacrificing quality. Such tools should be integral to the PMT team’s capabilities.
- Organization and Roles: Achieving a strategic goal like Cost Leadership necessitates capability building across the organization. In the context of procurement, buyers should be equipped with the requisite skills and tools to uphold the company’s cost leadership stance. This means that the buyer’s training regimen should include mastering strategic tools like e-Auction. Additionally, their role should evolve to become more strategic, evaluating suppliers not just based on price, but on the total cost of ownership, long-term partnerships, and the strategic fit to the company’s cost leadership goals.
Impact of Cost Leadership on Procurement Category Strategy (example)
When a company adopts a cost leadership strategy, the procurement category strategy must align to support this overarching goal. This alignment involves focusing on reducing costs while maintaining quality and efficiency across all procurement activities. Let’s illustrate this with a fictive category: Raw Materials for Packaging.
Trade-Offs for the Category Manager
Category: Raw Materials for Packaging
Objective: Achieve the lowest possible cost for packaging materials while maintaining adequate quality and supply reliability.
Key Trade-Offs:
Cost vs. Quality:
- Focus: Prioritize suppliers that offer the lowest prices for raw materials, such as cardboard, plastic, and adhesives.
- Trade-Off: May need to accept slightly lower material quality if it meets the minimum acceptable standards to reduce costs. However, the category manager must ensure that the quality is still sufficient to protect the products and meet regulatory requirements.
Bulk Purchasing vs. Inventory Holding Costs:
- Focus: Leverage economies of scale by purchasing raw materials in bulk to negotiate lower prices.
- Trade-Off: This strategy could lead to higher inventory holding costs and potential risks of obsolescence. The category manager needs to balance bulk purchasing benefits against the costs and risks associated with holding large inventories.
Supplier Diversity vs. Supplier Consolidation:
- Focus: Consolidate purchases with a few key suppliers to gain better pricing and more favorable terms through increased volume.
- Trade-Off: While consolidation can lead to cost savings, it may also increase dependency on fewer suppliers, which can pose a risk if a supplier faces disruptions. The category manager should ensure that the chosen suppliers have robust risk management practices in place.
Long-Term Contracts vs. Market Flexibility:
- Focus: Negotiate long-term contracts with suppliers to lock in low prices and ensure stable supply.
- Trade-Off: Committing to long-term contracts can limit flexibility to take advantage of market price drops or new, more competitive suppliers. The category manager should build clauses into contracts that allow some flexibility for renegotiation or adjustments based on market conditions.
Local Suppliers vs. Global Sourcing:
- Focus: Evaluate the cost benefits of sourcing raw materials from global suppliers, potentially at lower prices than local suppliers.
- Trade-Off: Global sourcing might introduce additional costs and risks such as higher transportation costs, longer lead times, and exposure to geopolitical risks. The category manager needs to balance these factors against the cost savings from global suppliers.
Implementation Considerations
Supplier Relationships:
- Develop strong relationships with key suppliers to ensure collaboration on cost-saving initiatives and quality improvements.
Continuous Improvement:
- Implement continuous improvement programs focused on cost reduction, such as value analysis and value engineering (VA/VE), to identify and eliminate unnecessary costs.
Technology and Automation:
- Use e-sourcing and e-auction tools to drive competitive bidding among suppliers, ensuring the best market prices are obtained.
Risk Management:
- Establish robust risk management practices to mitigate the risks associated with cost-cutting measures, such as supply chain disruptions and quality issues.
Summary Cost Leadership within the Procurement Function
When a company strategically positions itself with an operational target such as Cost Leadership, it has ripple effects on the various pillars within the procurement function. From the category management strategies to the PMT and even the roles and capabilities of individual team members, the goal of cost leadership shapes and defines actions, behaviors, and decisions. It’s a holistic approach, ensuring every aspect of procurement is aligned to deliver on the company’s strategic promise.
In a cost leadership strategy, the procurement category strategy for raw materials for packaging must focus on achieving the lowest possible costs while managing the associated trade-offs effectively. By carefully balancing cost, quality, supplier diversity, and flexibility, the category manager can support the company’s cost leadership objectives and contribute to its competitive edge in the market.
Learn more in the course Introduction to Procurement Management
This course will provide you with an understanding in managing a Procurement department and what should be on the agenda for a CPO (Chief Procurement Officer) is a relevant step towards strong Leadership within the Procurement Function.
An example of a company with Cost leadership in its customer market is IKEA. Visit IKEA Supplier Portal.
Note: Illustration to the blogpost “Cost Leadership within the Procurement Function” was created by Chat-GPT on June 21, 2024.
Information about our Online Procurement courses in Swedish.