How to Identify (and Significantly Reduce) Procurement Costs
Procurement costs are the expenses your organization incurs to provide the goods or services your customers expect. There are numerous procurement costs you need to monitor. Evaluating these costs against your budget for procurement is an essential KPI that indicates just how effective your procurement management strategies are.
Reducing procurement costs isn’t just about slashing expenses.
Instead, it’s about evaluating the purchases in your organization against alternatives. It’s also about using data to rethink how your business conducts improvement. Finally, it’s about building smarter, better relationships with vendors who will help you grow your business.
Done correctly, you’ll reduce your expenses and secure your bottom line.
This post will show you exactly how to make that happen.
Direct vs. Indirect Procurement Costs
There are two different kinds of procurement costs: direct costs and indirect costs. Direct procurement costs cover the costs related to the product and sale of goods or the labor costs for contractors. Indirect procurement costs involve expenses that aren’t related to product production but are necessary for the business to function.
- Examples of Direct Procurement Costs: Raw materials, manufacturing, transportation, and storing of products. Hourly labor costs for contractors.
- Examples of Indirect Procurement Costs: Pens, paper, marketing collateral, rent, IT services, employee travel, and capital expenditures.
When it comes to budgeting, most companies will have separate budgets and processes for managing both indirect and direct procurement costs.
Types of Procurement Expenses
In most businesses, there are 7 different types of procurement-related expenses. To effectively manage your procurement costs, you need to take all these expenses into account. Failing to do so can lead to significant budget miscalculations that can negatively impact your business.
- Base Cost: The total cost per unit of a product.
- Transportation Cost: The cost associated with acquiring new products.
- Closing Cost: Any costs associated with buying and selling inventory.
- Taxes and Duties: Any taxes you have to pay on your purchase orders.
- Negotiation Costs: Cost for researching, evaluating, and negotiating contracts with vendors.
- Inventory Costs: The cost of storing and managing inventory.
- Contract Management Costs: Costs associated with evaluating vendor performance, QA, enforcing contracts, arbitrating disputes, and renegotiating terms.
10 Ways to Reduce Procurement Costs
Cost savings is a key component to effectively managing your procurement process. Keep in mind that it shouldn’t be your overall goal as businesses now know the value of thinking about procurement more strategically. Still, if you overspend on your budget, you could end up running out of money before projects are complete. And this could put your business in danger.
To help ensure your procurement process stays lean and supports your bottom line, implement these 10 strategies. They’ll help you quickly identify the financial hemorrhages in your procurement process and reduce that waste before it permanently damages your organization.
1. Automate Procurement Processes
Nearly every strategy pointed out below is an offshoot of this centralized theme: replacing manual procurement processes with automation. Automation streamlines and secures workflows. Integrated systems share data, giving you real-time, accurate insights. And you’ll drastically reduce labor costs, errors, and waste with a more transparent procurement process.
Without automation, many of the processes described in this list are not possible or will simply fall flat. You can only shave off costs so much if your organization still relies on spreadsheets for data processing and storage.
The benefits of automating your procurement are numerous. If you want to experience those benefits, you need to invest in better systems.
2. Reduce and Eliminate Tail Spend
Roughly 80% of a company’s purchases make up 20% of its spend volume. These purchases are known as tail spend. It can cover a variety of purchases, from maverick spend to one-off purchases for services.
Tail spend tends to be high in organizations that lack visibility into their spending. Without that visibility, they’re unable to combine purchases or secure better deals with vendors. Over time, these expenses add up.
Procurement automation reduces tail spend by increasing visibility into your supply chain, better tracking purchases, and putting systems in place to block unapproved purchases.
3. Navigate Taxes and Duties
Luckily, there are a few ways you can lower the taxes and duties associated with your procurement costs. One way is to try and source locally to avoid VAT or GST, if that’s an option. You can also work with states or countries that have lower sales tax.
However, if the goods or services you need are location-dependent, you’ll need to pay the required duties and taxes for procuring materials and services. Still, it’s worth evaluating your options by comparing vendors.
4. Compare Vendors
Reduce costs by shopping around and comparing vendors. Cost reduction should not take priority over value generation. Instead, you’re looking for a balance between the quality of your goods and services against your overall cost.
There are a lot of ways you can work with a vendor to reduce costs. You should evaluate the types of materials, product design, and packaging. You can also evaluate the quality of each product. You’re looking for a balance between quality and cost. Additionally, bulk discounts can save you money on large orders.
If you’re working with vendors for services, you should weigh efficiency against cost. A vendor with a lower hourly rate for services may take longer to complete tasks or the quality of their work may require additional visits. In the end, a cheaper contractor could end up costing you more in the long run.
5. Evaluate Transportation Costs
You need to get your raw materials and products to where they need to go. But, if you’re not evaluating your logistics, you may end up paying more. Look to see if you can consolidate orders and deliveries. Try alternative transportation methods. And explore different types of warehousing to keep your goods closer to your customers, reducing transportation expenses.
6. Reduce Overhead
Reconsider the facilities your business uses to build and house products. Look for cheaper options that provide strategical advantages along with reduced costs. Evaluate the types of machinery you use to build products. Consider the cost of repairing against replacing. Ask yourself if you can purchase better quality machines to save costs in the long run.
Outsourcing production could also be an option if the vendor provides a similar quality product at a reduced cost.
If your business rents office space, consider going remote. After the pandemic, more companies are leaning toward remote work to reduce costs while increasing productivity. Ask yourself, "Does the office space add irreplaceable value? Or can we conduct operations remotely?"
Could your organization move to a smaller or shared office space? Abandoned dated beliefs. You don't "need" an office. It does not define your business. Instead, look at whether or not it facilitates or adds value to your day-to-day operations.
7. Review Inventory
Every item sitting in your warehouse costs your business money. It also runs the risk of becoming obsolete. Conversely, not having enough inventory on hand can cause lasting supply chain disruptions and damage your brand. Evaluating your inventory against current market and consumer trends is key to ensuring you have enough stock on hand without burning through your budget to store unnecessary goods needlessly.
8. Conduct Risk Management
Working with ethical vendors, transitioning to sustainable procurement practices, and reducing maverick spend are all great ways to reduce risk to your business. But they’re not the only risks to your procurement process. You need to regularly evaluate the resilience of your supply chain by conducting risk analysis to find potential weak points.
Inspect your vendor relationships. Make sure you’re not over-reliant on a particular supplier. Evaluate your company-wide spend and leverage it to secure supplier relationships that benefit your business.
Automating your procurement process helps centralize and secure data while eliminating human errors reduces potential threats to your bottom line. You’ll also gain greater insights into factors (natural disasters, political instability, etc.) that might impact your sourcing. With those insights, you can adjust your supply chain proactively, avoiding potentially catastrophic costs.
9. Minimize Administrative Costs
If you have to hunt down paper invoices, conduct manual approvals, or sort through a filing cabinet to find vendor contracts, you’re wasting valuable time and money. Automating your procurement processes will centralize that data and make it easier for you to track and store the files you need to streamline procurement management tasks.
10. Streamline Negotiations
Negotiation is part of the procurement process. It is not a zero-sum game, though. Instead, you need to be prepared to work with suppliers to build mutually beneficial relationships. Still, it’s hard to get the leverage you need in those negotiations without insights into your supply chain, specifically your vendors and their competition.
An automated vendor management system can track and store your vendor data. If it has a self-service portal, your vendors can upload their details, saving you time. When it comes time to evaluate your vendor contracts, you can quickly review their performance and pricing before comparing them to competitors in the platform.
These insights will help you get the best deal when it comes time to renegotiate or adjust your contracts.
11. Continuously Optimize Procurement Cost
Markets change constantly. Customer demands ebb and flow over time. Globalization adds complexities as easily as it provides simple solutions. The key to staying ahead of it all and minimizing your procurement costs is to continuously analyze your purchases against your companies current and future needs.
The challenge with continuously improving your procurement costs rests in how complex supply chains have become. And as your business grows, it will only become increasingly complex.
This is perhaps the greatest value add for procurement automation. By integrating your systems, cleaning your data, and storing it in a secure, centralized location, you’ll have the real-time insights you need to evaluate your supply chain at a glance.
As a result, you can quickly adjust to shifting conditions and demands, keeping procurement lean in your organization.
See how we've helped our clients improve their businesses and get insane ROIs by checking out our case studies below.