Professionals can miss areas of opportunity for supplier cost reduction and management.  Usually when we think about costs management, the manufacturing, retail, or wholesale environment comes to mind.  Service industries usually do not take top rung.  However, all industries as well as all areas within a business need to rein in costs for greater efficiency and profitability.  Manufacturing is not the only industry just as the inventory management process is not the only area for managing costs.  The supply chain also encompasses more than the production floor, and costs toward end user targets are just as important as costs toward value added and resale.  Three areas of opportunity exist for managing costs within a firm:

  1. Productions materials
  2. Product-related contract services
  3. Outsourced organizational components

Production Materials

The most obvious areas of cost reduction and management consist of production processes and inventories.  However, the obvious does not automatically translate into management best practices.  With more companies considering outsourcing for manufacturing, the following questions arise:

  1. What does the vendor outsource?
  2. Who supplies assembled component producer materials?
  3. Is your company in control of the entire supply chain concerning the number of vendor links in that chain?
  4. Does your risk management plan safeguard your supply chain?
  5. Does that plan insure provide for quality, proper disclosures, confidentiality, technical requirements, and on time deliverables?
  6. Do vendor deliverables meet your customer requirements?

Herein lays the key for supplier management: customer-driven management.  The customer drives answers to all of the above questions.  Therefore, the entire supply chain matters for quality, price, performance, and differentiation.  Brian Everett highlights this importance in Lenovo’s success.  He notes that outsourcing has its “competitive advantages” but highlights Jim Molzon’s concerns about outsourcing challenges, “coordinating the outsourced pieces may indeed create new challenges in product development and procurement along the supply chain interface.” Molzon states that some of those risk challenges include import and export execution, transportation, shipment visibility, and vendor managed inventories.  For this reason, it is important to have the supply chain trained on customer-driven management and to allow that principle to guide every vendor in the process.

On a similar note, successful manufacturing firms grasp the importance of multi-sourcing.  While doing so, best practices may not always be front and center.  Vendor transparency and risk management constantly tug at one another.  Vendors have concerns that too much disclosure will cause a loss of competitive edge while customers focus on risks with vendors.  Tension arises between these two areas.  How do you control risks while gaining greater disclosure from companies in your supply chain?

Anna Frazetto highlights several key management practices in a related supplier area – information technology (“10 Tips for Multisourcing Success,”  I will underscore five of these areas:

  1. A strong internal support team – Having a point person or team overseeing multi-sourcing
  2. Standardization across vendors – Criteria and requirements specification management
  3. Due diligence in vendor selection – A change control management team or something similar to one
  4. Proper internal governance and risk management – Governance and risk management strategic plan and written policies
  5. Key performance indicators (KPIs) and key risk indicators (KRIs) – These two types of indicators complement on another

Such a brief article cannot do justice in sufficiently explaining these five areas.   However, a good place to start is with the links provided for the above noted specified keys words.  Implementing these five best practices can provide substantial cost reduction and management. They can also address corresponding risks associated with costs due to lost opportunity, fraud, theft, and embezzlement.  Multi-sourcing best practices in themselves will drive costs down through increased vendor competition for your business and lend to streamlining internal processes.  Performance and risk indicators can highlight prior unknown areas of high business costs and set targets for further cost reduction.

Product Related Contract Services

Contract services relate directly to the supply chain.  They include functions as delivery, technical support, customer services, and warranty management.  They directly support the customer and have a substantial bearing on customer loyalty and the revenue stream.  All of these are value added services without which customers will seek another supplier.

Without being specific about them and have them well structured in your business, the customer and your revenue suffer.  Making your processes clear to everyone involved goes a long way toward customer loss prevention.  In my book, I write,

“Poor responsiveness from outside vendors or an ill-defined scope of work for the vendor can be distractive. One distraction is not having sufficient knowledge when needed for sound decision-making. This lack can lead to delays and added expenses.” (“Customer-Driven Budgeting: Prepare, Engage, Execute, The Small Business Guide,” Business Expert Press, 2012, 172).

These critical services are your products and revenue generators whether you charge a fee for them or not.  They provide the fuel for customer retention.  It is also important that your suppliers in these areas thoroughly understand your business model and that they completely champion your customers.  Vetting them through a comprehensive checklist not only establishes criteria for contracting with them but also leads toward developing performance indicators for measuring their success in supporting your business.

Figure 1: Measuring Vendor Performance Criteria

Figure 1 illustrates this process.  From the established vendor criteria, prepare performance objectives.  These performance objectives should include as their measurements KPIs or KRIs for identifying dollar savings, revenue generation, or desired results.  Set up a Start Date for implementation and an End Date for measuring progress. Cost reduction should follow suit.  Set up each criterion as an objective with corresponding measurements.  However, take care not to create too many objectives. They can overwhelm you and your staff.  Grouping criteria into categories and designing an objective for the category simplifies matters.  Additionally, review your current costs and compare their costs after a given period for each designed corresponding objective.  You will discover cost and risk reduction due to their improved management by the criteria and objectives you set up for them.

Outsourced Organizational Management

Many SMBs often overlook adequate management of outsourced organizational components.  They are also the most notorious for increasing costs in the business.  These business components consist of information technology (IT), payroll, human resources, legal, and other segments of the accounting function.  One way to insure that you do not overlook these outsourced functions is through identifying them on your company organization chart as outsourced as shown in Figure 2.

Outsourcing certain organizations comes with risks.  For example, outsourcing the CFO or corresponding management function because of its cost brings about several risks:

  1. Disclosure of confidential information
  2. Commitment challenges
  3. Strategic formation management
  4. Time dedication requirement

This is not to say that such outsourcing is not wise but that a company should have adequate controls in place for mitigating the above risks. While non-disclosure agreements are excellent and necessary mechanisms for risk reduction, they do not prevent them altogether.  If you outsource IT operations, access to sensitive information could make your company vulnerable.  Additionally, lack of availability to solving high priority network issues could lead to frustration and reduced service to the customer.  The same holds true with any other function you seek to outsource.  For these reasons, insure that you have strong criteria in place for minimizing costly or response issues arising from outsourcing operational functions.  If you are outsourcing a full function within an organization, insure that you establish five important practices:

Figure 2: Organization Chart Showing Outsourced Functions

  1. A transition plan when the time comes to internalize it
  2. Specific criteria within a performance contract
  3. KPIs for measuring effectiveness
  4. A monitoring mechanism
  5. Performance evaluation of the vendor

In setting up such criteria (See Figure1 for the process), consider the rule of 10 in Figure 3 for designing a contract and vendor criteria for the contract.  This applies as much to banks as to payroll services.

You can realize greater cost reduction across your company in these three areas than you would otherwise by simply considering one area, such as the production supply chain. While it may be easier to identify cost reductions in direct costs through the obvious mechanism of multi-sourcing and processes evaluation, other areas may not be as obvious.  Risks costs add another dimension to direct costs reduction challenges that are not as obvious and straightforward.  By applying the model in Figure 1 to risk identification, you can develop performance objectives and KPIs for realizing cost savings or performance results that lead to an improved bottom line.

The other two areas are not as obvious concerning cost savings.  However, major cost savings can result in product support and operational suppliers when following the model in Figure 1 and considering the criteria in the rule of 10 in Figure 3.  The two primary keys to this model are:

  1. Establishing vendor criteria for each of the areas of your company
  2. Designing performance objectives from these criteria

These two steps provide critical starting points.  This beginning makes it easier to design KPIs, desired results, and monitoring.  Once you identify vendor criteria, you take a giant step toward solving costs challenges across the company and not in just one area.  After designing these performance steps, consider incorporating them into a budget (italics for emphasis).  By doing so, you can identify net cost savings and process improvements.  Therefore, you most likely will realize greater performance, contributing to a stronger business foundation and bottom line.



About Floyd Talbot

Floyd Talbot is principal and founder of AFB Business Solutions and has more than 20 years of experience in advising small businesses in business financial management and planning, accounting, and business practices. He has served as interim financial manager for several small businesses, and has worked with business owners, CFOs, and accounting managers with implementing not only their accounting systems but also the entire financial accounting function within their companies, including financial reporting, budgeting, accounting practices, and strategic planning. Floyd earned his MBA from Pepperdine University and served on the Northern California Graziadio Alumni Network Board in the Northern California Bay Area. View all posts by Floyd Talbot →

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