As the old saying goes, “Take care of the pennies and the dollars will take care of themselves!” This phrase, or rather the British version thereof, is attributed to William Lowndes, who lived from 1652-1724. And taking care of the penny is as true now as it was those many centuries ago.
Any savvy professional who works in Procurement or in Finance knows that this adage applies to everything they do. But it is not only the pennies that matter any more, but the fractions of a penny are just as important as ever.
Micromanaging the fractions of a penny across hundreds and thousands of skus in your inventory can add up to substantial savings, and profits, for any company astute enough to understand the opportunity.
Opportunity Cost can be Opportunity Lost
Many companies purchase thousands, if not tens of thousands, of skus to support their day to day business. The number of skus can be so vast that many organizations take a stance that only the top skus will be managed and the large number of small volume skus will be either ignored altogether, or given virtually no attention at all. The 80-20 rule is often applied.
The problem with this approach is that the neglecting tail spend, which can make up 20% of your spend, is opportunity lost. A 5% negotiated savings on 20% of your spend is equivalent to a 1% savings on your total spend. And for most companies 1% savings, aka profit improvement, is a very big deal.
But the problem is not just confined to the 20%. The top 80% of spend can easily be mismanaged because people are too focused on the big dollars and big volumes.
When the individual price of high value skus is higher than a dollar, or perhaps five dollars or higher, many procurement teams can be focused on negotiating unit prices that are in some multiple of dollars, or quarters, or dimes. They don’t focus on the pennies.
When the individual price of high value skus is very small (eg. pennies), many procurement teams negotiate in multiples of whole pennies, instead of focusing on fractions of a penny.
For instance, if you are buying a million pieces of a sku that costs $0.01 each you are spending $10,000 on that single sku. Now if you were able to negotiate that price down to $0.009 you would be spending $9,000 on that sku. That’s a 10% ($1,000) savings. Now imagine that you are buying 100 other similar skus. Assuming you were able to get the same 10% savings by focusing on fractions of a penny extended across 100 skus would result in a $100,000 savings. That’s a lot for anyone.
While this example is meant to be illustrative, it is also very real, and very achievable. In my experience focusing on negotiating savings of fractions of a penny, extended across your entire spend portfolio, can result in annualized savings of literally MILLIONS of dollars! Purchase price variance (PPV) results can be enormous profit generators.
I don’t care what size company you are in. The savings potential can result in enormous profit improvements for your company.
But how do you Manage all these skus?
It remains a reality that small value skus can not be managed with the same hands on focus as high dollars skus. But they can’t be ignored. As such they must be managed differently.
The foundation for managing these skus, negotiating and achieving fractional savings, and driving profitability is a data warehouse. Thousands of skus can not practically be managed manually, or even on spreadsheets. You need a thorough and robust data warehouse which contains all of your data on every single sku in your company.
Within the data warehouse you will have a number of prices and costs for any given sku. The price you charge your customer, the standard cost of the sku, price breaks for the sku based on volumes, future costs for the sku, and more. Most critically the price, or cost, fields must not be just $x.xx, but ideally $x.xxxxx. That is, you have designed your tracking system to hold fractions of a penny for any cost or price.
Now with a tracking database in place the question still becomes how do you manage these numbers. It can still be a herculean task to manage, negotiate, and track all of these prices and costs across thousands of skus. When you are negotiating with suppliers you want to cover all of these thousands of skus so you will be asking for broad based price concessions to be applied to all of these skus, in a document which can be easily uploaded to your database.
Even if those savings are in fractions of a penny you can let the systems do the work instead of getting lost in manual data entry. It’s easy to ask for a percentage savings and letting the system do the math on a sku by sku basis.
Conclusion
The perspective that unit price, and cost, must be set to some combination of dollars and cents is the paradigm that must be broken. You need to negotiate all of your costs to fractions of a penny.
You can use central data warehouses, or even spreadsheets, to manage all of the data. This will mitigate any manual effort involved. Your attention can then be focused on the negotiations with your suppliers, wherein you will push them to give you savings that are reflected by reductions in the fractions of cents.
This approach applied across your entire aggregated spend portfolio can, depending on the size of your spend, result in literally millions of dollars of savings, and in turn improved profitability.
Procurement plays a vital role in driving company profitability and this approach can make Procurement professionals heroes and improve the prestige of the function in the eyes of the rest of the organization.