What can you do to avoid your clients’ procurement projects taking out 13% operating margin from your most profitable contracts?

How to defend your most valuable contracts from aggressive procurement strategies that could eliminate your entire profits and cash flow

There is an old story about the scorpion and the frog that were threatened by a flash flood drowning them both unless the frog could carry the scorpion to the other side of the river to safety before the flash flood arrived. The scorpion pleaded for its life to be carried to the opposite river bank. The frog responded that it couldn’t trust a scorpion who had always been trying to eat the frog. The scorpion replied killing the frog would be stupid as it depended on the frog for its survival. The frog was persuaded by this argument, asked the frog to jump on and started to swim across. Half way across the raging torrent, the scorpion stung the frog with lethal venom and with its dying breath the frog asked “why did you sting me? I’ll die and you’ll drown, why did you do that?” The scorpion replied, “what did you expect from a scorpion?”

So with apologies to all my dear friends in procurement and purchasing departments, I’m afraid these scorpions are going to go out there and attack all their major contracts looking for substantial savings. I know they talk these days about ‘strategic procurement’, ‘partnership’ and ‘total cost of ownership’ but this all boils down to taking large amounts of cost out of external spend whenever and however they can. Beware this money is most likely to come from your most valuable contracts.

Clearly procurement functions will be responding to a strategic imperative from their boardrooms. The impact of the recession on your clients’ sales and profits will put them under enormous pressures to save costs. A key client strategy will be to engage in strategic sourcing and procurement projects. What makes them strategic is the scale of the savings they are going to make from your profits and cashflow. Unless you are well prepared, the potential impact on you could be to eliminate the entire profitability of your business or worse.

Why are your most profitable contracts under threat?
Clearly during a downturn every business is fighting to protect its profitability, margins and cashflow. One of the most obvious places to make cost reductions is to look at what money is being spent on outside suppliers and how this expense can be managed down. The greater the spend within a particular supply category and the higher the margins that are being enjoyed within that category, then the more attractive the cost reduction opportunities are going to be for a sourcing/ procurement project to rationalise spending in that category. The bad news for your business is that your largest and most profitable contracts are therefore the most attractive candidates to get on a shortlist of candidates for your customer’s procurement function to target for cost reductions.

What’s the potential impact on your business?
Benchmarks savings for a typical sourcing project are around 13% (based on our experience and industry sourcing project analyses covering $190 billion of expenditure). Some categories such as Vehicle Leasing savings can be in the range of 7 to 10%, while other categories such as Travel the savings can range as high as 35 to 60%. These of course are averages, during a recession you can expect more aggressive competition to take place for contract renewals, so the target savings for procurement and sourcing projects are likely to be set higher than 13%.
Unless you are able to renegotiate a lower specification for your products and services allowing you to reduce your costs to serve (a possibility but I wouldn’t bank on it) then the cost savings are going to be made directly against your profit margins.

How will your clients go about running a strategic procurement project?
The worst-case scenario for your contracts is for your clients to run a well structured sourcing process with experienced external advisors to help them. An opportunity scan across all their spend categories can be completed in less than a month allowing them to focus on the most attractive categories (balancing savings potential against risk impact). If the first knowledge you have that the process is underway is receipt of an RFI (Request for Information) or RFP (Request for Proposal) then you are in a particularly difficult position. The likelihood here is that someone else (procurement seeking to maximise savings or even worse a competitor seeking to capture your business) has defined the evaluation and selection criteria already. Typically a sourcing project can be completed within 2 to 3 months per category, on an 8 step structured process the RFIs and RFPs are typically issued at stages 3 and 4 – so now you may only have a few weeks left to save your most profitable contracts.

What are 5 quick tips that you can use now to defend your contracts?
i) Perhaps your most valuable defensive weapon is your ‘value proposition’ and gaining clarity on how this is different and better than your competitors. You need to determine specifically how you help your clients do business more successfully. Your first starting point is the financial case, how do you help your clients increase their revenues, protect margins or reduce their operating costs and working capital requirements? Then you should look at their customer proposition, how do you make that more attractive, how do you help increase customer purchase rates or reduce customer churn? From an operational perspective, how do you help them run their business more successfully? Finally, and this may be your biggest trump card, what is their risk exposure should they switch your business to a competitor? As they say in the Dr. Pepper TV advert ‘what’s the worse that can happen?’