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Embrace Uncertainty to Improve Cost Driver Analysis

Procurement teams will boost their credibility if they spend more time on cost analysis, but uncertainty about the supplier information available can hold them back; it's better to embrace the uncertainty

Procurement teams are keen to boost their credibility with the business managers they work with and, of course, to find more cost savings. The best way to do this is to understand why suppliers charge what they do across a much bigger range of purchases, not just the “top-tier” most expensive ones.

But conducting cost analysis for lower- or middle-tier buys can be a frustrating task. Procurement teams will often feel they have more questions than answers, in contrast to the support and information that’s available for top-tier buys.

They’re probably not sure which part of a supplier’s pricing and product offer they should probe to understand why the supplier is charging a certain amount, which then makes it hard to help line managers reduce costs without compromising on quality. Sometimes – for lower tier purchases – the information that line managers have may be inaccurate or simply not exist.

All of this uncertainty makes it understandable that procurement teams might view cost driver analysis – the work to find out why a supplier is charging what they are – as a poor use of time. But this uncertainty is not an insurmountable obstacle. Procurement teams that embrace it can use incomplete information to their advantage and still find ways to cut line managers’ spending and boost the function’s credibility.

Imprecise Information Is Better Than No Information

The procurement team from a food and beverage firm in CEB’s network of procurement professionals has a useful approach to dealing with uncertainty in their cost models.

Procurement managers understood that employees’ knowledge about costs didn’t stop at what they were 100% certain about. So they found a way to make use of this information, and ultimately to improve its quality.

This function’s staff note not just information they’re sure of, but two further levels of information: estimates and best guesses (see chart 1). This helps them have more meaningful dialogue in spite of all the unknowns. When this function’s employees talk to business partners about cost, instead of highlighting the information they lack, they can now say, “This is what I think the drivers are and here’s how I’m going to get more information.”

It also helps employees acknowledge what they don’t know and, as a result, then points them to the questions that still need answers. The key to making this approach work is to understand how to use each type of data. Chart 2 has the application guidelines the procurement team provided to employees.

Other teams can use this as a starting point to determine how the extra details, such as estimates, can offer useful information about costs.


How to investigate further

Chart 1: How to investigate further  Source: CEB analysis

= Cost data could be a single number or a range of numbers from benchmark, RFP, subject matter expert, etc.

 

How to use different types of data

Chart 2: How to use different types of data  Source: CEB analysis


A Better Cost Model

While incomplete information is helpful, accurate data is, of course, even better. Ideally, procurement teams should view “best guesses” and “estimates” as temporary; when they come across such gaps, they should seek out the information they don’t have.

The best way for teams to do this is to come up with a plan and then hold themselves accountable. For the cost drivers they’ve categorized as “estimates” or “best guesses,” look for ways to transition the incomplete data into facts: for instance, scheduling a supplier site visit, comparing data with past buys, or finding an internal subject matter expert.

Then, create a plan to improve the quality of the information. Write down the steps you’ll take, a proposed time scale, and contingency tactics if your initial ideas don’t work out. Target areas where you know you’ll be able to gain access to the information, and where Procurement has the ability to influence the cost driver.

Making use of imprecise data will pay off. The procurement team that came up with this method say it now identifies an estimated 90% of cost drivers per buy, compared with just 25% previously.

 

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