Companies can save up to 5% of their annual purchasing spend by focusing on key suppliers

Aug. 1, 2005
Shippers can generate more than $50 million in savings per billion of procurement spending and also significantly cut the cost of the procurement function

Shippers can generate more than $50 million in savings per billion of procurement spending and also significantly cut the cost of the procurement function by reducing the number of suppliers they work with and focusing more spending with key suppliers, according to a new study from The Hackett Group.

According to Hackett, world-class procurement organizations spend 27% less than typical companies on the procurement function and operate with 38% fewer staff. One key strategy world-class organizations use to accomplish this is complexity reduction, including reducing the overall number of suppliers and focusing spending on key suppliers. Hackett’s research found that over the past eight years typical companies have significantly cut the number of suppliers with which they work. But world-class procurement organizations still have less than half the number of suppliers/billion of spending than typical companies.

“Few companies still cling to the belief that working with a large pool of suppliers keeps cost down. The empirical evidence is unequivocally to the contrary,” says Chris Sawchuk, Hackett’s procurement practice leader. “Procurement executives across the board are waking up to the potential cost savings of simplifying their supply base and associated processes. But world-class organizations have gone further. They have not rested on their laurels after picking the ‘low-hanging fruit’ of cost savings gained from quick-hit supply base reductions in low impact spending. Rather, they continue to pull away from the pack by working with suppliers to ruthlessly eradicate complexity in processes, specifications, organization and technology that increase total costs.”

Since 1996, typical companies have reduced the number of suppliers they work with by 36%, according to Hackett’s research, from 12,199 suppliers/billion of spending to just 7,805. But today, world-class procurement organizations rely on just 3,408 suppliers/billion of spend, 55% fewer than typical companies.

Hackett’s research found a direct correlation between a decrease in the number of suppliers/billion of spending and decreased total procurement cost as a percentage of spending. Each reduction of 2,000 suppliers/billion of spending generates savings of more than 5% of overall procurement costs. For example, by reducing the number of suppliers from 20,000 to 10,000, companies can net more than 2.4 million in savings/billion of spending. Hackett found that even companies without excessive numbers of suppliers can generate significant savings through this approach.

But Hackett found that reducing the supplier base has much more significant implications than simply reducing the cost of procurement operations. When companies reduce the number of their suppliers, they are able to focus proportionately more of their resources on building stronger, more strategic relationships, with the resulting effect that they are able to simultaneously gain purchasing leverage and lower the cost of ongoing supplier monitoring and management.

According to Hackett, if 80% of a company’s annual spend is spread across 20% of its suppliers, every dollar spent on procurement translates into 2.1 dollars of spend reduction. For a typical company with $1 billion in spending, this translates into an annual spend reduction of $21.5 million derived from a $10.1 million investment in the procurement function.

While this return on investment is significant, Hackett found that it pales in comparison to the impact on companies that concentrate their annual spend across less than 2.5% of their suppliers. In this case, the ratio of spend reduction to procurement process costs is over 5 to 1. In other words, that same company could realize an annual spend reduction of $51.4 million, doubling the previous savings figure, and increasing the procurement function’s return on investment to over 500%.

Hackett found that world-class procurement organizations embrace techniques to reduce complexity beyond supplier relationships in many other areas of procurement. For example, 100% of all world-class procurement organizations use both a company-wide item master file and company-wide commodity coding.