Positioning cost analysis at the heart of collective intelligence

Re-imagining procurement with digital solutions
2021-09-15

It’s summertime, inflation and slow growth continue to impact the economic situation in Europe. Business leaders are turning to their purchasing functions to cope with price increases and supply risks. This summer is not the summer of 2022 or 2023, it is the summer of 1974. Purchasing functions are about to become key for the performance of companies. This will accelerate in the future with the increasing internationalization of business activities and the lengthening of supply chains.

The years 1975-1980 saw the emergence of purchasing schools including EIPM with its Executive MBA. Purchasing processes became more structured and buyers’ skills were strengthened. At the heart of these approaches, buyers were increasingly using advanced cost analysis approaches. We talk about design to cost, target costing and value analysis. Over the years, cost analysis has become a key step in the procurement process and one of the key skills of buyers. In sectors where volumes are high, cost analysis became professionalized and sometimes they were handled by functions independent of procurement or R&D. These costing functions support “Make vs. Buy” decisions, supplier selection, and design activities. Companies have also increasingly automated cost analyses by using databases available on the market.

Today is the summer of 2022, the challenges look similar. With inflation and market volatility, purchasing organizations are on corporate deck and play a central role not only in weathering the storm but also in seizing the opportunities that arise. Understanding cost dynamics is at the heart of these emerging issues. But today it is not just one step in a process or one of many core competencies. It is a collective skill, at the heart of a company collective intelligence. More than ever, we need multi-functional teams capable of managing risks, costs, innovation and sustainable development issues in a systematic and integrated way. These teams must also be able to rely on decision-making tools and benefit from rich and reliable information on the markets.

We visualize this collective competence as an eight-sided diamond.

Side #1: A support for negotiation on the buying side but also on the selling side

Knowing the cost factors and the raw materials that have the greatest impact on costs is essential for negotiating with suppliers and also with customers. Good negotiations are a collective effort based on solid facts, which mobilize all commercial and sometimes technical functions.

Side #2: Optimising the total cost using scenarios

In an environment of uncertainty, total cost analysis should allow for the exploration of several solutions. Each solution can be defined as a scenario for optimizing investments, costs and gains over the long term. These scenarios can be discussed between functions and with the suppliers who have the necessary knowledge to implement these solutions. The challenge is not to calculate to defend a solution but to calculate and evaluate the feasibility of certain solutions over time. The result of a good full cost study is often a choice of solution in the short term but also avenues to explore for the future.

Side #3 Thinking of risks as costs

While there is a tendency to associate cost analysis with supplier selection, or with upstream and design activities that help implement a procurement strategy, cost analysis is also a formidable risk analysis tool. Defining a total cost means having a model that allows you to measure various risk impacts. If an event X occurs, what would be the costs incurred if we react quickly but also what are the costs incurred if we are slow to react? It is these types of dynamic measures of the “value at risk” that allow better detection and anticipation of risks.

Side #4: Measuring environmental impacts.

Analyzing costs involves breaking down materials, products or services into sub-assemblies or activities. This is a very good basis for evaluating the costs but also the environmental impacts of these materials, products, and services. This offers an opportunity to develop rich exchanges with suppliers and technical functions. If this is supported by digital tools that facilitate the analysis, it becomes a performance accelerator.

Side #5: Digitalizing cost analysis

Today, many data sources can be used to analyze costs, risks, environmental impacts, etc. Advanced analyses can be carried out using cost breakdowns and supplier locations. The digitalization of these analyses makes it possible to speed up costing activities, but it also offers multi-functional teams the possibility of quickly simulating the costs of new ideas.

Side #6: Innovation and value analysis

Understanding costs without understanding the added value of what you are buying is heresy. A good analysis should make it possible to associate costs with functionalities, with added value. Breaking down the costs will enable us to discuss serenely “What is it for?” “Do we really need it?” and “How much does this function cost? You need to ask the right questions in the right order and we need to have solid facts to decide together.

Side #7: Open collaboration with suppliers

Understanding costs without involving suppliers in a discussion is sometimes possible and useful. But open collaboration on critical and important purchases, where we look together at the options for improving performance more radically in terms of costs, risks, and environmental impact, is even better. This is not only about the quality of data but also the quality of the relationship and the shared values that can be developed.

Side #8: Market Watch

Knowing a market well means knowing the cost factors throughout a value chain, knowing the suppliers’ roadmaps, and being aware of new technologies that can change the situation. Being able to collect new ideas through market intelligence and quickly map the cost impacts of these ideas is one of the key collective skills of a company. But this requires anticipation, looking at new options well before the renewal of a contract becomes necessary. This is the role of a project or advanced project buyer.

In conclusion

So YES, cost analysis must be at the heart of inflation and risk issues for purchasing functions. Yes, we must continue to integrate it into our processes and know-how. But above all, it is an essential collective skill, a multi-faceted approach that must facilitate the exchange of ideas and exchanges within multi-functional teams, as well as exchanges with current or future suppliers.

By Bernard Gracia and Hervé Legenvre

 

EIPM