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How Category Management in Procurement Can Cut Total Cost of Ownership

October 27, 2016

 by Renaud Anjoran

Applying category management in procurement will force you to rethink your organization and will help you cut total cost of ownership.

But how to do this? Read on to discover the two major steps you need to take...

How is your purchasing department organized? Maybe you have a buying office in Shanghai for Chinese and East Asian suppliers, a buying office in Istanbul for Turkey and Eastern Europe, and some purchasers in your head office for nearby/domestic suppliers; and they may each be narrowly specialized on a type of product.

There may be a better way, so let's look at implementing category management...

How To Implement Category Management In Procurement In Your Business

As mentioned, there are 2 steps that need to be taken in order to adjust from local procurement, to a more global stance which lowers your company's total cost of ownership.

 

1. Organize around categories, not locations

category management in procurement

One way to negotiate better pricing is to consolidate the buying power (across brands, business units…) for a given type of production. In other words, fewer suppliers get a higher volume and are expected to give lower prices.

Notice that I write “production”, not “product”, because the same manufacturing unit might be able to make different products. That’s why buyers need to work on wider “categories” and understand the economics of their suppliers.

Let’s take an example. In the 1990s, Ikea reorganized their procurement department around categories:

The strategy was launched in a campaign with the slogan ‘Pump Up the Volume’. The initial objective was to increase the volumes purchased from the best suppliers and to benefit from reduced fixed costs. The organization was not used to industrial calculation principles and go help with a simple explanation: ‘If the supplier’s fixed costs are 30 per cent, a doubling of the the volume should give a 15 per cent price reduction.’

(Source: Strategy Sourcing and Category Management, by Magnus Carlsson, former purchasing development manager at Ikea.)

In addition, the procurement department is given more weight inside the company. They have a more central and more strategic role.

There might be cross-functional sourcing projects for each category. Designers and engineers might have to help in matching new product developments to the current suppliers’ capabilities, processes, and easy-to-find materials. Purchasers need to orchestrate these efforts.

 

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2. Look at the total cost of ownership

reduce total cost of ownership

Purchasers should take into account the price, but also other aspects of performance.

In the “classic” sourcing approach, many suppliers are pitted against each other in order to increase competition and negotiate low pricing. However, this single focus on price by purchasers has several drawbacks:

  • Generally poor relationship with suppliers;
  • Suppliers often “salt” bad products into batches after inspections to avoid having to rework those defective pieces;
  • Suppliers often change materials or the production process without telling the customer, and that might make entire batches unusable or even create the need for a recall;
  • Supply could be interrupted abruptly if the supplier finds a better customer.

All of these can add up to serious sources of cost for the buyer!

How to avoid these extra costs?

By working with fewer suppliers, and by avoiding the constant threat to switch to a slightly cheaper source.

Even better, by working together with key suppliers to reduce total cost together – for example by developing products and common standards together. The buyer-supplier relationship starts to resemble a partnership.

If your purchasers have no industrial experience, you might need to recruit new category managers. It is essential that your purchasing department be able to understand what makes factories “tick”, as well as what the main cost drivers are.

 

Tell Us About Your Thoughts On Category Management In Procurement

Have you tried to apply category management in procurement in your company? How did it go? What were the main obstacles?

Have you changed your relationships with your suppliers, and did you manage to reduce your total cost of ownership this way in spite of sometimes higher purchasing prices?

We’re interested in your experiences. You can write a comment below and we’ll be glad to respond!


 

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Topics: Procurement, Category Management, Total Cost Of Ownership

Renaud Anjoran

Renaud Anjoran

10 years experience in China.
President, China Manufacturing Consultants.
Audited and/or consulted for hundreds of factories in China.
Author of well-read blog, Quality Inspection Tips.

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