Applying this calculation to a procurement process typically results in total transaction costs ranging from $3 to $90. That’s not a typo. You can have a 30-fold uplift in procurement transaction costs if you don’t structure your processes properly.

To help you evaluate your procurement processes, below is my view of the simplest possible procurement workflow:

The workflow steps 1 through 5 show PO-based purchases. Steps 7, 9 and 10 show employee reimbursements and steps 8,9 and 11 show corporate card purchases.

You’ll notice a few things about this workflow. Firstly, the limit for pre-approval (PO-based workflow) is $10K. This may seem high but if you limit the number of people who can claim employee reimbursements or who hold a company credit card and you drive home the importance of restraint and regularly re-educate those who fail to show restraint then you can have a pretty high limit here. This is not about trusting your employees but about respect for their capacity to act responsibly. Provide guidance and monitor, monitor, monitor.

Secondly, all expenses above $10K are going through a Requisition. In my view, this is only possible (or even desirable) if you have a fairly broad definition of a Requisition. There will be a lot of workflows in your company where systems other than your procurement system are used to instruct suppliers and validate the work they do for you. For example, you may use a logistics provider’s system to ship and track products. Don’t interpret the above workflow to mean that you should ditch that system and put these transactions through your procurement system. You may be better off continuing to use your logistics supplier’s system and use the transactional reporting from the system to validate a consolidated invoice. In this instance, the Requisition is really the placement of transactions in the supplier’s system. The Requisition and PO in the procurement process is only used effect payment – and that’s OK.

Thirdly, even if you follow this process, your transaction costs may be high. At each step in the process you need to ask yourself “How can I simplify this?” and “How can automate this once I’ve simplified it?” An example is the requisition approval step. This step can range from fully automated approval for transactions that fall within certain expected thresholds to a fully manual process where only Madge, an administrative assistant who has worked in your company for 30 years, knows who should approve a purchase – resulting in everything getting routed through Madge. Automate, and let Madge enjoy her retirement.

Lastly, don’t forget about the final step above: AP review. If your processes leading up to AP review are robust enough, you can largely automate the final step. If your earlier processes are not robust, you create a mountain of work for your AP staff.

By combining the Monte Carlo simulation spreadsheets along with a workflow diagram like the one above modified to show each of your procurement processes, you can comprehensively model your current procurement processes and costs and, when combined with a model of your to-be processes, create a compelling business case supporting change.

Tip #21 provided an overview of the company we are looking to prepare cost management reports for. To summarise, ABC Services

1. provide software and consulting in the facilities management sector
2. have one office in Sydney and another in Melbourne
3. the bulk of their revenue comes from the sale of asset management software but have an active consulting arm.

The significant improvement in headcount driven costs really drove the company’s performance last year.

Headcount reduction and revenue growth is possible for ABC Services because they are maturing as an organisation. Their consulting work is becoming more standardised and repeatable and well within the capabilities of more junior consultants and their software prospects are seeking them out which greatly shortens the sales cycle and reduces the effort required for lead generation.

Drilling down into resource costs, you can see that overall costs have decreased across the three types of staff in our company. Note that the lines below are negative numbers because they are tracking cost.

To understand what has led to the reduction in cost across the three types of staff, headcount is the next item to look at. The chart below shows that G&A staff numbers dropped slightly, but real change has occurred in sales and consulting staff numbers. Sales staff numbers have decreased whilst consulting staff numbers have increased. This means that fewer sales staff are generating greater sales volume (and greater commissions) and that the company’s senior (and expensive) consultants are being replaced by a larger numbers of junior consultants.

In an upcoming post, I’ll share the simple data structure that allows you to generate these types of reports from your standard financial data.

Effective management accounts are critical to a cost reduction initiative. Without it, your stakeholders can’t see that their pain is justified. It’s like the difference between running on a treadmill (without a watch or odometer) and running through the countryside.  If you have a destination and can track your progress, your motivation will be higher.

Good management accounts are different from good financial accounting in that management accounts in a cost reduction initiative are concerned with real money out the door right now whereas financial accounts are often reporting on expenditure decisions made years ago (depreciation).

I’ve prepared a sample data set that I’ll use for the upcoming series of posts. The management accounts are from the fictional company ABC Services who provide software and consulting in the facilities management sector. They have one office in Sydney and another in Melbourne and the bulk of their revenue comes from the sale of asset management software but have an active consulting arm. They kicked off a cost management initiative in November 2010. The management accounts tracks their expenses and revenue over the 12 months from July 2010 to June 2011.

ABC Services: Revenue and expenses

You can see from the orange line above that revenue has consistently increased throughout the year and from January 2011 their cost reduction program has made some headway. Now let’s take a look at the impact of this on their profit:

ABC Services

As you can see from the above chart, moderate to strong revenue growth combined with a high impact cost reduction initiative can create some stellar results.

In the next post, we’ll look at the data elements underlying the above charts and slice and dice the monthly data by location, division, expense type and headcount to see what areas of the company contributed most to this turnaround and which areas require further work.

Note that I’ll be changing the underlying data throughout the series of posts to highlight  the importance of certain elements of the data set so don’t look for consistency across these posts. I’ll do a wrap up post at the end.

In the 1970s and 80′s, skateboarding went through a renaissance. Difficult tricks became commonplace and impossible tricks became possible. The invention of polyurethane wheels in 1972 and the US drought in 1976 (which led to the draining of concrete pools) kicked off these advances but it was not until groups of skaters such as the Z-Boys began challenging each other to innovate that we saw an explosion of new tricks.

A good example is the Ollie. Within days of Alan Gelfand’s arrival in California in 1976, the Ollie became a standard part of every skateboarders repertoire. The Ollie is a trick performed off a vertical wall (such as a swimming pool wall) where the skateboard sticks to the rider’s feet as he or she flys above the lip of the wall.

Every half-decent skater can do the Ollie but it’s not until you’ve seen it that you even realize it can be done.

We’re at this same stage with enterprise software. New entrants into the enterprise software space are performing impossible feats. Some of these new tricks such as SAAS delivery require new technology but many tricks simply require you and your existing vendors to re-conceive your service requirements and their service offering. This can both improve your vendor’s capabilities and significantly reduce your costs.

Certain problems when you first look at them seem intractable. But once you understand their natural fracture lines, breaking them up and solving them is actually quite easy. Most business process problems fall into this category and cost reduction problems are no exception.

The natural fracture line for cost reduction opportunities are people and COGS. It’s easy to get lost in arguments about what is and what is not included in COGS so it’s best to simply think of COGS as costs that do not vary with the number of staff you have. In fact, I’ll call these non-People costs in this and subsequent posts. For example, desktop support costs are driven by People costs whilst marketing expenses are driven by non-People costs. Certain expenses can fall into both or either category such as data centre costs where your data centres support both your intranet and internet sites. For these, you can split them by percentage or just lump the entire expense into the biggest driver – People or non-People

Identifying your cost reduction opportunities then is just a matter of categorising each expense line in your management accounts as being driven by People or non-People. Tackle the former by considering how you can deliver the same value with fewer people and the latter by identifying the drivers of that cost and looking at ways of minimising it.

Sound simple. It is.

When looking at cost reduction opportunities in an area, you should start by assuming that you can remove 100% of the cost. If that’s not possible, then look at ways to remove 90% of the cost. If you don’t start ambitiously, you’ll miss some real plum cost reduction opportunities.

Internal IT hardware logistics are a good example. You may have staff engaged in building and deploying hardware on site. Instead of looking at how you can improve the process, first ask yourself: Why are we doing this at all? Why can’t we get our vendor to build the hardware and ship it straight to our user’s desks. If the user can’t plug it into the network themselves then give them a help desk number to call for assistance.

Speaking of help desks, the internet provides countless opportunities to reduce your cost of service by an order of magnitude. Multi-million dollar help desk ticketing systems from BMC Software and others can be largely replaced with SAAS (or ‘cloud’ in the newest lingo) providers such as Assistly. Now, before you start defending the functionality of Remedy (BMC’s product) sit back and imagine a world where Assistly was the only option: What changes would you need to make to your processes and people? How much would you save and what would your end users have to give up? My bet is that you could deliver an equivalent service to your end users (perhaps better?) and cut your costs by 90%.

Unless you dream big, and act on those dreams, you’ll never realise dramatic cost reductions.

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In the Eric Carle children’s story, The Mixed Up Chameleon, a chameleon attempts to become the perfect animal by adopting the best parts of different animals e.g. an elephant’s trunk, a giraffe’s long neck etc. At the end of the book, he’s so mixed up that he cannot catch flies for dinner.

As obvious as it is that an animal has evolved to work well only as a whole, when companies outsource their back office operations, they often try to keep favoured parts of their current operations. For example, they may outsource payments but keep their approval processes or outsource claims but keep their task management system. This inevitably increases costs and regularly leads to the failure of the entire outsourcing project.

Clients aren’t wholly to blame here. Often outsourcing vendors, to close a sale, will pander to the requests of their clients to create a mixed-up chameleon and not properly recommend that they implement the complete chameleon.

If you are going to outsource a function at the lowest cost with the least change management then you need to find a vendor with a process that you can adopt completely. Don’t select a vendor based on some other criteria (e.g. they are the market-leader)  and ask them to implement only parts of their process. If you cannot find a vendor whose process you can adopt completely then don’t outsource the function.

Today’s tip isn’t really a tip so much as a mini-case study.

Looking through Commbank’s annual report, I was struck first by the impressive 39% operating efficiency of their Retail Banking arm (typical financial services operating efficiency is around 45%) and second by the variability in operating efficiency across the business units in Commbank. Below is a table showing the operating efficiency of each of Commbank’s business units:

Operating efficiency for Commbank Business Units 2011 (AUD $M)

Graphically, the variability from the weighted average looks like this:

Percent operating efficiency difference from weighted average

Understanding exactly what drives these differences is important for every business.

For further information, please see the Commbank Annual Report. Below, for your convenience, I have extracted the business unit descriptions from the notes to the financial report.

(i) Retail Banking Services

Retail Banking Services includes both the origination of home loan, consumer finance and retail deposit products and the sales and servicing of all Retail bank customers. In addition, commission is received for the distribution of business and wealth management products through the retail distribution network.

(ii) Business and Private Banking

Business and Private Banking provides specialised banking services to relationship managed business and Agribusiness customers, private banking to high net worth individuals and margin lending and trading through CommSec. In addition, commission is received for the distribution of retail banking products through the Business and Private Banking network.

(iii) Institutional Banking and Markets

Institutional Banking and Markets services the Group’s major corporate, institutional and government clients, creating customised solutions based on specific needs, industry trends and market conditions. The Total Capital Solutions offering includes debt and equity capital raising, financial and commodities risk management and transactional banking capabilities. This segment also has wholesale banking operations in London, Malta, New York, New Zealand, Singapore, Hong Kong, Japan and has regulatory approval for a banking licence in Shanghai.

(iv) Wealth Management

Wealth Management includes the Global Asset Management (including operations in Asia), Platform Administration and Life and General Insurance businesses of the Australian operations.

(v) New Zealand

New Zealand includes the Banking, Funds Management and Insurance businesses operating in New Zealand (excluding the international business of Institutional Banking and Markets).

(vi) Bankwest

Bankwest is a full service bank active in all domestic market segments, with lending diversified between the business, rural, housing and personal markets, including a full range of deposit products. Bankwest also provides specialist services in international banking and project finance.

(vii) Other

The success rate of software implementations is woefully low. There are lots of reasons for it ranging from overselling by vendors, overspecing by customers, lack of consultation with stakeholders, under-resourcing the implementation team, etc. But in my view, much of the source of failure comes from unnecessarily bundling high risk process change with the software implementation.

For example, if you are implementing a new payment system that changes your approval hierarchy then look for a way to implement the new approval hierarchy before you implement the software. If you are implementing a new public transport ticketing system, change the fares before you implement the system.

If you can unbundle your high risk process changes from the software implementation then you’ll improve your software implementation success rate – at the very least you’ll discover you have an insurmountable change management program before you spend any money!

Over the past 12 years I’ve looked at the sourcing, procurement and payments processes in 150+ companies spanning every continent except Antarctica. At a detail level, the best of these companies took very different approaches to managing their suppliers – approaches tailored to the subtleties of their industry, geography and economic climate. But the best shared one common trait: Their supply chains were as simple as possible given the constraints of their operating environment. That’s not to say they weren’t sophisticated – often they were (in a surprising number of cases they were not) – but they were all simple.

Commonly, but not universally, the best companies regularly tendered categories that didn’t matter much. Commonly, but not universally, they would set up longer term relationships (with both parties incentivised to meet a common goal) in the categories that were critical to their ability to deliver value. In all categories, their sourcing, ordering and payment processes were as invisible as possible.

Many of the best companies did not even view their supply chains as strategic. In their drive to reduce costs, keep their operations as simple as possible and eliminate bureaucracy they just ended up with an efficient supply chain.