Cost Breakdowns – As Much About What’s Important As About Price

“As I hurtled through space, one thought kept crossing my mind – every part of this rocket was supplied by the lowest bidder.” John Glenn, NASA

Time was that the old-school view of procurement, as illustrated above, prevailed. Of course, since then, times have changed, and procurement has emerged after the Lopez era to prioritise quality alongside purchase price.

However, companies continue to hold purchase price as a primary driver in making decisions, with other factors remaining as things that need to be taken into consideration somewhere along the way.

Procurement organisations following this track are likely to find themselves under more and more pressure in the coming years without really understanding why. And it is because the concept of cost itself is changing – and nowhere is this clearer than in the cost breakdown.

Changing the Meaning of Cost

There are two things changing what cost means. First of all, procurement is expected more and more to act strategically. In addition to all the obvious costs on top of purchase price: installation, operating, maintenance, and disposal costs, procurement is expected to think several steps down the line, or at least should be.

As well as looking at short-term cost, it is important to have an idea of future prices, and therefore the behaviour of the cost drivers that might influence this. Not all purchasing is a simple transaction – suppliers need to be developed, strategies need to be formed.

In structuring cost breakdowns, procurement organisations have to ask two key questions – am I making the best economic decision today? Is my decision helping my company to gain a competitive advantage tomorrow?

Secondly, the development of information technology and increasingly globalised supply chains present a wide range of risks as well as opportunities. This all has an effect on what we mean by cost. Globalisation is opening supply chains up to new risk challenges: the unknown quantity of a new supplier from abroad, disruptions from natural disasters and political instability, differing local conditions like lead times, and growing awareness of lacking environmental and labor standards outside of the EU.

The same global media network that can feed vital information to procurement organisations also opens corporations up to risk: specifically brand damage when an environmental or labor scandal goes viral, with all the costs of revenue loss and re-call expense that come with it. Global brands like Apple and Adidas have recently become much more active on this front in China.

Coupled with incoming legal requirements in Europe, such as the UK Modern Slavery Act, procurement organisations have to factor much more into their cost breakdowns. It’s no wonder that people talk about procurement delivering value.

Procurement Value

This is a colossal amount of information to process. But procurement value is not some nebulous concept floating over all of this. It’s simply a matter of defining what is important for your company – what is going to produce value. Maybe it’s making productivity faster or better, maybe it’s reducing risk in quality or in logistics.

You can only identify this by working with your internal customers, for example, engineering and manufacturing, and working cross-departmentally. Procurement professionals will also need to be attuned to how values change across an organisation. For example, as public awareness of supply chain ethical scandals grows, procurement will be expected to value Corporate Social Responsibility as much as other departments.

Crucially, these values can define what gets prioritised in the cost breakdown and help you navigate the jungle of information out there.

This is also where technology can play a massive role. With an expanding market in procurement technology, especially in Software as a Service (SaaS) and big data analytics, there are great opportunities to bring together the data you need in one place, rent extra information from business intelligence suppliers who can turn qualitative information into figures, and understand it all in a way that makes sense to you.

As the nature of cost changes, procurement organisations need cost breakdowns that do justice to this. It follows that they need to select the right software to support new cost breakdowns.

One thing is for sure: the day of the Excel spreadsheet cost breakdown is over.

Charlotte Spencer-Smith works for POOL4TOOL, based in Vienna, Austria.