Cost driver analysis is fast emerging as a vital part of negotiation in procurement management. Most procurement professionals would agree that getting to the bottom of the issue by understanding what the key cost drivers are is the first step in ensuring value for money.
Product Vs Service
While it is easy to define the factors that drive the cost of a product such as: material used, components, overheads, labour and transportation, analysing the cost of a service is more complex as it involves a deeper understanding of the supplier's process. This can however be achieved by
- Mapping the supplier process – through a detailed breakdown of the process
- Allocating costs to each activity – with a combination of information from job boards and indicators of labour prices
- Considering the overheads – gleaned from annual reports
While it’s true that the information gathered is not fool-proof, it is however a handy estimate of productivity.
What hinders cost driver analysis?
The blind spot in effective cost driver analysis is most often a lack of cost visibility across buys. And the culprit isn’t just a lack of time. The solution lies in creating a supportive environment, with easy-to-use tools and consistent messages about the value of cost driver analysis. Supporting your staff with tools and direct coaching will help your procurement staff to
- Push towards more complete cost driver models
- Identify the right opportunities quickly
- Understand that cost driver analysis is how procurement does its job
- Connect incentives to desired behaviour change.
This will help Chief Procurement Officers increase cost visibility across more buys – resulting in higher cost saving opportunities.
The right approach
A supportive functional environment for cost driver analysis does not happen overnight. There are many roadblocks along the way, but here’s how you can pave the way for successful cost driver analysis:
Include low tier buys in cost analysis – Statistics reveal that 77% of procurement teams use an active approach for top tier buys, compared to just 25% for middle or low tier buys. An active approach to cost visibility for middle and low tier buys is the need of the hour.
Include cost analysis in day-to-day execution - Most incentives and rewards associated with day-to-day execution focus on savings, not understanding the drivers of cost. Add to this the fact that heads of procurement usually talk about the importance of cost driver analysis in terms of strategic direction — not day-to-day execution. Because of this, cost driver analysis often finds itself overshadowed and deemphasized. This needs to change with cost analysis woven into day-to-day execution.
Create the right climate - A supportive functional climate is the most important factor in a procurement team's willingness to actively investigate the drivers of cost.
Support with tools and direct coaching – Equip your staff with the confidence to identify the right opportunities quickly
Connect incentives and create a climate that encourages cost driver analysis – to increase your savings!