In our current business climate, leverage is what matters for sourcing savings

In our current business climate, leverage is what matters for sourcing savings

In an era of higher inflation and interest rates, the easy wins in sourcing are gone. Suppliers weigh current profits ahead of future volume growth. The typical sourcing plays no longer work. So the key to incremental savings is building and exerting leverage. We explain what this entails and the opportunity for prepared companies.

When capital is cheap, companies prioritize growth. Future profits are not discounted that severely as compared to current profits. The incentive is to grow- gain scale, gain market share. Suppliers discount as needed in pursuit of future profits. Moreover, the supplier landscape is rife with well-funded new entrants, eager for growth and content to depress industry price levels. In such a world, finding procurement savings can be easy. Procurement professionals and GPOs (Group Purchasing Organizations) emphasize volume and growth as the key levers to obtain discounts. Companies who relied on benchmarks could obtain modest discounts- a fair reward for relatively little effort. Quietly, however, true leverage remained the more potent lever, albeit harder to employ. Companies who invested in building and exerting leverage obtained superior pricing.

The world has changed.

The higher interest rates render the old playbook less effective. The straightforward tactic of obtaining volume discounting is no longer as potent as suppliers increasingly favor current margins relative to future profit growth. Old benchmarks no longer apply, given much higher input costs. So what is a company to do? Accept price increases? Push back on principle? Try to limit price increases as best they can, hoping their own price increases can maintain margins?

While the easy roads might be closed, the hard road– systematically building and exerting leverage– remains open. While suppliers have tightened up volume discounting, and while the competitive field may have thinned, they still value customer retention (also see Dave Kellogg’s 2023 prediction “retain is the new add”). Credible threats of churn still carry weight.

How to proceed

We find there are five major steps to the process of identifying/building/applying leverage:

  • Identify creative alternatives: This sounds simple yet we encounter a surprising degree of resistance in even the best run companies. Don’t close your mind and assume you have only one option. Could you use a lower functionality alternative & supplement it? Could you use an in-house solution with minor modifications?
  • Quantify the downside scenario– Most people overestimate the difficulty of switching & most vendors know this. Get granular and cost it out- and you might be surprised how low switching costs are. Don’t assume your internal team would have to handle everything- cost out 3rd party support.
  • Quantify the value created by each party. How are cost, risk, quality affected a given solution? What are the value drivers affected and to what extent? The best approach: build a driver-tree model for the main scenarios.
  • Consider the information asymmetries (what they know, what they don’t know– what would they likely suspect based on the evidence visible to them). Get specific: understand exactly what information the supplier’s Customer Success Rep sees about a customer. Understand exactly what pattern a supplier is likely to infer from the transaction data they have. Infer what a supplier believes their customer’s options to be.
  • Resist bluster: beyond just being cordial this requires demonstrating credibility and a sense of proportion. acknowledge what is true (builds credibility). Maintain sense of proportion (don’t overemphasize given factors unduly). Show you know what matters economically to you and to the other party and that you understand where ‘win win’ space exists. By adopting this tone one can move past adversarial zero-sum interactions and explore mutually beneficial arrangements- which is the real key when you want to continue doing business with key partners after the negotiation.

Not every contract merits a full-blown study and negotiation campaign. So companies should prioritize. As a practical first step, we suggest conducting a diagnostic: identify, given finite time and money, in which parts of the spend base would dedicated preparation yield the best return. Far better to focus deeply on a subset of areas where you have leverage than to apply a standard approach (and one whose effectiveness is waning) across the board.