1. Savings Strategy Development
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2. TABLE OF CONTENTS
Lesson
Lesson 1 - Executive View of Purchasing Savings & Savings Definitions
Lesson 2 - Avoidance Definitions & Outlining A Savings Strategy
Lesson 3 - Spend Categorization & Analysis
Lesson 4 - Quick Hit Opportunities
Lesson 5 - Supplier Relationship Opportunities
Lesson 6 - The 10 Phase Approach To World Class Sourcing (Part I)
Lesson 7 - The 10 Phase Approach To World Class Sourcing (Part II)
Lesson 8 - Reporting Savings & Continuous Improvement
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3. Lesson 1 - Executive View of Purchasing Savings & Savings Definitions
Saving money for our organizations is arguably the #1 reason that the
purchasing profession exists. Sure, we purchasing professionals do an
impeccable job of supporting our operations, ensuring that all business
transactions are ethical, protecting our organizations from undue risk, and so
forth. But it is our contribution to the bottom line through savings that justifies our
paycheck. An organization may not be able to measure a return on its investment
in human resources for many of its functions. The return on investment in the
purchasing function can be measured very easily – we can show that for the
money invested in our salaries and benefits, we save (hopefully, a larger amount
of) money that goes to our organizations’ profits. Because this type of visibility
can result in senior management’s expectations of strong performance, it is
critical to develop and execute a strategy that maximizes savings.
This course will take you step-by-step through the process of developing and
executing a savings strategy. This process is written so that you can apply it to
your company, irrespective of the industry. We will begin by discussing an
executive view of purchasing savings and will define savings in this lesson. In
the next several lessons, we will outline a savings strategy and explain each
component of that strategy.
Let’s begin by talking about savings from an executive perspective. For
executives like CEO’s and CFO’s, the most important result of their businesses’
operations is profit. Simplified, profit is the amount by which revenues (monetary
value coming into the company) exceed expenses and taxes (monetary value
leaving the company). CEO’s and CFO’s spend their energies trying to maximize
profit. Most CEO’s and CFO’s set an annual goal of earning more profit than the
organization earned in the previous year. There are two ways of increasing profit:
increasing revenues and/or decreasing expenses. As a fellow purchasing
professional, you know that we are relied upon primarily to decrease expenses.
In other words, we save money.
Many purchasing professionals think that because we save money, thus
supporting the goal of our executive management to increase profits, that we will
be recognized as valuable to the organization. This is not necessarily true. There
is an important job of communicating our value to executive management that
needs to follow our savings efforts. This communication must be done in a way
that is probably different than most of us are used to. CEO’s and CFO’s often
come from an accounting background. To communicate effectively to CEO’s and
CFO’s, you must speak their language – the language of accounting.
We’ll teach you a little portion of the accounting language. Allow us to introduce
you to an accounting document called an income statement. Income statements,
also called statements of operations, profit and loss statements, P&L’s, etc.,
essentially show you a monetary value for revenue or sales, monetary values for
different categories of expenses and taxes, and the difference between the two.
If this difference is a positive value, it is referred to as net income, or profit. If this
difference is a negative value, it is referred to as a net loss, or loss.
1

4. Income Statement Examples
We will now look at two examples of income statements. The first income
statement is for a service company – specifically, a natural gas and electric utility.
This income statement begins with listing revenues and then lists expenses and
taxes. Subtracting expenses and taxes from revenues will result in the net
income. As you review this income statement, keep in mind that if the revenues
were higher without a change to the expenses, the net income would be higher.
Likewise, if the expenses were lower without a change to the revenues, net
income would be higher.
Revenues
10,558,000,000
Electric fuel and energy purchases, net
1,369,000,000
Purchased electric capacity
680,000,000
Purchased gas, net
1,822,000,000
Liquids, pipeline capacity, and other purchases
219,000,000
Restructuring and other acquisition-related costs
105,000,000
Other operations and maintenance
2,938,000,000
Depreciation, depletion, and amortization
1,245,000,000
Other taxes
395,000,000
Interest expense
899,000,000
Subsidiary preferred dividends and distributions of
subsidiary trusts
98,000,000
Income taxes
370,000,000
Net income
418,000,000
2

5. Now we’ll look at an income statement for a manufacturing company –
specifically, a food manufacturer. Manufacturing income statements are similar to
service income statements, however, manufacturing income statements usually
calculate gross profit. Gross profit is simply the difference between the price at
which you sell a product and the cost you incurred in buying or making the
product. In retail, gross profit is the price paid by the customer minus the price
paid by the store for the item purchased. In manufacturing, gross profit is the
price paid by the customer minus the cost incurred by the manufacturer. This
cost can include not only materials incorporated into the final product but also the
internal and outsourced labor involved in converting the raw materials into a
finished product. Thus, net income is gross profit less indirect expenses and
taxes. When reviewing this income statement, think about how changes to sales,
cost of products sold, and expenses can affect the amount of net income – "the
bottom line."
Sales
9,431,000,000
Cost of products sold
6,093,827,000
Gross profit
3,337,173,000
Selling, general and administrative expenses
1,746,702,000
Interest expense
294,269,000
Other expense, net
45,057,000
Income taxes
444,701,000
Net Income
806,444,000
3

6. Income Statement Line Item Explanation
If you have begun asking yourself "what does all of this bean counting have to do
with purchasing?” wonder no more. As we have mentioned earlier, the
purchasing function reduces expenses through the savings that we generate.
Because financial statements are so near and dear to the hearts of our executive
management, it is important to know what part of the income statement is
affected by our savings. We will refer to the manufacturer’s income statement to
illustrate where purchasing impact is felt. Specifically, we will look at each of
these line items: sales; cost of products sold; selling, general, and administrative
expenses; interest expense; other expense, net; and income taxes.
Sales: While purchasing can help sales figures by ensuring that supplier
performance gives our company products or services that meet the
marketplace’s cost, delivery, quality, and service demands, it is difficult to
quantify the real impact that purchasing has on sales. Therefore, for the
purposes of this discussion, we will say that purchasing does not affect this line
item on the income statement.
Cost of products sold: Because this line item includes the costs of materials and
outsourced services involved in producing a finished product, purchasing
definitely impacts this line item. However, because this line item includes costs
associated with internal labor, purchasing may not be able to have 100% control
over the amount of the cost of products.
Selling, general, and administrative expenses: This line item includes expenses
not considered to be directly allocated to producing the products to be sold. It
includes a variety of types of expenses: from office supplies to utilities; from
salaries to facility lease payments; and from employee benefits to advertising.
Therefore, it is easy to see that purchasing can impact a portion of this expense,
but not all of it.
Interest expense: This line item covers all expenses related to interest incurred
by a company. A company may be financing its purchases of facilities or vehicles
or may have taken out loans for operating capital. Interest incurred on those
financing activities is captured in this line item. Purchasing generally does not get
involved in financing transactions, so we will consider this expense outside of the
scope of the purchasing function.
Other expense, net: This line item captures all expenses that Generally Accepted
Accounting Principles deem unallocable into the foregoing categories. Because
the expenses captured in this category are commonly unusual expenses and
relatively small compared to the expenses in the aforementioned categories, we
will consider them to be outside of Purchasing’s control.
Income taxes: Unless someone can show me an example of how purchasing
negotiated favorable treatment from the government, this category will be
outside of Purchasing’s control also.
4

7. Purchasing Impact Exercise
Now that we have examined those areas where Purchasing’s impact can be felt,
it is time to engage in an exercise to demonstrate how our impact affects an
income statement. We’ll see how much better purchasing performance improves
profits. And, remember, improving profits is commonly the #1 goal of CEO’s and
CFO’s.
Before beginning this exercise, we must clearly state our assumptions. Here they
are:
•
•
•
•
•
Sales will remain constant
We’ll consider Purchasing to have the capability of impacting 50% of cost
of products sold. The other half will be considered to be comprised of
costs associated with internal labor.
We’ll consider Purchasing to have the capability of impacting 50% of
selling, general, and administrative expenses. The other half will be
considered to be comprised of costs associated with salaries, benefits,
and the like.
We’ll consider Purchasing to have no impact on interest expense or other
expense
The income tax rate (approximately 35.5%) will stay the same. Thus, if net
income before taxes increases as a result of decreased expenses, the
amount of taxes paid will increase.
Given these assumptions, Purchasing has control over $3,920,264,500 in
expenditures. This next exercise will enable you to see the impact on net income
when purchasing saves money on the company’s purchases. Simply enter a
percentage of savings that the purchasing department can achieve on the total
value of expenditures under its control. Then, click on the See Impact button and
watch as several of the dollar values in the income statement change. Pay
particular attention to the Net income line. Try several different percentages. This
exercise clearly demonstrates the fact that when Purchasing saves money, profit
increases. When profit increases, our executive management achieves its goal.
5

8. NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY
Sales
9431000000
Cost of products sold Gross profit -Selling, general, and administrative
expenses Interest expense 294269000 Other expense, net 45057000
-Income taxes -Net income Enter percent:
%
Use this exercise to gain a clear understanding of where Purchasing’s impact
can be found on financial statements. When communicating the money that
Purchasing has saved the company, specify the place on the income statement
affected by Purchasing’s performance. Always indicate exactly how net income
would have been lower if it weren’t for good purchasing. Remember, CEO’s and
CFO’s are often accountants – by using financial statements to communicate
Purchasing’s performance, you will be "speaking their language." It is always a
good communication technique to position your thoughts in a framework that is
embraced by the listener.
Savings Definitions
OK, so now what is meant by "savings?" Unfortunately, there are no standards in
the purchasing profession to dictate exactly what qualifies as savings and what
does not. As a result, some purchasing departments have very rigid qualifications
for savings while others consider many questionable methods to be valid savings
definitions. Because this course is geared towards developing a savings strategy
that is embraced by executive management, we will provide recommendations
for defining your savings in a manner that CFOs and CEOs will generally
consider valid.
6

9. In this section of the lesson, we will cover different savings types. Information
about each savings type will be broken down into four sections:
1.
2.
3.
4.
A definition of the savings type
The formula for calculating savings
An example scenario to which the savings type would apply
A calculation of the savings in the example scenario
All formulas are algebraic in nature. They calculate a result by performing
mathematical operations on variables. Variables are simply values in the formula
that change depending on the situation. For example, a formula may be cost =
price x quantity. Price and quantity are variables – they will change depending on
the situation. All formulas in this section use acronyms as the variables. Each
formula will then be followed by the word "Where" and a description of what each
variable represents. Therefore, you determine what the proper value of the
variable is and then plug that value into the formula.
For some savings types, the fourth section will be replaced by an exercise. In the
exercise, you will be asked to enter values for some of the variables. When you
click on the "Calculate" button, the total savings will be calculated and the correct
answer will appear on the screen directly below the values you entered. This will
allow you to check your understanding of how the savings types are calculated.
Alright. Let’s discuss some savings types…
Year-Over-Year Savings: Your company pays a lower price this year for a
product or service than it has paid in the past for the identical product or
service. Year-Over-Year Savings can be achieved using the same supplier as
before or a different supplier.
Year-Over-Year Savings = (OP – NP) x QP
Where,
OP = Old price
NP = New price
QP = Quantity purchased
For example, if you purchased 10,000 ten-packs of Imation CD-R’s for $0.50
each this year and spent $0.60 on the same disks last year, your Year-Over-Year
Savings would be calculated as follows:
Year-Over-Year Savings = ($0.60 – $0.50) x 10,000 = $1,000
7

10. Payment Term Savings: Your company receives more favorable payment terms
for products or services purchased this year than it has received in the past for
the identical products or services or from the same supplier. Note that when your
company must pay earlier to receive a discount, your company's cost of money
must be factored into the calculation.
Payment Term Savings = {(ND – OD) – [(ON – NN) x (CM/365)]} x SP
Where, ND = New discount where percentages are written as numbers
with two decimal places (e.g., 2% = 0.02)
OD = Old discount where percentages are written as numbers with
two decimal places (e.g., 2% = 0.02)
ON = Old number of days in which payment is due
NN = New number of days in which payment is due
CM = Annual cost of money (i.e., the interest or other return earned
by your company through investing idle cash). This value can be
best estimated by your Finance department.
SP = Spend on the products and/or services to which the new
discount applies
For example, if you spend $10,000 with a supplier who has changed your
payment terms from Net 30 to 2%/10, Net 30 and your annual cost of money is
6%, your Payment Term Savings would be calculated as follows:
Payment Term Savings = {(0.02 – 0.00) – [(30 – 10) x (0.06/365)]} x $10,000 =
$167.12
Substitution Savings: Your company pays a lower price this year for a new
product or service than it has paid in the past for an old product or service that
served the same purpose. Note: If there is a degradation or improvement in
quality as a result of the substitution, you must adjust the savings such that it
reflects any costs or avoided costs as a result of the change in quality.
Substitution Savings = (OP – NP) x QP
Where,
OP = Price for old product or service
NP = Price for new product or service
QP = Quantity of new product or service purchased
Now, you can calculate Substitution Savings through an exercise. In this
scenario, you used to buy for 20 cents each stainless steel nuts and bolts to be
8

11. used in the manufacture of a product and you have determined that aluminum
nuts and bolts can be bought for 10 cents without degrading quality. You will buy
10,000 nuts and bolts and wish to calculate your Substitution Savings. Enter
values for OP, NP, and QP on the "Your Answer" line, then click on the Calculate
button. Your answer will be calculated and you'll get to compare your answer to
the correct answer.
NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY
Substitution Savings = (OP
- NP)
x QP
Your Answer =
($
-$
)
x
=$
Correct Answer =
($
-$
)
x
=$
Alternate Condition Savings: Your company pays a lower price for an alternate
condition or non-new version (used, repaired, remanufactured, etc.) of a product
than it has paid in the past for a brand new version of the same product. If the life
cycle of the alternate condition product is shorter than the life cycle of the new
version of the product, you must account for the increase in the quantity that you
will purchase.
Alternate Condition Savings = (NP x NQ) - (AP x AQ)
Where,
NP = Price paid for the product in new condition
NQ = Quantity purchased of the product in new condition
AP = Price of the product in alternate condition
AQ = Quantity to be purchased of the product in alternate condition
For example, let’s suppose you bought 100 new toner cartridges at $20.00
each to satisfy your needs for one year. The next year, you decided to buy
remanufactured toner cartridges for $10 each however, because the
remanufactured toner cartridges did not last as long, you needed to purchase
150 of them. Your Alternate Condition Savings would be calculated as follows:
Alternate Condition Savings = ($20 x 100) – ($10 x 150) = $500
Note: When labor costs are significant in the replacement of end-of-life parts
(e.g., a union mechanic replacing an aircraft component), the replacement labor
costs should be included in your calculation of Alternate Condition Savings.
9

12. Fee Waiver Savings: Your company is not charged certain incidental fees that
were paid in the past. Commonly waived fees include shipping, set up, and other
charges that are in addition to the direct cost of the product or service.
Fee Waiver Savings = AF x NT
Where,
AF = Amount of fee
NT = Number of times fee is waived
For example, you have previously paid an average of $5 in shipping charges per
shipment from a supplier who ships 1,000 boxes per year to you. If the supplier
waives shipping charges, your Fee Waiver Savings will be calculated as follows:
Fee Waiver Savings = $5 x 1,000 = $5,000
Specification Change Savings: Your company has changed its specification for a
product or service such that you will pay a lower price than you have in the past
for the product or service. Note: If the idea of modifying the specifications
originated in another department and that other department is responsible for
reporting cost savings, the purchasing department should not attempt to take
credit for the savings.
Specification Change Savings = (OS – NS) x QP
Where,
OS = Price based on old specifications
NS = Price based on new specifications
QP = Quantity purchased
Now, you can calculate Specification Change Savings through an exercise. In
this scenario, you paid $10,000 per month for janitorial services that included
twice-per-week vacuuming, once-per-day trash removal, and twice-per-month
window washing. You now want to change the specification to include window
washing only once per month thereby reducing your price to $9,000 per month.
You wish to calculate your Specification Change Savings over a 12 month
period. Enter values for OS, NS, and QP on the "Your Answer" line, then click on
the Calculate button. Your answer will be calculated and you'll get to compare
your answer to the correct answer.
10

13. NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY
Spec. Change Savings =
(OS
Your Answer =
($
Correct Answer =
($
- NS)
x QP
-$
)
x
=$
-$
)
x
=$
Resource Reduction Savings: Your company has made a purchase that will
eliminate the need for certain employees, facilities, or other resources.
Resource Reduction Savings = (DO – DN) + (AR - AC)
Where,
DO = Annualized direct costs of using the old resources (salaries,
benefits, rent, utilities, etc.)
DN = Annualized direct costs of a new process to replace the old
resources
AR = Additional revenue generated as a part of the change
AC = Additional costs associated with eliminating the resources
For example, your company operates a print shop in a facility that the company
owns. This print shop is responsible for printing your company’s brochures.
Salaries and benefits for the print shop employees cost your company
$350,000 per year. Utilities, materials, supplies, and other overhead cost an
additional $150,000 per year. By purchasing its brochures from an outside
vendor, your company can have the same brochures printed for $400,000 per
year. By outsourcing its printing, the company will lay off all print shop
employees, who will be paid $35,000 in severance pay. The company will also
sell its printing facility and equipment for $300,000. The Resource Reduction
Savings will be calculated as follows:
Resource Reduction Savings = ($500,000 – $400,000) + ($300,000 - $35,000) =
$365,000
These savings categories are the types of savings most recognized by executive
managers as being valid. All savings are based on the premise of paying less
than you paid before. Well, what if you didn’t buy the product or service before?
Can you still produce financial benefit for your company? Yes! Financial benefits
that your actions produce for products or services not previously purchased are
called "avoidances." We’ll talk about avoidances in the next lesson.
I hope that you’ve enjoyed your first lesson. As you will at the end of each lesson,
you now must take the quiz. Click on the Quiz button below to begin. If you have
11

14. any questions, please click on the Ask Charles! button below to ask a question
and get a response from your instructor by email within 24 hours.
12

15. Lesson 1 Quiz
NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK
1. Which of the following income statement line items does Purchasing most
commonly affect?
a.) sales
b.) taxes
c.) net income
d.) none of the above
2. Buying an item at a lower price than was paid in the previous year is an
example of:
a.) year-over-year savings
b.) payment term savings
c.) an avoidance
d.) all of the above
3. Substituting a purchased item for a previously purchased, more expensive
item:
a.) is not a legitimate way of achieving cost savings
b.) is a legitimate way of achieving cost savings
c.) is an example of an avoidance
d.) must be approved by Engineering to be considered a savings
4. If Purchasing is depended upon to generate savings:
a.) negotiation cannot be used
b.) payment terms should not be a factor in looking for cost saving opportunities
c.) avoidances should be the focus
d.) it can be beneficial to work with other departments to improve specifications
5. Resource Reduction Savings can be realized when a company:
a.) makes a make-or-buy decision
b.) negotiates later due dates on its payments
c.) continues to purchase a product in the same manner at the same price
d.) all of the above
13

16. Lesson 2 - Avoidance Definitions & Outlining A Savings Strategy
All of the savings types that we discussed in Lesson 1 are based on the premise
of paying less than you paid before. Well, what if you didn’t buy the product or
service before? Can you still produce financial benefit for your company? Yes!
Financial benefits that your actions produce for products or services not
previously purchased are called "avoidances." But beware…avoidances are not
always recognized as legitimate by executive management. Remember, CFOs
and CEOs are often accountants and if you cannot show them where your
impact is recorded when comparing this year’s income statement to last year’s
income statement, they may discount your claims. However, some avoidances
clearly result in a better financial picture for your company. We’ll cover five
common avoidance types. For each of these types, we’ll discuss common
executive manager’s perception of that type.
Negotiated Price Avoidance: Your company is seeking to purchase a product or
service that it has not purchased in the past. You solicit proposals from suppliers
and determine the price offered by the low bidder. After negotiating with one or
more suppliers, you agree to purchase the goods or services at a price that is
lower than the original low bid. This is the only type of avoidance that is almost
universally accepted as legitimate. The Negotiated Price Avoidance is calculated
as follows:
Negotiated Price Avoidance = (LB – PP) x QP
Where,
LB = Lowest bid
PP = Price paid
QP = Quantity purchased
For example, if you purchased 1,000 cases of copy paper for $2.50 each and the
original low bid was $3.00 each, your Negotiated Price Avoidance would be
calculated as follows:
Negotiated Price Avoidance = ($3.00 – $2.50) x 1,000 = $500
Be sure to note that the lowest among the original bids is the price used for
comparison purposes, no matter which supplier was selected. In other words,
you do not compare the final price to the selected supplier’s original bid if the
selected supplier did not provide the lowest price in the initial round of bids – you
use the lowest of those initial bids as your comparison price.
Request Change Avoidance: A requisitioner submits a request to purchase a
product or service and the purchasing department persuades the requisitioner to
acquire an alternate product or service that is more cost effective. This type of
avoidance is not always accepted. Executive managers may feel that the
14

17. requisitioner should be capable of identifying the proper product or service. The
Request Change Avoidance is calculated as follows:
Request Change Avoidance = VO - VM
Where,
VO = Value of original request
VM = Value of modified request
For example, the Human Resources department requests that 500 procedure
manuals be printed and bound in three-ring binders at a cost of $15 each ($7,500
total). The purchasing department persuades HR to have the manuals spiral
bound at a cost of $12 each ($6,000 total). The Request Change Avoidance
would be calculated as follows:
Request Change Avoidance = $7,500 – $6,000 = $1,500
Forgone Purchase Avoidance: A requisitioner submits a request to purchase a
product or service and the purchasing department persuades the requisitioner to
reduce its quantity or not make the purchase at all. This type of avoidance is not
always accepted. Senior managers may feel that the requisitioner should be
capable of identifying the proper quantity of product or service. The Forgone
Purchase Avoidance is calculated as follows:
Forgone Purchase Avoidance = VO - VM
Where,
VO = Value of original request
VM = Value of modified request
For example, a requisitioner requests that a mini-van be rented for business
travel on August 20 for the one-day rate of $90. The purchasing department has
previously rented a mini-van for another department who needed the mini-van
from August 14 to August 18. Because the one-week rental fee of $420 was less
than the aggregate cost of five individual days, the purchasing department rented
the mini-van through August 20. The purchasing department then arranges for
the requisitioner to use the mini-van already in the company’s possession, thus
avoiding the second rental and its fee. The Forgone Purchase Avoidance would
be calculated as follows:
Forgone Purchase Avoidance = $90 – $0 = $90
15

18. Inventory Reduction Avoidance: You determine that inventory levels are too high
and decide to reduce the quantity of certain items that are kept in stock without
substantially increasing the number of times that you order the items. There are
many costs associated with inventory: the cost of money that could have been
invested rather than spent on inventory, the costs associated with storage,
insurance costs, and so forth. These costs are collectively called "carrying costs."
Many companies estimate their annual carrying costs to be 20% to 30% of the
value of items in inventory. Your Finance department may have an estimate of
the carrying cost percentage that your company uses. This type of avoidance is
not always accepted. Senior managers may feel that a small reduction of its total
inventory does not necessarily eliminate many of the costs that comprise the
carrying costs – they cannot lay off any employees, divest any facilities, etc. It is
difficult to prove exactly where a small Inventory Reduction Avoidance would
impact the income statement. The Inventory Reduction Avoidance, which is
expressed as an annualized value, is calculated as follows:
Inventory Reduction Avoidance = (OQ – NQ) x CP x CC
Where,
OQ = Old average quantity of certain item kept in inventory
NQ = New average quantity of certain item kept in inventory
CP = Current price of certain item
CC = Annual carrying cost percentage expressed as a number
with two decimal places (e.g., 25% = 0.25)
Now, you can calculate Inventory Reduction Avoidance through an exercise. In
this scenario, you purchase motor oil for your fleet of company vehicles for $2
per bottle. You have kept an average of 2,000 bottles of oil in stock in the past,
have annual carrying costs of 25%, and now decide to reduce your average
stock levels to 500 without placing substantially more orders. You wish to
calculate your Inventory Reduction Avoidance. Enter values for OQ, NQ, CP,
and CC on the "Your Answer" line, then click on the Calculate button. Your
answer will be calculated and you'll get to compare your answer to the correct
answer.
NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY
Inv. Red.
Avoidce.=
(OQ
- NQ)
Your Answer =
(
-
x CP
)
16
x$
x CC
x
=$

19. Correct Answer =
(
-
)
x$
x
=$
Note that if you must place more orders for items in order to reduce the inventory
levels, you should deduct the costs associated with placing more orders, known
as "acquisition costs," from your avoidance.
Process Improvement Avoidance: Purchasing professionals are becoming more
and more involved in process improvement assignments. Process improvements
can generally be defined as changes made in an effort to reduce the time, effort,
complexity, human involvement, or cost associated with a certain activity. In
many instances, time, effort, complexity, and human involvement can be
measured in dollars. Therefore, any reduction in any of these elements will result
in a reduction in cost. Unlike the other types of savings and avoidances, the
Process Improvement Avoidance is commonly recorded over a period of years.
Because it is costly, in terms of time, technology, and human resources, to
analyze and improve a process, it may take years of reduced costs to recoup the
money spent on improving the process. The act of recouping money spent on
process improvements is referred to as achieving return on investment. This type
of avoidance is not always accepted. Senior managers may feel that unless a
process improvement results directly in layoffs, facility divestitures, etc., no costs
are necessarily eliminated. The Process Improvement Avoidance is calculated as
follows:
Process Improvement Avoidance = CO - (CM + CI)
Where,
CO = Cost of original process, prorated over a certain time span
CM = Cost of modified process, prorated over a certain time span
CI = Costs associated with implementing the process improvement
For example, your company has just instituted a supplier certification program. In
this program, suppliers who have had no defects in their shipments over the past
two years will no longer have to have their shipments inspected by your
company’s receiving personnel. The parts will go directly into stock. The first
supplier who qualifies for this program ships 20,000 individually packaged parts
to your company per year. This supplier’s shipments account for 5% of the total
shipments that you receive each year. Because inspection work will not be
required for this supplier’s shipments, your inspectors’ workload will decrease by
5% per year. The aggregate compensation packages of your inspectors totals
$300,000 per year. Theoretically, the annual cost of the modified process would
be $285,000 – this accounts for a 5% reduction in work. Your time spent in
implementing this program equated to $10,000 in cost. Management is only
interested in the first year of avoidance. Therefore, your Process Improvement
Avoidance would be calculated as follows:
17

20. Process Improvement Avoidance = $300,000 – ($285,000 + $10,000) = $5,000
If management wanted to know the avoidance over a three-year period, your
Process Improvement Avoidance would be calculated as follows:
Process Improvement Avoidance = $900,000 – ($855,000 + $10,000) = $35,000
Avoidances To Avoid
As previously mentioned, other than the Negotiated Price Avoidance, the concept
of avoidances is often not embraced by senior managers. Even the types of
avoidances described in this lesson are often subjective and difficult to prove.
However, there are avoidances that are downright despised by senior managers.
Here’s one:
You purchase $100,000 worth of office products per year and your demand is
relatively constant. Your office supply vendor approaches you and indicates that
your prices will be raised by 10% across the board. Thus, you can expect your
spend for office products to increase to $110,000. After negotiating with your
vendor, you are able to persuade them to increase your prices by only 8%
rather than 10%. Thus, your spend will be $108,000. Many purchasing
professionals will report a $2,000 avoidance. This is not a valid avoidance! What
really occurred in the minds of the accountants is that you have incurred an
$8,000 price increase. We generally advise you to never report a reduced
increase as an avoidance except in cases where you are primarily responsible
for managing volatile commodities and the entire market is experiencing even
greater inflation as measured by a valid third-party index. It will undermine the
integrity of your savings capabilities in the eyes of your senior management.
These situations will occur. If you only report your savings and avoidances, you
may be challenged and accused of ignoring certain categories where you incur
price increases. To have a fully defendable cost savings and avoidance program,
it is advisable to record your cost increases as well. Reporting your net savings
(savings + avoidances – increases) would be the ideal situation. However, this
approach does take a lot of resources and would require you to be familiar with
pricing for virtually every line item you buy. Therefore, if you at least record your
savings and avoidances, you will be off to an excellent start.
7 Components of a Good Savings Strategy
At this point, you have a good understanding of how executives view purchasing
savings. Now, we will review the outline for a good savings strategy. Here are the
seven components of a good savings strategy:
1. Spend Analysis
2. Target Setting
3. Quick Hit Opportunities Execution
18

21. 4. Supplier Relationship Opportunities Execution
5. Strategic Sourcing Opportunities Execution
6. Savings Documentation and Reporting
7. Continuous Improvement
More detailed descriptions of each of these components are forthcoming in this
course, so we don’t expect you to know what each component means at this
time.
A Microsoft Excel file
(http://www.NextLevelPurchasing.com/classes/ssdhandout.xls) accompanies
this course in the Downloads section above the Lessons Menu. This file
contains spreadsheets of purchasing data. In order to use an example that
most of us can relate to, we are using sample data from a fictitious fast food
restaurant chain. The Excel file contains several tabs located at the bottom left
of your window. Each tab is numbered. Therefore, when we ask you to
reference Worksheet x (where "x" is a number), simply click on the tab bearing
that number to access the example.
After completing this course and before beginning the implementation of your
own savings strategy, you create a spreadsheet similar to Worksheet 0 to map
out your savings strategy. We’ll call this spreadsheet your "Savings Strategy
Outline." Here are explanations of what should be entered in the various columns
in the Savings Strategy Outline and when such data should be entered.
Target Commencement Dates: These dates represent the dates by which you
expect to begin work on the corresponding component of the savings strategy.
These dates should be entered into the spreadsheet as soon as you have
decided to implement a savings strategy.
Actual Commencement Dates: These dates represent the dates on which you
actually started work on the corresponding component of the savings strategy.
These dates should be entered into the spreadsheet as soon as you start
working on the corresponding component of the savings strategy.
Target Completion Dates: These dates represent the dates by which you
expect to finish work on the corresponding component of the savings strategy.
These dates should be entered into the spreadsheet as soon as you have
decided to implement a savings strategy.
Actual Completion Dates: These dates represent the dates on which you actually
finished work on the corresponding component of the savings strategy. These
dates should be entered into the spreadsheet as soon as you finish working on
the corresponding component of the savings strategy.
Target Annual Savings: These values represent the amount of money you
estimate saving for each of the opportunity classifications. These values should
be filled in immediately after you have completed your spend analysis but
19

22. before acting on any of the opportunities.
Actual Annual Savings: These values represent the amount of money you expect
to save or have saved after executing the corresponding opportunity
classification. These values should be filled in immediately after signing any
contracts for goods and/or services in the corresponding opportunity
classification. These values should be updated frequently and finalized at the end
of the accounting year to document actual savings.
In the next lesson, we will begin going over each of the seven components of a
good savings strategy.
20

23. Lesson 2 Quiz
NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK
1. Which of the following is true?
a.) An avoidance is realized when you have achieved a cost reduction on a
product or service that you did not purchase in the past
b.) Avoidances are generally not as easily accepted as savings by executive
management
c.) A lesser than originally proposed price increase should not be mistaken for an
avoidance
d.) All of the above
2. A reduction in inventory:
a.) is obviously a savings, not an avoidance
b.) is not associated with a reduction in carrying costs
c.) can result in the avoidance of carrying costs expressed as a percentage of the
value of the inventory
d.) all of the above
3. Process Improvement Avoidances have a higher probability of being
recognized as legitimate if:
a.) layoffs are avoided
b.) staffing is reduced and facilities are divested
c.) facilities are added
d.) carrying costs are calculated
4. If a supplier proposes a 12% price increase but, after negotiation, concedes to
a 5% increase, you should consider this scenario:
a.) a savings
b.) an avoidance
c.) a price increase
d.) breaking even
5. What should you do immediately before implementing a savings strategy?
a.) develop a Savings Strategy Outline
b.) set target completion dates for each component of the strategy
c.) set target dollar values for savings
d.) all of the above
21

24. Lesson 3 - Spend Categorization & Analysis
During this lesson, you will be given instructions on how to manipulate
spreadsheets containing your company’s purchasing data. However, we
recommend trying these exercises using the sample spreadsheets first so that
you can compare the results of the exercises that you complete with our versions
of the same exercises before you manipulate your own data.
While many students taking this class have already taken Microsoft Excel For
Purchasing Professionals and, therefore, will know how to apply the Excel
techniques used in this class, we have made instructions available for certain
Excel techniques that will be required to manipulate the spreadsheets. Where we
give instructions on what to do in Excel, we will follow those instructions with the
underlined word "(How?)". To open a pop-up box with specific instructions,
simply click on "(How?)". This pop-up box will provide the commands that you will
need to execute on the sample spreadsheets to complete the exercise.
Before beginning work on the spreadsheet, we recommend that you save the
Excel file under a second file name. This will enable you to always have the
original copy just in case you make changes and wish to save your changes
while also preserving the original data.
What Do You Buy?
The first component of a good savings strategy is spend analysis - assessing
exactly what you buy. You probably have some type of computerized records of
either purchases or payments for purchases. Perhaps these records exist in your
purchasing system or your accounts payable system. You need to extract these
records of your purchases into a format that will enable you to analyze them.
Unless your organization has invested in one of the feature-rich spend analysis
tools on the market, Microsoft Excel is perhaps the most user-friendly tool
available when it comes to analyzing data.
For the purpose of this class, we’ll assume that Excel will be your software of
choice for spend analysis.
Unless you already have access to a data warehouse, you must request that
your IT department extract your purchasing records from your purchasing or A/P
system into Excel. This extraction is simply called a "data dump." It would be
optimal if your data dump contained at least one year of purchasing transactions.
We recommend that this year be the financial reporting year of your company.
The most compelling way to illustrate Purchasing’s value to CFOs and CEOs
(who are often accountants), is to examine two year’s financial statements and
show exactly how Purchasing made improvements from one year to the next.
However, some versions of Excel limit the number of records in a spreadsheet to
approximately 65,000. Therefore, it may be necessary for you to accept less than
a year’s worth of data. If you must accept less than a year’s worth of data, select
22

25. the month or months that would represent the most typical months from a
purchasing pattern perspective. If your business is cyclical (consistently less or
more busy at certain times of the year), you should select months that are neither
at the peak nor at the trough of your business cycle.
Here are guidelines that you can provide to your IT department when requesting
your data dump:
One year’s worth of purchasing transactions exported into a Microsoft Excel
spreadsheet. The fields that should be included are:
•
•
•
•
•
•
•
•
•
Date of transaction
Part number (if used)
Description of product or service purchased
Unit of measure
Supplier
Category or Commodity (if available)
Quantity purchased
Unit price
Extended price (quantity x price)
Other fields are acceptable. You may use this spreadsheet for other analyses, so
having things like PO number, receiving information, and other data will not hurt.
Open up the Excel file that accompanies this class
(http://www.NextLevelPurchasing.com/classes/ssdhandout.xls). Click on
Worksheet 1. This is an example of a data dump for our fictitious fast food
restaurant.
When we have advised certain individuals to consult their IT department for
purchasing data, we have met resistance: "We can’t ask I.T. to do THAT!"
Believe it or not, extracting information from your system’s database into an
Excel spreadsheet is not that difficult. You will not be asking IT to do any
customization of your system, create new reports, or anything complex and time
consuming. All you need is the data in a spreadsheet where you will do the
analysis. Most of the techniques taught in this course are dependent upon having
this information, so you cannot develop your savings strategy unless you follow
this step. Don’t be shy!
23

26. Categorizing Purchases
Some purchasing systems require that a commodity or category code be
assigned to each purchase order or line item. If your data does not have a
commodity or category code (we’ll call either of these "categories") associated
with each transaction, this section will teach you strategies for categorizing the
transactions in your data dump. If your data does have categories associated
with each transaction, you will avoid having to do a lot of work. However, this
section will still have value to you because you may want to restructure your
categories so that they optimally support the development of your savings
strategy.
Categorizing purchases is a daunting task. How do you look at everything you
buy, determine a limited number of relevant categories, and then associate all of
your purchases with one of these categories? One strategy is to avoid
reinventing the wheel by using a categorization system that already exists. One
of the categorization systems that has rapidly gained popularity since the late
nineties is the United Nations Standard Products and Services Code –
affectionately called the UNSPSC. The UNSPSC is a hierarchical classification of
products and services with several levels of classifications. The top level (called
a Segment) is associated with a broad category of products or services and each
succeeding level is associated with more specific categories. There are over 50
Segments in the UNSPSC. A product or service can be classified at any level,
therefore, the UNSPSC offers over 15,000 total unique categories. Each level
has a description and a number. Here is an example of finding a category four
levels deep within the hierarchy:
10 - Live Plant and Animal Material and Accessories and Supplies
10 – Live Animals
15 – Livestock
01 – Cats
Therefore, cats would have a UNSPSC code of 10101501.
24

27. The UNSPSC
To access the entire UNSPSC hierarchy after you have completed this lesson,
you can visit this website which was available at the time this class was last
revised: http://www.unspsc.org/search.asp. For now, you can review just the
Segment values below to get ideas for how your categories can be structured:
10000000
11000000
12000000
13000000
14000000
15000000
20000000
21000000
22000000
23000000
24000000
25000000
26000000
27000000
Live Plant and Animal Material and Accessories and
Supplies
Mineral and Textile and Inedible Plant and Animal
Materials
Chemicals including Bio Chemicals and Gas Materials
Resin and Rosin and Rubber and Foam and Film and
Elastomeric Materials
Paper Materials and Products
Fuels and Fuel Additives and Lubricants and Anti
corrosive Materials
Mining Machinery and Accessories
Farming and Fishing and Forestry and Wildlife
Machinery and Accessories
Building and Construction Machinery and Accessories
Industrial Manufacturing and Processing Machinery and
Accessories
Material Handling and Conditioning and Storage
Machinery and their Accessories and Supplies
Commercial and Military and Private Vehicles and their
Accessories and Components
Power Generation and Distribution Machinery and
Accessories
Tools and General Machinery
31000000
Structures and Building and Construction and
Manufacturing Components and Supplies
Manufacturing Components and Supplies
32000000
Electronic Components and Supplies
39000000
Lighting and Electrical Accessories and Supplies
30000000
25

28. 40000000
41000000
42000000
43000000
44000000
45000000
Distribution and Conditioning Systems and Equipment
and Components
Laboratory and Measuring and Observing and Testing
Equipment
Medical Equipment and Accessories and Supplies
Communications and Computer Equipment and
Peripherals and Components and Supplies
Office Equipment and Accessories and Supplies
Printing and Photographic and Audio and Visual
Equipment and Supplies
47000000
Defense and Law Enforcement and Security and Safety
Equipment and Supplies
Cleaning Equipment and Supplies
48000000
Service Industry Machinery and Equipment and Supplies
46000000
50000000
Musical Instruments and Recreational Equipment and
Supplies and Accessories
Food Beverage and Tobacco Products
51000000
Drugs and Pharmaceutical Products
49000000
53000000
Domestic Appliances and Supplies and Consumer
Electronic Products
Apparel and Luggage and Personal Care Products
54000000
Timepieces and Jewelry and Gemstone Products
55000000
Published Products
56000000
Furniture and Furnishings
52000000
71000000
Farming and Fishing and Forestry and Wildlife
Contracting Services
Mining and Oil and Gas Services
72000000
Building and Construction and Maintenance Services
73000000
Industrial Production and Manufacturing Services
76000000
Industrial Cleaning Services
77000000
Environmental Services
70000000
26

29. 78000000
Transportation and Storage and Mail Services
80000000
81000000
Management and Business Professionals and
Administrative Services
Research and Science Based Services
82000000
Editorial and Design and Graphic and Fine Art Services
82100000
Advertising
83000000
Public Utilities and Public Sector Related Services
84000000
Financial and Insurance Services
85000000
Healthcare Services
86000000
Education and Training Services
90000000
91000000
Travel and Food and Lodging and Entertainment
Services
Personal and Domestic Services
93000000
National Defense and Public Order and Security and
Safety Services
Politics and Civic Affairs Services
94000000
Organizations and Clubs
92000000
Creating Your Own Categorization Scheme
The UNSPSC has become popular because many buyers and sellers engaging
in eCommerce related transactions have been using it to classify their
transactions. The UNSPSC essentially allows both the seller and the buyer to
have the same classification system thus making integration of their technologies
easier. As more and more companies adopt eProcurement, eMarketplaces, and
other technological tools, the UNSPSC will continue to become a preferred, or
perhaps even standard, categorization methodology that enables buyers and
sellers to transact business electronically with less customization.
Despite the eCommerce advantages of the UNSPSC, it also has disadvantages.
Like anything that is intended to be "all things to all people," it may be perfect for
no one. Your particular situation may require more flexibility than the UNSPSC
provides. We recommend adopting the categorization methodology that is perfect
for your situation. If that categorization methodology is the UNSPSC, fine. If not,
you can create your own.
When creating your own categorization scheme, we obviously recommend that
27

30. you gear it to your needs from a purchasing perspective. Create your categories
such that suppliers that offer similar products or services are in the same
category. We call this "Think RFP Categorization." In other words, think of all
items that could be grouped into a single Request For Proposal and be awarded
to a single supplier. When developing your categories based on Think RFP
Categorization, you do have to find the right balance between being too specific
and not being specific enough.
For example, if your company buys computers and computer components, you
may think that you need a category for hard drives and a separate category for
CD-RW drives. You may be thinking that you could group all of your
requirements for various hard drives into a single RFP and award the contract to
a single bidder. You may think the same about your requirements for CD-RW
drives and prepare a second RFP. However, you may find that most computer
peripheral distributors sell both hard drives and CD-RW drives. As such, you
could do an RFP that included both hard drives and CD-RW drives and award
the contract to a single bidder. Therefore, it would make more sense to have a
more general category such as "Computer Components" that included hard
drives, CD-RW drives, modems, and other componentry that is available from the
same group of suppliers.
The opposite situation can also be true – your categories may be too general. A
great example is office supplies. Look around your desk right now. Almost
anything you see could be considered by someone to be an "office supply." But it
does not always make sense to buy all of these things from a single source. For
example, copier paper can often be purchased up to 20% less expensively from
a paper distributor compared to an office supply vendor. Therefore, it may make
sense to have a category for copier paper that is separate from the office
supplies category because you would want to do separate RFPs and/or have
separate contracts.
If you are having difficulty determining which categories to select, a short
analysis exercise can help. After you have received your data dump with noncategorized transactions, create a PivotTable so that your supplier names are
in each row with the total amount that you spent with each supplier appears to
the right of each supplier name. (How?) Next, sort the PivotTable so that it is in
descending order with the supplier with the most spend on top and the supplier
with the least spend on the bottom. (How?) You can practice creating this
PivotTable by using Worksheet 1 in the Sample Excel File
(http://www.NextLevelPurchasing.com/classes/ssdhandout.xls). Worksheet 2
shows you a sorted PivotTable. By counting from the supplier with the most
spend downward, determine the suppliers who comprise 80% of your spend.
We’ll call these suppliers the "80% Supplier Group." Worksheet 3 shows you
the same PivotTable with calculations used to determine the suppliers that
comprise the 80% Supplier Group. Those suppliers who are in the 80%
Supplier Group are highlighted.
Now that you have identified the suppliers who comprise 80% of your spend,
determine the category of products or services they provide. You can use the
28

31. UNSPSC or you can make up categories on your own.
Go back to your data dump. Sort your spreadsheet by supplier name so that all
transactions for a given supplier are grouped together. (How?) Create a new
column in your spreadsheet and label it "Category." One-by-one, find each of the
suppliers in the 80% Supplier Group and enter the category that you identified for
that supplier. Some suppliers may provide more than one category, so pay
attention to the descriptions and assign categories that apply to the descriptions.
Assigning categories by description should take precedence over assigning
categories by supplier. Even though you most likely have most of your categories
identified by this point, you probably have not categorized the majority of your
transactions. Go through your remaining transactions and assign a category. Is
this tedious work? Yes. Will it be worth it? Yes! Only when your purchases are
categorized will you be able to effectively identify savings targets.
Once you have all of your transactions categorized, create a new PivotTable so
that your categories are in each row with the total amount that you spent in each
category in the period covered by the spreadsheet appears to the right of each
category. Next, sort the PivotTable so that it is in descending order with the
category with the most spend on top and the category with the least spend on the
bottom. This sorted PivotTable is called your "Spend Profile." Worksheet 4
contains the Spend Profile for our fictitious fast food restaurant. If you have
obtained less than a year’s worth of data in your data dump, prorate the data you
have so that your Spend Profile approximates one year of purchases.
Forecasting
Now just because you purchased a certain volume of products and services in
those categories you have identified in the past year does not mean that you will
purchase the same volume in the next year. You may never purchase those
products or services again. You may purchase twice as many products or
services. So while a Spend Profile is an excellent foundation for your savings
strategy, it must be complemented with a forecast. To fail to complement your
Spend Profile when developing a savings strategy would be like driving while
looking in the rear view mirror thinking that the road ahead of you will be exactly
like the road behind you. Translated to a purchasing situation, if an electronic
pager manufacturer expects to enter the cell phone business in the coming
year, they will purchase more miniature microphones than they had the previous
year. The purchasing manager who used only the Spend Profile as a source for
planning information, would be ill prepared to save money on microphone
purchases.
There are a variety of ways that companies do their forecasting. Some
purchasing departments are intimately involved in the forecast. Other purchasing
departments don’t even know that other departments are working together on a
forecast. To properly develop your savings strategy, you must have access to
forecasting information. How you access forecasting information will depend on
your particular company. Find out who in your company has possession of a
29

32. forecast of activity. This could be Finance, who carefully plans cash flow. It could
be Production, who has to arrange for an appropriate amount of capacity. It could
be Marketing, who is in touch with your company’s client and prospect bases in
an effort to estimate sales. Someone in your organization probably has some
type of forecast that will enable you to compare projected performance with past
performance. This forecast will ensure that any estimated deviations from the
Spend Profile are properly prepared for as you implement your savings strategy.
If you cannot determine where a formal forecast can be found, at least sit down
with your company’s key end users to see how their demand for products and
services may differ in the coming year.
With a Spend Profile and forecast complete, you now know what you will buy
in the coming year. You can now develop a strategy for saving money on
those products and services you will buy.
You have already seen that the information in your data dump is powerful. With
your knowledge of Excel, you can conduct high impact analysis using your data
dump. Using PivotTables, we found out how much we spend with certain
suppliers and on certain categories of products and services. The next section
will allow you to get more powerful information from your data dump.
Baselining
The simplest explanation of savings is that we pay a lower price in the present
than we paid in the past. Therefore, it is mandatory that we know the price that
we paid in the past. You cannot calculate savings without first having a "baseline"
– a measurement of performance prior to implementing an improvement. While
there is no standardization in the purchasing profession for properly determining
a baseline, we recommend using the average price for a product or service in the
previous accounting year. Again, because we want to demonstrate our value to
CFOs and CEOs who are often accountants, it is important that we report our
savings in a structure that they will embrace.
Using our data dump, we can determine average prices in three steps in Excel:
sorting, filtering, and subtotaling.
First, sort your data dump by category then description or part number (part
number is preferable). (How?) Worksheet 5 shows our data dump sorted by
category then description. Next, we will filter our data so that we will see
only those products or services in a particular category.
Right now, your screen will show all of your transactions. We are going to isolate
those transactions in a particular category. Make sure that one cell containing
data in your spreadsheet is selected.
If using Excel 2003 or earlier:
Click on Data to open the Data Menu. Click on Filter to display the Filter
submenu. Click on AutoFilter. Notice that the cells containing your column
30

33. headers now have drop down arrows on their right sides. Click on the drop
down arrow in the Category column header. A list containing, among other
things, each value in that column appears. By clicking on one of the
values, your spreadsheet will show only those records whose category
matches the value you selected. This is called filtering. Worksheet 6
shows our data dump filtered such that only records in the Paper Cups
Category are shown.
End of Excel 2003-specific material
If using Excel 2007:
Click on the Sort & Filter button in the Editing group within the Home tab to
display a menu. Select Filter from the menu. Notice that the cells
containing your column headers now have drop down arrows on their right
sides. Click on the drop down arrow in the Category column header. A list
containing, among other things, each value in that column appears. By unchecking the box next to (Select All) and checking the box for one of the
values, your spreadsheet will show only those records whose category
matches the value you selected. This is called filtering. Worksheet 6
shows our data dump filtered such that only records in the Paper Cups
Category are shown.
End of Excel 2007-specific material
Now that you have isolated a category of products or services, you can get
average prices for each product or service in that category. Simply set your
spreadsheet to subtotal your records such that for each change in description or
part number the average function is used to add a subtotal to the unit price.
(How?)Your spreadsheet will then show you the average price for each product
or service that you purchased in the selected category. These average prices will
be your baselines. Worksheet 7 is an example of our baselines.
Here’s where you have to be careful, though. Notice that you bought the same
quantity of 16 ounce cups with each purchase. But that is not true for the 12 and
20 ounce cups.
Could this affect your average price baseline? Yes, it could because a “true”
average price is calculated by dividing total cost by total quantity. Let’s see how.
The following formula will give a true average price paid for every single cup
bought by dividing total cost by total quantity. Type it into Cell I40 of Worksheet
7:
=((F37*G37)+(F38*G38)+(F39*G39))/(F37+F38+F39)
You see a different average price, huh? It’s a good lesson to always carefully
scrutinize your data – you could have presented a higher baseline (making it
31

34. easier to show savings) which, if challenged by management, could have
embarrassed you.
Figure out the appropriate formula to apply to the 20 ounce cups as well and
enter it into Cell I48 to see the true average price.
When you have executed your savings strategy and lowered your prices, you will
compare your new prices against these old prices then multiply by the quantity
purchased in the new year to calculate your savings.
After completing all of this analysis, it is now time to prioritize your savings
opportunities. We will break our opportunities into three categories: Quick Hit
Opportunities, Supplier Relationship Opportunities, and Strategic Sourcing
Opportunities. We’ll talk about each briefly now and in more detail in the next few
lessons.
Quick Hit Opportunities, also called "Easy Wins" and "Low Hanging Fruit" by
consultants, are categories of purchases where savings can be achieved easily
and rapidly. Supplier Relationship Opportunities are categories of purchases
where changing suppliers is not a viable option for realizing savings. Strategic
Sourcing Opportunities are categories of purchases that are critical and
challenging. Selecting and/or changing suppliers for these opportunities must be
done carefully through a diligent process.
Setting Targets
The second component of a good savings strategy is setting targets or goals.
Working towards a goal is simply smart business. How will you know if you are
doing a good job unless you have a goal against which to compare your
performance? Targets and goals are motivators as well as indicators. You will
set goals immediately after analyzing your spend (but not until after this class
because you have much to learn).
To set goals, you will identify which categories you will address as Quick Hit
Opportunities, which categories you will address as Supplier Relationship
Opportunities, and which categories you will address as Strategic Sourcing
Opportunities. Then, you will estimate a percentage of spend that you expect to
save through each of the three opportunity classifications. Multiplying this
percentage by the aggregate spend in each opportunity classification will give
you your target savings that you will enter on your Savings Strategy Outline. At
this point, you are unfamiliar with each of the opportunity classifications, so you
will not enter any targets until you are familiar with these. The important part is
that you set targets before taking action and executing any of the opportunity
classifications.
32

35. Lesson 3 Quiz
NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK
1. Which of the following is the best way to access purchasing transaction data if
your organization has not invested in a spend analysis software package?
a.) use your system's standard reports
b.) dump purchasing data into an Excel spreadsheet
c.) ask each of your suppliers to provide reports
d.) begin searching for data warehousing services
2. "Think RFP" categorization:
a.) is more universal than the UNSPSC
b.) does not help to group similar suppliers into a single category
c.) is not flexible towards your organization's needs
d.) can facilitate a savings strategy better than a standard classification scheme
3. A spend profile:
a.) shows you how much you spend in each category of goods and services
b.) shows you how much you spend on each purchase
c.) shows you how much you spend over budget
d.) all of the above
4. A baseline:
a.) is a measurement of performance prior to improvements
b.) should not be used to judge improvements
c.) is applicable to America's favorite pastime, but not the purchasing profession
d.) is a snapshot of performance after improvements have been made
5. Targets:
a.) are vastly different than goals
b.) motivate high achievement
c.) A & B
d.) none of the above
33

36. Lesson 4 - Quick Hit Opportunities
The third component of a good savings strategy is Quick Hit Opportunity
Execution. Quick Hit Opportunities should always be addressed first - before
Supplier Relationship Opportunities and Strategic Sourcing Opportunities.
Achieving savings through Quick Hit Opportunities delivers rapid results for
management and inspires confidence in your savings strategy right at the
beginning of your sourcing initiative. Management, purchasing staff, and
stakeholders will see that your strategy really works and will be supportive of it.
Support is critical because the other two categories of savings opportunities are
more challenging and require more collaboration and buy-in throughout the
organization.
After completing your Quick Hit Opportunities, there is no rule on whether to
address Strategic Sourcing Opportunities or Supplier Relationship Opportunities
next. You should assess your organization’s situation, culture, available
resources, etc. to determine which of these two categories you will address
next.
So, let’s find our Quick Hit Opportunities. Take a look at your Spend Profile. You
will have several categories of purchases sorted in descending order from most
spend to least spend. To identify your Quick Hit Opportunities, you must consider
both the impact and the effort for each category.
Impact
First, let’s talk about impact. When evaluating a category, you must consider the
impact of reducing prices for goods and services in each category. High impact
categories are those categories for which the most potential savings exist. Low
impact categories are those categories for which the least potential savings exist.
We want to concentrate on those categories that are high impact. Here are some
ways of determining whether a category is high impact:
•
The spending in the category is high. A rule of thumb is that any category
whose total spend is 50% or more than the spend in the highest spend
category in your Spend Profile is a high impact category.
•
Prices in the category have not been historically challenged. For various
reasons, some categories of our purchases have not gotten very much
attention paid to them. You can be sure that suppliers providing these
categories have not gone out of their way to give us the best deal. There
are probably ample opportunities for savings in these categories.
•
Profit margins are high in the market. There are various ways of
34

37. determining the margins for the products and services that you buy.
Business publications, the Internet, and suppliers’ annual reports are all
sources of information about margins in certain categories. If you find that
a particular category has large margins, chances are that you will be able
to wrestle a price decrease – there is plenty of room for the supplier to
move.
Effort
Let’s now talk about the second criterion in identifying Quick Hit Opportunities:
effort. When evaluating a category, you must consider the level of effort involved
to reduce prices for goods and services in each category. High effort categories
are those categories where changes to suppliers, purchasing methods, etc.
would involve a great deal of preparation time and/or involvement of others. Low
effort categories are those categories where changes to suppliers, purchasing
methods, etc. would involve little preparation time and/or involvement of others.
We want to concentrate on those categories that are low effort. Here are some
ways of determining whether a category is low effort:
•
•
•
There is little differentiation in the marketplace. Most suppliers provide
similar delivery, service, and quality.
Customized or detailed specifications are not required. A simple
specification, description, or part number is all you need to ensure that
suppliers understand your product or service needs.
There are few line items involved.
After you have assessed the impact and effort for each category, add two
columns to your Spend Profile. One column will have the heading "Impact" and
the other will have the heading "Effort." For each category, assign an Impact of
either "High" or "Low" and assign an Effort of either "High" or "Low". When you
are done assigning impacts and efforts, evaluate each category in terms of
where it fits in this Quick Hit Opportunity Matrix.
Our Quick Hit Opportunities target those categories that are high impact and low
35

38. effort. In other words, Quick Hit Opportunities are those categories for which we
can achieve significant savings relatively quickly and easily. Before finalizing your
list of categories that qualify as Quick Hit Opportunities, review your forecast.
Find any categories that were purchased during the period for which the Spend
Profile was created but will not be purchased in the immediate future. Eliminate
these categories from your Quick Hit Opportunities. Worksheet 8 shows our
Spend Profile modified to make use of the quick hit criteria. Those categories that
meet these criteria are highlighted.
Quick Hit Groundwork
At this point, you have your Quick Hit Opportunities identified. You are ready to
take action and begin realizing savings for your organization. Here is a little
groundwork that you should do internally to communicate your targets and nail
down your requirements:
Advise management of your targets. Sometimes management can be secretive
about its plans for the organization. Be sure not to attempt to achieve savings
on something that will be phased out as a result of a forthcoming strategic
decision by management. Advising management of your targets will give them
the opportunity to inform you of any conflicts with their plans.
Collaborate with stakeholders. Ensure that any stakeholders, particularly end
users, are involved as early as possible and as often as they would like to be.
Create an atmosphere that screams "we are going to deliver benefit to our
organization together." Make them feel as if they will get credit for something
good. A well involved stakeholder can help you succeed. An ignored stakeholder
would celebrate if you failed and may even try to facilitate your failure. Even
though you will be creating a spirit of collaboration, clearly establish, preferably in
writing, the goals of the savings strategy and the roles of each stakeholder.
Consider standardization. Standardization is a concept all to itself and will be
discussed later in this course. For quick hits, identify any variations of a certain
product or service that could be consolidated into one single specification. This
type of consolidation could increase your requirements for a certain product or
service, thus giving you more buying power, which usually results in lower prices.
Acquire current specifications. Make sure that the products or services that
you are buying meet the current, as well as future, needs of the organization.
Determine quantity, delivery, service, and quality needs. In your collaboration
with stakeholders, determine the amount of products or services in the quick hit
categories that you will buy over the next one to three years. Determine a
schedule or desired lead time for the products or services. Document any service
requirements you would have from suppliers of quick hit products or services.
Formalize any requirements you may have for passing incoming inspection,
warranty, and other quality issues. When you have all of this information, you will
be able to determine the suppliers who are capable of meeting your needs, not
just offering lower prices.
36

39. Develop baselines. As previously described, determine your current average
price for the quick hit products and/or services. Once you do this, you will be able
to determine the amount that you’ve saved by seeking cost reductions for these
products and/or services.
Now it’s time to take action that results in savings. The tried and true way to
achieve savings is to utilize competitive bidding, also referred to as sourcing.
Simplified, competitive bidding involves asking several suppliers for their best
price and terms with the intention of awarding a contract to the qualified supplier
who offers the best overall deal. Suppliers naturally want to offer better pricing
than their competitors in an effort to earn the business, so the buying
organization can often achieve significant savings. Because most of us are
familiar with competitive bidding and sourcing is covered in detail later in this
course, we will focus this section on how to make competitive bidding effective
and efficient (i.e., fast) when acting upon Quick Hit Opportunities.
Key To Effective & Efficient Sourcing
The key to effective and efficient sourcing is to identify and avoid bottlenecks
while maximizing competitive leverage. We’ll take a look at three bottlenecks that
can be avoided with proper strategy.
One bottleneck that we have seen organizations run into over and over is
qualifying the low bidder. This bottleneck arises when organizations blindly
send out requests for proposal to suppliers who reply with bids. The low bidder
ends up being a supplier who is unfamiliar to the buying organization. The
buying organization then scrambles to determine whether the low bidder is
qualified: visiting the supplier’s site, checking references, reviewing financial
statements, etc. It becomes difficult to determine if the low bidder is qualified
and it is also difficult rejecting the low bid. This process can take an
unbelievable amount of time.
To avoid this bottleneck, supplier pre-qualification is necessary. You should
determine which criteria a supplier needs to meet in order to be considered
"qualified" to do business with you. Supplier pre-qualification should be done
before a request for proposal is sent to bidders. Only qualified bidders should be
given the opportunity to bid on your requirements. This process will force the
sellers to sell in order to be considered for the opportunity to bid. It is their job to
communicate the advantages of doing business with them. The buyer should
not have to work so hard to figure out those advantages.
A couple of additional notes on supplier pre-qualification…
This is another great opportunity to involve your stakeholders. Determining your
supplier selection criteria up front can make the selection process smoother once
proposals are received. Waiting until proposals are received to determine
selection criteria can result in heated debates among stakeholders, which of
course can slow down a quick hit.
37

40. You may find that when you start working on pre-qualification criteria, common
elements are found. Pre-qualification criteria such as positive references, solid
financial statements, and good historical performance may be found in prequalification rituals for a variety of categories. When you find these common
elements, it can be easy to document a standard pre-qualification procedure that
is embraced by present and future stakeholders.
Another bottleneck that we have seen is late contract introduction. This
bottleneck arises when an organization puts a requirement out to bid. After
proposals are received and discussions have taken place with one or more of the
preferred suppliers, either the supplier or the buyer gives the other party a
contract to review. Several weeks usually pass before the attorney for the
receiving party completes his or her review. When the review is complete, the
attorney recommends changes that the other party’s attorney must review, then
that attorney recommends additional changes, and the revisions go back and
forth for months. This process is unacceptable for Quick Hit Opportunities.
To avoid this problem, develop a contract template with the assistance of your
legal department. A contract template will have all of your company’s standard
terms and conditions in it and will leave room for variables such as price, lead
time, warranty, and specifications. When preparing an RFP, simply enter all of
the variables that apply to your purchase and include the contract template in
your RFP. Make sure that the instructions in your RFP communicate that bids
must be made based on the requirements outlined in your RFP including all
contract terms and conditions. The bidders should treat your contract as they
treat your specifications – your terms and conditions are requirements not to be
deviated from. This practice commonly results in fewer exceptions to your
language and a lot less time spent involving attorneys.
Internet Reverse Auctions
A final bottleneck is price negotiation. Price negotiation is another process that
can add months to competitive bidding. After receiving initial proposals,
purchasing professionals are often not convinced that they have suppliers’ best
offers on the table. So we persuade bidders to lower their prices. Now, there is
nothing necessarily wrong with this approach. Negotiation is a core competency
of purchasing professionals and those who are good at negotiation save their
companies millions of dollars. But remember the concept of Quick Hit
Opportunities – we want to achieve significant savings relatively quickly and
easily.
For achieving savings in a short amount of time, Internet reverse auctions can be
extremely effective. Most of us are familiar with a "traditional" auction - where
one individual, group, or selling organization has a product or service to sell and
a host of buyers compete with each other to buy that product or service. The
competitive forces at work ensure that the seller gets the highest price in the
market for the offered product or service. A reverse auction is where one buying
organization has a requirement to buy a product or service and a host of sellers
compete for the opportunity to sell that product or service to the buying
38

41. organization. The competitive forces at work ensure that the buyer gets the
lowest price in the market for the required product or service. An Internet reverse
auction is a reverse auction that is conducted live, in real time, over the Internet,
thereby permitting sellers in different locations to simultaneously attempt to
outbid each other. Internet reverse auctions have generated billions of dollars in
savings and have become embraced by modern purchasing professionals across
many industries.
When submitting a sealed bid, suppliers usually don’t offer their best price
possible. They usually don’t feel the pressure to do so. Why should they
minimize their profit margin when the probability exists that they can make more
money? Then, when their pricing is challenged by purchasing professionals, they
employ a variety of techniques to delay or prevent them from giving the best
price possible. So not only is traditional negotiation slow, it may not get to the
true lowest price.
In an Internet reverse auction, the suppliers see the pricing submitted by their
competitors, even though the identity of competitors is kept secret. Suppliers can
resubmit bids continually throughout the auction until the time that the auction
ends. This process puts maximum pressure on the suppliers to get to their true
lowest price quickly. When used in conjunction with pre-qualifying suppliers and
positioning your contract template as a requirement, you can generate great
savings and conclude the competitive bidding process quickly. Internet reverse
auctions overcome the obstacles found in traditional competitive bidding and
negotiation – buyers typically can save 5 to 12% more and can award a contract
on the same day that proposals are due. These results and speed support the
fundamental premises of Quick Hit Opportunities.
On the next screen, you will get to participate in a mock Internet reverse auction.
On the right side of the screen will be a table displaying a series of bids. You will
submit a bid by entering a price in the space to the left of the table, then clicking
on the Next button. When you click on the Next button, your bid will be recorded
and you will see it in the table with the other bids. The objective is to provide a
price that is lower than those that had been previously submitted. Just remember
when entering your price to use a format with no dollar signs, no commas, and a
decimal point with at least one digit to its left and exactly two digits to its right. An
example price would be:
10078.99
And, oh, some students like to bid 0.00, which takes the fun away from the
process. So please resist that temptation. If the bids do get that low, please let
us know so we can reset the auction. OK. Ready to go? Have fun!!!
39

42. NOTE: THIS EXERCISE AVAILABLE ONLINE ONLY
This Page Was Loaded Onto Your Screen On 09-10-2008 At 4 : 11 : 54 PM EST
This auction is for one million widgets. This auction ends at 12:00:00 PM on
February 30, 2012.
Bidder ID: customer
Enter Your Find your bid...
Price
$8.35
$8.50
$8.90
$8.93
$8.94
$8.96
$8.99
$9.01
$9.02
$9.03
$9.05
$9.94
$9.96
Bidder ID
Time Of Receipt
08/4/2008 3 : 56 : 40 PM
linda.moisey
EST
07/1/2008 10 : 48 : 51 AM
jackie.maldonado
EST
07/1/2008 8 : 56 : 21 AM
rskonier
EST
05/30/2008 7 : 33 : 11 PM
jnunez
EST
05/24/2008 3 : 15 : 25 PM
john.rine
EST
05/22/2003 5 : 41 : 46 PM
john.rine
EST 05/17/2003 10 : 54 :
41 AM
02/26/2008 1 : 10 : 1 PM
j_ml john.rine
EST
EST
03/11/2008 9 : 22 : 33 AM
cdominick
EST
02/26/2008 1 : 7 : 49 PM
j_ml
EST
02/25/2008 2 : 7 : 57 PM
erojas
EST
02/22/2003 5 : 6 : 2 PM
EST 10/27/2002 9 : 5 : 9
erojas rfisher
AM EST
40

43. Price
Bidder ID
Time Of Receipt
09/10/2008 4 : 12 : 58 PM
$8.34
customer
EST
08/4/2008 3 : 56 : 40 PM
$8.35
linda.moisey
EST
07/1/2008 10 : 48 : 51 AM
$8.50
jackie.maldonado
EST
07/1/2008 8 : 56 : 21 AM
$8.90
rskonier
EST
05/30/2008 7 : 33 : 11 PM
$8.93
jnunez
EST
05/24/2008 3 : 15 : 25 PM
$8.94
john.rine
EST
05/22/2008 5 : 41 : 46 PM
$8.96
john.rine
EST
05/17/2008 10 : 54 : 41
$8.99
john.rine
AM EST
02/26/2008 1 : 10 : 1 PM
$9.01
j_ml
EST
03/11/2008 9 : 22 : 33 AM
$9.02
cdominick
EST
02/26/2008 1 : 7 : 49 PM
$9.03
j_ml
EST
02/25/2008 2 : 7 : 57 PM
$9.05
erojas
EST
02/22/2008 5 : 6 : 2 PM
$9.94
erojas
EST
10/27/2007 9 : 5 : 9 AM
$9.96
rfisher
EST
10/11/2007 1 : 41 : 53 PM
$9.97
michael.smith
EST
10/3/2007 7 : 48 : 7 AM
$9.98
rskonier
EST
10/2/2007 9 : 15 : 30 AM
$9.99
rskonier
EST
08/29/2008 3 : 42 : 1 PM
$10000.00 student101
EST
08/29/2008 8 : 43 : 5 PM
$10001.00 student101
EST
08/30/2007 11 : 50 : 36
$10077.00 student102
AM EST
09/10/2007 11 : 17 : 34
$10077.07 customer
AM EST
05/8/2008 11 : 59 : 58 AM
$10077.08 customer
EST
08/30/2007 11 : 37 : 28
$10078.99 student101
AM EST
41

44. To summarize the process for achieving quick hits:
•
•
•
•
•
•
Find categories that are high impact and low effort
Communicate your targets and nail down your requirements
Prepare for competitive bidding
Pre-qualify suppliers
Position your contract template as a requirement of bidding
Conduct reverse auctions
42

45. Lesson 4 Quiz
NOTE: TAKE THIS QUIZ ONLINE FOR IMMEDIATE FEEDBACK
1. It is important to address Quick Hit Opportunities first because:
a.) you can gain momentum and confidence by succeeding quickly
b.) management will be supportive of your later, more challenging efforts if you
show rapid results
c.) you can prove your success to stakeholders whose support you will need later
d.) all of the above
2. Which attributes characterize Quick Hit Opportunities?
a.) high effort and low impact
b.) high impact and low effort
c.) high impact and low interest
d.) low effort and high tension
3. When laying the groundwork for Quick Hit Opportunities, what should you not
do?
a.) concentrate on keeping your current suppliers
b.) advise management of your targets
c.) consider standardization
d.) collaborate with stakeholders
4. What is likely to happen if you wait too long to introduce a contract?
a.) your supplier will sign the contract without review
b.) your competitive leverage will be diminished and your supplier's attorney will
suggest changes to the contract language
c.) the supplier will decline the opportunity to do business with you
d.) your attorney will permit the use of the supplier's contract without review
5. Which of the following is a benefit of reverse auctions?
a.) they apply a great deal of competitive pressure on suppliers, resulting in a
lower price for the buyer
b.) they speed the negotiation process
c.) they intimidate old fashioned purchasing managers
d.) A & B
43

46. Lesson 5 - Supplier Relationship Opportunities
The fourth component of a good savings strategy is Supplier Relationship
Opportunity Execution. Unlike Quick Hit Opportunities and Strategic Sourcing
Opportunities, Supplier Relationship Opportunities are those categories for which
you cannot or do not want to switch suppliers. You do not need to switch
suppliers, or even threaten to switch suppliers, to achieve savings. However, it is
probable that you will not achieve as high a percentage savings as you would
with Quick Hit Opportunities and Strategic Sourcing Opportunities.
To determine which categories are Supplier Relationship Opportunities, evaluate
each of the categories that you did not select as your Quick Hit Opportunities by
asking these questions:
•
•
•
Does my organization already have a long-term contract in place with a
supplier for this category?
Is the supplier for this category the only supplier with the capability of
producing this product or providing this service to my organization’s
requirements?
Has using the incumbent supplier in this category eliminated the problems
my organization has had with most of its competitors without creating new
problems?
If you have answered "yes" to any of these questions, then the category would
be appropriately deemed Supplier Relationship Opportunities. As we have stated
earlier, you will probably realize the least savings in Supplier Relationship
Opportunities, so be sure not to haphazardly consider a category a Supplier
Relationship Opportunity rather than a Strategic Sourcing Opportunity. Beware of
lame excuses for not switching suppliers. Let’s do an excuse check…be sure that
these are not your reasons for not switching suppliers:
"We’ve always used that supplier."
"We get a good price now."
"I don’t have time to think about switching suppliers."
All of these are invalid excuses and should not preclude you from considering
switching suppliers. You must treat the evaluation of excuses as if the excuse
was on trial. The burden of proof for not switching suppliers is on the individuals
who object to switching.
To be a valid justification for not switching suppliers, your stakeholders need to
present evidence. Instead of "we’ve always used Supplier A," a valid justification
would state "we have had no late deliveries from Supplier A in the last 3 years. I
have a letter from the purchasing director from the company next door that has
stated that Supplier A’s only other competitor has only been able to deliver 80%
of orders on time." Instead of "we get a good price now," a valid justification
would be "I have checked our prices against the publicly released prices that our
44

47. state and local governments get for the same products, in similar quantities, with
similar service and delivery requirements. Our price is already 5% lower. The
cost of competitive bidding would not justify the small or non-existent savings
we would achieve." Do you see how using evidence is much more compelling?
Accept justifications with evidence only – not excuses!
There are many techniques for achieving savings by working with existing
suppliers. These include:
•
•
•
•
Standardization
Value Analysis
Savings Sharing
Negotiation
We’ll talk about each of these one by one.
Standardization
Standardization is the process of consolidating the purchases of several similar
products or services into the purchase of a single product or service. For
example, a hospital may purchase 10,000 16cm tongue depressors per year and
5,000 19cm tongue depressors per year. The purchasing department may learn
that no medical justification exists for two sizes and may be able to standardize
on a single size. By standardizing, the hospital increases its buying power for the
single size and can attain greater volume discounts.
Analyze your own spending. Take each Supplier Relationship Opportunity
category and create a PivotTable within that category. Find similar goods or
services that may be ripe for consolidation. Then, forecast your quantity
requirements if you were to consolidate the many varieties into a single variety
or, at most, a few varieties.
Now, you need to approach the existing supplier (who you have identified as a
supplier you cannot replace) seeking cost reductions. However, be careful not to
create an atmosphere in which it seems like you are beating the supplier over the
head for a discount (even though you are in no uncertain terms seeking lower
prices). Make it seem like you have both companies’ interests in mind.
Tell the supplier that you have an idea that will help them reduce their inventory
and streamline their process of fulfilling your orders. Ask the supplier to
collaborate with you on a standardization program that will reduce both
companies’ costs. Present your specific ideas and let the supplier know that
you would like to increase your volume discount in return for purchasing more
of a certain item. In every way possible, try to quantify the financial benefit the
supplier will realize as result of collaborating with you on a standardization
program. If the supplier is convinced that it will realize savings through
standardization, the supplier will be more likely to concede discounts.
45

48. Value Analysis
Value analysis is the process of evaluating the design of a product or service
(including all components thereof) and identifying changes to such design that
will result in a reduction of the cost to produce the product or provide the service
without a substantial loss of functionality. Let’s consider an example of a
weightlifting equipment manufacturer. This manufacturer essentially designs its
equipment, purchases all components for its equipment, assembles portions of
the equipment, then packages and markets the equipment which will have its
assembly completed by the consumer. This manufacturer has historically
purchased metal plates for use as its barbell weights at an average cost of $1 per
pound. By examining each part that went into its equipment, the manufacturer
notices that it can purchase sand-filled plastic weights for an average cost of 50
cents per pound from the same supplier. Because the manufacturer’s research
has shown that its customers generally have no preference for metal or plastic
weights, the manufacturer can keep its selling price the same while reducing its
cost which, of course, increases profit. Let’s dissect this example by comparing it
against the definition of value analysis.
Portion of Definition
Action Taken
evaluating the design of a product or
service (including all components
thereof) and
The manufacturer looked at all
components that went into its
weightlifting equipment
identifying changes to such design
The manufacturer opts to use plastic
rather than metal weights
that will result in a reduction of the cost
to produce the product or provide the
service
The cost for weights is decreased by
50%
without a substantial loss of
functionality
The consumer still lifts the same
amount of weight when using the
barbells
The use of value analysis is not limited to manufacturers. Service industries are
filled with value analysis opportunities. Consider something as simple as a
purchase requisition. One company had a purchase requisition that made four
copies: one that the originator kept when submitting the requisition, one that the
approver kept after signing, one that the purchasing department kept, and one
that the purchasing department sent back to the originator to confirm placement
of the order. After examining the purpose of each copy, it was found that the
approver rarely kept a copy – the originator’s confirmation copy was usually
enough of a paper trail for a department. Therefore, the number of copies was
reduced to 3 and the cost of the requisitions decreased by nearly 20%. Of
46

49. course, this company could take the idea farther by implementing an
eProcurement system and eliminating paper entirely, but you get the point.
When conducting value analysis, always try to determine the financial benefit of
each component of the product or service and then compare that benefit against
the cost of that component. For example, because most people keep their
computers at a low volume, a computer manufacturer may not be able to charge
more for a computer with 200-watt speakers, but you can bet that it would cost
more to produce the louder speakers.
When possible, use value analysis to compare component prices between
product lines. A manufacturer of three different lines of tractors found that it was
paying similar prices for the horn installed on two of its tractor lines. However, it
was paying 6 times as much for the horn installed on the third tractor line. It
became obvious that the horn didn’t have 6 times the value – a horn is a horn, it
beeps. Therefore, the tractor manufacturer was able to find a horn that was more
appropriately priced.
Savings Sharing
Savings sharing is another way to reduce costs without changing suppliers. In
its most basic form, savings sharing works like this: you agree with a supplier to
analyze characteristics of the way you do business with them. Each party
comes up with suggestions on how to reduce the costs of doing business. For
those suggestions upon which both parties agree, the cost savings is calculated
and shared equally, usually in the form of lower prices for the buyer.
For example, let’s say that an automobile manufacturer has had a contract with a
supplier of windshield wipers for many years. Because windshield wipers are
somewhat delicate, the contract includes strict requirements for packaging the
wipers for shipment. It costs $5 to package a case ($100 worth) of wipers and the
packaging cost is absorbed by the wiper supplier. Thus, packaging represents
5% of the price paid by the automobile manufacturer. The wiper supplier
suggests that the automobile manufacturer allow the packaging to be comprised
of less expensive recycled materials and the two parties will split the savings. By
using recycled material, the packaging costs for a case worth of wipers
decreases to $3 – a savings of $2. When the savings is shared, each party is
entitled to $1 of the $2 worth of savings. Therefore, the wiper supplier reduces
the price for a case of wipers to $99.
There are countless ways to evaluate shared savings opportunities. The best
part is that it is often easy to get suppliers to collaborate with you on shared
savings projects. Because the suppliers can improve their bottom line by working
with you, they are eager to listen to and identify ideas for savings.
Negotiation
47