05/06/2011 12:19 pm ET Updated Jul 06, 2011

The Next Generation of Cost Savings

In these times of anemic economic growth, businesses must continue to increase profits by reducing costs. Procurement officers have become experts at extracting savings and innovations from suppliers, negotiating raw-materials contracts and managing complex global supply chains.

But large amounts of goods and services are purchased too casually. Market researcher Gartner Inc., estimates that a typical company spends 30 to 60 percent of revenue on indirect goods and services. That's not surprising in enterprises like law firms and ad-agencies where, except for salaries, almost all spending is "indirect." But even manufacturers spend a lot of money on purchases related to sales and administration, rather than the production of goods.

At packaged good companies, about 20 percent of non-core spending is logistics, encompassing everything from ocean-freight to short-haul trucking. Another 17 percent is in marketing services. About 9 percent is information technology and telecom.

Corporate CFO's are aware that indirect spending is significant, but do not appreciate the aggregate size, and find it difficult to control. Internal procurement managers are often stretched thin and focused on ensuring supply and optimizing pricing for core commodities.

Even companies that have addressed indirect spending may still be leaving a considerable amount of money on the table. Although they have dedicated people and tools to improve the purchasing process, they do not have the full infrastructure to effectively managed indirect spending. With hundreds of supply markets to address and thousands of purchases to control, companies lack the market intelligence, specialized category expertise, structured processes and technology to maximize cost savings.

Knowledge of the market, commodity experts and better buying processes can cut total indirect costs by 15 percent or more. One company I know had just negotiated 6 percent savings on linerboard, a dramatically fluctuating commodity. What they didn't know was that the market had deflated further while they were negotiating. Using this outside intelligence they secured a total of 13.5 percent savings.

Savings like this require a whole different level of discipline and resources. Some manufacturers such as Whirlpool, Kimberly Clark and Goodyear are using outside providers, leveraging the provider's investments in dedicated category teams, market intelligence, and technologies to manage buying and enforce purchasing policies. But many are not.

In one study by ICG Commerce, average companies were able to affect about half of indirect spending, while world-class companies were able to affect 93 percent. World-class companies have established business processes to make certain that everyone who buys anything used preferred suppliers to maximize savings. With $2 billion in indirect spending, an average company received a bottom line benefit of $54 million. A world-class company would save $272 million over the same time, and could increase that by 3 percent a year through continuous improvement.

In today's competitive environment, few companies can afford to overlook the opportunity to achieve this next generation of cost savings, which could amount to as much at 1 percent or more of a firm's profit margin.

Jerry Jasinowski, an economist and author, served as President of the National Association of Manufacturers for 14 years and later The Manufacturing Institute. Jerry is available for speaking engagements.