Underlying Basis of Successful Procurement: Cost Modelling

Procurement functions are no longer across the table negotiation exercise but procurement is now a very important part of the strategic decision making of any organization enabling better cost saving.  

Procurement functions is directly impacted with evolving manufacturing footprint, supplier innovations, higher saving objectives from the company, hence procurement must adapt to company’s needs more frequently than the rest of the company. Procurement need to be highly flexible at the need of the hour.

Procurement along with revolution has evolved itself as cost center but the underlying basis of savings still holds good ‘COST MODELLING’.  Any Procurement professional using his strategic skills as per experience definitely has to put his ownership and money on Cost Modelling.   

Cost Model is not just an accounting practice, it is an enabler to be used in strategic decision making by the Procurement function.

Cost modeling adopted perfectly absorbed in day to day activities helps in negotiation, sourcing and decision making which are the key aspects for any procurement leader.

Cost model selection is done by the purchaser, which should be inclined towards the total cost of ownership. Here we mean that ownership of spends is with the purchaser, likewise, ownership of savings on spend is also tagged with the purchaser.

Industry-specific cost models are very much needed so that decision making is 100% perfect, but the basics of the modeling are same across all industries :

  1.  Listing out expenses: Expenses should be listed out and categorized as per regulatory bodies (if any). In case of similar drivers to the cost, they need to be group together. In short, all expenses are listed to have clarity on what you actually spend.
  2. Cost drivers: Identifying the drivers for the expenses listed out is the next step. These are intermediate inputs and hence should be calculated on the basis of inputs in the model automatically.
  3. Total Cost of Ownership: Once you have determined the expenses and the drivers for these expenses, it is time to segregate the total cost of any decision for decision making. The total impact will be visible at one place.
  4. Supplier wise cost allocation: Cost can never remain same for all suppliers. There will be difference in overhead, raw material cost etc. The cost can be apportioned accordingly. This is very important for cost decisions for any company.
  5. Standard Costing:  This is a base of any company and this is done for every accountant. But tweaking the same to enable take a decision for the purchaser is very important. This helps the purchaser to keep track of expected cost and simultaneously the financial model can keep a track of the actual cost.

There is a linkage of the cost model to different variables, like sales cost and other areas of operations. All these complicate the model but must be taken care of at the time of preparations as it impacts the buying decision.

In such a model, savings are generated directly in earnings before income tax as they are generated in coordination of various stakeholders including Finance.