By: George Mathew
Procurement expenses: A full breakdown
The cost a business incurs to acquire various goods and services goes under the umbrella term “procurement expenses.” Such expenses could vary considerably across corporate sectors and are based, further, on the nature of the business and volumes transacted. For instance, bulk purchases and consolidated procurement at the headquarters level tend to reduce per unit costs of transportation, packaging, handling as well as customs duty and insurance premiums. This has the effect of shrinking overall procurement expenses. Larger volumes provide suppliers with scale economies, which means they can produce more units of a good or service, which translates to lowered input costs.
The cost benefits thus realized pass on to the customer in the form of lower prices for bulk orders, so it’s essentially a win-win for both sides of the purchase equation. Buyers who purchase in bulk also stand to gain by way of volume discounts, resulting in lower unit prices. There are sound reasons why suppliers incentivize customers with discounted prices (volume rebates) on their larger orders. Besides, helping them realize economies of scale, with larger orders, vendors need grapple with fewer number of orders per customer, which helps them save on administrative charges (e.g., overheads, wages, infrastructure, software usage fee) and shipment costs associated with purchase orders. Moreover, vendors who sell in quantity are more likely to have simpler and more streamlined procurement and less likely to be sitting on excess or dead inventory. Obsolete inventory is nothing but tied-up capital that acts like an oppressive burden on the business to pull down profitability.
Importance of managing your procurement expenses
Purchase price deconstructed
Let’s take a close look at what constitutes procurement expenses. Purchase price is the cost a business pays for a good or service, plus taxes, duties, as well as administration, processing, packing, and transportation charges. This constitutes the single largest piece under procurement expenses. So, even small changes in the purchase price can have a significant impact on business profitability, and the reason why prudent and forward-thinking businesses feel it’s important to keep a check on purchase prices and optimize them from time to time. Mindful of this, businesses closely track the variance between the actual price paid for an item and predetermined costs. The latter is worked out based on the cost of materials that go into a manufactured product, salaries and wages paid to workers directly involved in the production of a specific product, and indirect costs incurred in the manufacturing process.
A negative purchase price variance (PPV) suggests a drop in actual costs, and procurement teams can achieve this in more ways than one. Clinching more favorable deals and pricing terms out of hesitant suppliers is a sure-shot way to realize favorable PPVs. Businesses should consider adding more muscle to their negotiation capability by joining a group purchasing organization (GPO), apart from centralizing all their purchasing.
Brokerage fees explained
These are fees paid to brokers or intermediaries who connect buyers and sellers in procurement and help negotiate favorable deals. Typically, brokers charge a certain percentage of the transaction value. By availing two or more services from the same broker, businesses could become eligible for lower fees. Negotiating a flat fee, in place of a percentage fee, will also help save on brokerage charges and overall procurement expenses.
A quick glance at other expenses
Apart from the procurement expenses detailed above, businesses might have to bear substantial government expenses, such as the cost of certain mandatory testing in government-regulated procurement. Interest on loans availed from various lenders is another financial consideration for procurement organizations.
How SpendEdge can help you
At SpendEdge our experts with more than two decades of experience in procurement help businesses obtain goods and services cost-efficiently by fostering the best possible vendor relationships. On the cost front, we go to extra lengths to meticulously dissect each cost component to uncover the true cost of products and services. As a result, our clients across sectors are able to respond at full speed to risk scenarios and foresee price fluctuations before they can start to hurt. That’s not all. Armed with highly accurate cost data, our clients realize they have more headroom in supplier negotiations compared to their peers in industry, and this is translating into more opportune deals with their supplier base. Moreover, our detailed procurement expenses analysis enables organizations to uncover ever-newer opportunities for cost savings and work out cost estimates for each activity in a project. Client businesses also stand to gain a strategic advantage by understanding current and future market trends to contain costs while making the most profits.
Cost analysis is O&G business’ top elixir to trim spend, improve productivity
Our client is a North American oil and gas industry player owning more than a 1,000 horizontal wells. On the one hand, the oil sector is under growing pressure from shareholders to distribute excess earnings in the form of dividends, which could leave many of these businesses with scarce exploration funds. At the same time, environmental, social and governance (ESG) issues are often coming in the way of fresh investments in the sector.
With diminishing oil reserves and associated supply chain complexities, oil and gas companies are struggling to deliver projects within budget. This has prompted market participants to focus significant time and effort on cost analysis to boost productivity. Businesses realize more efficient allocation of resources is key to maintaining profitability, minimizing procurement expenses, and remaining competitive in a volatile market. Our client was particularly keen on identifying the key cost components with a laser focus on the North America market. To this end, the oil and gas player decided to tap our proven expertise in cost analysis to develop a cost analysis template capable of accurately gauging how each cost factor weighed in on overall business growth.
The mandate was to generate a template that can deliver the goods even in the most rigorous circumstances of the business and meet criteria such as ease of use and customizability. With this as the basis of their actions, our experts carried out extensive research, which comprised, among other things, interviews and discussions with important stakeholders in North American oil and gas industry. Our primary and secondary research (e.g., paid industry databases) yielded comprehensive and thorough information pertinent to systematic cost analysis. Our rigorous exploration of data and detailed analysis of the same resulted in a cost analysis template that is helping the client get a true measure of project costs, revenues, and potential ROI. Unlike ever before, cost analysis is serving as a strong basis for prioritizing projects and making more data-driven decisions at the client enterprise. The result is productivity maximization along with a significant reduction in procurement expenses.
