Strategic savings on the right track

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How Canadian Pacific Railway has saved millions of dollars In the past four. years through strategic sourcing of many people would point to the purchasing department when deciding how

to increase the bottom line - but the fact is that it can have a tremendous impact. The unfortunate truth is that most senior executives pay scant attention to material and services purchasing. As long as the costs are in line with last year, there is no perceived need to worry. This assumption should be questioned. It has been in the supply services department (purchasing) at Canadian Pacific Railway (CPR).

With the exception of labour, most corporate expenditures, including long-term capital investments, flow through this department. Large contracts most certainly have a significant purchasing input. Capital projects may not originate within purchasing, but they certainly make their way there. With all that flowing through a department, it's no wonder that opportunities exist for cost savings.

Strategic sourcing involves a fundamental re-examination of corporate purchasing behaviour. It consists of a total analysis of current purchasing practices and the systematic application of a select number of business drivers to the input stream, ranging from rate negotiations to long-term strategic alliances. It eliminates the "three bids and a buy" mentality and entrenches a mentality that requires a true understanding of the needs of internal customers, and of the dynamics of the marketplace. Fundamentally, it requires a deeper understanding and stricter adherence to the processes that drive the corporation.

Dollar impact

Unlike gross revenues, where a dollar of sales contributes only a small percentage to net income, (in relation to the operating ratio), a reduction in external third party spending will have a direct and substantial impact on net profits and income. A dollar saved on expenses goes directly to the bottom line. An equivalent additional revenue dollar will only contribute a portion to the bottom line, equal to one minus the operating ratio (expenses over revenue).

Typical cost reduction initiatives often aggressively focus on labour productivity, causing substantial disruption and ill will while completely ignoring larger external spending opportunities. Systematic and comprehensive third party spending reductions on material and services avoids much of this internal disruption, and forces the corporation to examine how to fully leverage its core activities while allowing for assistance on peripheral activities.

Process development

To focus on the greatest opportunities, you need to fully understand the spending streams of the business. You may want to omit the labour component, inter-company transfers and all other non-third party expenditures. As a general rule, purchasing isn't involved in these areas. The focus is on the third party spending - how much is spent, with whom, at what time of the year, etc. Once this is completed, costs can be segregated into separate and distinct spending streams. In the case of the CPR, 14 inter-departmental cross-functional teams were created, one for each spending stream. The immediate focus was on the easy targets, the "low hanging fruit," to provide an immediate and positive momentum. Although met with initial skepticism, the initiative's detractors were silenced when the cost savings quickly accumulated. Now, the process is embedded in the company culture and each year a work plan is developed for all of the cross-functional teams to address specific opportunities.

Savings summary

The results of the strategic sourcing initiative to date have exceeded everyone's expectations. The challenge now is to build on these successes and achieve meaningful results in future years. The savings from the low hanging fruit have long since been harvested and the focus has shifted to meticulous research on the high value spend streams. The CPR needs to focus on a larger fundamental realignment of business processes in concert with a sustained involvement from senior management.

Buy-in

Don't even bother to start this process if you haven't got the full and unwavering support of senior management. Crossfunctional teams and the investigation of departmental spending needs the full support of all of the functional NTs. Anticipate resistance from front-line supervisors, field personnel and even middle management, when any change is discussed, let alone imposed. If the same old purchasing behaviours and routines are allowed to continue, there will be no change. The old ways are always easier at the outset because they are understood and comfortable, but they need to be challenged and modified in today's very tough and quick-paced business environment.

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Cross-functional Team Savings 1998 - 2001

At the CPR, a steering committee was formed consisting of the three most senior executives in the company. For two years, they met monthly to review the progress of the strategic sourcing initiative. They were instrumental in ensuring that middle and senior managers remained on board. To this day, they continue to demonstrate their commitment to the process.

Cross-functional teams

It may sound tempting to simply try to leverage the current expertise of the purchasing department. But this is ill advised for two reasons - purchasing doesn't have the necessary expertise in all of the operational areas and the cost savings need to be legitimized. The emphasis is on alternatives and purchasing will not be aware of substitute parts, alternative processes, etc. They also need the buy-in of the affected departments. An operational field manager is going to be much more amenable to a savings strategy, and continue with the process, if he is a fundamental part of it.

The CPR has formed 14 cross-functional teams, each of which is responsible for defined functional spending, as mentioned before. A team consists of a member of all of the functional areas affected by the spending under review. This always includes, but is not limited to, a manager from supply services, senior management from operations, and a manager from finance. As a general rule, sub-teams are formed from employees who are more directly involved in the day-to-day activities of the processes. These sub-teams report progress on a regular basis. The sub-teams are given a specific task or tasks to complete, or generate ideas and projects on their own, and typically disband after the task is completed. In many respects, the cross-functional team acts much like a steering group or committee.

Strategic sourcing expertise

Having the necessary expertise on staff is critical to the success of a strategic sourcing program. It took CPR two years to find appropriately qualified people. This was due in part to the job market, but was also a function of the skill set that is needed to function within a strategic sourcing framework. The skills required depend heavily on analytical abilities and a creative viewpoint. This would be a person who is not afraid to question the status quo.

The incumbents would be required to data mine for opportunities and then promote ideas to internal users. The analysts would conduct negotiations with the vendors, draw up the appropriate agreements, ensure long-term sustainability of such agreements, and aid in the implementation of such agreements both administratively and operationally. Finally, they are responsible for identifying the quantity of savings that will accrue to the company over the life of the contract report accordingly. As the agreement nears expiration, strategic sourcing will again be involved in re-examining the original underlying assumptions for relevancy, assessing changes both in the business and the market, defining current needs and finalizing negotiations.

Budget adjustments

This is by far the most contentious issue. We have heard of corporations canceling entire projects due to an inability to agree on the outcome of the "excess" funds. Functional departments will generally insist on retaining all funding to pursue other opportunities. Finance wants to recapture and reallocate the savings to projects with more potential. While these are structurally important issues, they are not within the purview of the purchasing department, nor of any strategic sourcing initiative. It's critical that these issues are resolved at the most senior levels first, and then communicated to everyone involved. This doesn't diminish the importance of the process, nor of the savings.

Communication and timing

Communication is a central ingredient to the successful implementation and ongoing success of any paradigm shift in management. The frequency of the message should increase exponentially with the size of the company and the complexity of the reporting structure.

If CPR were re-implementing the strategic sourcing initiative, it would double the amount of communiques sent. Even with regular communication, there was always some degree of uncertainty among field personnel, resulting in a proliferation of obstacles.

Timing, meanwhile, is a function of the size of the company, the mandate of the program, the skill sets of the personnel, and the support of senior management. We estimate that the process took close to three years to fully germinate at the CPR. We were able to build on early successes and use them as a springboard into bigger and more lucrative spending areas. This implementation is typical of other larger corporation's material and services process re-engineering initiatives. It is a daunting task and one that can't be done piecemeal or with any reservations. Once initiated, the effort and focus must be maintained for the long ran.

Strategic sourcing is one of the most underused levers and one of the best opportunities for Canadian companies today. Is your company up to the challenge?

SIDEBAR

Strategic sourcing consists of a total analysis of current purchasing practices and the systematic application of a select number of business drivers to the input stream, ranging from rate negotiations to long-term strategic alliances.

AUTHOR_AFFILIATION

By Robert-Lepine, CMA,

and Ken Rawson

AUTHOR_AFFILIATION

Robert Lepine, MBA, CMA, and Ken Rawson, MBA, CPP, are both managers in Supply

Services at Canadian Pacific RaiLway.