In the Trenches...How to Identify Hidden Procurement Costs

In the Trenches…How to Identify Hidden Procurement Costs

In this continuing series, Jennifer Ulrich shares her experiences in the trenches of executing strategic sourcing projects, to give you practical insights into best practices.

Anyone who buys anything, whether it be a commercial or consumer purchase, is subject to hidden costs. Some are soft costs such as those in the procurement process itself, like administrative costs to process orders, research and collect quotes, track inventory, and maintain the overall process flow. Others are hard costs that buyers may not consider upfront such as shipping, surcharges, labor costs, and taxes. Regardless of the type of costs and where they are found, buyers need to be conscious of them when making procurement decisions. More often than not, these costs cannot be avoided; however this article will provide some advice on how to identify these hidden costs.

One of the first steps in gaining visibility into the various costs of procurement is awareness. Understanding the total cost of the goods or services being purchased may change how they are purchased. Let’s consider the good old widget purchase, for example. A widget from Supplier A may cost $0.09 (including tax) and from Supplier B $0.05 (not including tax). Both suppliers are local. Seems fairly simple doesn’t it? But consider this: the widget from Supplier B is being shipped from a plant in Taiwan to a local shop where it will be assembled and packaged for shipment, adding $0.03 to the cost. Supplier B also adds a fuel surcharge of 18% to the base unit cost, adding $0.009 to the total cost. Finally, Supplier B adds 7% tax to the total cost. Now the comparison looks more like $0.09 from Supplier A and $0.09523 from Supplier B. Multiply that variance by the 1,000,000 units that the company needs and they will have paid an extra $5,230 by choosing the “lower” unit cost. While this scenario may not apply in all cases, it provides you with an idea of what to consider when looking at the total cost of a purchase.

So how do you find out about all of those costs? Ask! Ideally, all suppliers will be upfront and honest about all costs when quoting, but this is not always the case. Ask the supplier what other costs are not included in the price of the item. Also, make sure to research the information they provided. For example, if they indicate that they will need to charge you a 20% fuel surcharge, ask them to provide an explanation for the percentage. Is this in line with what other suppliers are charging for this product? Does it follow some kind of index that you can track and verify? Another important cost is shipping. Find out what method of shipping the supplier is using and if you can use a more cost efficient and/ or effective method. Ask about discounts and rebates. Just because they are not offered, does not mean they are not available.

It is also important to track these costs over time with the same suppliers, especially when there is a contract in place. Surcharges and labor costs, for example, can slowly creep up when not monitored closely. While there may be valid justifications for increasing costs, it is still important to understand and monitor them for accountability and compliance. The takeaway here is that buyers need to understand all of the costs associated with a particular purchase in order to make the best and most educated decision for any type of purchase, whether it is one–time purchase or establishing a long term relationship with a supplier.

As a side note, improving efficiencies should be on the forefront of a company’s goals at all times, not just in times of reduced profit or economic downturn. Oftentimes this is not the case; companies retain the belief or mindset that they are making money so why focus on costs and processes, especially non-core costs such as marketing, office supplies, and facilities. Considering cost improvements throughout the profit lifecycle can help sustain profitability in the long-term. Regardless of when a company decides to pursue cost reductions and process improvements, one of the biggest challenges finding the time and resources, let alone the expertise to adequately assess their needs. Companies can benefit from hiring a strategic sourcing firm, like Source One, to support these initiatives.

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