The hidden costs of cost-cutting

April 22, 2010
by Christopher Barbieri

In today’s market, procurement professionals are being challenged to optimize the supply chain by cutting costs. These adjustments matter, as every dollar saved has a direct impact on a company’s bottom line. This stands in stark contrast to the experience of salespeople, who must subtract costs from every dollar of revenue before they know how it influences the bottom line.

It is important for purchasers to keep the proper perspective so that the steps taken to reduce costs do not end up carrying a hidden price tag. If not identified up front, “boomerang costs” can change the entire outcome of important procurement initiatives.

So how can we best prepare ourselves to avoid this situation?

Understand cost and value
A wise CFO once said that in finance people know the cost of everything but the value of nothing. This type of introspection is not common in the financial field.

Value is something that we must not lose sight of when looking to cut expenses. We must keep in mind when making changes that our decisions may carry additional hard or soft costs.

For example, changing a key component in any process, service or finished product could lead to a higher failure rate, which could cost the company much more than the initial savings.

Furthermore, cuts to areas that affect employees’ work or quality of life on the job can have serious morale consequences that can decrease productivity. We must take care to consider these types of consequences because value is often forgotten or underestimated in these situations.

Yes, we need to optimize our organizations and be as lean as possible. However, the value component must be considered, identified and captured in the equation of our analyses if we want to guarantee our initiatives don’t end up hurting the financial future of our companies.

Photo: iStockphoto

Precise data
Every procurement optimization initiative must be based upon a solid analysis of the current scenario, including costs, volume and any special circumstances related to the product or service. A good initial analysis will provide you with information necessary to move forward in your attempt to cut costs; it must be the foundation of any changes. A misstep during this phase can have dire consequences. If decisions are based on imprecise or non-representative data, the opportunity cost can be significant.