I bumped into an old colleague last week and we soon started talking about our respective ‘war stories’ – one of which I became fascinated with and want to share with you today.
Mike was completing due diligence on a potential acquisition for one of his clients and was looking into the supply chain contracts of the target company. The CFO of the company being acquired was confident that the contracts were in order and all geared to delivering significant short and long term benefits to the company.
“Our Supply Chain guy is top notch – he has been able to negotiate some amazing deals for us over the last 18 months” he was often heard saying.
“On the face of it”, Mike went on to say, “the deals did look great – collectively Paul had negotiated savings of over £3m on a cost base of just £12m – so very impressive”
These savings had been hard-wired into the budgets, resulting in a significant uplift in the overall forecast profitability of the company. Mike could see that some immediate benefits had been received and was about to move onto the next area until something caught his attention.
The supply base had been able to provide the competitive pricing because it was agreed that they would have far earlier sight of future requirements, which enabled them to plan their production more effectively and efficiently.
Interestingly, if the forecast requirements were not available with a minimum level of notice, the unit price would automatically increase and would immediately wipe out any benefit.
So, in essence, all of the potential savings were completely dependent upon the internal processes of the business and the effectiveness of the planning process in particular.
When Mike investigated further, it became clear that the planning function was not aware of this and although they could understand the benefits of longer term planning, they expressed significant doubt on whether they would be able to consistently meet the deadlines.
In a stroke, Mike had to place a big risk against the £3m annual saving that had been factored into the budgets, the result being that £15m was wiped off the overall acquisition price.The Little Mistake That Cost a CFO £15m - Make Sure You Don't Repeat It... Click To Tweet
I was intrigued about how the CFO had reacted and what Paul, the Supply Chain guy had put in place to ensure that the savings could actually be realized.
To cut a very long story short, it transpired that the CFO would take the savings at ‘face value’ and hard wire these savings into the budget as a control measure. His view being that any variance to budget would be identified and corrective action taken.
To some extent, I understand why the CFO did what he did. However, I question whether this is the most effective way to track the savings. It is highly likely that a ‘missed budget’ would quickly be followed by a period of anal checking and the identification of short term opportunities to bridge the bottom line gap.
This is not sustainable and often comes back to bite you!
I found this example illuminating especially when you consider that I come across this issue time and time again. Procurement/ Supply Chain re-negotiate fantastic deals only for the Realised Savings to be significantly diluted from the savings promised!Procurement re-negotiate fantastic deals only for the Realised Savings to be significantly diluted from the savings Promised! Click To Tweet
Why is this the case?
Do you have any similar war stories? I’d love to hear them!
In my experience, this is not uncommon, partly because the ‘thrill is in the chase’ – procurement/ supply chain people love to get into the detailed negotiation with suppliers and push for the best possible deal. The final negotiation may come after 6/9 months of effort – putting the specification together, running the RFP process, evaluating the initial bids etc.
All this work culminates in the final negotiation and we can ‘celebrate’ before moving onto the next one!
However, the very point where many organizations fall into the trap of moving onto the ‘next one’, is the one where they really need to start to concentrate on delivering the benefits.
Up until that point, they haven’t delivered anything tangible – its all promises.
This issue is seen time and time again and was the catalyst for the development of the COST Optimisation Formula, a four stage approach that guarantees Realised Value being much more aligned to Promised Value.
More often than not, organisations focus just on one element of the formula, namely supply chain management – ‘let’s get the suppliers in and negotiate better prices’, – whilst ignoring the other three. In reality, it is the other three elements that determine how much benefit is actually realized.
So, what is the Formula?
The four stages of the COST Optimisation Formula are;
- Change Management
- Optimised Internal Processes
- Supply Chain Management
- Tracking of Benefit Realisation
How many times have you seen an initiative fail?
I’ll wager that in the majority of cases, the failure was caused by a lack of effective change management. Although change is inevitable, nobody likes it! Although some people embrace it, many consciously reject it and continue to operate in the established ways.
Your ability to change behaviours, attitudes and processes, will determine your ability to deliver maximum value.
Does this mean that Mike, the Supply Chain guy should have taken responsibility of the change across the business?
Not necessarily, that will ultimately depend upon the internal structure of the organization. However, what Mike should have taken responsibility for is to acknowledge the change requirements and ensure that somebody within the organization was taking accountability of its delivery.
Successfully managing change is not easy, but those organisations that have a structured approach to change management perform significantly better than those that don’t. Within the COST Optimiser Programmes, we have developed the CHANGE Accelerator, a proven 6 step approach to successful management of change.
The other main area of the COST Optimisation Formula often forgotten, or probably more accurately stated, under-estimated, is the need to formally track savings.
In the same way that when a plane leaves an airport, because of the prevailing winds etc. it is off course for the majority of its journey –it’s only the correcting actions of the pilots that result in the plane landing in the correct destination, the same can be said about your savings.
Irrespective of how detailed your analysis is, or how structured your project is, I can absolutely guarantee that things won’t go according to plan. Things happen, change happens, resulting in the best laid plans being off the mark. Caught early and these slight variations can be corrected and in some cases the benefits can be enhanced by adapting to these lessons.
However, if ignored over a few months, small monthly variances can become significant and much more difficult to correct, thus resulting in a dilution of benefits and discrepancy between ‘promised’ and ‘realised’ value.
A recent client engagement is a perfect example – a significant contract had been renegotiated and mobilized across the business. This was forecast to deliver both short and longer term benefits. The business in question was expanding rapidly through acquisition and as such, tracking on a like for like basis was not an option.
We therefore adapted a two stage approach, one which would provide early indication of whether we were on or off track, based around a ratio between sales revenue and the cost of goods sold whilst another much more detailed analysis tool was developed that allowed investigation at a much deeper level.
Not surprisingly, after the first few months, the ratio’s started to move away from the projections and a small team was mobilized to review. The outcome was that the supply chain partner became much more aligned to the business, information and data was shared and a deeper sense of collaboration resulted, leading to even greater savings being realized.
How do you track your projected savings?
Do you have an early warning signal? Would you benefit from doing so?
The COST Optimisation Formula works – it’s as simple as that. Moreover, it doesn’t take a massive investment to embed it into your culture, it’s not a project in itself, so you won’t have a conflict on resources etc.
It’s a philosophy that focuses on maximizing the benefits realized from any activity undertaken. Irrespective of whether the initiative is a cost saving/ revenue enhancing or indeed nothing to do with your cost base, the formula works – it is the compound effect of your;
- Ability to successfully manage the required Change
- Ability to Optimise your processes
- Ability to align your Supply chain partners and collaborate effectively
- Ability to Track the benefits right through to being realized on the bottom line
That determines the success or failure of any individual initiative.
If you’re interested to learn how you can apply the COST Optimisation Formula into your business, download our 84 page book that goes into more detail. Alternatively, lets arrange a short call and we can discuss and agree the potential benefits that you will be able to realize through its adoption.