Procurement
Measuring the “hidden” risks of rising prices and cost-saving responses in procurement

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Measuring the “hidden” risks of rising prices and cost-saving responses in procurement

by Jon Hansen

Over the past few months, there has been a good deal of coverage on battling price increases related to inflation and shrinkflation. For those unfamiliar with shrinkflation, your costs increase if a supplier shrinks the size of their product but maintains the same pricing. Shrinkflation is also a challenge when it comes to services.

The question this raises is how you, as a procurement professional or executive, respond to rising prices. What measures do you take to offset price increases to drive cost savings?

While it’s reasonable to look at the situation through a financial lens, far too often, a cost-saving strategy’s “risk” element is overlooked. This article focuses on assessing the risk of rising prices from the standpoint of organizational response. 

When the cure is worse

“A major US-based retailer discovered that, over time, the initial savings and related benefits they realized through the rationalization of their supply chain eroded. Within a few years, their average cost of goods actually increased by 23% above open market costs.” – Supply Chain Risk: Addressing Regional Complexities with an Understanding of Global Impact

In this recent webinar on supply chain risk, the lead-in case example may surprise you. 

It was about a major US retailer whose cost-cutting strategy was to implement a vendor rationalization program. On the surface and through early savings assessments, the results indicated that they had made the right decision. The company could negotiate volume discount pricing from the remaining suppliers by reducing the number of suppliers to a “more manageable” level. In addition to lower costs for goods, dealing with fewer suppliers also streamlined their procurement processes resulting in added cost savings in administration. It was a win-win situation for all stakeholders – at least in the short to near mid-term.

“Within a few years, their average cost of goods actually increased by 23% above open market costs.” – Supply Chain Risk: Addressing Regional Complexities with an Understanding of Global Impact

Unfortunately, the unintended consequence of their rationalization strategy was their inability to gauge pricing fluctuations consistently and accurately in the broader market. Their market intelligence was limited to the suppliers with whom they were dealing. Based on the products they were buying, the initial savings bump steadily eroded over time due to the decrease in general market price.   

I have never been a proponent of broad or generalized rationalization strategies such as the one implemented by this retailer. For the record, I do believe in the merits of strategic rationalization initiatives. In a future article, I will provide a more detailed breakdown of the differences between the two, including the importance of line-of-sight clarity and having access to real-time market intelligence.

However, in all fairness to the retailer, at the time, they did not have access to the advanced, AI-driven technology that we have today. In most instances, actionable knowledge was not readily available or even reasonably accessible.

The power of data

In my previous article, I discussed the importance of having “a robust risk management strategy” and “the ability to access real-time information and trends to identify vulnerabilities before they reach the crisis stage.”

The same rule regarding a robust risk management strategy applies when identifying and responding to real-time price volatility. By utilizing current technology, the days of static, outdated information and spreadsheet dependence are over.

So, when it comes to your strategy for dealing with rising prices, does your organization have the data culture and corresponding actionable knowledge to respond effectively to price volatility?

Book your spot now for our next webinar on predictions for 2023! Chris Sawchuk (Hackett Group), Jason Busch (Spend Matters), Michael Cadieux (Procurement Foundry), Kelly Ruigrok (GSES), and Roger D. Blumberg (Scoutbee) will discuss what 2023 has in store for procurement – and if theres any sense in even making predictions any more!