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Case Study in Purchasing Rationalization

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Introduction

In 2002 a major American chemical company had completed a year of supply chain reengineering and decided upon a number of best practices that should be implemented. One element of the reengineering was that they decided upon creating a shared service function at their headquarters which rationalized the purchasing and accounts functions of seven separate businesses already located at the site.

The creation of the shared services function was estimated to produce a cost saving of 10%, or $20 million, of their purchasing budget each year. The problem that they faced was overwhelming. The seven companies had overlapping vendors, items, numerous contracts with the same vendor with different pricing structures and a variety of payment terms. The company created a task force to develop and implement a plan to create the shared services function.

Identifying the Problem

The seven business functions were located at the one site, but were distinctly separate. Each of the businesses had implemented their own technology strategy; systems, hardware, and vendors. If the shared services function was to use the company’s new ERP system, there had to be a data cleansing and conversion process devised for each of the seven business functions.

The task force received data from each of the businesses and it became clear that there was a significant level of duplication within each of the businesses as well as across businesses. One business function had seven separate contracts with the local telephone company, three of which were still valid. In a startling revelation, it was found that the seven companies had over 60 contracts with FedEx, and 43 with UPS.

Implementing the Plan

After reviewing the data from the businesses, it was decided that a separate teams would be required to complete the following:

  • rationalize vendors across businesses
  • update or delete existing data
  • negotiate new contracts and pricing with existing vendors

The team found that there was a significant overlap of items that were purchased across businesses and that the company was not using the purchasing power it had to gain the best prices from vendors. As further investigations were made into common items that were purchased across the company, it was found that greater savings could be achieved by limiting the number of vendors for specific groups of items, such as lab supplies and computer equipment. The seven businesses used nine lab supply companies and by offering a larger volume of items to be purchased by only one or two lab supply vendors, the savings could be as much as 60%.

Once this level of saving reached the ears of senior management, more focus was put on rationalizing vendors and in some cases, single sourcing was found to be appropriate when one vendor offered even more significant levels of saving.

The Result

The shared services function went live on their ERP system fifteen months after the start of the task force. The combined seven businesses had reduced their total number of vendors from 34,000 to around 900. The number of items they purchased was reduced from 110,000 to 15,000 and a team was put in place to monitor and approve new items and new vendors as they were required. Although the company estimated they would save 10% in the first and subsequent years, the estimate was raised to 23% for the first year and 15% for subsequent years based on the results of the task force.

The company decided that after making such large savings, that they would continue implementing best practices in the purchasing function. They developed a plan for adopting procurement cards and the introduction of evaluated receipt settlement, where they would pay vendors based on goods received to gain vendor discounts for prompt payment.

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