Eight steps to navigate the headwinds of cost inflation

Dr. Howard Price is an accomplished Chief Procurement Officer, with over 30 years of experience. He led the procurement practice at KPMG, and holds a PhD for his research into strategic procurement.

On board procurement's ship, we set sail across the tempestuous seas with him at the helm as captain - eyes on the distant shores...

How big is the problem?

The problem is global, the worst we’ve seen for over 40 years. Some experts think inflation may now have “peaked.”

Even if this is correct, we’re likely to see the highest inflation rates for decades continuing over the next few years. In terms of what this is doing to supplier prices, most procurement people will never have faced anything remotely like this before in their careers.

And it’s not just inflation in isolation – a global economic turndown, geopolitical tension, a pandemic, a war… and running through all this have been prolonged, major global supply chain disruptions.

What can we do?

It’s daunting but there’s a lot that we can all do!

1. Be cross-functional - and stay close to finance

In some areas, the levels of cost saving achieved in previous years will be close to impossible. “Cost Avoidance” has often been challenged as not “real savings”, but it certainly is now.

If the market price is up 10% and you hold that increase down to 5%, that’s something to be proud of.

You need to make sure your organisation recognises that value. So, work with Finance and make sure they support and validate what you achieve. And get their advice as well.

Set up a centralised “inflation management hub”, and invite representatives from other functions – sales, operations, logistics to work with you.

Provide regular updates on status to the board and to all who need to know.

2. Be forensic

You’ll need to be really rigorous and analyse the numbers in depth. One of the biggest problems is “price gouging” – suppliers using market conditions as a cover for unjustified price rises.

How do the costs for their product or service break down, and how much have they really been affected by the market?

Demand solid evidence for these requests and reject/renegotiate them if not valid.

Suppliers will tend to quote percentages such as CPI or wage increase data – whichever figure gives them the best bargaining position – but how does that map against their real costs?

There are a lot of techniques you should know and apply to help with this, such as cost breakdown analysis, market cost analysis, and “should cost” analysis.

3. Be innovative/collaborative

We can’t navigate our way through this, just by bullying suppliers. Ask your suppliers for innovations and make suggestions to take costs out of the whole supply chain.

This could include challenging and modifying product/service specifications, and streamlining working processes to remove non-value-added activities.  

4. Be disciplined

The core tools we use as procurement professionals in the good times, are even more powerful in tough times.

Double down on applying professional sourcing and category management processes. Focus on increasing the percentage of spend that is professionally sourced (in many companies this is less than 50%).

Stop “savings leakage” where you have a great contract deal with a supplier but not everyone is using it.

Look hard at “Contract Price Adjustment” clauses and make sure they are not favouring the supplier. Change them if they are. Some contracts may not have such clauses, consider adding them if it will help you manage future costs.

Apply demand management – make sure you are not over-ordering on expensive items, but at the same time you should also consider holding strategic stocks of items if they are expected to massively increase in cost.

You also need to make sure you’re not buying things you don’t really need, like recurring subscriptions and licence payments for software that nobody uses.

Also analyse your spend for hedging and forward buying opportunities.

5. Be careful

We’re in a complex world, bordering on chaotic. Avoid “whack a mole” solutions where you take action on a cost problem and it simply creates a different problem somewhere else.

Bargain too hard with a supplier, for example, and they may go bust!

Consolidating spend with fewer suppliers, may help you with your price negotiations but cause you resilience problems later.

6. Be focused

We all know that we’re supposed to segment our suppliers and our spend, and focus on the high cost and/or high-risk items.

Do this process again, but this time also filter it for the high inflation risks as well.

We can’t tackle everything at once, so highlight the key areas and prioritise.

7. Be supportive

A recent McKinsey review identified rapidly increasing levels of employee burnout.

This is where employees are damaged mentally and physically by having more work to do than there are resources to deal with it.

Procurement is in the eye of this particular storm. Watch each others’ backs and offer support. Don’t think it’s just you, it’s probably most of your colleagues too!

8. Be Capable

In difficult economic times training often gets trimmed down. This is a mistake.

Is your whole procurement team as good as it could possibly be, enabling it to triumph in the face of the biggest challenges for 40 years?

Take a look at the seven areas above, and identify the priorities where your team needs to upskill to survive in 2023.

Conclusions

We’ve been wrestling with supply chain resilience as a major problem for several years now. We’ve learned from that. We now know that there ARE things we can do to tackle big, scary, challenges.

We can apply this to inflation too. As well as tackling the cost challenges confronting us today: the “reactive” approach - we also need to think forward as well: the “proactive” approach:

What potential price disruptions may happen next? Where are we vulnerable? What steps can we take to prepare?

These could include strategies such as alternative sources, different specifications, design changes, or make or buy.

There is no denying that we are in choppy waters, but if we focus, learn and upskill, we can emerge from them stronger and better.