The purchasing department is in a strong position to leverage cost savings into profit. The profit leverage effect dictates that reducing operating expenses is more efficient than increasing sales. Situated at the beginning of the production process of a product or service, the procurement stage is in an excellent position to reduce overall costs, especially in the short term. This is why companies often resort to reducing headcount when they run into financial difficulties. Reducing operating costs is the fastest way to produce a short-term impact on the bottom line.


With this in mind, let’s talk about purchasing’s profit leverage effect. The following example will display how every dollar saved in purchasing goes directly to the bottom line, and it does so in a way that is more efficient that it would be through increased sales.


Your sales are $120,000 and your cost of goods sold (COGS) are $60,000. Within your COGS is your cost of purchased goods, which is 75% of your COGS ($45,000). Let’s say you reduce your cost of purchased goods through a combination of supplier relations and negotiations by 10%, you would save $4,500. Your cost of purchased goods is now $40,500. Your COGS are now $55,500.

Reducing costs of goods sold decreases your COGS from 50% to 46.25% of sales. Your operating income (net profit) therefor increases by the same amount. Let’s say operating income was $25,000 or 21% of sales, after the 10% of purchasing cost savings, net profit increased by 18% to $$29,736. That’s pretty good!


Now let’s look at what the sales department would have to do to achieve a comparable increase in net profit. To calculate how many more sales dollars would have to be generated we divide the needed additional profits ($4,500) by the operating profit margin (21%). The sales department will therefore have to sell an additional $21,428.57 worth of your product or service, which is the equivalent of increasing sales by 15%. And that does not factor in the marketing costs associated with increasing sales.

Which is easier? Decreasing the cost of purchasing by 10% or increasing sales by 15%? For most companies, that large of an increase in sales with no increase in advertising spend would be an incredible challenge, especially in the short run. On the other hand, reducing the cost of purchases by 10% is very attainable for organizations who have not traditionally managed purchasing as a strategic function.


Key Takeaway: every dollar saved through purchasing goes straight to the bottom line. By contrast, only 21% of sales goes to the bottom line, the remainder is consumed by the costs associated with doing business.



SAP, Supply Chain Management

I received my SAP TERP10 Associate certification in the mail this week. Actually, the full name of the distinction is C TERP10 67 SAP Certified Application Associate – Business Foundation & Integration with SAP ERP 6.07, which required an intensive two-week long course and three-hour exam. Pursuing this certification was important to me as I aimed to solidify the past 8 months of recently completed hands-on Supply Chain Management focused SAP training. In addition, I wanted to expand on my knowledge of the Purchase-To-Pay (purchasing/procurement), Plan-To-Produce (manufacturing), Order-To-Cash (selling), FICO (financial and management accounting) and Project Systems (project management) SAP proficiencies.

Supply Chain Management
Why ERP?

ERPs (Enterprise Resource Planning) software is used by large-scale organizations to aid them in communicating their flow of raw materials and finished goods from manufacturer to consumer. It provides full financial and inventory management integration at every stage of the buying, selling and logistics functions. The key factor with any ERP is integration. In an internal intranet type network, information is restricted to within the organization. Enterprise Resource Planning software allows for major time savings, and ultimately cost savings, derived from the real-time sharing of information between buyers, suppliers, warehouses as well as across internal departments. There are three major players in the Supply Chain Management ERP market: SAP, Oracle and JD Edwards, where SAP is considered by many to be the industry’s gold standard.


An Advantage of ERPs in Supply Chain Management


One example of buyer-supplier integration at work relating to supply chain management is Vendor Managed Inventories (VMI).  In VMI systems, the supplier (vendor) is responsible for maintaining the buying organization’s inventory levels. The supplier has access to the buyer’s inventory levels and ships out inventory in accordance to agreed upon thresholds, creating purchase orders in the process. An ERP such as SAP is used to communicate the buyer’s inventory levels to the seller. It can be further integrated to both organizations’ supply chain through its incorporation with the buyer’s or seller’s private carrier, or a third-party logistics provider.



Supply Chain

An Advantage of Vendor Managed Inventories

VMI directly results in a reduction of the Bull-whip effect, where large fluctuations in demand from a consumer or industrial retailer oscillates up the supply chain through the wholesaler, distributor, manufacturer, and raw materials supplier. Real-time communication of inventories therefore leads to the cost savings associated with increased inventory management efficiency in addition to insurance against inaccurate forecasting of demand.