Aberdeen InSight: Yield Savings With Total Cost Management

Apr 4, 2002

Tim A. Minahan

Effectively controlling costs and performance across the supply chain will require the development of new operational and technology infrastructures that blend proven supply chain strategies and market intelligence with emerging sourcing, planning, procurement execution, monitoring, and analytics technologies. This "Total Cost ManagementTM" framework will position organizations to identify, capture, and maintain the complete cost savings and operational efficiencies available in the supply chain.

Procurement Leads the Charge
Cost cutting has become job one for most businesses. After reducing headcount and streamlining internal processes, companies are looking to trim fat and inefficiencies from their extended network of supplier partners. Procurement and supply chain management are heading this charge.

With half of every revenue dollar spent on external goods and services, procurement provides the largest opportunity to reduce costs. Procurement is also responsible for organizing and managing a wide array of supply relationships. Procurement's role is becoming increasingly important as firms outsource critical activities, such as manufacturing, logistics, and design.

Suffering Savings Leakages
In their short existence, Internet-based sourcing, procurement, and Supply Chain Management (SCM) technologies have delivered considerable cost and performance benefits. However, deployment of these technologies has often been isolated and disconnected from larger SCM and business initiatives. This fragmented approach has resulted in the "leakage" of procurement savings.

Examples include:

  • Planning: Traditionally focused on production ("direct") material purchase requirements, most planning initiatives and engines fail to examine supplier capacity and capabilities. Planning technologies also overlook non-production ("indirect") expenditures, limiting opportunities to aggregate buying volumes and optimize purchase plans for indirect spending.
  • Sourcing: Aberdeen research of early adopters of e-Sourcing found that users reported cost savings of 14.3%, on average. However, most users were unable to fully implement or realize these savings. Reasons include a lack of savings implementation strategies, an inability to effectively communicate negotiated terms to the enterprise, and insufficient integration between e-Sourcing and order execution systems.
  • Procurement: Aberdeen research of e-Procurement users found that enterprises push only 18% of total indirect spending through these systems, on average. Reasons for low penetration rates include a failure to conduct detailed spending analysis at the outset of a project, poor supplier enablement, and lack of a system adoption plan.
  • Contract management: Nearly 80% of business transactions are governed by a contract, yet few companies effectively communicate and manage the terms of these contracts. As a result, companies miss huge savings opportunities by not enforcing internal compliance with contracts or ensuring appropriate price breaks and rebates from suppliers.
  • Supplier performance measurement: Evaluating a supplier's operational and financial performance requires metrics to be assimilated from multiple enterprise systems. Capturing an accurate view of a supplier's current and future performance also requires enterprises to access information from external sources as well. Lack of insight into supplier performance can cause buyers to make poor sourcing decisions and to miss indicators of supply chain risk. As a result, most enterprises have only realized a fraction of the potential benefits of procurement and SCM automation. Such findings are evidence that advances in procurement and supply chain technologies have outpaced the strategies needed to effectively deploy them.

TCM: Capturing the Total Opportunity
Effectively controlling costs and managing performance across the supply chain will require the development and coordination of new organizational and technology infrastructures that blend proven supply chain strategies and deep commodity and market intelligence with emerging sourcing, planning, procurement, monitoring, and analytics technologies.

This new Total Cost Management (TCM) framework provides the supporting infrastructure necessary to identify, capture, and maintain cost savings and operational efficiencies across all areas of enterprise spending - from operating supplies and business services to production materials, parts, and assemblies.

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TCM is an organizational and technology framework for effectively analyzing, sourcing, and managing purchasing costs and supply chain performance enterprise-wide. This framework blends the supply chain strategies and commodity expertise of an organization's procurement professionals with supporting sourcing, planning, procurement execution, monitoring, and analytics technologies.

Developing an effective TCM framework requires enterprises to organize and integrate their strategies for every cost category around five key processes:

1. Analyze: Conduct company-wide spending analysis to identify and prioritize savings opportunities, including supply base rationalization and purchase aggregation.
2. Plan: Develop optimal sourcing and procurement strategies for both direct and indirect expenditures based on existing and future purchase requirements across the enterprise.
3. Source: Identify, evaluate, negotiate, and configure trading relationships.
4. Buy: Communicate, execute, and settle payment against negotiated trading agreements and contracts.
5. Monitor: Measure and enforce internal contract compliance and external supplier performance.

Effectively executing these activities requires organizations to build technology infrastructure that supports the following:

  • Collaboration - enables intra-/inter-enterprise collaboration for all procurement and supply chain processes;
  • Process control - provides a central platform for standardizing and enforcing common processes across the enterprise and the supply chain; and
  • Procurement intelligence - provides a "single point of truth" for all procurement-related data and intelligence.

To support integration and interoperation within the enterprise and across the supply chain, companies must adopt a technology infrastructure that supports system-to-system and system-to-person communication between trusted trading partners.

This infrastructure must also support integration with internal business systems, including financial, Enterprise Resource Planning (ERP), Manufacturing Resource Planning (MRP), Design/Product Data Management (PDM), and legacy applications. Finally, TCM requires the exchange of all document types and formats, particularly the dialects of EDI and XML. This TCM framework provides a comprehensive and consistent approach to identifying, capturing, and managing supply chain costs and performance.

The TCM (R)evolution Has Begun
TCM is not merely a new technology segment but a larger business movement, like SCM or Total Quality Management (TQM). Just as enterprises and the IT industry supported these business concepts, TCM is now being embraced by thought-leading enterprises, business software application providers, and consulting organizations - even if the term TCM has yet to proliferate.

Pure-play solution providers in the areas of spending analysis, contract management, and supplier performance measurement are aligning themselves with consulting firms and procurement technology providers to solidify their position in the TCM framework. e-Sourcing vendors are expanding their solution footprints beyond online negotiations to address the broader requirements of TCM. And SCM and e-Procurement platform providers are moving beyond their transactional roots to support additional TCM functions.

The TCM opportunity is also attracting leading ERP players, who are developing process- focused, Web-based suites built around the TCM concept. Leading consulting firms are also entering the fray by partnering with procurement, sourcing, and SCM solution providers and creating strategies supporting the TCM framework.

Economic and resource constraints will force most enterprises to take an incremental approach to deploying TCM. However, TCM presents a self-funding model in which savings in one area, such as e-Sourcing, can fund other TCM initiatives. Regardless of the approach, capturing the full savings opportunity will require enterprises to make application purchases and organizational decisions with the TCM framework in mind.

Aberdeen Conclusions
Procurement is at a critical inflection point. Empowered as a leading business initiative, the procurement function finally has the resources to deploy automation to support and improve operations. Early experiences with e-Sourcing, e-Procurement, and SCM technologies indicate that there is a wealth of cost savings and performance improvements to be had through the automation of supply chain activities. While incremental benefits provided by these technologies are significant on their own, capturing the full procurement savings opportunity will require companies to adopt a well-defined and integrated strategy that addresses all procurement costs and processes.

Total Cost Management provides a framework for organizations to identify, capture, and manage the cost and performance of all corporate purchasing dollars and supply chain resources. Early signs indicate that TCM will also be the next hotly contested enterprise business technology segment.

Tim A. Minahan is Vice President and Managing Director, Supply Chain Research, for Aberdeen Group, an IT market analysis and positioning services firm based in Boston. For more information go to


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