Focus on Costs – Day 2: Introduction to Cost-Base Segmentation

Focus on Costs – Day 2: Introduction to Cost-Base Segmentation

Yesterday we explained the necessity of really looking at your business’s cost base during this pandemic. Over a fortnight and in the spirit of pulling together, we’re issuing daily advice building into a full programme to show you how to review and reduce your cost base, whilst maintaining supply chain resilience. Today it’s about how to start. 

How do we pull together an efficient and effective plan? Where do we focus our efforts to reduce third party costs?  The answer lies in some old school, back to basics mnemonics and models. Our old friend KISS should be retained at forefront of mind.  Keep It Simple Stupid!  Let’s not over complicate things.  

The starting-point and key model to guide our efforts to address third party costs (the spend) is a simple four-box matrix and for our purposes we use the tried and tested Kraljic Matrix (see Fig.1).  

The Kraljic Matrix segments total spend into four classifications, based on two important parameters:

  1. Supply Risk – the higher the supply risk the less ability your organisation has to conduct its business, at least in the short term, should the supply position fail or be interrupted.
  2. Size of Spend – the higher the spend the greater is the financial weight or burden placed upon your organisation and potentially the greater is the scope for making savings.

Spend categories are groups of goods or services which have identical or similar specifications and are sourced from third party suppliers operating in particular markets.  So, the first step is to segment your business’s cost base into spend categories and then map those categories onto the matrix. This requires some category management insight & expertise.   Once completed the matrix indicates the most appropriate strategy to deploy to achieve your business’s sourcing goals, including but not limited to spend reduction.  

We’re going to look at Quick Wins in tomorrow’s article and these tend to be found in spend categories classified as Tactical, either Tactical Acquisition or Tactical Profit. Intuitively that makes sense since these spend categories carry relatively low supply risk.  For example, if the supplier withdraws as a result of being pushed for a price reduction or indeed the market fails, it will not be too disruptive to your business.  These segments are typically defined by being for commodity goods & services, with a high level of competition existing and the ease of changing brand or specification.  

Spend categories classified as strategic, Strategic Security or Strategic Critical carry a relatively high level of Supply Risk meaning that in the event of a supplier or supply market failure the impact on the ability of your business to conduct its activity could be really severe. So best not to try and get any quick wins here, you might trip-up! We’ll address your approach to these categories on day 5 of this Programme.

In the meantime, if there’s anything we can do to help please email me, Jonny Michael at j.michael@jmclconsulting.com.