Reducing the impact of the National Living Wage on supplier costs
With the recent introduction of the National Living Wage (NLW), anyone aged 25 or over and previously on the minimum wage has received a 7.5% pay increase. That’s good news for workers, but it also means that many businesses are now seeing a rise in direct costs, particularly those who rely heavily on low cost labour.
Industry sectors such as retailing, warehousing and logistics, soft facilities services, and low-tech manufacturing stand to be hardest hit, and with the NLW set for a further 25% increase to £9.00 per hour by 2020, this cost pressure will only intensify. What’s more, the NLW has narrowed the earnings gap to workers in higher pay bands, which is forcing a growing number of companies to increase wages for other employees.
So, if profit margin is the difference between value created and captured, and the cost of creating that value, how do companies that are reliant on minimum wage labour rebalance their business to protect the bottom line? The companies we work with are increasingly seeing the importance of procurement expertise in mitigating the impact of the NLW – through both direct and indirect intervention.
Direct intervention – avoid the issue and innovate
In the past, paying low wages for low skilled jobs has often negated the need for innovation. But with labour costs rising rapidly, many companies are now looking to reduce reliance on minimum wage workers through the introduction of innovative automated technology – from self-service checkouts in supermarkets, to automated dispensing machines in high street coffee retailers.
Technology-driven security services are also helping to deliver savings, as we’ve seen recently with one of our own clients. They previously used a number of security firms across the UK for guarded presence at six sites, but were hit by rate increases of 3-11% when the NLW was introduced. After engaging our help, we commissioned an audit of each site to assess whether technology such as remote monitored CCTV and infrared perimeter detection could be introduced.
One site was able to switch to a completely technology-driven solution, realising a 33% reduction in cost, while the introduction of technology at a second site reduced the security guard’s duties and allowed him to take on additional administration work as well. These changes gave the security services provider higher margin returns and enabled us to leverage traditional purchasing levers to secure cost benefits at the other four sites. The overall result was a 10% cost reduction across the client’s entire security spend.
Indirect intervention – accept the issue but find savings elsewhere
To claw back margin without addressing labour cost, businesses need to optimise their indirect spend. Normal procurement techniques such as introducing competition will usually deliver results, for example through bundling or supplier rationalisation. But the most effective strategies involve a detailed analysis of all purchases to get a clear picture of where costs can be reduced.
Value chain mapping is a powerful tool that enables each element of the product purchase to be broken down at every stage and highlights exactly where value and cost are added. This understanding opens up the potential for challenging costs and provides the visibility required to identify previously hidden savings opportunities.
The process involves drilling down into the Bill of Materials (BoM) for each purchased good and then assigning value creation to each level – and at sub-tier or multiple sub-tier levels if appropriate. For each part of the BoM, it should be clear where the purchase comes from and what is the key cost driver and the key value added activity. As a result, cost control becomes more manageable and a number of alternative strategies can then be considered.
Buy products from value-adding suppliers
Over time, companies often take on the supply of products outside their core competence. This has benefits for the purchaser because it rationalises the number of suppliers – but it always comes at a cost. Realigning products with the most appropriate supplier will usually yield cost savings.
Understand and control sub-tier cost to ensure margin is paid only on value-added activity
This approach is based around the principles of a directed-buy strategy where suppliers are instructed to purchase a key product or material from a nominated supplier who has a direct contractual agreement with the end-user. It’s a strategy often used by companies that need to hedge against the volatility of commodity prices, for example, and it enables them to split out the true cost from their suppliers value-adding cost.
Clear visibility of material input cost and the value-adding supplier cost strengthens the negotiating position through a deeper understanding of the supply chain and also helps to control supplier relationships for mutual benefit, regardless of whether a directed-buy strategy is implemented.
For example, we recently conducted a value chain mapping exercise for a client on a leased refrigerated van fleet. By assessing the value chain, we could focus on each key value-added component and evaluate the options of directed-buy, free issue material and supply competition. We were able to validate that the supplier was performing well, but had overlooked the potential for one specific component.
After interrogating the sub-tier supplier of this component, a large value-added assembly, we found that it had a life greater than its historical usage. By reusing this component on future lease vehicles a significant saving was possible – and this was despite like-for-like competitive benchmarks showing that savings were not achievable.
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