A beginner’s guide to cost benchmarking

The award for the most basic and easy-to-use procurement tool goes to cost benchmarking. Here’s a how-to guide. 

Cost Benchmarking is a method used to compare the cost of a product, service or supplier against the market or its competition.

Benchmarking can be used to:

1. Quickly test a potential new supplier’s pricing to see if they are worth investigating

2. Finding out what market rates are

3. Ensuring incumbent suppliers remain competitive in the market

4. A negotiation tool for cost reductions.

Here’s how to run a benchmark exercise:

Step One – What to benchmark

Pick a spend category or supplier in which you wish to benchmark. Complete a spend analysis on what you have purchased in that area over the last 12 months by line item into an excel spreadsheet. Sort the data from the highest to lowest spend. Then highlight 80 percent of the spend. This will normally be less than 20 percent of the line items and should be a manageable amount of data to go out into the market place with as well as capturing the majority of your spend.

Obviously, this does not cover every aspect of the potential scope of supply and in certain circumstances additional items may need to be added such as bottle-neck and specialised items. The idea is to gain an idea of the market rates. This is not a fully comprehensive tender for instance, but it will help you decide if a full tender or RFx will be worthwhile completing.

The incumbent supplier should be made aware and accept this benchmarking exercise. If they are not happy with this process taking place, this is probably because they’re not happy with you discovering where their prices fit against market rates.

Step Two – Going out into the market

Once you have selected the items that you will put into your benchmark, add these into a simple standard Request For Quote (RFQ) document that can easily be sent out to the market. In this document allow the suppliers to add their pricing to your specific items, including your estimated annual volumes and any other specific requirements such as delivery terms, batch sizes, T&C’s and so on. Set a clear reply by date so you can plan your workload.

To ensure you are covering enough of the market to find out what market rates are, it is recommended that you go out to five to ten suppliers if possible. You are likely to miss out on a vast amount of information and potential data if you just go out to the standard 3 quote rule.

To find potential suppliers, utilise the internet, trade shows, trade magazines, engage your business networking/recommendations and advertise on your company’s website.

Step Three – Results analysis

Enter all of the supplier’s responses into a simple excel spreadsheet and use the excel tools to determine the price difference between what you currently pay from the incumbent supplier against each of the potential new suppliers.

You will now be able to show what the best market rates are, what the worst market rates are, what the average market rates are, as well as identifying where the incumbent supplier fits into this.

Step Four – What next?

If you are happy with where the incumbent supplier’s pricing fits in comparison to market rates, then it illustrates you have selected and are working with well priced suppliers. You can still use this benchmark to send to new, potential suppliers who may come knocking on your door to see if there prices are worth investigating.

If you are not happy with where the incumbent supplier’s pricing fits, then invite them into a meeting to discuss the results. You do not have to show the specifics but a simple graph showing where their prices fit against market rates would be a great visual aid to support your cost reduction claim.

If the supplier is willing to accept that their prices are not in line with the market rate then this will be a relatively pain free cost reduction for you. If the supplier is unwilling to negotiate a reduction, then you have the possibility to develop a new relationship with suppliers who have already shown an interest and have the possibility to give you cost reductions.

There are a number of ways you can move forward once you have this information. The key is getting the market rate information. I have seen where a buyer has proudly negotiated a 5 percent cost reduction with his incumbent supplier but a quick benchmark exercise proved that market rates where closer to 40 percent lower than his negotiated prices.

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