Leverage Alone is Not Enough: Why Hotel Operators Should Consider Supplier Expenses as Part of their Procurement Strategy

Posted by: Stuart Amoriell | President, Seva Procurement on Jun 4, 2014 at 12:35 pm |

It is not uncommon to observe hospitality operators and department managers adopting a procurement strategy rooted in conflict and competition rather than supplier partnership.  This strategy seeks the best product price through the application of continuous pressure on the supplier, and while this may seem like a logical stance, in reality, leveraged negotiation is only one piece of a comprehensive procurement strategy.  Any successful solution must also attempt to understand supplier expenses so that costs can be limited and pass-through savings captured by the operator. The following article examines the savings available to hotel and hospitality operators by moving from transactional purchasing to a strategic procurement solution that includes adopting supply chain efficiencies as a major component.

The importance of considering supplier expenses can be summarized in the following example.  If a supplier’s total cost of delivering a case of product to your location is ten dollars, then leveraged negotiation will never generate a price that passes below this break-even point.  However, if your organization can work with supplier partners to lower the break-even point below this ten-dollar threshold, then the result of leveraged negotiation plus expense reduction will ultimately produce significantly more value than leverage alone. 

Before proceeding, it is probably worth making a quick note about profit margins and loss leaders.   Seva recognizes that the previous example only holds true when referring to average case prices and profit margins with suppliers.  A conflict-driven supplier strategy that seeks to apply constant pricing pressure may, in fact, result at various times in individual product cases being sold below supplier cost, but this is not a victory for the customer. There are basic economic realities that need to be recognized when developing a procurement strategy, and it is important not to disregard these realities and confuse good negotiating skills and purchasing strategy with something that is too good to be true.  One of these realities is that no viable company will service an account at a continued loss.  Therefore, while loss leaders exist and your personnel may very well be able to get a supplier to sell a product at or below cost from time to time, the ultimate result will always be that other products are marked up at a higher rate to offset the loss leader and create an acceptable average account margin with that supplier. We often compare loss leaders as a slight of hand trick employed by a magician, but while this may be a good analogy, it is also a bit unfair to the supplier.  For the most part, suppliers play the loss leader game because those are the ground rules set by the customer.

With this in mind, the following examination of expense reduction considerations assumes that we accept the fact that while some products may be loss leaders, when taken on average, a supplier will not maintain a relationship with an operator at a negative margin.  Therefore, driving the most procurement value to your organization will always be the result of both leveraged negotiation and supplier expense reduction to achieve the lowest overall margin possible. 

The following are several ways to work with your suppliers to achieve this goal:

  • A critical method in reducing supply chain expenses is maximizing your drop size with those suppliers that provide routine delivery of products, such as foodservice broadline distributors.  Consolidating your orders as much as operationally possible will have a significant impact on their costs and understanding these potential savings will enable you and your team to negotiate incentives and lower margin structures based upon agreed delivery metrics.

  • A supplier expense that operators often overlook (but never the supplier) is the operator’s performance against accounts payable requirements.  Ensuring that you are current with accounts payable helps to ensure that you are in the strongest position possible to negotiate the best available pricing program. Additionally, most operators are able to negotiate early-pay incentives should they opt to pay their bills in less than the traditional net-30 manner.

  • As every business operator knows, there is a significant cost to accepting credit cards from customers.  While many operators feel that suppliers should accept these costs just as they must do with their customers, the reality is that if you work with your supplier to find less costly payment methods, this savings can be passed on as lower margin.  We all love our reward points, but make sure you understand their true cost.

  • Reducing your reliance on a supplier representative is also a significant step toward reducing supplier costs.  By embracing e-procurement and inside sales to place routine orders and using a representative only for higher-level support and product issues, operators are able to negotiate lower margin structures due to the lower cost of service for the supplier.  Relying on a representative to be on-site to take orders and work up weekly, routine bids ensures that all of the costs to produce this are passed on in the final price to the operator.  Negotiating a supplier contract that balances service requirements with financial goals will result in a lower overall margin.

  • Defining the rules of a supplier relationship up front through execution of a proposal and contracting process is critical in controlling costs.  While Seva is not opposed to supplier bidding, this process should only be utilized as part of a structured, clearly defined contracting process that seeks to establish a long-term relationship, not bidding as part of a transactional purchasing process with every product order—better known as “cherry picking.”

  • Few things are more costly to a supplier than frequent operator ordering mistakes.  The more an operator can do to ensure personnel are following best practices to limit these issues, the more credibility and leverage they will have with suppliers during contract negotiation.  If a supplier reviews the prior record of an operator and realizes that personnel seem to always be requesting off-day deliveries to recover from mistakes and missed orders, or are unable to follow a routine set of delivery days, then the supplier will most likely hold back on providing the best margin program possible due to a belief that the cost of service will be slightly higher than with efficient operators.

  • Another powerful way to reduce mistakes, as well as reduce human labor costs, is to use online ordering.  These days, most vendors provide e-procurement options to their customers.  Additionally, Seva Procurement members have access to a multi-vendor e-procurement system that enables personnel to place all of their orders electronically utilizing a single, web-based platform.  Over the years, as online ordering has become a proven best practice, significant research has been compiled that clearly indicates that not only does electronic ordering reduce service costs by not having a dedicated order taker, but far fewer mistakes are made when ordering electronically versus manually. 

  • Operators can also reduce costs by planning ahead.  If personnel know they will be making a product purchase that is outside the set of routinely ordered products from a vendor, then it is advantageous to provide the supplier with as much advance notice as possible.  Not only does this enable the supplier to find the most affordable and efficient way to source the product, but provides sufficient time for the supplier and operator to discuss potential cost saving alternatives.  A common example of this for hospitality operators would be linen and terry purchases.

  • When negotiating contracts with suppliers, be cognizant of standard costs and don’t hold suppliers to an unrealistic standard.  For example, blindly requiring “free shipping” on products from suppliers that deliver via third-party shipping is not a realistic stance, as there is no such thing as free shipping, just shipping that the supplier pays and then passes on as higher prices to the customer.   In such cases, an operator should work to negotiate the best possible pricing program that separates shipping in the pricing formula.  This way, by working together, the operator can attempt to reduce this expense and capture the resulting savings.

While all of these methods can be employed as part of a comprehensive procurement strategy that will result in the best possible pricing structure with your vendors, Seva also understands that the successful implementation of these processes is not always a simple task, especially if an operator does not have personnel with specific domain expertise for each product category.  In fact, it is typical to discover that most hospitality personnel buy into the premise of this article, but that they lack sufficient understanding of the suppliers’ businesses to accurately gauge a fair price and understand exactly what to expect in efficiency gains from utilizing these strategies.  Often, this lack of understanding inevitably leads back down the slippery slope of cherry picking, as no operator is keen on instituting these supplier efficiencies if the savings are kept by the supplier and not passed through to the operator.

There are two main ways to combat this issue.  First, you can employ purchasing professionals with specific domain expertise in each product area.   Unfortunately, the overhead costs associated with such resource investment often offsets the potential savings that can be gained.  To be clear, by supplier domain expertise, we are not referring to expertise on the quality or utilization of the product ordered by hospitality personnel, but rather expertise in the manufacturing and distribution business models and the input costs that ultimately drive the price of the products. 

As directly employing this level of domain expertise across all product categories is typically cost prohibitive, operators will often gain access to this expertise by leveraging procurement services organizations, such as Seva Procurement, that are able to spread this overhead across a much bigger spend base, providing economies of scale benefits to member operators. 

If you would like to understand more about how Seva Procurement can assist your operation with reducing your cost of goods and services by driving supply chain efficiencies or to learn whether Seva is the right solution for your business, please do not hesitate to contact us.  If you made it through this entire article and got to this sentence…your dedication to managing a quality, efficient, and effective organization should be commended.

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