Study confirms reducing supplier costs more effective for improving profit
Sep 9, 2013 3:08:00 AM
CHICAGO, IL and LONDON, UK - September 9, 2013 - Proxima today released the results of a global study of nearly 2,000 publicly and privately traded companies, examining trends in spending and implications for profitability.
The research demonstrates that companies are continuing to externalize their cost base, concentrating a greater portion of spend on third-party suppliers. As a result, reduction and efficient management of non-labor costs will have a much more pronounced and positive impact on profitability than headcount reductions.
Key findings from the research, corporate virtualization: a global study of cost externalization and its implications on profitability, include:
- Among companies analyzed, 69.9% of revenue is directed toward externalized, non-labor costs with only 12.5% going toward internal, labor costs
- In nearly half of the companies analyzed, labor costs account for less than 20% of revenue, while non-labor costs chew up more than 60%
- In the last three years alone, companies have increased their external spend as a percentage of revenue by nearly 4%
- Conversely, labor costs, as a percentage of revenue, have declined by just over 1% during that same period
- A 1% reduction in non-labor costs would mean a 4.1% (or $115 billion) uplift in EBITDA, while the same reduction in labor costs would only accrue a 0.7% ($21 billion) increase
"Our research demonstrates quite conclusively that the notion of 'Corporate Virtualization' is a very real and continuing trend," said Matthew Eatough, CEO of Proxima. "The definition of a 'Company' has undergone a dramatic transformation as a significant portion of revenues are now being spent outside the organization with third-party suppliers. It is therefore incumbent on the C-Suite and broader executive team to mitigate this externalized risk by having more complete visibility into the extended supply chain and to ensure it is being managed properly."
This latest research initiative corresponds with Proxima's 2012 UK study of FTSE 350 companies that found that a 1% reduction in non-labor costs would result in a 3.6% EBITDA lift, while a similar labor cost reduction would only offer a 0.8% increase. Taken together, the results strongly suggest that efficient management of non-labor costs will have a more pronounced and positive impact on revenue and profitability than headcount reductions.
"Companies tend to look to headcount reduction as a first response to economic uncertainty and as a means to improve financial performance," Eatough continued. "It's an inherently flawed approach. Instead, companies should direct efforts to tightening management of the supplier base, which can result not only in revenue lift but better operational performance, increased innovation and improved risk mitigation. Getting it right can help support growth and develop the organization's point of differentiation."
In an analysis of companies by industry sector, Proxima found that certain sectors have more to gain. According to Proxima's P-PEP index, which analyzes the ratio of labor to non-labor costs, retail companies have the greatest opportunity to lift profitability by addressing non-labor costs, given its reliance on a complex network of global suppliers. The automotive and healthcare sectors also ranked atop the P-PEP index.
"We're not surprised to see the Corporate Virtualization trend continue across a number of sectors given the variety of drivers pushing companies toward increased third-party spend. The nature of logistics, the increased focus on specialization and the belief that externalizing costs removes HR burdens from the organization have all played a large role in the changing definition of the Company," concluded Eatough. "That said, the sourcing that is needed to enable all of this brings its own unique set of reputational and operational risks. Companies can mitigate that risk and drive innovation through a more intelligent and strategic approach to their supplier partners. As the research suggests, there is significant bottom-line incentive to do so."