How the “Profit Leverage Effect” Works When Using Reverse Auctions

The Profit Leverage Effect in purchasing tells us that if your organization must find ways to reduce or contain costs, the best place to start is in the Purchasing function. This is because a high percent of many organizations’ total costs are in purchased goods and services. When cost containment becomes a strategic necessity, whether due to reduced sales or revenues, high labor costs, or other factors, companies too often focus on cutting costs in areas such as labor and overhead rather than on purchasing. It is too often assumed that it is easier to implement job cuts than it is to reduce purchasing costs.

For example, as an industry average, 60{da74ea48cec7d1c659e4125ffe517180d7bd6cbbe5631d32f11d21c45900f39b} of all sales dollars are spent on purchased materials, and therefore, small changes in the cost of purchased materials result in large changes to profit. So if your business spends 10{da74ea48cec7d1c659e4125ffe517180d7bd6cbbe5631d32f11d21c45900f39b} of the revenues on labor and salaries and 25{da74ea48cec7d1c659e4125ffe517180d7bd6cbbe5631d32f11d21c45900f39b} on overhead, then your profit is an industry average of 5{da74ea48cec7d1c659e4125ffe517180d7bd6cbbe5631d32f11d21c45900f39b}. A five percent reduction in purchased costs will result in a three percent impact on net income ~ (.05 X 60{da74ea48cec7d1c659e4125ffe517180d7bd6cbbe5631d32f11d21c45900f39b} = 3{da74ea48cec7d1c659e4125ffe517180d7bd6cbbe5631d32f11d21c45900f39b}). This will boost your profits up to 8{da74ea48cec7d1c659e4125ffe517180d7bd6cbbe5631d32f11d21c45900f39b} from 5{da74ea48cec7d1c659e4125ffe517180d7bd6cbbe5631d32f11d21c45900f39b}, resulting in a 60{da74ea48cec7d1c659e4125ffe517180d7bd6cbbe5631d32f11d21c45900f39b} increase in profits. In conclusion, a 5{da74ea48cec7d1c659e4125ffe517180d7bd6cbbe5631d32f11d21c45900f39b} reduction in purchase costs will result in a 60{da74ea48cec7d1c659e4125ffe517180d7bd6cbbe5631d32f11d21c45900f39b} increase to profits.

Reducing your procurement costs will also help your company in a highly price competitive market. Your company most likely will be losing margin as lower prices are required to compete in your market. If you can reduce your purchasing costs, then you will be able to lower prices without losing your profit margin.

Fortunately, e-sourcing technologies like reverse auctions have become affordable, easy to implement, and are being used by mid-market and small organizations to control purchasing costs.

While reverse auctions cannot be used to procure everything, they can make a positive impact in the profitability of your company without implementing painful decisions.

You can visit eDynaQuote for examples of reverse auctions that companies have been successful with.