Purchased goods and services can account for 50 to 80 percent of a company’s expenditure. It is hardly surprising, therefore, that after pricing, reducing purchasing costs is the most powerful way to improve shareholder returns, and that most companies have at some point embarked on a purchasing cost reduction program (Exhibit 1 and Exhibit 2).

What is surprising, however, is that many executives still believe the benefits of better purchasing and supply management (PSM) begin and end with a one-off cost reduction, essentially achieved by telling their purchasing departments to lean on suppliers to cut prices.

Those executives would do well to think again. For, properly managed, PSM can give companies a network of suppliers capable of delivering the technology, knowledge, products, or service quality that will beat competitors, at the same time as securing ongoing cost reductions. There are many examples. A leading fast-food company cut the number of its suppliers so that it could work closely with the remainder to improve their performance. The result has been not only annual cost reductions of 4 to 5 percent over several years, but faster product development and innovative packaging that sees the company now selling its food in unique...