Supply Chain Cost Reduction: Where the Money Actually Goes

Supply chain costs often represent a considerable percentage of the sales price of a good or service. Cost savings flow directly to the bottom line.

If net profit on sales is 5%, a reduction in supply chain costs from 9% to 4% (or from 12% to 7%) will double net profits. That’s the attraction of cost reduction in a supply chain: profits can be increased without having to increase sales.

The field for potential reductions is wide open. Given the complex, multi-faceted nature of modern supply chains, there are many areas where savings can be found. But they can’t be reduced in isolation.

Breaking a supply chain down into its components is the only sensible way to see where the opportunities lie. Even so, cost reductions and their impacts must always be assessed for the supply chain as a whole. Careless cuts in one part will end up increasing costs elsewhere, and you’ll have gained nothing.

What Does Your Supply Chain Cost You Today? And What Should It Cost You?

Running a spend analysis is the first step to understanding what you’re spending, and therefore where you might look for savings. Depending on how your systems are set up, this may be information you can pull out of existing databases quickly.

If not, this is the right time to invest in a suitable IT solution. The data will change, and you’ll need it again to maintain and consolidate savings later. Let’s see some example supply chain costs as a percentage of sales, by industry sector:

Industry Sector	Best-in-Class	Industry Average
Pharmaceutical	<5.3%	6.3%
Manufacturers	<6.8%	10.3%
Retail Suppliers	<5.8%	8.6%
Industrial Suppliers	<7.9%	13.2%
Distributors (Local)	<6.3%	10.6%
Distributors (Import)	<6.0%	10.2%
Food & Bev Ambient	<4.3%	7.6%
Food & Bev Chill/Frozen	<8.0%	10.7%

Your spend analysis and this basic benchmarking will show you where you are, and where you could be. They also give you better negotiating information for suppliers and other third parties contributing to your operation: transporters, warehousing companies, product assemblers and the rest. More detailed cost benchmarking from an expert will help further still.

Be aware that individual costs move at different rates. Oil prices were relatively low for much of the period between 1984 and 2004, while labour and technology costs changed more quickly. That encouraged enterprises to make more use of parcel and air transport. When oil prices rose, so did those transport prices, and the smarter enterprises shifted their focus to re-balancing supply chain spend in light of the new situation.

Three Fundamental Areas for Supply Chain Cost Reduction

A cost reduction programme may end up being executed from the bottom up, but the analysis should start at the top. That keeps the big picture in view and improves the chances that you’ll scrutinise all of the right areas, departments, categories and elements.

1. Transaction Costs

The act of placing or accepting an order can be surprisingly expensive once you add in issuing and managing invoices, organising deliveries, responding to customer queries and checking progress.

Following a workflow from the arrival of an order through to delivery and invoicing is one way to estimate these costs, although inefficiencies in the workflow itself may still be hiding more expense.

Some of the cost comes from overly complicated processes. Some of it comes from poor information sharing, caused by a reluctance to collaborate. Technology such as e-commerce platforms will solve the first problem. It won’t solve the second. That part only improves when people work together better.

2. Mismatched Processes

Within an overall process, such as “order supplies and produce finished goods”, there may be several separate processes: the supplier’s own process to deliver, the reception and stocking process within the client business, and so on.

If the end of one process doesn’t dovetail with the beginning of the next, you get interruptions and duplicated work. Both increase costs and both make further cost reduction harder.

If a supplier’s product codes or pallet sizes don’t match those used by the client, for instance, products have to be recoded and reorganised. In the consumer packaged goods sector this problem is big enough to have prompted collaborative planning, forecasting and replenishment (CPFR) between manufacturers and retailers. The same idea works in other sectors.

3. Uncertainty

Those who don’t know what will happen take out insurance. When the uncertainty is in demand and supply, the insurance is stockpiling inventory just in case.

That happens at every level. Producers don’t know which orders they’ll receive. Resellers and end-customers doubt the producer’s ability to supply when needed, so they hold their own buffer. Safety stocks grow at each juncture of the chain, from raw materials to work in progress, from finished goods to regional distribution centre holdings.

Holding inventory costs money in more ways than one. It costs money to store and manage, it consumes working capital and blocks the income that capital could otherwise earn, and it increases the risk of writing off obsolete stock. Depending on the item, holding it for as little as a month can eat up its entire profit margin.

From Improved Processes to Lower Supply Chain Costs

From those three areas, it becomes clear that savings depend on having the right information, the right processes, and a properly optimised supply chain.

Speeding up a fundamentally inefficient process, such as recoding and reorganising goods on receipt, still leaves cost reduction on the table. Fix the process first. Once the right strategic processes are in place, the opportunities for tactical improvement tend to be plentiful.

Economies of scale. These may be available in supplies ordered, but also in batches of goods manufactured or assembled, spreading overheads like setup time over larger numbers of products. Learning time for producing a particular article or delivering a certain service can also be amortised over more iterations of the same process.

Smarter use of storage. Using too much space is costly. So is having employees spend too long looking for items. Better use of space, and better information about what’s stored where, will both produce savings.

The right system is the one that makes sense for your organisation, not the one that made sense for somebody else’s. Amazon uses a system of “chaotic storage” based on barcodes rather than product categories, which makes its operations more accurate and more efficient. It would be a poor fit almost anywhere else.

Accelerated movement of supplies. When supplies move faster you can order later and hold them for less time, which means lower inventory holding costs and less risk of loss or damage.

A better ordering system. One central system, and the bare minimum of people needed to raise and authorise an order.

A Grocery Chain Reduces Costs by Minimising Touch Points

Costco is one of the largest grocery retailers in the United States, with net sales of $269.9 billion in its 2025 financial year. A big contributor to Costco’s cost position is the elimination of product handling stages between supply and sale.

The chain buys most of its merchandise direct from manufacturers. Supplies are delivered to a network of cross-docking points, where truckloads are consolidated for onward delivery to stores.

Allocation and shipment to stores is generally done in less than 24 hours. Wherever possible, merchandise is handled in full pallets without being broken out into individual cases. The first time an individual item is handled on its own is when a customer picks it off a rack to buy it.

Like the Amazon example above, this works for Costco because it fits the kind of retailing Costco does. The low-touch method relies on moving huge volumes through large stores, restricting choice to a limited number of lines with few packaging options. Customers often have to buy in multiples. Forklift trucks operate in the same space as shoppers, though not at the same time, giving the store a warehouse feel that suits Costco’s low-cost positioning.

Balancing Cost Reduction and Good Service

Squeezing costs down is self-defeating if it puts customers off. The Costco warehouse-style approach works because it fits what Costco’s customers expect. Customer satisfaction comes first, and cost reduction has to sit behind it. That said, cost reduction and good service aren’t always opposed. Sometimes cutting cost improves service.

Packaging is the clearest example. In consumer packaged goods particularly, wasteful packaging is everywhere. It costs the seller retail shelf space and it gives the consumer the nuisance of disposing of a pile of cardboard and plastic after the purchase.

Optimal packaging techniques fit the packaging to the product dimensions using the least material possible, at both unit and case level, with reported material savings of 10 to 25%.

Optimising Your Supplier Base

Whether “supplier” means the business delivering raw materials or subassemblies to your factory, or a third-party service provider such as a shipping or logistics company, there’s a happy medium between using too few and sacrificing competitive prices, and using too many and sacrificing economies of scale.

Geography matters too. Money saved through fast, local resolution of problems can justify paying a few dollars more for the goods or services themselves.

Over time, businesses have developed a number of approaches to increasing supply efficiency and reducing supply costs.

Integrated supply. One supplier handles the supply and warehousing of all the materials for a particular product line. In this vendor-managed inventory arrangement, items may be stocked at the customer’s site or in the supplier’s warehouse, depending on the overall cost advantage to the customer.

Just in Time II (JIT-II). Supplier employees are stationed at the customer’s site to improve communication, coordination and procurement with the supplier. Usually reserved for large, frequent order quantities. In manufacturing, the approach was pioneered by Bose Corporation, the hi-fi manufacturer based in Massachusetts.

Supplier city. Suppliers co-locate close to the customer’s site to hold all the inventory the site needs to function. Typically used for large manufacturing plants or complexes.

Distributor cooperative. Distributors come together to offer their combined product lines. A customer dealing with one distributor can order the products of the others through the first, cutting down the number of contacts and processes the customer has to manage, and often reducing geographical distance too.

A related development in retail is continuous replenishment, sometimes called efficient consumer response, which Walmart and Procter & Gamble did more than anyone to establish. The mechanism differs from JIT-II, but the principle is the same: replenish stock continually rather than hold inventory.

Not Every Cost Reduction Is a Success

It would be unrealistic to assume every kind of cost reduction is beneficial.

Slashing transport budgets, for instance, usually means holding higher levels of inventory. When inventory contributes more to overall supply chain cost than transport does, as is often the case, that’s back to front. Overall costs may well be reduced by increasing transport spend instead.

The hurdle for most companies here is mindset. They treat the transport department solely as a cost centre and set out to reduce those particular costs, and the result is a false saving.

Sole sourcing produces the same kind of false economy. Consolidating a category down to a single supplier looks efficient on the procurement scorecard, and it concentrates risk in one place.

On 1 February 1997, a fire destroyed the Aisin Seiki plant in Kariya, Japan, which produced around 99% of the brake proportioning valves used in every Toyota vehicle. Toyota’s plants held roughly four hours of stock. Almost the entire Toyota group in Japan shut down.

It was only because more than 200 firms across and beyond the Toyota supplier network improvised alternative production, in some cases having never made a car part before, that assembly restarted after two days rather than the weeks that had looked inevitable. The recovery is rightly held up as a case study in supplier collaboration. The exposure that made it necessary came from putting a critical part in one building.

Running a Cost Reduction Programme

Identifying savings is the easy part. Realising them and keeping them is where most programmes come unstuck. Four things make the difference.

1. Start with the analysis, not the target. Plenty of businesses set a percentage reduction figure first and then go looking for ways to hit it. That’s how you end up with cuts that shift cost sideways rather than removing it. Work out where the money actually goes across procurement, production, transport and inventory before you commit to a number.
2. Bring the affected departments in early. A saving in transport that lands as a cost in warehousing will be resisted, and rightly so, unless the people involved can see the overall picture and are measured on it. Cost reduction fails more often for political reasons than technical ones.
3. Renegotiate contracts on the basis of good data. Your spend analysis and benchmarking give you the negotiating position. Volume consolidation, longer terms in exchange for better rates, and a hard look at what you’re actually buying will usually produce more than an aggressive round of price pressure.
4. Measure it afterwards. Savings decay. Set KPIs at the start, track them past the point where the project is declared finished, and expect to find that some of the savings have quietly reversed.

The ideas in this article will help you get into the right mindset for finding cost reduction opportunities and acting on them. If you’d rather move quickly and start seeing results sooner, our consulting team can give you more direct, hands-on help.

Where to Start

Effective cost reduction relies on a macro view as well as a micro one, and on mental flexibility, all while staying aligned with your overall supply chain strategy. Anyone still working in silo mode will be blind to the trade-offs between departments that produce the best overall result while protecting customer service.

Anyone who applies somebody else’s cost reduction programme without thinking will likely end up disappointed and out of pocket, for much the same reason.

There are general principles that give you good starting points. Benchmarking against your industry is one. “Information rather than inventory” is another.

From there, work on the specific characteristics and needs of your own organisation, compare the techniques and solutions available, and build your own cost reduction programme the same way you built your own supply chain.