10 Golden rules for measuring procurement savings
Measuring procurement savings - every large organisation does it, but everyone does it differently.
How many hours are spent every year debating what constitutes a realised cost saving? Procurement may have one view, finance will have another, the budget holders hold a different opinion. Then the consultants you hired to run a cost reduction programme will have a completely different number entirely.
I’m not going to get into the mechanics of exactly what constitutes a saving here - that topic is covered elsewhere, including in our downloadable benefit type analysis, but here are 10 helpful rules of good practice for savings measurement.
1. Clearly define your savings types and how they are measured.
Key factors here are what’s permissible as a baseline, especially if there isn’t an obvious last-price-paid, how fluctuating markets are catered for, if at all, how first-time or one-time purchases are measured, and how you handle one-off payments like signing bonuses or volume rebates. There’s often no absolute right and wrong, although there is common sense and also good accounting practice. Make sure the definitions are understood by the whole procurement team.
2. Be completely aligned with Finance.
This really goes without saying, but if Procurement is to have any credibility in the business when it comes to declaring savings numbers, the CFO needs to at least be in agreement that the savings definitions and measurement methodology are sound.
3. Reward innovation.
It frustrates us when we talk to companies who think measuring Purchase Price Variance is everything there is to reporting savings. Procurement has evolved far beyond simple price reduction and is now much more focused on adding wider value to the business. With this in mind, make sure that the kind of value that can be derived from lateral thinking is measured. For example what if we don’t buy this thing at all because we can do things completely differently, or what if we actually pay more but we get all this great additional functionality that really helps our efficiency or our sales?
4. Look at the total cost.
Following on from rule 3, remember piece price alone is not everything. Make sure delivery, payment terms, supplier management, one-off costs, life-cycle costs etc. (as far as reasonable) are taken into account when calculating savings. Most negotiations involve some give and take and a price change is not usually achieved in isolation.
5. Understand your cost of capital.
$10,000 now is not the same as $10,000 in 12 months’ time. Make sure you know the value of a signing bonus compared to a retrospective rebate, and how much lower a price on 15 day payment terms needs to be to provide better value than a price at 90 days. Knowing the value of your cash will also help of course in negotiations.
6. Don’t stop tracking procurement savings at point of contract - measure what actually happened.
It’s been documented that up to 40% of cost savings go missing somewhere between the point of contract and the savings actually materialising. Some form of post-contract monitoring, real-time or retrospective validation is key to ensuring a decent level of accuracy.
7. Be accurate, but don’t seek perfection.
As a balance to rule 6, don’t be tempted to take things too far. It can be easy to want to take savings accuracy to the nth degree. This might be possible in some instances, depending on technology and particularly on direct materials, but in many cases it’s simply not realistic to be 100% accurate across the board. Make a judgement call on effort vs return. With a robust process and the right tools, accuracy in the high 90%s should be easily achievable.
8. Don’t forget the increases.
We all love declaring our cost reductions, but how many of us like to admit our increases? It’s a fact of life that these sometimes happen and we can’t completely avoid them no matter how careful we are. If we forget to include these and measure them we only see a distorted picture. We also introduce a disconnect between our reported numbers and what our colleagues in Finance are seeing and lose credibility.
9. Have a clear governance process.
Ensure that savings are approved. The level and type of approval may vary depending on spend, criticality etc., but it’s important that the savings rationale and calculation method are ratified and agreed. Approval should ideally performed by the Finance function to ensure it's not just Procurement self-reporting.
10. Remember it’s a means to an end.
The final rule is to keep the big picture in mind. Savings in isolation don’t mean a whole lot, in fact they could be bad for the business if reduced spend in certain areas is stifling productivity. It’s what those savings bring the business in terms of value that’s important, whether it’s profit, cash or the ability to spend more to fund growth. It’s vital to keep this in focus.
You may recognise all these rules and already follow them. You may have more rules that could be added to the list.
However you measure and report savings, using the right tool to log and report on your activity will make a big difference. It will improve efficiency, accuracy, and help to ensure the correct process is being followed. If you're still using spreadsheets or stuck with a legacy system and would like to see how Provalido could improve things for you, then please get in touch. We're always happy to provide a quick demo or just contact us directly if you have any questions.