Measuring procurement savings - don’t you just love it?
How many hours are spent by organisations every year discussing and arguing about 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 debate of whether spending less but at a higher price is a saving (“we managed demand”), or spending more but at a lower price is a saving (“we reduced the cost-per price”), but here are my 10 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.
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 makes me sad when I talk to companies who think measuring Purchase Price Variance is everything there is to measuring 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. 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 service that really helps our efficiency?
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.
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 a well-documented fact 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 adjustment 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, 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.
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, to help standardisation and provide credibility.
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 or the ability to spend more to fund growth. It’s important to keep this in focus.