Spend Matters welcomes a guest post from Kurt Albertson of The Hackett Group. Kurt Albertson is an Associate Principal with The Hackett Group managing Advisory Programs and benchmark offerings. Mr. Albertson works with Fortune 100 companies providing strategic direction and best practice business advice within Procurement and Finance.
The Hackett Group has long stressed the importance of viewing procurement and cash disbursements as an end-to-end process in order to maximize value. While many of the benefits of an end-to-end approach are "soft," the benefits from greater alignment around an organization's payment strategy is one example of "hard" spend savings in line with Procurement's bread-and-butter value proposition. Too frequently, "how" a supplier gets paid is left in the hands of finance to architect with objectives related to efficiency, on-time payment rates, and working capital. The Hackett Group, however, sees a change in the CPO's interest around the payment strategy as the benefits to spend reduction have become more evident and attainable.
Spend cost reduction is supported through the payment strategy in two primary ways: 1) taking discounts for paying suppliers early and 2) achieving rebates for settling with suppliers via a purchasing card program. The Hackett Group's metrics show that those that aggressively pursue a strategy of achieving spend cost reduction through their payment strategy deliver between $1.2 and $2.3 million annually per billion of addressable spend. And we see from our studies that the majority of organizations recognize these benefits as "hard" savings. For a typical company that The Hackett Group benchmarks, this is approximately $10 million annually of spend cost reduction "simply" from optimizing how suppliers are paid.
I say "simply" tongue-and-cheek.
Conceptually, the strategy for achieving spend cost reduction through the use of early payment discount or a purchasing card payment is pretty simplistic. Certain suppliers value working capital to the extent that they will pay for the privilege of accelerating their receivables--so let them do so and collect a discount/rebate for the privilege. Whether a buyer should leverage an early payment discount or a purchasing card program is simply a matter of whether the buyer would like to fund the accelerated payment or outsource this to a third-party provider to do so on their behalf. This decision should naturally hinge on the buyer's cash position and their level of focus on managing their own working capital. If I am flush with cash, pursuing a strategy of self-funding, the spend reduction makes sense. If not, then leverage a purchasing card provider to do so and pay them a small fee (e.g. the difference between the rebate and the early payment discount rate) to fund the spend reduction opportunity.
This first brush perspective, however, leaves out some critical analysis around the complexities of implementing rebates versus purchasing card programs and fails to take into account the different profiles and value propositions of perspective suppliers. In truth, The Hackett Group sees organizations employ both strategies to optimize the level of spend cost reduction--achieved with dependencies around the focus on working capital, maturity of the Procure-to-Pay function, and supply base profile.
As mentioned, another critical consideration that must be factored into the payment strategy is the maturity of the procure-to-pay function. It is reasonable to assume that an organization with an immature procure-to-pay function will have the following characteristics: non-consolidated supply base, poor spend visibility, poor adoption to standard payment terms, low adoption of POs and preferred suppliers, little alignment between Procurement and Finance, minimal process automation, and long invoice processing cycle times. An organization with such a profile will need to take into account the limitations posed by its immaturity when formulating its payment strategy and understand the impact on potential benefits. Some of the common problems encountered include:
- Lack of internal compliance to the use of preferred suppliers or a formal purchasing process
- Preferential payment terms based on supplier paper as opposed to standard buyer terms
- Push back from sourcing managers on negotiating extended net and early payment terms
- Inability to pay an invoice with duration needed to earn early payment discounts
- Fragmented supply base requiring an unmanageable number of suppliers for program adoption
- Lack of visibility to suppliers that are good candidates for adoption to either an early pay discount or Purchasing Card program
These factors will hamper the success of an organization's ability to drive spend reduction through its payment strategy and also dictate the extent to which an organization will be successful at leveraging early payment discounts versus purchasing card programs.
Let's take for example the standardization of payment terms, which is foundational to the success of both an early payment discount and purchasing card strategy. The primary benefit to a supplier for offering a discount or paying the fee on a purchasing card is that they get their cash faster. How much faster depends on the net term attached to their payment.
This brings up the first hurdle encountered by many organizations that embark on a payment optimization strategy: standard payment terms. Organizations have generally viewed terms extension programs through the lens of improving their working capital position, which means that many companies with lots of cash (e.g. financial service firms, oil and gas companies) felt little need to trouble themselves with such efforts. These same organizations, however, do value spend cost reduction and as they pursue the optimization of their payment strategy to drive spend reduction they out of necessity must address the terms standardization and extension issue or find that supplier have little incentive to participate. Many immature organizations for example, pay based on terms stipulated by suppliers if no contract is in place (or even if there is in some cases) or pay suppliers immediately upon processing the invoice. Other organizations have net 30 as a standard term--even through most industries have moved to net 45 or 60 for many supply markets.
So before an organization can optimize its payment strategy, standardization and extension of terms is a basic requirement regardless of working capital objectives. And once again, while a terms standardization effort seems simplistic in theory, the devil (and program success) is in the details.
The Hackett Group has helped many organizations optimize their payment strategy although throughout the recession quite often the objective for an organization was working capital related. And as large organizations standardized and extended net terms, they did indeed see working capital benefits from related to longer DPOs. A side benefit, however, that many organizations have yet to fully realize is the opportunity to reduce spend through the pursuance of a combined strategy of early payment discounts and settlement via purchasing card programs.