Spend Matters welcomes this guest post from Paul Gurr, managing director at Provalido.
An obsession with savings can give anyone a bad name. If you’re a procurement professional, however, chances are you will be measured, at least to some extent, on savings. Even if you have a value-based measurement system, savings in some form will still likely deliver a portion of that value.
Although everyone measures savings, there are remarkably few areas of consensus around how to actually do it. Practitioners have spend countless hours debating exactly what constitutes a saving, and although different organizations will have valid reasons for wanting to measure things in a certain way, there are a few principles that can help when considering savings measurement. Here are seven you can start applying today.
1. Clearly Define What You Will Measure
Ultimately, this should, of course, be broader than just savings — It should look at all of the elements of procurement that are most valued by the business. But here we are just looking at the savings aspect.
What types of savings are viable? Is cost avoidance something that should be measured? What baseline is acceptable? How are one-time savings measured? Do you claim savings for 12 months, or the duration of a contract, and why? All of these questions need clear answers, as well as align with how finance accounts for savings. For example, are savings deducted from the previous year’s budget or is zero-based budgeting used?
2. Reward Innovation
There is more to savings than purchase price variance (PPV). Focusing purely on price reduction will restrict the thinking and creativity of your team. Good demand management can actually be penalized if measurement is not setup correctly (the “spaving” phenomenon where the more you buy, the more you save).
Technological breakthroughs changing what is purchased or the way that something is purchased can bring huge real benefits yet deliver no measured savings if your definitions are not set up to reward lateral thinking.
3. Understand and Measure the Total Cost
Following on from the last tip, price is not everything. Have good TCO models in place to ensure everyone understands the true financial benefit.
This includes any costs incurred to make the saving and also the timing of expenditure. Make sure you know your own cost of capital so you can explore whether market conditions make it prudent to opt for long payment terms, or shorter terms at a discount, or whether to take that signing bonus versus a lower ongoing cost.
4. Measure What Actually Happens — To a Point
The savings leakage typically seen between point of contract and actual receipt has been well documented. How to plug that leak is a whole other topic, but it’s important to report how the actual savings compare with the identified savings by doing some form of monitoring for the duration of the savings period.
In certain areas of spend (e.g., direct materials) this should be relatively easy, but for others, depending on technology used, this may involve significant effort. Consequently, make a judgement call on effort versus return. One-hundred percent accuracy may not always be achievable in every category, but there should be enough accuracy to have high confidence that the declared numbers are hitting the bottom line. As processes and technology evolve, try to improve accuracy year-on-year.
5. Don’t Forget the Increases
It’s procurement’s dirty secret that cost increases happen. No matter how careful we are, we can’t always avoid these. Yet we hate to admit them, and many organizations never declare them.
Without these, our total savings number is meaningless. Make sure you have the capability and technology to both recognize and declare the increases, too.
6. Have a Clear Governance Process
Ensure there is effective control in your cost reduction workflow, with the appropriate level of approval as you move through your projects. This is fundamental, yet can prove difficult particularly if there are conflicts of interests between stakeholders and procurement — another reason why goals should be aligned in the first place. There can also be a fine line between good workflow control and bureaucracy, so keep your process as clear and as simple as practically possible.
7. Remember Savings are a Means to an End
Finally, savings in isolation are not a credible goal in itself. In fact, savings can be bad for a business if they stifle growth or productivity. When they become the be-all and end-all then procurement quickly gets that savings-obsessed bad name.
The value that the savings bring is the key, whether it’s improved cash flow, increased profits or cash that be put to use in some other way to ultimately increase shareholder value. Always keep the bigger picture in mind.