We continue our series of the top procurement myths here on Chief Procurement Officer. In this series, Pierre tackles the top 25 procurement myths that exist. Make sure to check out previous myths here on the CPO website.
16: Always Use Procurement ROI As Your No. 1 Procurement Metric
If you had to pick one single metric to measure procurement, what would it be? Most procurement organizations look at cost savings as a percentage of spend. It’s a classic measure of normalized spend management effectiveness on a single (but critical) variable called cost. But, since we must serve our finance overlords and be efficient, and more popular metric is “Procurement ROI” (which is annual cost savings divided by the annual cost of procurement) – and different variants such as AT Kearney’s ROSMA metric.
We’ve written extensively about the latter, and my colleague Peter Smith penned a nice piece on the issues with “Procurement ROI.” To sum, you can have high ROI, but if “I” is very low because you’re not investing enough in procurement resources that can manage spend deeply and broadly, you are under-invested and leaving money on the table. And, you’re still only measuring the hard cost savings and not counting avoidance or broader value chain improvements.
Don't get me wrong. Procurement ROI is in fact a good single composite metric that should demonstrate the massive payback (10X is an excellent target) of proper supply management. However, it is only one metric, and doesn't speak to the broader “balanced scorecard of supply” that is important to the budget/business stakeholders that procurement can help them improve. For example, what about internal customer satisfaction that you are aligned with those stakeholders to accomplish their objectives? What about “Profit at Risk” to track as a composite supply risk metric? And, of course, what about the ultimate output metric in terms of the improvements made to enterprise value, ROIC, ROA, or anything measuring sustainable profitable growth that your firm uses?
Obviously, if you have the last one in place at your firm, you should plug into it. You want to reuse as many useful metrics that are already in place and have measurement systems in place as well. There is a trade-off between level of insight on a metric and the level of effort to collect it, so if you can reduce the latter, you can get more of the former. This is why something as seemingly simple and basic as spend analysis is so important. In other words, you can't measure supply management performance if you can't measure the improvement of supply performance, and it’s awfully hard to measure supply if you can’t measure spend (i.e., spend is what you pay and supply is what you get).
This is why we embarked on a 50-part series called “50 Shades of Pay” that starts with basic forensics spend analysis and then evolves into more sophisticated analyses toward strategic supply analytics. It might not seem sexy, but we think it is (perhaps we don’t get out enough). We’re only about a quarter of the way of through that series, which is available to our Plus-level readers ($19.99 a month).