Making Savings Stick (Part 1)

In this two-part series, 4C Associates’ Bob Friend examines how leading procurement departments can reduce the gap between negotiated and realised bottom-line savings.

The economic crisis forced a number of companies to reassess their costs and led many to switch their focus to cutting spend. As a result, many now operate in much leaner fashion and have been able to optimise a number of key processes. However, as the financial climate begins to improve, it is vital that these businesses continue to assess, identify and implement savings.

A number of industry studies suggest that on average only 40 percent of savings identified and negotiated by procurement actually hit the bottom line. This situation is a source of frustration for procurement, but also a risk to its credibility with key stakeholders. This is particularly true in relation to finance, where the function’s contribution to cost competitiveness is often under most scrutiny.

Indirects and directs – a tale of two cities

In my experience, most businesses have rigorous procedures in place to manage savings in relation to direct materials. This is due to the sophisticated standard costing, variance reporting and governance processes already in place. When it comes to indirect spend, however, the approach is typically less developed.

This situation needs to be remedied as, depending on the industry, indirect costs can account to between 30 percent and 50 percent of a business’ spend. The lack of process in place to deal with the area means there is often a much greater gap between procurement’s negotiated and realised bottom-line savings.

Of course the scale of the challenge facing procurement departments trying to ‘make savings stick’ varies widely depending on the organisation. There are four broad themes which help maximise the impact of procurement savings on bottom-line results:

  1. Savings definition and tracking approach
  2. Stakeholder engagement and accountability
  3. Standardised and enabled P2P channels
  4. Compliance policy and management

Savings definition and tracking approach

Surveys consistently show that the highest priority for CPOs is the delivery of cost savings. This mirrors the view of CFOs, who see the reduction in operating expense as a top priority.  While there are variations in how organisations define what constitutes procurement savings, there exist two broad categories: hard savings and value add. It is vital that businesses define each properly to ensure they are implemented.

Hard savings are commonly defined as a measurable reduction in the new purchase cost compared to an existing cost (the current cost baseline). For recurring demand items this is a relatively straightforward measure, although the values used for measurement may need adjustments when quantity price breaks apply.

Other hard saving scenarios and cost components also need to be incorporated into the approach. These often include non-recurring costs, new items, demand/usage drops, exchange rate gains, transport costs and, in some cases, TCO approaches and import duty reductions.

Value add contribution

Value add contribution, on the other hand, is not necessarily traceable to the bottom line as a saving.  That’s not to say it cannot be just as significant in terms of impact on business competitiveness. Properly implemented, it can deliver increased ROI on projects, reduced price increases, process efficiency gains, SLA performance improvements and working capital improvement.

The point at which savings are tracked and reported is key to demonstrating bottom-line impact. Typically, the savings life cycle is made up of three stages:

  1. Identified (an initial target based on a level of informed insight)
  2. Implemented (the point at which a new contract is put into place)
  3. Realised (the point of an actual purchase transaction at the reduced cost)

Whilst tracking is often in place for identified and implemented savings, roughly 20 percent of organisations have designed their processes and enabling systems to track realised savings. This gap in the tracking process can mask a material difference between the expected and actual impact of procurement initiatives on the bottom line.

In part 2 we will look at how to manage stakeholders, implement standardised and enabled P2P channels and compliance policy and management.

First Voice

  1. Paul@Provalido:

    Good points on an age-old problem Rob. Perhaps this will be covered in part 2, but I would also add that the technology used to report the savings can make a big difference. Using the right tool can help process adherence, increase visibility and improve credibility, not to mention be a whole lot more efficient than the cumbersome spreadsheets many organisations still use.

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