Measuring procurement savings – part 1

We had a comment on a post the other day which is worth repeating as it has triggered my urge to write something on this issue! Our reader (who works in a local authority) was arguing with a procurement colleague...

He thinks that savings gained from a reduction in service levels (e.g., reducing the number of home visits, or number of bin collections) should be counted as ‘procurement’ savings, whereas I was of the view that, regardless of where the initiative came from, in most cases reductions in service levels should really be counted towards departmental savings.....

I broadly agreed - my answer is also here as a comment.  But it got me thinking about savings more generally, which is a perennial issue and problem for procurement practitioners.  The issues can be broken down into three stages;

  • How do you measure savings?
  • How do you attribute them (my correspondent's question)?
  • And how do you capture or make use of them?

Sounds like a series of 3 posts I think!  But just to frame the problem a little; this story is pretty much a real-life case study.

This very large organisation has poor (but improving) spend management information.  They could just about say that in 2008 they spent (let's say) £10 million on consultancy.  But in fact, there was almost certainly some of that spend that was interim or even other services such as training.  Equally, consulting assignments were almost certainly categorised under other headings.

In 2009, they declared a 'procurement saving' of £ 3.6 million on consultancy. So how much did they spend?  £6.4 million?  No. It was £14.4 million.  How could that be, I hear you ask.

Well, procurement put in place a framework contract, exclusively with a range of  large consulting firms.  The day rates they were offered represented - based on what those firms told them - a discount of 20% on average from full list prices.  So the logic was that £14.4 million would have been £18 million were it not for the 20% 'discount' achieved by procurement.  20% of £18 million is £3.6 - hey presto, a major saving and a big bonus for the CPO!

Now, what is obvious is that we have no idea whether that saving is 'real'.  The 20% could be nonsense; the framework rates may still be higher than those firms' average rates.  The firms used previously - a mix of smaller and large firms - may have had an average day rate much lower than the new framework providers.  There was also no way of recording or measuring how many days in total had been worked for £10 million or indeed £14.4 million.  And of course the quality of output, or the output per day, may have changed in either direction which changes the real 'savings' calculation again.

So it is quite possible that the £14.4 million had bought fewer consulting days than the £10 million, at a much higher average daily rate, with less total output delivered by the consultants, and less happy clients.  Then might not.

I'm not going to give any simple answers to these problems, but one thing is clear.  This is the sort of 'smoke and mirrors' savings methodology that many procurement organisations, public and private sector, have engaged in for years.  Let's be honest, I've done it myself.  But I'm increasingly coming to the view that it isn't doing us any favours as a profession; cynicism about 'savings' claims is a real risk to our credibility, particularly as users and Boards themselves get more savvy about what we do.

So in the next post in this series, I'll look at some of the more credible ways to measure savings; but I can't promise a magic wand I'm afraid to address some of the issues; they are just intrinsically difficult!

Voices (3)

  1. Florence Gregg:

    Efficiency gains, cash savings have always been and will continue to be a challenge to those trying to ‘measure’ and report them. My view has been that in order to report a cash saving I, or the department, must be able to show that there is genuinely ‘real’ cash remaining in the ‘pot’ that can be spent on other things. I’ve been involved in developing efficiency measurement protocols over the last 5-6 years – we moved away from savings meaurement ages ago because many of the efficiencies were not ‘real’ cash. Using whole life costings I can demonstrate that by buying the more expensice item A I will save on the running costs. The protocol is that the additional purchase price is reported in Year 1 with the operating cost savings being reported over the following years. This clearly displays the cost (investment); the savings; and the pay back period. By running reports the net or the gross (no investment value removed) figures.

    We also look at the ‘legacy’ of the procurement sometimes reporting the efficiencies achieved and for some efficiencies we don’t actually attempt to put a value on it. Ok, this doesn’t help towards a cash saving target however, dare I say it, it’s more transparent.

    The other key approach we have is that, although the procurement staff are actively involved in the procurement, we identify the ‘lead department’ thereby giving recognition to the actual spending area that achieves the cash saving or the efficiency gain.

    I think the key approach is to be ‘reasonable’ in the calculation of the efficiency values reported. If it ‘feels a bit high’, then it probably is (and vice versa). Many, many years ago (in the last century – the early 80’s in fact). I worked in what was called ‘The Best Buy Team’ (a team of 2 – obviously ahead of our time!) we worked on vfm initiatives and reported what we had achieved. Our basis was ‘did we do something extra, beyond normal purchasing activity?’; if yes, then we sought to put a value on the improvements, however, the values reported were grounded on common sense and could be explained. So, to illustrate, say we always received 25% off the stationery catalogue price; after a robust exercise (with genuine commitment) the new discount moved to, say, 30%: we didn’t report 30% of the spend, we reported ~5% being the ‘real’ difference. Ok, we didn’t have access to good, easy to get, MI and based our reported figure on the actual spend for the 1st year of the new arrangement.

    I work mainly at the coal face with small public bodies where the procurement people (where they exist) don’t have access to lots of MI or the time to dig and dig to find out baselines from 20xx. We’ve had to develop something practical and, I believe, reaonsbly realisitic.

  2. Richard:

    I totally agree with your example of the difficulties of reporting “savings” claims, particularly in areas as vague as professional services and recently came across an even better example of the ridiculous nature of some reporting structures.

    I am currently working with a government organisation that wants to move towards best practice for its consultancy procurement. A National Audit Office report that they are using states (with little hard evidence that I can see) that moving from “Red” to “Amber” status in their demand control processes saves organisations on average 20% of their spend and that a move from “Red” to “Green” saves 30%. Based on this report the department is proposing to claim “savings” of 20 or 30% of last year’s expenditure based simply on implementing the demand management processes the report recommends.

    What’s this year’s budget? No idea. Does it matter that the recent cuts mean they’ll spend virtually nothing in any case? No. Is there any consideration of the price or volume of any consultants they do manage to sneak past the relevant Minister? No. Totally daft? Yes.

    As a very experienced procurement manager I have on several occasions had to write the savings policy for a procurement department and have always asked the Finance teams whether they want to distinguish between “direct” savings, i.e. price/cost reductions against a previous price for the same or comparable service, and “cost avoidance” which covers discretionary spend (such as consultancy), one-off spend (projects, most marketing campaigns) and capital investments. The latter will never show up directly on the bottom line of a company’s performance but are often no less valuable. Similarly there’s always the problem of multi-year agreements and whether procurement should be motivated to deliver long-term benefit or short-term cashflow but I suspect that will need to be the subject of future discussion.

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