“Now, About Those Savings You Promised …” (Part 1)

We hope you find this guest post from Alex Klein, COO Efficio, interesting and informative. In two parts Alex gives his expert opinion on why procurement savings don't always materialise and advice  on how to avoid that happening. 

You ran the procurement process, agreed the budgets, signed the suppliers. And now the moment of dread – having to explain to the CEO why the expected savings never hit the P&L

The procurement was textbook, but what happened next? When it comes to sleuthing the savings that weren’t, that truly is the multi-million dollar question. Whether it’s implementation, discipline or post-procurement budgeting there are potentially more leakage points than a 1980s water main waiting to catch you out.

The generation of cost reductions is a fundamental goal of any procurement function, and for most, “savings delivered” is a key KPI. And yet, in many organisations, there seems to be a perennial mismatch between what is promised by the CPO at the start of the year, and what is found in the P&L at the end of the year. Why does this mismatch exist? Were the CPO’s projections unrealistic? Did the savings simply not happen, despite being reported? Or did they happen, but just can’t be pin-pointed in the P&L?

As with most questions in business, there isn’t one single, simple answer. Rather, there are a number of “leakage points” along the “journey” of a cost saving as it travels from supplier price negotiation to P&L account, as illustrated by Figure 1 below. These various leakage points combine to erode the saving, and the more of them we can plug, the smaller the delta between what’s promised and what’s delivered.

Figure 1 - Savings Leakage Points

Efficio fig 1

 

But before we consider each of these points in turn, it would be good to take a step back and consider why savings measurement and identification seems to be such a difficult thing. Surely it’s simple to articulate “what I paid last time versus what I’m paying now,” so where is the problem?

Let us use a hypothetical example, which we can refer back to throughout this article. Let’s imagine that, in a medium-sized manufacturing company, the buyer for MRO (Maintenance, Repair and Operating Supplies), which includes factory supplies such as valves, pumps, motors, bearings, pipes and nuts & bolts, has just concluded a new deal with a new MRO supplier. The buyer (let’s call him John) has followed a world-class strategic sourcing process – he has articulated last year’s baseline down to the price paid for each and every nut and bolt; he has agreed with Manufacturing to harmonise the number of products used, so that instead of using 1,500 SKUs, there is a new parts list of only 800 SKUs; he has negotiated favourable prices for each of these items and he has produced a document that calculates the annual savings, showing that the coming year’s cost across the 800 items is 27 percent lower than last year’s cost of buying 1,500 line items. It’s a great result, the contract with the supplier is signed, and as far as the buyer is concerned, his work is done … may the money begin flowing in!

If only it were that simple! The first problem is that it’s already apparent that the “saving” is not actually that easy to define. What the buyer is telling us is that the 27 percent is “the difference between what we WOULD have bought IF we had bought at last year’s prices, and what we THINK we’re GOING to buy next year, ASSUMING that we will buy a similar volume, and that we actually buy off the harmonised items list rather than continuing to buy the items we buy today.” Plenty of assumptions then, which means plenty of things that can go wrong. Even if we buy exactly as planned, one could argue that the saving is still predicated on the assumption that, if we hadn’t made the saving, we would have bought at last year’s prices. But what if steel prices had crashed and sent MRO prices nose-diving? Then the saving inherent in the new deal would be much smaller. The point is that a “saving” in this context is a somewhat theoretical construct based on a number of assumptions, so even before we start to look at what happens to John’s savings in reality, we need to recognise that, whatever happens, the numbers WILL change.

But let’s turn back to Figure 1, and consider each of our leakage points in turn.

The first leakage point is the savings calculation, or savings business case. This is John’s calculation of “baseline cost versus new cost” as discussed above. Clearly, if this is erroneous, then the savings figure will also be wrong. So it’s important to get this right, which means basing it on very granular volume and pricing data, and making assumptions that stand up to scrutiny.

The next leakage point comes during implementation. The savings will not materialise in their entirety if the deal is not properly implemented. This includes making sure that the new deal is fully communicated to all business units / divisions, that the buying channels and ordering mechanisms are set up, and that the supplier is clear on what products are to be delivered to whom and at what price. Failure to complete any of these tasks properly will lead to the company continuing to buy from the wrong suppliers, or at the wrong price points.

But even if the contract is properly implemented, there will be compliance issues that need to be proactively managed if the full savings are to be fully realised. In fact, it is not uncommon to lose more than half the savings through lack of compliance, and we will investigate this further tomorrow in part 2.

First Voice

  1. RJ:

    A very clear articulation of the problems in savings measurement even when it concerns pretty straightforward areas of spend. In part 2 (or even 3) I am sure you will get onto the even thornier issues that crop up in relation to services, new buys (cost avoidance, anyone?) or where the budget is simply reallocated, as with most “savings” that are negotiated in marketing or advisory areas.

    Savings do “leak” and ensuring compliance and buy-in to new approaches is absolutely critical to driving business improvement but it really is high time that Procurement teams moved away from purely measuring “savings” and we had a proper positive debate about the measurement of “value delivered”. Until we solve this, we are forever going to be condemned as short-termists who never actually deliver against our promises.

    For what it’s worth, ATK’s “ROSMA” has many fundamental flaws (as have been discussed on these pages) but at least it’s trying to move the debate in the right direction.

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