“Now, About Those Savings You Promised …” (Part 2)

Today we continue our guest post from Alex Klein, COO, Efficio.

Yesterday (in Part 1) we began looking at savings leakage and how, even if a contract is properly implemented, there will be compliance issues that need to be proactively managed if the full savings are to be realised. We said that in fact, it is not uncommon to lose more than half the savings through lack of compliance.

Compliance has a number of elements, including vendor compliance, price compliance and item compliance. In our MRO example, some of the factories will likely continue to buy from their existing suppliers rather than from the new suppliers (vendor non-compliance), or they may continue to buy “off-spec” parts (item non-compliance). Finally, the supplier itself may be non-compliant, in terms of not honouring the agreed prices (price non-compliance). For example, if the MRO deal is a pan-European one, then one of the supplier’s country units may apply its own local prices rather than adhering to the centrally-agreed prices.

Compliance is a major issue for most companies. In most cases, post-contract compliance is simply not measured or managed, because it falls between two stools – procurement steps out of the process once the contract is signed, and the users of the contract have little interest in measuring the savings. It is simply assumed that the savings will materialise as per the plan, but of course this is naïve. Leading companies implement a proactive compliance measurement and management process to address savings leakage from non-compliance.

Figure 2 shows a real example of compliance metrics for an MRO contract put in place by one of Efficio’s clients. It shows how vendor, item and price compliance were very weak in the first two months of the contract, and how they were managed to an acceptable level over a number of months. The key point here is that, LEFT TO ITS OWN DEVICES, compliance will simply not happen -- it needs to be managed. Managing compliance is a time-consuming, iterative process that involves (i) identifying instances of non-compliance (ii) looping back with users to understand the REASONS for non-compliance, and (iii) addressing those reasons, and/or taking corrective/punitive action as appropriate. Driving up compliance involves changing behaviours, which is never easy.

Figure 2 – Example Compliance Metrics

Eficio fig 2

Next up in the list of savings leakage points is poor budgeting. Let’s assume that John’s MRO deal has been diligently implemented and compliance has been proactively managed. If this is the case, then there will indeed be a saving. However, if this money is not taken out of budgets, then the result will be a “windfall,” i.e., the company’s various factories will simply spend the money on other goods and services. The saving will only hit the bottom line if the saved monies are taken out of the users’ budgets. This sounds obvious, but is often not done. Good CPOs work closely with Finance to make sure that operational savings are translated into budget cuts. When and how these cuts are made is also important. Wherever possible, Finance should look to cut the users’ budgets BEFORE Procurement comes in to do the sourcing; that way, Procurement can be positioned as the “friend” who comes in to help save the money that’s already been taken away by Finance.

“Poor measurement” is a close cousin of “poor budgeting.” Suffice to say that, as the old adage goes, “if you can’t measure it, you don’t save it.” Doing the budgeting of course doesn’t in any way facilitate the operational saving; this still needs to be diligently tracked and measured. Again, because most companies operate in functional silos, the ongoing measurement of procurement-generated savings falls between the cracks. No surprise then, if the savings can’t be found in the P&L!

Lastly, business-driven volume or mix changes can obscure the savings delivered, even if they don’t actually reduce them. Thus, in our MRO example, if the company opens a new factory, spend will go up, and if the company switches to new machinery that requires more expensive parts, the item mix will be unfavourably impacted. These changes need to be stripped out/corrected before the P&L saving can be clearly articulated.

Clearly then, there is A LOT that can go awry as a saving “travels” from contract signature to bottom line. Significant, 50 percent-plus levels of savings leakage WILL occur if leakage points are not proactively managed. In order to do so, companies have to work effectively across functions, in other words across Procurement, Finance, and the budget-holder functions. Specifically, they need to ensure that (i) one of these functions actively monitors and manages compliance, and that (ii) Finance takes the money out of budgets. For this to happen seamlessly, Procurement, Finance, and the budget-holder functions need to work together from the start, not just when it comes to finding the money at the end. If all parties are involved in the sourcing process from start to finish, then they will jointly agree on the cost baseline, on the supplier volume allocation, and on the compliance picture as it emerges over time. Articulating and capturing the savings then becomes easy.

Maximising realised savings is all about diligent execution, good measurement, and cross-functional alignment. In summary, based on Efficio’s experience with clients, we can draw out the following recommendations:

  1. Get your savings calculation / business case right, by making sure it is based on granular volume and pricing data, and makes reasonable assumptions.
  2. Make sure the supplier contract gets implemented properly, and that all divisions/business units are aware of the new contract and how to buy from it.
  3. Make someone accountable for measuring and managing vendor, item and price compliance -- without this, you will fail! Engage Finance early, and ideally have them take the savings out of budgets UP-FRONT.
  4. Make sure you measure both budget savings and operational savings, stripping out any extraneous factors such as business-driven volume or mix changes.

Your procurement function’s reputation and credibility can live or die based on the validity of your proclaimed savings, so it’s paramount that you get it right.

Good procurement and nailing down those savings before they blow away, is about what happens after the deal is signed. Remember the old adage about leading the horse to water? Processes need to change and finance staff need to be on the ball.

And the key to getting it right is being proactive: if you wait until your CFO asks you “Where are those savings you promised me?” then it will likely already be too late.

First Voice

  1. bitter and twisted:

    Reasonable but surely better to deal with the root causes of CFO monomania and end user wastrelry?

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