Procurement Is About Value, Not Cost – But Easier Said Than Measured …

A couple of weeks back, I mentioned my session with some of the procurement team from a very large UK firm in the context of my strange coincidental train conversation. But today, on a more serious note, we’re looking at one of the topics we discussed at the session.

I was talking about the future of procurement, a favourite topic, and that took us into a paper I wrote a while ago (sponsored by BravoSolution), titled “Three Occasions When Procurement Should Spend More”.

In that, I look at spend categories such as marketing services and professional services where “unit cost” is almost meaningless, and the aim for procurement must be to maximise the value from the spend. Procurement may also, if possible, work with the budget holder to work out the optimum level of spend as well.

What do we mean by that? Well, suppose we know that marketing spend has the following return.

£2 million spend brings £5 million of value  - net return £3M

£5 million spend brings £10 million value - net return £5M

£10 million spend brings £14 million value - net return £4M

Now let’s say that the current situation is that spend is at the £2 million level. The traditional procurement approach is to say “let’s try and get the £2 million down to £1.5 by using our procurement skill”. If we can do that, then the net return has increased from £3 million to £3.5 million.

But hang on a minute. The net return at the £5 million spend level is already £5 million, even before procurement has worked its magic. Moving to that level brings a bigger gain than simply beating up the suppliers at the lower level of spend. But we don’t want to move to spending £10M because the net return actually falls. (Of course, the optimum spend may be somewhere else between £2M and £10M but I’ve simplified the issue for clarity here.)

So rather than the pure negotiation angle, in this case, a more valuable role from the organisation’s point of view would be for procurement to help the budget holders identify what that marketing return curve looks like, to establish where the optimum net return falls. Then by all means then make sure the procurement is as effective as possible – there is no need to pay more than a fair market price, whatever the return.

But one danger in these categories is that (going back to the £2 million starting point) procurement beats the supplier down from £2M to £1.5M, but the supplier in response then alters what they deliver for that lower amount. So the value delivered might drop from £5M to £4M, and the net return has actually gone from £3M to £2.5M. Procurement has cost the business real money.

Now back to the firm I was with. It is a very smart firm, one of the leaders in procurement practice for some years now. So there was a lot of nodding when I talked about these ides - this wasn’t an amazing new idea for them. But, one of the senior people said, the problem is in measuring the value. If we could do that, then this all makes perfect sense. But when the value of spend in areas like marketing is hard to quantify, you can see why  procurement and finance often fall back on “savings” as a goal.

In the case above, if we have no idea whether £5M really generates more value than £2M, then let’s just let procurement loose on the £2M with a brief to get it down to £1.5M.  Indeed, we might question why the organisation is spending anything if it can’t track the value gained!

So the challenge from my friends in the session to me (and others) was this. Leading procurement practitioners and organisations do understand it is about value, not savings. But what methodologies, processes, tools, are procurement leaders using to measure the value generated by spend, particularly in these complex service categories?

First Voice

  1. Dan:

    Its not a new problem. John Wanamaker (1838-1922), a US businessman, once said “half the money I spend on advertising is wasted. The problem is I don’t know which half”.

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