Seven-fold return for procurement, but CPOs note – you might still have too many people

AT Kearney, CIPS and ISM have produced a report titled Building the Brand of Procurement and Supply. It makes the case for procurement generally, and promotes the ATK concept of Return on Supply Management Assets (ROSMA). It's worth reading and a good source of material of interest for CPOs and other senior practitioners.

We will come back to it in more detail, but one point is worth highlighting immediately in order to explode a common fallacy in the procurement world. According to the report, top performing procurement functions deliver a seven-fold return on procurement investment. Avoiding the thorny issue of measurement and the fact that I wouldn't trust the figures produced by most procurement functions more than the output from spinning a roulette wheel, the corollary to that rate of return, many people assume, is that organisations should have more procurement people. If you get seven times return, then surely it is worth investing more?

No. It ain't necessarily so, I'm afraid. The problem is that the headline figure is an average of the return from across the whole function, from each individual in effect totaled and then averaged. That categorically does not mean the function needs more people – or indeed works efficiently currently. Let’s look at a small function just as a worked  example to show how this works.

Assuming the CPO or head of the procurement function is good at prioritising, and puts the first procurement person (on a salary, let’s say, of £50K) onto the work that generates the most benefits, and the next person onto the next most beneficial area, and so on, then the pattern of return might look like the table below. The first three people pay for themselves comfortably. By number 4 it is a little marginal, and the fifth unfortunate procurement manager does not cover their own costs of £50K, saving just £25K.

So after four people, the net benefit is £1525K – adding another person reduces that to £1500K. But the overall return from the function with five people is still seven- fold. Yet actually, logically, there are too many procurement people! The return would be better in absolute terms with four people rather than five.

Now we’re not saying this is usually the case, just that we have to treat this sort of analysis with care. It is the marginal cost and benefit of the last person or the next person coming into Procurement that is the critical business case factor – not the overall return from the function.

Number of people in procurement   1 2 3 4 5
Individual’s cost (£K) 50 50 50 50 50
Cumulative cost (£K) 50 100 150 200 250
Individual savings generated (£K) 700 600 350 75 25
Cumulative savings for function (£K) 700 1300 1650 1725 1750
Net benefit of procurement (£K) 650 1200 1500 1525 1500
Return on cost multiple (savings / cost) 14 13 11 8.625 7

 

Voices (2)

  1. RG:

    I get tired of this type of analysis, the real number to focus on is the net benefit in £ not the ROI ratio as you may have a case where the cost of service provision e.g. through an outsource provider is greater than the lower internal cost but the net return (£) higher.

  2. RJ:

    All good points, Peter, as ever. Of course, though, the issue is not quite as simplistic as your analysis shows: person no. 5 may well in fact add no direct value whatsoever but may be an analyst or business support team member who facilitates the value delivery of people 1 to 4. The key point you’re making, though, is that procurement teams need to think very carefully about the business case for expansion rather than relying on simplistic headline-grabbing figures. Indeed leveraging this “added value” service is part of what outsourcing firms trade on (Note: I do declare my interest here, although I comment in this forum on a personal basis).

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