Don’t Forget the “R” in Procurement ROI

My fearless colleague Peter Smith over at Spend Matters UK recently penned a piece titled “ROSMA – a Flawed Measure of Procurement Performance.” ROSMA is basically A.T. Kearney’s version of a popular metric called “Procurement ROI” that is calculated by dividing annual spend savings from procurement by the “investment” (costs) in those procurement resources. If you save 5% on your total spend and your procurement resources cost 1% on your total spend, your ROI is 5. For more analysis and commentary on ROSMA, see the related links at the bottom of this article, and certainly do check out Peter’s article.

Free Research Report: What it Takes to Implement Cost Saving Measures

Peter argues that ROSMA (or any incarnation of a procurement ROI metric) is flawed because you could have a minuscule investment (i.e., a tiny procurement department) with a very high ROI, but very little total economic impact on the enterprise. It is a fair point and illustrates how any single metric usually does not capture the complexity of a broader set of issues. We did an entire webcast on the top 10 procurement benchmarks that procurement organizations should use, and procurement ROI came in at No. 3, whereas spend-normalized total economic value delivered to the organization came in as the No. 1 metric.

I have researched this topic and correlated procurement ROI with procurement savings (a major subset of the “R”) over hundreds of real life benchmarked firms, and what I found is that the correlation is expectedly very high…to a point. Once you exceed and ROI of about 3, the correlation weakens and then ends. In other words, some procurement organizations get very expensive and inefficient without seeing a commensurate return on that investment. Others, however, spend somewhat more, but do get disproportionately high payback from those investments. For example, the firm may be in the early stages of a major transformation where there are tons of savings being realized (especially if it has big spending areas with favorable market tailwinds).

Anyway, the bottom line is that you have to look at total economic impact as well as the relative payback against your investment. Think of it this way: Procurement is a big machine in a savings “factory.” If you have a small machine that is highly efficient and produces a highly profitable “product,” but is backlogged with additional product (i.e., savings) that could be made, you obviously would want to increase your capacity and your savings throughput. So, procurement ROI is like a machine efficiency rating (efficiency is output divided by input right?), so it’s about “savings efficiency” rather than effectiveness from a total economic impact. A smart enterprise, however, doesn’t measure its effectiveness on machine utilization and efficiency, but rather, throughput of value creating output (read Eli Goldratt’s The Goal if you haven’t and you’ll understand). If you do so, you’ll want to start adding other “machines” in the areas of innovation, working capital improvements, tax expense reduction, asset variabilization, revenue uplift and other areas – and you’ll follow world class supply chain principles to add flex capacity to your “procurement factory.”

Returning to where we started, I do think Peter is being a little harsh on ROSMA (yes, I’m actually defending A.T. Kearney!), because if you had to pick a metric, albeit “defensive” and internally focused on a single function’s performance, that encapsulates how procurement is “earning its keep,” then procurement ROI is a good one. But, procurement ROI in any form (including the ROSMA incarnation), to quote Goldratt, is clearly “necessary, but definitely not sufficient.”

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