Who Gets to Keep Procurement Savings – our Paper Answers this Question!

We announced our new research paper (sponsored by BravoSolution) a couple of weeks ago - Three Occasions When Procurement Should Spend More. And you can download it here, free on registration. Today we’ll feature the third excerpt from the paper.

We have established by now that it is right for us to spend more on certain occasions – for instance, on marketing services, if that gives a return which generates shareholder value. In the paper, we then get into a little bit of economic modelling and even draw some charts! Here is a sample.

“To see how procurement can contribute here, we need to consider the rate of return for any given example of marketing spend, which describes a return curve. Each unit of spend generates some return, and generally, at some point, that curve starts flattening out – we get into diminishing returns, although note that these returns may still exceed the marginal cost at this point. But at some point, investing another unit brings less return than the incremental cost. Now, we have passed the breakeven point. In theory, if we knew exactly where it lies, it is worth increasing spending up to this point because return exceeds marginal cost.

Show more TV adverts for a certain chocolate bar and more people will buy it. Run an advert ten times a day instead of five and you will get a greater return. But 15 times instead of 10? 20 instead of 15? The incremental gain will start declining, and at some point, the cost outweighs the additional return.

Now of course we can’t map this curve exactly, but understanding it as well as possible is key for colleagues in marketing and indeed the organisation generally. And when the spend is with third parties, it is within the procurement sphere of interest too. What it means is that, in principal, we should keep spending money on marketing (or each sub-sector within marketing) until we get to that marginal break-even point.”

We can then start looking at what happens to the return curve and the breakeven point because of procurement actions. Back to the paper.

“Then, procurement can address two aspects of that chart. The first option is to change the gradient of the cost line – in other words, buy the same output at a lower unit cost. That is traditional procurement, if you like, and we are certainly not arguing for instance against buying media space at as low a unit price (for a defined result) as possible. This moves the straight line on the chart as shown in Figure 2.

Procurement has created real value here, but what is interesting is that the best return now comes from buying more units than we did before - because the point at which we reach break-even on a marginal unit of spend has changed, as our price is lower. However, as each unit costs less, the total optimal spend level is lower than before.

The second way in which procurement can contribute is to change the shape of the return curve – to get more value and better return per unit of input. Now if we move the curve, as in Fig. 3, then logically we should actually spend more – the point at which the marginal return equals the cost has increased, so the optimal spend level has increased.”

All this is illustrated with charts in the paper – do take a look, it is much clearer once you can consult those! And then we provide our answer to an age-old conundrum – who gets to keep marketing savings?

 “Another conclusion from this analysis gives the answer to the age-old question. If procurement saves marketing money (and the same applies in many other situations) by negotiating a better deal, should the saving be returned to the business / CFO, or should marketing be allowed to spend it? Based on the reasonable assumptions made here, the analysis suggests the answer almost certainly is a bit of both! Buy more units, but not up to the point where all the original budget is spent. So for example, if we bought 1000 units at £100 each, total spend £100,000, and now we reduce the price to £80, it may well be that the new best solution is something like buying 1100 units at £80, getting more return but also saving £12,000 (£100,000 - £88,000)”.

So, you can download the paper here, free on registration, if your appetite has been whetted. And whilst we’re on the subject of BravoSolution, a final reminder that a Real World Sourcing briefing session takes place at 11am on Wednesday 3rd December, at the Don restaurant in London. The theme is “The Twelve Days of Procurement Christmas”, so we’re going to make it an enjoyable session, but with some serious points too. We have just a couple of places left, so book here and do come along for some merriment and interesting debate!

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