Savings in procurement, yes, but why?
In the perfect dashboard of a Procurement Department, the evaluation of savings plays a key role. However, while this cornerstone of a procurement department’s deliverables should only be one of the indicators used to analyse a situation and determine areas for progress, their preponderance only meets the immediate objective to be achieved. The procurement savings indicator must be dual and here is how.
A dual indicator! This is not to vary the pleasures, but there are a multitude of ways of evaluating Procurement Performance. The scientific literature on this subject is very rich and provides an excellent basis for work. But before delving into these works, we can ask ourselves what is the purpose of this indicator? Should Procurement Performance simply communicate performance or should it also be used to explain phenomena in order to be able to carry out improvement actions?
When I took on this task, my choices were first to evaluate the impact of procurement on the profit and loss account, and then to evaluate the added value of the procurement function. The first orientation was based on a comparison with historical prices. This process is simple and understandable to all, even if the devil is in the detail and biases can distort this first assessment.
“The rules for calculating cost avoidance differ between procurement categories.”
Procurement performance! I had several options for assessing the added value of the function: internal benchmarking, external benchmarking or performance measurement. Between the relevance of the comparison and the availability of reliable data, the implementation of the two benchmark approaches was too complex and not relevant enough. Conversely, the calculation of performance appeared simpler to me by asking the question in the following way: without an intervention from Procurement, what would have happened? A difficult question, you may ask? Not really! For direct procurement, we can use market indices. They are known to the teams and easy to follow. For indirect procurement, the indices exist but are they always representative of the procurement carried out? Not necessarily, which is why I used the concept of cost avoidance to measure this performance. Depending on the procurement category concerned, I have laid down clear rules for calculation. Therefore my procurement performance was derived from the difference between the gains on the historical price and either the cost impact of the index for direct procurement or a cost avoidance calculation for indirect procurement.
“Procurement performance is the comparison between gains on historical prices versus the impact of the market index evolution.”
Proof by example! Let’s take a concrete example and see wh”at conclusions we can draw. The buyer has to renegotiate the prices of product A, whose raw material share is 50% and whose price has increased by 10%. After negotiation, the buyer manages to limit the increase to 5%, the product has only suffered the market increase. Compared to historical prices, the increase is therefore 5%, the market impact is also 5%, so the procurement performance is 0. But is this a bad result? In the opposite case, i.e. a 10% drop in the raw material. The buyer makes a saving compared to the historical price, but has he only obtained the bare minimum? Certainly, in one case, the company reduces its costs and in the other, it experiences an increase. These are the hazards of business life that we all face. Beyond the strict mathematical calculation, the information obtained from the analysis of the results is the real value of this exercise.
“Beyond the discussion of purchasing performance, the information obtained from the avoided cost analysis is the real value of this exercise.”
Measuring is acting! The results of these calculations only make sense if they are used to understand and explain past events. Of course, the results put forward by this type of tool also respond to the objectives that have been assigned to us! These may have been set to improve an existing situation, to respond to a particular issue or to resolve a dysfunction. Beyond the achievement of objectives, measuring allows us to shed light on the impact of exogenous phenomena and to understand the effectiveness of this or that procurement lever. Because it is necessary to investigate to identify what is behind a value or a ratio. And consequently, these analyses allow us to act! They help us to define the strategies to be favoured by associating the appropriate tactics to satisfy our customers and meet the company’s cost competitiveness challenges. In this way, we will make our contribution to meeting future challenges.
by David Delalande (write to David)
Partner of the consulting firm Del C&M
Purchasing transformation consultancy: purchasing strategies, category management, performance plans, digital roadmaps, plural performance, organization and talent programs