Daily Archives: April 20, 2012

Procurement Game Plan: A Review Part III.2

Charles Dominick of Next Level Purchasing and Soheila R. Lunney of Lunney Advisory Group recently released The Procurement Game Plan: Winning Strategies and Techniques for Supply Management Professionals. So far, in our review, we’ve covered the Purchasing Professional’s 10 Commandments, organizational role, Supply Management strategy, talent, social responsibility, strategic sourcing, supplier qualification, negotiation, and supplier relationship management. This post, which continues our review of Part III, dives into procurement performance — measurement and methodology.

If you do not have a solid way of measuring procurement performance, you do not know how well you are doing or, more importantly, how you can improve. If you don’t measure performance, you can be guaranteed that performance, inside and outside your organization, will not be what you expect, and possibly not even to the minimum levels that you contracted for! You’ll have no way of knowing if your supplier understands your expectations, cares, or if your buyers are keeping up their end of the bargain (and buying on contract).

As a result you should keep a scorecard that addresses, at a minimum, the six classifications of procurement impact identified by the authors:

  1. True Expense Reduction / Cost Savings
    When you obtain a true cost reduction and hold volume requirements steady, this is a huge win that is easily understood by all.
  2. Price Reductions that Offset Volume Increases
    If volume requirements increase 20%, chances are total spend is going to go up, but if you negotiated good price reductions, the organization is still saving on a unit basis and the organization must get credit for this.
  3. Expense Reductions through Negotiation
    If the organization did not buy a product or service under contract in the past, but started buying such product or service under contract, then any cost reduction against average historical unit pricing is a savings. If the organization did not previously buy the product or service, then any cost reduction against a market average is a saving (as that is what the organization would be likely to pay, at a minimum, without Procurement’s involvement).
  4. Volatile Commodity Price Reductions Against Market(-Based) Pricing
    There are some commodities, such as crude oil (where the price is essentially set by Wall Street, as we explained in a recent post here on SI), where it is virtually impossible for an average Procurement Pro to reduce cost. Markets drive the prices, and there’s little a Procurement Pro can do. But if the average year-over-year increase is 25%, and the Procurement Pro manages to keep the year-over-year increase to 20%, that’s a win.
  5. Savings that could be obtained with Procurement Involvement
    If Procurement saved 1 Million on 10 Million of spend, that might not be much to an organization that spends 50 Million, but if Procurement was instead allowed to manage 80% of the organization’s spend instead of 20%, then, instead of reducing top-line costs by 2%, it could reduce top-line costs by 8%, and that is a significant contribution that will carry straight to the bottom line [(c) Robert Rudzki]! And if Procurement identifies any areas where it can exceed the average organizational savings percentage, they should be clearly communicated.
  6. Price Increases Incurred
    If Procurement only reports the good, and hides the bad (which will happen from time to time as that Black Swan, who makes Hannibal look like a juvie in comparison, is one nasty little bugger), then it is risking having its reputation ruined when someone in the finance office, bitter about the recognition Procurement is receiving, digs where you don’t want him too. Report the bad. If Procurement is doing its job well, this number is going to be dwarfed by the other numbers and the total-savings-across-the-board calculation is still going to make Procurement look like a star.

The chapter does a great job of identifying, and explaining, the appropriate cost savings formulae you will need to report the above; explaining what a financial performance analysis is; and explaining some key financial terms (such as EPS, EBITDA, and ROI); but the only other section I wish to point out is the section on measuring total team performance that outlines some common mistakes that should be avoided in your reporting:

  • Cost Savings as the Lone Metric
    The first reaction of a skeptic will be what are you trying to hide? As every organization contains a number of skeptics, don’t do this.
  • Not Using Net Cost Savings as Metric
    It’s not how much you negotiate, but how much you capture. That’s why SRM/SPM and spend monitoring (as described in the 100%-free no-registration-required eBook on Spend Visibility: An Implementation Guide) is so vital!
  • Not Taking Markets into Account When Setting Goals
    If raw material costs for steel went up 30% and your product is 60% steel, then your raw product costs have shot up 18% and a 10% year-over-year cost reduction ain’t gonna happen. Don’t expect it!

Remember, it’s all about cost savings credibility. If you have it, your Supply Management organization will get the respect it deserves!