Procurement needs to generate value. But Procurement is usually evaluated on savings. It’s a disconnect, but one that needs to be addressed. The best way is to start in the middle. What is the middle ground? Spend optimization. What’s the best way to optimize spend? Focus on total value.
When one focus on total value, one simultaneously optimizes
- Total Cost of Ownership (TCO)
- Customer Benefit and
- Indirect Value Creation
which are the three occasions where one should spend more as per Spend Matters’ UK recent piece on Three Occasions When Procurement Should Spend More.
How does one focus on total value? One starts with the definition of Total Value Management as given in the e-Sourcing Wiki Paper on Strategic e-Sourcing Best Practices. In this classic wiki-paper, Total Value Management (TVM) is defined as a comparative cost metric that quantifies the overall cost of each acquired unit relative to the overall value of the spend category as it relates to the organization’s sourcing strategy and supply chain goals.
In other words, TVM not only maximizes the net benefit between the return curve and the cost line, which is computed during a calculation of indirect value generation, but identifies the cost line and associated return cost among all possible cost lines and their associated return curves that allows for the largest maximum net benefit. In other words, TVM does a Pareto optimization and identifies the maximum benefit to the business. Since cost is optimized relative to the return, not only is TCO optimized but the organization has saved as much as it could because any attempts to spend less would result in more dollars being spent somewhere else.
And when we review the three occasions where one should spend more, we now know that
- TCO is directly optimized because it has to be to compute the cost line,
- customer benefit is indirectly optimized because the return is only optimized if the activity results in more customer sales or more revenue per customer sale and
- indirect value creation is directly optimized because marketing, services, etc. spend will be optimized under this model.