In yesterday’s post, we discussed an article in a recent edition of Purchasing Tips (by Charles Dominick of Next Level Purchasing) that asked What is Best Value Procurement where he stated that “best value” should be a hard metric measurable in financial terms and expressed in units of currency and not a soft metric where factors other than price are used in determining a supplier and/or product to select for purchase (as that is weighted average supplier/product scoring).
We noted that SI tends to agree, but that there are often issues with trying to assign a(n exact) hard dollar revenue increase or cost decrease to an event that has not yet happened. Even the illustrative example used by Mr. Dominick in trying to choose between machine A and machine B to automate a production line is not cut and dry. For example, if the organization stops manufacturing a product before production line end of life or has the option to lease vs. buy the machine, the calculations get complex. But this is just the beginning.
When it comes to making an IT purchase, the “best value” calculations become a bit of a nightmare. First of all, there is system cost. Depending on whether you want to go with a true SaaS, hosted ASP (which might be wearing a cloud disguise), or on-site hosted solution, as discussed in our classic series on the Enterprise Software Buying Guide (Part V: Cost Model), there are anywhere from four to eleven core up-front and on-going costs that need to be considered (plus ancillary costs for complex or special systems). (And even with the free calculation template provided in the classic SI post on uncovering the true cost of an on-premise sourcing/procurement software solution, the calculation is still a nightmare. How confident are you in the integrator’s estimate? How secure do you feel about the amount of training time (and budget) that will be required? How reliable are the ongoing support level and associated cost calculations.)
Assuming you can work through the system cost equation, which can be quite a doozy (doozy, not doozer, although you will likely need doozer cooperation levels to make any new IT system work these days), you then need to work through the value equation. Just how much value can be expected from the system over the timeframe, and how accurate is that prediction. There are multiple components to this calculation.
- Throughput Increase
if the system increases the number of invoices that can be m-way matched, increases the number of sourcing events that can be run, or automates the production of trade documents, this needs to be calculated first as these numbers are need to compute the savings
- Efficiency Savings
how much manpower is saved (and how much can therefore be reassigned or eliminated) and how much is the HR expenditure accordingly reduced
- Cost Savings
how much cost is expected to be avoided either by increased throughput or the increased performance offered by the system (such as defect reduction, which reduces repair costs)
Obviously, these calculations are not straightforward. In the case of efficiency savings, since every resource (and type) has a different cost (based on salary and associated benefits), the best you will be able to do is estimate an average cost for the manpower by hour (or day). In the cast of cost savings, it’s more than just an industry average, it’s an industry average for a company at a similar stage of competency, with a similar sized workforce, and a similar production or spend pattern. Let’s take spend analysis. If the company is a leader with close to 80% of spend under management, has been sourcing against industry benchmarks, and has used advanced negotiation (and optimization) techniques on high value or key categories (with the help of a third party, if necessary), the company is likely not only aware of its top n categories, but has likely strategically sourced the majority of next n categories as well and the untapped opportunities would represent less than 20% of its spend. This company would only expect to see the industry average 11% savings on roughly 10% of its spend and would likely only see a few percentage points on the spend under management in the current economy. In comparison, if it is an average company only had 45% of its spend under management, had not used advanced sourcing techniques in the past, and only sourced a few categories against benchmarks, it might expect to see the industry average savings of 12% on 40% of its spend and 5% to 6% on the rest. The up-front savings potential (over 1 to 3 years) for this average company on a new spend analysis system would be four times that of the industry leader! It might be the case that the industry leader might need the new system to properly monitor and analyze its spend going forward more efficiently to help it avoid bad decisions in the future, but now we are in cost avoidance territory, and fuzzy territory at that. In hard dollar costs, all one can argue is additional manpower reduction.
And we still haven’t dived to the bottom of the iceberg. In other words, the best definition of best value is a hard dollar metric, but it might be the hardest metric of all to calculate.