For time immemorial, Savings has been THE KPI against which the performance of a procurement organization has been judged. As businesses and industry sectors became more competitive, the role of Procurement evolved from a “PO Creator” to an active contributor to the bottom line of a company.
Today, as the world moves to a more sustainable, socially responsible outlook towards life and business adapts to it, the role of Procurement within a company is also gradually evolving.
Sustainability, sustainable supply chains, and risk management are just a few examples of “new” areas that Procurement can and should contribute to. However, to contribute and create value for these areas, a Procurement function needs the mandate of the business.
It is the position of this article that Procurement functions that have matured and evolved from “savings factories” into equal business partners with their stakeholders will find the opportunity to move away from traditional “Savings” discussions but to achieve that, a robust savings concept must first be established and delivered.
So long as a company operates in a competitive profit-making environment and is saddled with the task of creating value for its shareholders, Procurement will always be a source of efficiencies in the form of savings.
Therefore, Savings can be seen as a “License to operate” for Procurement- if well executed and delivered, will enable Procurement to focus additionally on other equally (if not more) important value-adding work.
It is hence essential to set up and implements a successful Savings Program to address this fundamental ask towards Procurement.
Defining what Savings are
While the title of this section might seem simplistic, having a crystal-clear definition of Procurement Savings is the first fundamental step towards a savings program. A further fundamental question to ask while setting up a savings program is, “Why are we doing this?”
If the intention is to treat Savings as a “License to operate” and become financial value-adding business partners for the organization, then this must be reflected in every part of the savings program.
If the intention is to check and enhance Procurement performance only, then the definition of savings must encompass that instead.
Addressing the former definition, Procurement savings should be defined as measurable and demonstrable reductions in the P&L statement of the company.
Exceptions to this definition do exist, for example, CapEx savings will not be seen in the P&L until the asset is capitalized. Nonetheless, this concept of Procurement savings enables Procurement to immediately demonstrate financial contributions and forms a powerful basis for discussions.
Where a comparison to the previous year P&L statement (Previously paid price) is not possible, (e.g. Marketing campaigns are affected by many variables such as seasonality, target audience, platform, etc.), Procurement must strive to work closely with their stakeholders and use whenever possible the P&L budget for that activity as a basis of comparison to show savings (Budget Price).
If neither Previous nor Budget price baselines are available, Procurement may showcase negotiation performance compared to a market benchmark or inflation or reduction in initial supplier offers.
These figures should only be used for Procurement performance and ideally should not be communicated to financial stakeholders.
Setting up the Program
After defining what Procurement savings mean for a specific organization, the Savings Program can be formulated and implemented.
Step 1: Spend Analysis & Segregation
Before any discussions on savings and where to find them, a function must know where its business is spending its budget. A detailed spend analysis enables a Procurement function to understand exactly that.
The entire Spend map of the organization must be scrutinized and if not already done, should be categorized into an identifiable Taxonomy (Procurement Categories).
Once a broad category classification is achieved, work their moves into the detailed understanding of each of the Procurement Category. The Procurement function must ask each of its categories managers to perform detailed spend analytics to gather volume of spend, number of suppliers, volume spread across suppliers, the risk profile of category, impact on business (critical or not), nature of products or services bought (commodity vs niche), etc.
An efficient e-sourcing software solution can play a vital role in assisting the category managers by untangling the data related to the spending.
Step 2: Category Intelligence
Step 1 described above provides valuable insights to a Procurement function on “where to play”. Once this question has been answered, the next thing on the agenda is to investigate “How to play”.
The next step in the savings program is to gather intelligence- market and internal. As the immediate next step, Procurement must strive to understand what the drivers are for each category that they operate in. Specifically, for each category, there must be a clear understanding of:
- How critical the category is to the business?
- How is the category going to evolve over the next 3-5 years for the business?
- Is it a stable spend area where to a large extent only volume demand changes every year or is the area subject to many specification changes as well?
- How critical are savings for the stakeholders of the category?
- How is the supply market evolving for the category?
- How powerful are the suppliers- is it a monopolistic market or can demand be switched between suppliers easily?
- What savings levers are already employed in the market and are therefore available to be used?
- Are there regulatory considerations to be satisfied?
The above questions are by no means a fully exhaustive list but do provide a basic understanding of a specific category which will form the basis of identifying savings opportunities.
The above-collated information should be put together on an XY-plane of “Business criticality” vs “Market complexity”.
As an outcome of the Category intelligence work, the procurement function should be able to identify categories with significant savings potential as well as areas where savings are hard to find.
Here, care must be taken to realistically define savings potential based on the gathered intelligence. This forms the answer to the question “How to play”. In short, Porter’s 5 forces need to be defined for each category to guide one’s approach to a specific category.
Step 3: Category Strategy
The next question to answer is “How to win”. All the information gathered above should inform how Procurement approaches a category from a savings perspective. Depending upon the category, a variety of approaches can be defined:
- Business Critical Complex Categories– If the category in question is a complex business critical category, maintaining long-term supplier partnerships to ensure no interruption of supply might be the best strategy. In such cases, the approach to generating savings will be fundamentally different. One way to achieve savings in this case is to establish strategic supplier relationships and using significant volume share to incentivize the strategic partner to supply at lower cost.
- Non-critical low impact categories– Typically these categories are characterized by low impact goods and services and low market complexity. These are the “C” categories. Procurement can be more aggressive in chasing savings in such categories. Depending on the fragmentation, digital procurement systems such as eAuctions, Expressive bidding (lot auctions) can be employed to continuously look for savings. Alternatively, these categories are also prime candidates for outsourcing. Outsourcing enables Procurement to truly focus on critical and value adding categories and provides additional opportunities for savings.
- Business as usual Categories (BAU)– The BAU categories are the playground for Procurement professionals. These categories need expertise in understanding the market, the business as well as procurement tools for generating savings. For these categories, procurement should be free to use as many techniques (conducting eAuctions themselves or leveraging auction services from a reputed e-procurement consultant, should-cost modelling, tenders every so often) to constantly find the right deals for their company.
Once these strategies are defined for all categories, Procurement has the answer to “How to win”. However, these strategies must be revisited periodically (e.g. once a year) to capture any evolutions or shifting priorities, or additional opportunities that may become available.
Step 4: Proactive, Not Reactive
Once all the hard work is done on category strategies and identifying “How to win”, Procurement can finally start implementing the Savings program. A reactive mindset to Procurement comes when Procurement becomes active after a demand has arrived.
For truly world-class Procurement functions, the approach to savings generation must however be proactive. This involves early recognition of where opportunities lie, forecasting of possible savings, and maintaining a robust pipeline of specific “projects” that will be implemented over the coming year.
Notice the usage of the word “year”. It is specifically used to signify that as businesses typically plan their budgets and P&Ls 12 months at a time, Procurement must also maintain a pipeline of ideas matching the budget cycles of the stakeholders.
This allows Procurement to demonstrate knowledge of the business and to further show that it is not working in a silo but rather is fully prepared to enable the business based on their requirements.
To truly win at the savings game, a Procurement function must have the ability to pipeline and project its savings contribution, ideally just before the close of the annual budget cycle.
Step 5: You Cannot Manage What You Cannot Measure
This adage is particularly true in the case of savings. Once a pipeline has been created as mentioned above, Procurement must realistically project a savings target for the next year to their financial budget owners.
Once a target has been agreed upon, Procurement must then periodically, ideally every quarter, report on the target achievement and equally importantly any upsides or downsides that are becoming evident.
Savings figures should not be reported just once a year at the end of the year but should be part of the overall pipeline management concept. The pipeline should be a “living thing”, constantly evolving and developing.
As mentioned at the very beginning, there are many approaches to a savings program. The approach posited here is one where Procurement transforms into an equal financial partner for the business, is ambitious in recognizing ideas and opportunities, and maintains a proactive approach to the concept of Procurement Savings.