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How to measure Procurement Savings?

How to measure Procurement Savings?

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Procurement savings is not just about spending less money. For surely, there's more to procurement savings than is usually acknowledged. The savings / benefits that result from a procurement activity are generally the result of a better deal, improved efficiency or a combination of the two. It can also lead to a whole lot of intangible benefits like for example, improved service delivery.

Why measure and report procurement savings?

Besides profitability, there are a host of other reasons too for measuring and reporting procurement savings, and the most important ones are
  • To aid continuous improvement – as measuring gives valuable insights into price trends, deviations and other matters that need attention
  • To improve credibility – a good track record in cost savings improves the credibility of procurement and helps procurement get involved early in new initiatives
  • To motivate - linking realization of cost savings to the right Key Performance Indicators can be a good way to motivate buyers.

Procurement Savings – the various types

Cost savings in procurement has three facets. They are the demand side, the supply side and the total cost side:

Purchase demand management

The easiest way to achieve cost savings is to decrease the demand by reducing consumption, consolidating spend and encouraging people to be more specific in demand. It helps to remember that the most expensive solution to a problem need not always be the best.

Supply base management

The supply base is directly associated with procurement, and the possibilities here are endless. There is plenty of scope here to
  • Restructure supplier relationships - by intensifying the collaboration with suppliers, starting up partnerships and striving for a sustained cooperation.
  • Increase the competition among suppliers through fair practices – to achieve favourable results.
  • Explore all options by sourcing from low cost countries or by spreading the total demand for a certain product over multiple suppliers.

Total cost management

Assessing the total costs related to the acquisition of products or services (Total cost of ownership, TCO) offers scope for:
  • Optimization of total supply chain costs – an area that has expanded enormously over the last 30 years, led by the Japanese, with the introduction of methods like JIT, Kanban and Kaizen.
  • Reduction of total life cycle ownerships costs - this involves the assessment of additional costs besides the product price. For example, Can special tools be developed, like moulds? Is there a possibility to buy a standard product instead of developing a unique part? Would it be better to lease a product rather than buy it? Can we share ownership of an installation with other parties?
  • Reduction or elimination of transaction costs – as these are often overlooked. This includes the costs related to the process of ordering, receiving and paying for purchases. Examples of ways to limit these costs are vendor managed inventory, electronic ordering and invoicing and the usage of P-cards.

Overcoming complexity in Procurement

As procurement is not an isolated function, but one that operates in co-operation with other disciplines, cost savings cannot be measured with one standard formula. This complicates both measuring and gauging the value of savings too. For examples, the spend on sourcing a product may increase over time due to the greater demand, while the unit price may still be the same. Or, there is a possibility of the savings getting counterbalanced by the disproportional usage of hours and other means to achieve the savings number.

An increase in costs can also be detected as a consequence of late deliveries, bad quality of goods delivered, etc. A robust procurement saving system should be able to factor in all such inevitable situations and arrive at a solution.

Measuring and reporting effectively

It helps to remember that cost savings initiatives must be based on a solid spend analysis. This will be a starting-point for identifying saving opportunities and as a benchmark to verify claimed savings. The kinds of data gathered must include:
  • Spend
  • Number of suppliers
  • Spend per supplier
  • Spend per cost center
  • Comparison of measured values with benchmarks etc.

The identification of saving options is done per commodity and preferably in interdisciplinary teams to ensure involvement of the different stakeholders. Identified alternatives are analyzed to determine the savings potential (quantitative) and impact (qualitative). The outcome of the analysis can be used to set priorities and to decide on the implementation of saving initiatives.

And while reporting, it is important for the sake of credibility to report the good as well as the bad, bearing in mind that it is not always possible to avoid price-rises. For a correct, complete report which gives a clear insight into the performance of the procurement function is sure to enhance the esteem and trust of the management.

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