‘Savings’ are a crucial part of procurement, no doubt! But as companies move to tackle indirect spend areas, they need to adopt new techniques to ensure that savings are actually delivered, plugging the leakage between sourcing and spending. This new focus on realized savings, and developing the skills to deliver and measure those savings, is the path to
credibility with finance organizations.
‘Identified savings’ is basically savings that are theoretically possible, but haven’t yet occurred. And since they are in the future, there is a possibility that these savings won’t be realized. ‘Realized savings’ on the other hand, could mean savings calculated from company or supplier spend data or savings associated with spend for a current or previous period.
The Everest Research Institute provides helpful definitions for identified, contracted, and realized savings. Realized savings represents the most rigorous methodology for counting
savings, and it is the definition that most finance organizations prefer to use.
Realized savings vs. identified and contracted savings
||Savings potential based on analysis of existing spend base, benchmarks, industry best practices, market intelligence and category expertise. Identified Savings are measured as the savings identified by this analysis whether or not those savings are actually delivered.
||Post spend analysis, a strategic sourcing and negotiation process results in new negotiated contracts. Contracted Savings are measured as the differential between the new/re-negotiated contracts vs. The old contracts over the volume of purchase for that category.
||In Realized Savings, savings are not considered valid until spending occurs. Realized Savings are measured as the difference between the original cost (pre-sourcing cost) and the actual price paid.Savings are calculated after the transaction is complete.
Source: Everest Research Institute: “Get More From Your Noncore Spend – Realizing Value from Procurement Outsourcing”
How to drive realized savings
Driving savings realization in indirect spend areas differs significantly from direct spend areas. For example, in direct categories, after sourcing has occurred, raw materials and components are often loaded into a bill of materials and auto-replenished based on forecasts and demand plans. Thus, once contracted, the path from contract to spending and savings realization is fairly direct with relatively few opportunities for savings leakage.
But in most indirect spend categories there can be a numerous points of leakage, making it much more challenging to achieve realized savings once they are identified. Consider an indirect expense category like travel. The buyer base (like for example, thousands of travelling employees from across the organization) is highly fragmented, multiplying the opportunities for noncompliant spending. These travellers may deliberately choose to use their favourite airline carrier rather than a preferred carrier. Or policies may not be well communicated or enforced, leading employees to inadvertently use non preferred suppliers due to a lack of awareness of policy. Problems can also arise on the supplier side where pricing discounts may not be properly applied, and individual buyers are not well equipped to monitor supplier price compliance.
But, with end-to-end alignment on driving realized savings, procurement, finance and the
rest of the organization (HR, operations, etc.) can create a corporate culture and supporting policies to minimize points of savings leakage. This example also reinforces that counting savings at the point of contracting is premature, as realized savings can differ materially
from identified savings.
Key enablers for achieving realized savings
Alignment and accountability – Getting all key players aligned on measuring realized savings is critical to achieving the cultural shift that will help prevent savings leakage. Procurement and finance must also agree on what savings methodologies will be employed, and who will be responsible and accountable for measuring and validating savings.Stakeholder engagement - Engaging stakeholders in the development of policies and processes will help control spending and drive compliance.
Awareness and access - Once new or revised agreements have been put in place, all stakeholders need to know how to access these agreements and operate within established policies.
Proactive monitoring and management at the purchase order level – Once agreements have been put in place and fully communicated and implemented, it is crucial to establish a proactive monitoring capability to identify and stop noncompliant purchases before they are approved and executed.
Savings measurement and reporting - Companies should rigorously measure spend, savings and compliance to identify opportunities for improvement. The more detailed the savings and compliance visibility, the better equipped companies will be to celebrate successes and proactively identify and mitigate issues.