The Monthly Metric: Procurement Savings

Last month’s edition of The Monthly Metric ascended to the C-suite, where one of the most important supply management analytics to company executives — procurement ROI — was examined. This installment maintains the lofty view from the boardroom, focusing on a metric that has the biggest impact on a procurement leader’s performance review: savings.

Our guest expert on this measurement is Mark A. Crowder, C.P.M., a specialist master at Deloitte Consulting (deloitte.com) who is based in Chattanooga, Tennessee. In the November/December 2017 issue of Inside Supply Management^®, he authored “Procurement Data That’s Interesting and Insightful,” which offers four criteria — relevance, linkage to real outcomes, confidence in the source data and indicator clarity — procurement practitioners should utilize when determining which metrics to track.

When used properly, procurement savings meets all four prerequisites. Crowder says savings is “the biggest single driver, I think, for sourcing specialists and professionals. There is big pressure on procurement professionals to meet those targets, so establishing good baselines to track against performance is extremely important.”

Meaning of the Metric

Savings can mean different things to different departments in a company — we’ll get to that later — but Crowder defines it as the price paid for a good or service, as compared to previous reporting periods and such objective market data as the U.S. Bureau of Labor Statistics (BLS) Producer Price Indexes. A high-performing procurement department, he adds, should not only measure savings against itself, but other organizations around the country.

“You’ll want to measure if you found a clever way to save, but a more interesting way to look at it is, ‘What did we do against the market as a whole — that is, what everyone else in the country is paying for these materials?’ ” Crowder says. “You want to compare your performance, up or down, to the relative movements of the market. That’s a factor some (practitioners) overlook.”

A case study: Years ago, Crowder worked in procurement for a large consumer and medical products company. Among its procurement practitioners, one in the IT category was getting accolades and promotion speculation for cost savings; another in maintenance, repair and operations (MRO) was getting modest results, Crowder says. When their performances were finally gauged against their respective markets, however, the results were surprising.

“The buyer who looked like he was doing a mediocre job fighting cost increases was actually beating the market by double-digit percentages,” Crowder says. “The market was going up significantly in his category, and he was doing a great job holding the line with suppliers. The other guy? From a performance snapshot, he was looking like a hero. Against the market, though, he was subpar.

“The point is that it’s difficult to define cost savings without those published indicators. Sure, measure against your own standard, what you paid previously for the identical item or service. But there are other variables to account for.”

Cost Savings vs. Cost Avoidance

A 2014 report by CAPS Research, the Tempe, Arizona-based program jointly sponsored by Arizona State University and Institute for Supply Management^® (ISM^®), identified benchmarks for cost savings as a percent of managed spend in such industries as aerospace and defense (3.9 percent), financial services (5.3), industrial manufacturing (2.5) and utilities (2.2). The overall average was 3.1 percent.

CAPS Research found an overall cost-avoidance average of 2.0 percent. Crowder says that cost avoidance — a preemptive action taken to avoid future costs, and never reflected in financial statements or a budget — is a useful barometer if it’s clearly defined and has strong internal and external data to compare with. “I avoided X dollars, but was it really because I did this or didn’t do that?” Crowder says. “Since it’s not tangible on a financial document, I think you need a lot of evidence that it’s real savings. … Otherwise, it’s a question of if I really saved that money or budgeted too high.”

A clear definition is especially critical to the next step — reconciling “procurement savings” with how it’s defined by the finance department and C-suite. The hard truth for supply management organizations is that finance is going to win most definition battles. Cost avoidance will likely not be recognized as savings. Neither will contract-negotiation savings. The invoices and financial reports will tell the tale.

As a result, it’s vital to work with finance and executives to find alignment on savings definition and evaluation. “Get everyone around the table to buy in to what the definition of savings is,” Crowder says. “That way, there are no surprises, and at the next quarterly review session, when you tell senior leadership that you achieved X-percent savings on a product and that’s a good number, the finance person can say, ‘Yes, we concur with that.’ ”

The Law of Diminishing Returns

Perhaps the biggest caveat with savings is that, as procurement organizations get better at it, year-over-year percentages level off. Even world-class organizations experience a drop in their ability to reduce spend over time.

“If you come into a newer sourcing or procurement department, opportunities abound,” Crowder says. “You can imagine there are untapped savings opportunities where the spend hasn’t been as tightly managed as it would be in an organization that’s been actively engaging in savings endeavors for five or 10 years.”

When returns diminish, Crowder says, don’t minimize the value of holding the line — especially when performing well against the market, as with his earlier example of the MRO buyer. This kind of a scenario affords procurement organizations an opportunity to look beyond savings and pursue a more strategic supplier relationship management.

“I’m not a proponent of irresponsibly slashing quality or efficiency just to save a few bucks,” Crowder says. “But a mature organization can start moving into more collaborative efforts with suppliers and try to create shared incentives. Sure, keep looking for inherent savings — but take the widget and try to make it or the process more efficient and better. You can always strive for continuous improvement.”

To suggest a metric to be covered in the future, leave a comment on this page, email me at dzeiger@instituteforsupplymanagement.org or contact us on Twitter: @ISM_Magazine.