This post was authored by: Ian Cotter, Guest Contributor, and Shahid Batty, ISG
Regardless of company or industry, delivering cost savings is and will remain a primary objective of procurement departments. Companies now spend up to 70% of revenue with external vendors, as the trend toward outsourcing non-core spend categories of the business to third-party specialists continues. Procurement is also taking a more active role in managing categories like marketing, insurance, audit and legal, which previously had little or no procurement involvement.
As a result, procurement is having a dramatically bigger impact on financial performance than in recent years. With this increased influence, procurement needs to take increased responsibility for bottom line results. Procurement has traditionally focused on identifying and negotiating savings and has been perhaps less concerned with ensuring that these identified savings actually get realized. However, getting money into a company’s coffers is just as difﬁcult as identifying savings —and in our experience, just as important. An ineffective process for deﬁning and capturing those savings may potentially eliminate any advantages that had been negotiated.
For a procurement department to be credible, finance must play an integral role in the validation of savings that procurement delivers. When it comes to savings, finance and procurement don’t always speak the same language. While both departments are focused on controlling and reducing costs, finance normally assumes that reported procurement savings will translate immediately into a decrease in the P&L. This, however, isn’t always the case — especially without a structured framework on measuring and capturing savings that has been agreed to by all parties and implemented uniformly across the organization. Procurement needs to educate finance on the intricacies of procurement savings to ensure internal alignment and realistic expectations as to how reported procurement savings will impact the business. Spending significant time upfront with finance on these points is worthwhile and will eliminate a lot of headaches down the line.
The cost savings measurement framework should also clearly describe the types of savings that can be claimed and reported. Finance needs to understand and recognize that cost savings cannot be measured using one standard formula. In addition, the accountability for realizing these savings is not always in procurement’s hands, as projects are often cross-functional engagements with interdisciplinary teams. As such, the final decision to implement may not always lie with procurement. The cost savings measurement framework should articulate how to resolve, and if necessary, escalate any savings opportunities lost within the organization.
Clarity around how savings will be documented and validated also is essential. A cross-functional project needs alignment as to which party is allowed to claim the savings. For example, if engineering proposes a simplification in the manufacturing process which leads to a saving, can this then be claimed by procurement? Having these discussions upfront is always preferable to bickering and squabbling after the fact, which ultimately leaves a bad taste in everyone’s mouth and detracts from the good work done in delivering the savings in the first place.
Procurement also needs to admit that sometimes delivering savings year over year is not possible due to unfavorable market conditions. Unfortunately, price increases do occur, and instead of sweeping this bad news under the rug, procurement should report the price increases to the wider business. This will also build credibility with other departments. Traditionally, procurement has too often been accused of only reporting favorable wins, while indulging in selective amnesia towards unfavorable results. If procurement wants to gain credibility, reporting the good along with the bad is the place to start.
Ian Cotter is Senior Manager, Consulting, with GEP. For more information, download a recent white paper on this topic.
About the author
Shahid is a procurement and supply chain management expert. In his more-than-20-year career, he has led multiple multi-tower outsourcing engagements that included everything from strategy assessments and benchmarking and feasibility studies to RFP development, supplier selection and contract negotiations. His work leading outsourcing and procurement transformation programs has helped generate and sustain more than $3 billion in savings. He also has enhanced clients’ procurement capabilities by leveraging digital strategies across the source-to-pay cycle. Shahid has an electrical engineering degree and an MBA. He has published white papers and taught classes on strategic sourcing methodologies, gainshare approaches and negotiations.