Marketing Procurement’s Value: Defining Cost Savings

Three major benefits of conducting a spend analysis

While many corporate procurement teams have been tasked with lowering costs and buying on lean budgets, the value that these professionals can bring to financial planning and significant cost reduction is overlooked.  According to a recent article in the May/June issue of Procurement Leaders Magazine, “Procurement has an image problem.”  The article about recruiting and talented procurement professionals goes on to state “Internally, the image of procurement as a backroom bean-counter, while horrendously outdated in many organizations, still means that attracting internal talent over procurement involves correcting pre-established perceptions and making sure that the representatives of the team sell procurement to their counterparts.” The question remains, how do you market procurement’s value, internally?

One of the first steps to improving the perceptions of procurement is to define the key term that is most associated with procurement: cost savings.  Cost savings can be defined in multiple ways and can be unpersuasive if presented in an insignificant way.  Procurement personnel should understand how and when to use different metrics with various departments to communicate successes.  These numbers will be interpreted differently by an organization’s various internal groups based on their day-to-day operations and established management goals.

Unit Cost Savings & Discount Improvements

The most basic of cost metrics, these models provide a simplified view of achieved successes. However, the numbers in both of these metrics can still result in a budget increase due to increased volumes.  For example: Product Development asks procurement to purchase Widget A for a new product they are developing.  In the first year, procurement ordered 100,000 units of Widget A at
$1.00 per unit equaling a $100,000 budget for Year 1.  In the Year 2, procurement re-negotiated the price of Widget A down to $0.85.  At the same time, in Year 2 of making the new product, demand increased by 25%.  Therefore, 125,000 units of Widget A were purchased in Year 2, increasing the annual budget to $106,250.

Procurement managers need to ensure that if they are reporting to Finance that they communicate unit cost savings and discount
improvements and are not solely measured based on annual budgetary achievements.

Index-Based Commodity Cost Reduction

Most of the items bought by procurement departments are tied back to a commodity index of some kind.  Whether it be increased shipping costs due to fuel cost increases or the decrease of pulp and paper costs for office supplies.  Procurement also buys commodities directly and is subjected to the market price of products.  Savings achieved in this arena are hard to qualify for management and finance departments.  Increases or decreases in cost should not be tracked as savings unless the cost reduction was a direct result of a change to the procurement process, such as hedging.

Hard Dollar and Soft Dollar Savings

Hard dollar savings are defined as quantifiable metrics such as hard-dollar savings projections, payment terms, lead-time, rebates and signing bonuses, and quality improvements.  While these numbers are quantifiable, if they are not communicated in a meaningful way to interested parties, they will be of no benefit to procurement.

Soft dollar savings are not as easily quantified.  Such savings include exclusive distribution rights, quality improvements (as they impact consumer opinions), procure-to-pay efficiency gains, and process improvements.  It may seem difficult to communicate these items to other internal departments, but the best way to do so is to relate the savings to the goals the department has set.  Marketing loves quality improvements and product development loves process improvements.

Defining your cost metrics is just the first step in promoting the value procurement brings to an organization.  By continually communicating with internal departments and presenting meaningful data, procurement has an opportunity to present and promote successes and create a reputation for meeting and exceeding expectations.

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