An article recently published on the French website Décisions-Achats.fr suggests doing a little maths. In addition to enthusiastically answering the question of how to highlight the results of a procurement strategy, it also provides a formula for calculating procurement savings.
The challenge is putting this type of calculation into practice. Calculating the quantitative benefits offered by a company's procurement strategy can demonstrate how well a procurement department is performing in terms of its specific contributions. For example, increasing the R&D budget by additional 10% may make a lot of sense for the procurement team.
Depending on the type of expenditure, the article suggests three different methods to evaluate the performance of the procurement strategy:
- Calculating procurement savings in relation to a known expense
- Calculating savings in relation to estimated expenditure
- Calculating procurement savings within the framework of a budget forecast
The first scenario examined to assess the performance of the procurement strategy is also the simplest. In this instance, we are assuming that a reference price is available. For example, this may be:
- The average price paid during a comparable period for a repeat purchase.
- The last price charged if it is not an annual expense.
- The commonly accepted market price.
The procurement saving is the difference between the price paid in practice and the reference price, multiplied by the estimated consumption volume provided when the budget was created.
- (reference price – price paid in practice) x estimated volume
However, the real issue lies in how the procurement savings that we want to assess are made.
Was the saving made by:
- Negotiating effectively with the supplier?
- Changing the logistical situation, for example by agreeing to a reduction in the number of deliveries?
- Reducing the number of delivery points?
- Being flexible in terms of delivery days?
- Changing supplier ?
- Rationalising product information according to a specific need?
In reality, the unit price secured demonstrates just one aspect of the procurement team's talent and is only a part of the procurement strategy in place.
The second scenario envisaged by the article's author is outsourcing a task. The difficulty in calculating the procurement saving lies in the absence of a reference value. Internal tasks, such as sending invites for customer events, are very rarely evaluated. In general, the decision to outsource a task is determined by the lack of availability of the person normally responsible for it, rather than for economic reasons.
To calculate savings and therefore highlight the performance of the procurement strategy in an outsourcing scenario, the recommended method involves comparing the price paid in practice for the service and a reference for this type of task, from a market study for example.
- reference price – price paid in practice
Although the article does not challenge the validity of the formula, it does question whether an evaluation makes sense if there is a strong risk that the cost of the calculations could outweigh any savings made.
In this third scenario, the reference value comes from a budget forecast, which is based on an estimated volume of purchases in itself. The effect that the procurement strategy has on performance is calculated using the difference between the initial budget provided and the estimated volume, multiplied by the purchase price secured in practice.
- budget – (estimated volume x price paid in practice)
This method therefore compensates for any variation in volume. The difference, in terms of savings or losses, results only from the unitary amount negotiated using the buyer's expertise.
The reliability of this method for evaluating the performance of the procurement department is based on two conditions:
- Whether the price estimated at the outset to draw up the draft budget for the relevant purchase category was realistic.
In order to be credible, the initial target budget must be established using a well-documented unit market price or a reliably referenced past experience.
- Whether the estimated volume requirements are realistic.
If the annual volume of orders placed differs greatly and is much higher than the volume used to calculate the initial budget, the effect of volume in the secured unit price risks clouding the performance message.
The article from Décision-Achats.fr mentions that public procurement services complete a series of calculations to try and ensure reliability in evaluating the savings made in this third scenario:
- The identified saving: based on the buyer's initial idea.
- The target saving: fine-tuned following authorisation.
- The saving made: adjusted at the end of the project.
In conclusion, assessing the performance of the procurement strategy provides motivation and recognition for procurement teams. In this respect, they must actively seek out this quantification to gain proper recognition for the savings made using an effective procurement strategy.
However, it is important to bear in mind that a very large proportion of the procurement department's work is qualitative.
The most important thing for the procurement team is to promote their contribution to the collective dynamic of the company, and portray themselves as an innovative and successful department, recognised by all their stakeholders for their quality and reliability.
To find out more about the necessary strategic alignment between procurement departments and companies, take a look at the "Should the procurement strategy be aligned with the company strategy?" article.