The guts and glory of procurement savings
Procurement savings is a double-edged sword.
Some colleagues use it to massage their egos by claiming millions of hot-air dollars that make no good to the company balance sheets or end-user prices.
Others save to create a lifeline for troubled businesses or to fuel up the competitive advantage.
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This post will cover the most essential aspects of procurement savings management based on best practices and actual working examples.
Spend under management
Whenever you commit to procurement savings, it is essential to distinguish the basis of your future KPIs.
Naturally, the total spend is what the company's expenses are.
Having committed to X% annual savings, make sure the underlying spending excludes pockets of uncontrolled expenses, e.g., state-controlled communal services, executive consultancy, litigation, or else.
Spending under procurement control is the broadest possible selection of expenses covered by the procurement policy.
Out of that, not every expense falls under a contract, as your company got tail spend - small-value transactions managed via default buying channels, e.g., p-cards or petty cash.
Therefore, your spending under contract is lower than the one under control.
Not every expense is managed (planned, analyzed, sourced, negotiated) in the current fiscal year as you have multi-year contracts untouchable before the next maturity date.
So, you need to consider all new agreements and ones coming for renegotiations this year to derive the spending under management.
It is suggested to monitor the procurement savings based on spending under management.
Procurement savings types
Soft savings
Hard savings
How to manage procurement savings
We suggest the following best practice for procurement savings governance:
- Savings must be measured against the budget.
- A distinct savings bucket should apply to the current fiscal year (hard savings.)
- Savings reports must be verified and formally signed-off by financial control.
- Negotiated benefits realization should be monitored based on actual consumption (not contractual forecasts!);
- Verified savings attributable to the current fiscal year must be deducted from a respective business unit's budget.
With these six simple rules in mind, the practical implementation could be staged into
- Forecasting of savings targets (category planning).
- Delivery of projected savings.
- Tracking of realized savings.
- Budget adjustment.
Pre-tender cost estimate
- Historical prices of the preceding period(s) adjusted for inflation and/or applicable price indices (e.g., manufacturing or commodity ones.)
- The fair market price is calculated as an average of at least three quotations collected before the RFP. It is essential to eliminate "atypical" costs, which deviate by 30% and above the median level.
- Commodity formula-based prices, e.g., Platts-based fuel price, LME-based price of metal products, price-at-hub formulas for coal or natural gas, etc.
- Open-data price benchmarks for similar products or services, e.g., customs declarations, public procurement tenders.
- Industry expert estimates, e.g., trade chambers, ministries, state or independent price registers, renowned industry consultants, etc.
Procurement savings calculation methodology
- future year's benefits;
- additional deliverables over and above the initial scope of requirements;
- extended warranty;
- improved payment terms.
Four critical steps to take before celebrating procurement savings
- First, your category plan must include the forecast of savings and other benefits.
- Second, your forecast will be gradually fulfilled in source-to-contract activities. However, this isn't the point where procurement enjoys its achievements!
- Therefore, tracking realized benefits on a Purchase Order basis is the critical stage of the procurement savings management process!
- Lastly, procurement needs to obtain the acknowledgment of the delivered savings. Usually, this comes from the Financial Control, who would then adjust end-user budgets accordingly.