Procurement Savings
Second only to ‘strategic reasons’, accountants should approach any ‘procurement savings’ in their financial models with suspicion. The chances are high they will turn out to be a will-‘o-the-wisp. To an accountant, a procurement saving means paying less cash this year than you spent on the same thing last year. In a depressingly large number of cases, this is not what actually happens, no matter what your buyers tell you.
One of the main reasons is simply that procurement savings (accountant’s definition) are so darn difficult to achieve. There are three factors that drive real procurement savings.
Standardisation
This is easiest to achieve when procuring physical things such as raw materials or packaging in a production environment, or where the quality of the product is homogenised and subject to regulatory standards such as petrol, electricity and gas. Such items are big ticket costs under the control of a small numbers of suppliers.
Standardisation gets progressively more difficult to maintain for small things used by large number of people: stationery being a classic example; or where the quality of the product changes rapidly, such as computers and mobile phones; or where the product is not very homogenised, such as construction.
Standardisation is even more difficult when it comes to services, where quality is everything. If the client can specify what they want in some detail, such as with facility management services, a degree of standardisation is possible. But when it comes to the sort of specialist services that bosses care about such as advice or project delivery, the quality of the product is impossible to standardise, nor would you want to buy it if it were.
The challenge with standardisation is maintaining control over your organisation in accepting both the standard and the restricted supply chain.
Aggregation
The greater the size of the contract on offer, the more commercially attractive it is. Therefore, the more you can aggregate your demand the better the deal you can get. Aggregation can be either across departments within a business, or across a group of businesses, or even across different organisations, although this is easier in the public sector than in the private sector.
There are several challenges to overcome before you can benefit from aggregation. The first is co-ordination of all the different requirements. The second is control, as above. The third is a market mature enough to have big suppliers capable of meeting the demand.
Competition
Competition should be the easy part. The tender process is meat and drink to procurement professionals. Or is it? I’ve met a surprisingly large number of people in procurement who are inexperienced in running a professional tender or lack the organisational clout to tender certain supplies or don’t re-tender at pre-determined, regular intervals. The result is less competition than you might expect.
A proper competitive tender is a time-consuming, energy-absorbing, emotionally draining process for both client and vendors. I think sometimes people don’t want to put in the effort required to get the competition they need. That’s good news for incumbents. If you want further insight into the reluctance to tender you need look no further than the procurement concept of ‘partnering’. This explicitly removed competition from the process and treats a supplier like an employee: their service is based on close working relationships and trust.
There’s no doubt partnering can be effective. If you’ve ever come to the end of a successful project you just ‘know’ that the same team could roll straight on to the next project and do a great job. For that reason, partnering works only where you have a secure project pipeline. How sustainable is such a situation? Rarely. It’s no surprise that many partnering arrangements broke down during the recent recession and clients suddenly became keen on competition again.
If you have ever prepared a tender from the vendor side, you know the truth; namely, that vendors sharpen their pencils when they know they are in competition, no matter how confident they are in the quality of their product or the closeness of their client relationship. They don’t do this when they know they are not in competition. It’s as simple as that.
Why does it go wrong in practice?
I’ve experienced countless examples of local organisations complaining they can source locally cheaper than some Europe-wide tender negotiated by a central buying authority. On the other side of that same story, I’ve heard suppliers complain that the promised aggregate demand never materialises. I’ve spoken with employees so annoyed with the grey tissue-paper thin notepads that in frustration they’ve gone down to the local shop and spent their own money buying a pad of decent quality paper. I’ve known executives waste hours configuring their travel plans to avoid certain pre-defined cheap and cheerful route deals. And I’ve seen senior executives call in personal contacts to carry out professional services on the basis that ‘This is the only firm that can do the job’.
Achieving procurement savings requires a level of control over your organisation that many firms don’t realise they haven’t got. And it’s probably just as well because, if they did, many of their staff wouldn’t want to work there.
Is this just a counsel of despair from someone who’s spent a career chasing ambitious but ephemeral procurement savings that have been used to pad out a weak business case? Not at all? But it is a request to be cautious the next time you hear a politician or manager claim procurement savings will fund some policy initiative or business project. It won’t.
How then should you handle procurement savings in your financial calculations? The truth is the more professional your procurement team, the greater check they will be on the underlying inflationary pressure on your cost base. They are a source of productivity improvement, not necessarily of extra cash. I’d recommend incorporating procurement ‘savings’ within your overall inflation forecasts.