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Procurement Value - A Penny Saved

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Benjamin Franklin said, "A penny saved is a penny earned". True indeed, but the common problem faced by CPOs has always been - How to define a "saved penny" or "Procurement Value" as few call it.

Traditionally, getting the price reduction from suppliers was the only objective of the procurement organizations. Hence measuring Procurement Value was only based on material cost reduction. The most basic method is to use the difference between the current price and last year's price and multiply it with quantity received. Simple as it may sound, things get complicated in case of non-repeated buy items or items which are not comparable to items bought last year. In such situations, the saving is calculated by taking the price from initial rounds of quotation as base price v/s the final negotiated price. This is where things get trickier and various "games" are played among the suppliers, end users, buyers and financial controllers. Even though companies have well defined policies and methods to determine a baseline price/budget cost or take the lowest initial bid and compare these with the final negotiated price to arrive at a saving calculation, this calculated dollar figure is a very narrow metric to measure the overall Procurement Value. There is a lot of value which doesn't get measured and is often subjective in nature. Over a period of time, the role of procurement function has evolved to control this subjective procurement value. Buyers are not only just issuing purchase orders but also playing the role of planner / inventory controller to ensure security of supply. Apart from running RFQ events, Sourcing Managers are using their commodity expertise and market knowledge to reduce Total Cost of Ownership (TCO) and Procurement General Managers are becoming a trusted business partner and change agent for business units.

The procurement value is now reflected in both the effectiveness and the efficiency of acquiring goods and services. Economic value added (EVA) is a good measure of procurement value which gets linked to revenue earned or gross/net margins of the firm. Procurement led patents creation also gets included in such EVA/procurement value. While the saved penny is important, the process of saving and defining it in the right manner is equally vital.

So, have you saved your Penny today? Please share your views.

Comments

Very simple and crisp article.

The problem faced by procurement professionals to define 'savings' is due to the fact that savings generated through procurement is intangible. This is the reason why sales guy bags all the incentives and kudos in the organization whereas procurement guy always faces the heat to ensure cost saving and security of supply though both have common goal to ensure company's goal is achieved.

True that there is no foolproof mechanism to measure savings. Every method has its pitfalls. An organization can adopt any one method and continue using it year on year. The relative improvement in savings YoY will reflect that efficiencies are improving. So it's a relative measurement or trend analysis which will give the comfort to CPO that things are moving in the right direction. Would be good to have a post on EVA, Durgesh!

EVA is infact even more complicated (some even say "dangerous") method. I remember a case study where even though the new negotiated price was more than the historic price (hence no penny saved) but EVA impact was 2 times the total cost of value of the material. It was almost impossible for the finance guys to digest that!!!
EVA still needs to evolve and mature before being implemented. (Though would love that to happen soon....it makes us procurement guys looks more handsome!)

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