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September 14, 2015

Baselining purchase savings - Is there a best way? Part 1

How to baseline / calculate purchasing savings? You would expect this to be a subject of the past; discussed, debated, standardized and adapted. Unfortunately No. Only one thing is standard - there are no standards.


How to baseline / calculate purchasing savings? You would expect this to be a subject of the past; discussed, debated, standardized and adapted. Unfortunately No. I have worked in several purchasing organizations across industries and have had access to savings methodologies of a variety of clients in my consulting role, and one thing is standard - there are no standards. It's like one of those things - with all the developments in electric and electronics engineering, we have different plugs and sockets all over the world.

I will cover this topic over a series of blogs. I will try and analyse various types of savings and how they are baselined / calculated, and will then leave it open for discussions. There are no rights or wrongs in such methodologies, but then certain approaches are more logical than others, and that is what I will try and bring forth.

Savings are primarily of two types - Hard and Soft. There are different names used - Cost reduction and Cost avoidance; Cash Savings and Other Savings etc. However the fundamental difference remains same. Hard savings contribute to organization's bottomline and are usually the measure of success for Procurement function. Soft savings are good to have and generally 'add' to the overall rosy picture.

For today, lets pick up the classic Hard saving - saving achieved while purchasing an item which has a previous price reference. Sounds simple! Well, largely yes, unless you start asking 'What if'. What defines 'previous price reference'? There are several possibilities:

  • Last price paid, at whatever point in time it was
  • Last price paid within the last one year
  • Last price paid when the quantity purchased was comparable to current quantity
  • Average / weighted average of the last 3 purchases (or 5 or 10 or any other number)
  • Average / weighted average of all the purchases made in the last one year (or 6 months or 3 months)
  • Contracted price

Which of the above is best or most appropriate? Well, none, except for the 'Contracted price'. Contracted price is indisputable. You have a contract with item A at price X; you do a new contract and item X now costs Y; saving per item is (X-Y). Pretty straightforward. Complexities come in when the item is not contracted. To me, simple is the best. Weighted average of all the purchases made in the last one year, may be the most technically correct method, but sheer tracking of this moving average is a mammoth task, and I believe, is not worth the effort. The concept of last few purchases also doesn't go well with me. What if the last few purchases happened to be great deals or bad deals. To me, the last price paid, whenever it was, is the simplest and most straightforward method. It has its downside, that the quantity could have been incomparable, that the last deal could be dated, that the last deal could have been too good or too bad and hence gives a skewed baseline. All this is true. But when you talk of hundreds of spot buy transactions, all these parameters even out eventually.

The key assumption in the above approach is that the non-contracted items are purchased as spot buy or thru' tactical sourcing (small value, large volumes), and that strategic sourcing events are largely covered by contracted spend. With this assumption, 'last price paid' is the simplest and most straightforward method, which evens out all its anomalies over a large volume of small value transactions.

I would be very keen to know your views and what methods you have seen in your organization. Please note however, that this topic is only about savings from an item which has a price reference. For other types, we will discuss in subsequent blogs.

September 9, 2015

Beware - Your purchasing might be incongruent and not novel

Often the actual state of procurement functions is dismal and under the radar of usual KPIs and CPIs which don't have adequate entropy to make meaningful business assessment.


Ask any CPO (Chief purchasing officer) or their team members "how is your function doing" and most likely a pat/safe reply would come. "We are doing fine although some usual challenges exist". Most will dole out supporting numbers like savings delivered, spend under management, cost of procurement etc. relative to internal targets or benchmarks. More often than not, these statistics would show a hunky dory or novel (all in green or yellow) state. However, often the actual state is dismal and under the radar of such usual KPIs and CPIs which don't have adequate entropy to make meaningful business assessment. I call this state as "incongruent and not novel". This refers to a state and on-ground reality that most of the purchasing functions, their stakeholders and often suppliers are not congruent with purchasing and other intra-organization mandates. On the other hand, there is no composite measure defined ever or exists which can report the extent of such congruency.  Here are top 3 incongruences and typical "someone" that you may serendipitously find in your firms. "Someone", please excuse me for candour.

  1. A C level executive calls a supplier he knows, finalizes techno-commercial requirements and forwards an email with supporting files etc. to procurement to "raise a PO as per process". The organization has a policy to route such spend through preferred supplier(s) only while this supplier is new and yet to be empanelled. Procurement, knowing policy well and that there is no exception process allowed, creates an exception approval note and get couple of other senior folks to approve this. PO goes out as requested. "Someone" - Chief Training/HRD Officers, Chief Financial Officers, Chief Operations Managers and their deputies.
  2. A new PO is released by procurement on same supplier for same commodity at higher rates following specified procurement process when an open PO was available on same supplier for same commodity had sufficient balance quantity at lower rates. Such scenario is not described by any procurement policy or process. "Someone" - Sourcing managers, procurement managers.
  3. A stakeholder unduly narrows or broadens specifications to qualify sole supplier stakeholder wants to work with, while it was possible to create standard and/or universal specifications and run a competitive bid. "Someone" - Chief Marketing Officers, Chief Risk Officers and their deputies.

While I can go on and on, topic is too big to be congruent with space of a blog. You let me know your views and how congruent or novel your firm's purchasing practices are.

September 7, 2015

"Commonsense" Procurement

Somehow, in the flurry of fast evolving technological changes and other environmental distractions, the four fundamentals of procurement (which I call "commonsense procurement") have been relegated to the background.


In the last few years, Sourcing and Procurement, just like most of the other business functions has been immensely influenced and impacted by numerous internal and external factors like fast changes in technology, changing products and services, shorter business cycles, cost pressures, ever changing customer behaviors, and macroeconomic changes. All this has brought in quite a significant change in the procurement organizations like more investment in new procurement tools and technologies, frequent restructuring of the organizations (including downsizing and outsourcing), new skillsets, additional focus on governance, emergence of global / virtual teams, new suppliers, and new engagement models.

But most of these changes are ornamental when measured in terms of real value add to the business. The effectiveness of any procurement function is still governed by the four fundamentals - strategic sourcing, contract management, supplier management and order fulfillment. As long as the procurement organizations are doing these four things well, they are assured of good results. These results could be improvement in organizations' bottom-line or TCO (Total Cost of Ownership), supplier rationalization, better contract compliance, better supplier risk management, collaborative supplier relationships or better stakeholder management. The new technologies like Automation, Robotics, SMAC (Social Media-Mobility-Analytics-Cloud) are just the paraphernalia to the fundamentals. They are not the core or substitutes to the fundamentals.  The success and effectiveness of procurement organizations is still governed by how well the fundamentals are performed.

This is where procurement leadership and talent have a key role to play. As long as a procurement organization has the competency to understand and deliver to the fundamentals, it shall contribute and play a vital role in any organization or business. But it's not as simple as it sounds. Somehow, in the flurry of fast evolving technological changes and other environmental distractions, the four fundamentals of procurement (which I call "commonsense procurement") have been relegated to the background. There is a lot more focus from a resources standpoint on the new "procurement gizmos" rather than demonstrating and executing "commonsense procurement". This has directly or indirectly led to mediocre output and dilution of procurement loci standi as a strategic corporate function.

Therefore, the question I have - why is it so difficult to focus and demonstrate "commonsense procurement" when the real value lies in it? Curious to get your thoughts and comments.

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