Accelerating Procurement's Impact on the Bottom Line

Accelerating Procurement’s

Impact on the Bottom Line:

Building Corporate

Consensus by Enabling a

360° View of Savings

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Iasta European Headquarters

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Website: www.iasta.com

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Accelerating Procurement’s Impact on the Bottom Line: Building Corporate Consensus by Enabling a 360° View of Savings

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TABLE OF CONTENTS

Executive Overview ................................................................................................................................ 3

Should Procurement be Focused on ROI? .............................................................................................. 4

The Potential of Bottom-line Savings from Procurement ........................................................................ 4

The Burden of Proof: Trying to get to the Bottom line ........................................................................... 6

Cost Reductions .................................................................................................................................. 6

Cost Avoidance ................................................................................................................................... 7

Other Value Drivers to Savings ........................................................................................................... 8

How Procurement Savings Gets Lost in Translation .............................................................................. 8

Ensuring Visibility to Savings Identification .......................................................................................... 10

A Call to Action for Procurement Savings ............................................................................................ 12

About Iasta .......................................................................................................................................... 14

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Executive Overview

In this age of über-cost management and ROI, procurement professionals need to clearly demonstrate

their value to the organization. For procurement, demonstrating value involves the unique challenge of

showing finance and other leading executives their ability to reduce costs and increase profitability.

But the story of procurement’s struggle to contribute to ROI and bottom line results is nothing new,

and is often illustrated by how frequently their efforts are put aside by finance. According to research

conducted by the management consultancy Arthur D. Little, executives typically analyze less than 50

percent of the savings reported from procurement. One can’t help but wonder, why is this percentage

so low?

Part of the explanation is simply a lack of credibility, where claims of savings generated in the past

have been overstated or have been misaligned due to lack of a common understanding of what savings

is or should be. Another possible reasoning is based on a lack of investment in technology that actually

focuses on how spend management activities work in conjunction with realized savings.

To improve its corporate image, procurement organizations today yearn for simplified and automated

ways to consolidate their disparate internal spend and sourcing systems. They are also actively looking

for ways to streamline savings information to the appropriate financial executive or line of business. By

doing so, procurement is better enabled to monitor and show KPIs related to cost savings, while

enhancing business decisions that reflect wider-corporate savings goals.

This paper takes a brief look at procurement’s challenge of savings tracking and reporting, and

describes how tools such as Iasta Savings Tracker are designed to focus on improving procurement’s

savings identification for establishing deeper savings insights, and removing the traditional barriers that

arise between procurement and finance.

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Should Procurement be Focused on ROI?

Why is procurement so focused on Return on Investment (ROI)? The quick answer: because so is

everyone else. ROI has become that current buzz-word for most industries and operational aspects of

business today. The emphasis on ROI is not surprising considering the increased need to focus on how

investments in both working capital and operational resources translate to profits. With global price

competition and regulatory pressures on the rise, every line of business is being forced to do more with

the financial resources at their disposal, which even includes justifying their actions by measuring their

own results. And of course, procurement is no exception to this trend.

When a company commits to spending money on goods or services, CFOs and other senior executives

like to see, and better yet, like to understand how procurement departments are able to improve the

return on their efforts. While ROI is often discussed in terms of the amount of time necessary to

recoup their expenditure in pure financial terms, establishing a positive procurement ROI also means

ensuring the costs of managing a procurement organization are less than the amount of savings it

generates.

However, industry experts note that using ROI as the sole measure may be inadequate to understand

the true value of procurement’s contribution.1 “Procurement ROI” is not just "cost savings," but the

actual impact that the procurement organization has on source-to-pay activities and their ultimate

impact on the bottom-line of the business.2 Yet, understanding where savings comes from and how

savings get applied remains one of the largest challenges for building a corporate consensus on

procurement’s organizational impact.

The Potential of Bottom-line Savings from Procurement

Taking a step back into understanding the potential of procurement helps us understand the challenges

procurement still faces for establishing a consensus on activities related to savings identification and

recognition. The classic example is weighing the difference between cutting costs and generating

income, where due to profit margins, one dollar in savings is more valuable than one dollar in sales.

Studies have shown that a 5 percent cost savings is the equivalent of a 30 – 50 percent increase in

sales.3 Furthermore, not only can a reduction in costs directly impact the bottom line as reflection of

1 http://info.proximagroup.com/buyingBlog/bid/87575/Does-your-procurement-function-exist-to-deliver-savings-

Then-you-re-doomed 2 spendmatters.com/2012/10/02/procurement-roi-the-righ-metric-part-1

3 http://www.mhprofessional.com/downloads/products/0071770615/0071770615_ch01.pdf

http://www.mhprofessional.com/downloads/products/0071770615/0071770615_ch01.pdf

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corporate performance, but cost reductions can also generate improvement on shareholder value

through increased earnings per share for publically traded companies.

Throughout all of the years that procurement automation has been put in practice, one presentation

after the other has argued that procurement’s potential is based on the capability of significantly

reducing costs. Hence one can understand the allure of procurement technology by simply looking at

an income statement model. For instance, Figure 1 below demonstrates the potential financial benefits

that can be derived from reducing SG&A costs. By using eSourcing technology, a $15 billion publically

traded company can better source specific categories related to indirect spend in their SG&A and

identify significant savings.

Figure 1: The Potential of Identified Savings through eSourcing on the P&L:

Realizing a 10 percent savings across all categories related to SG&A generates a 16 percent increase in

operating income and a 14 percent increase on EPS. If the company is best-in-class, they have the

opportunity to achieve a 15 percent savings, increasing operating income by 23 percent and EPS by 21

percent. This high impact potential in cost savings explains the immediate gravitation towards

procurement automation in the late nineties for both upstream and downstream procurement. For

WHAT TO CONSIDER:

The savings in SG&A can be

impacted by the effective

use of eSourcing platform

technologies that leverage

features such as eAuctions,

RFx, Optimization, Contract

Management and Spend

Analysis.

But the challenge in

recognizing Procurement’s

contribution to both bottom-

line and non-bottom-line

efforts remain steeped in

the inability to establish

consistent definitions and

more visible approaches to

finance and other lines of

business.

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more than a decade, leading technologies like Iasta that focus on strategic sourcing, continue to pique

the interest of CPOs and other CXO executives. Strategic sourcing solutions help these executives with

the ongoing challenge of trying to increase revenues by reducing the impact of price volatility required

for managing the day-to-day activities of the business.4

The Burden of Proof: Trying to get to the Bottom line

Based on the simple example above, it would appear that simply automating the process to identify

and incorporate savings into the P&L is all that needs to happen. But technology alone is not a

panacea to solving business problems. One of the real challenges in driving procurement’s efforts home

is the ability to drive acceptance in savings recognition. There are several clear examples that

demonstrate how procurement management must deal with the complex issue of translating savings to

both bottom-line and non-bottom-line impacts. This starts with procurement establishing a

fundamental understanding of what defines cost reductions versus cost avoidance, and the external

market variables driving the need to expand how procurement understands savings.

Cost Reductions

Cost reductions or “hard cost savings” are all about quantifying and measuring. Hard cost savings can

often be understood as the tangible bottom line reductions. Some example definitions of cost

reductions include: 5

Year-on-year savings over the constant volume of purchased product / service

Direct reduction of expense or a change in process, technology or policy that directly reduces

expenses

Process improvements that result in real and measureable cost or asset reductions

Examination of existing products or services, contractual agreements, or processes to determine

potential changes that reduce cost

Net reductions in prices paid for items procured when compared to prices in place for the prior

twelve months or a change to lower cost alternatives

When it comes to specialty projects like Six Sigma, organizations are focused on the hard dollar cost

reductions. However, procurement is also faced with the challenge of accepting and using accounting

approaches to recognizing to bottom-line savings that may not translate to the income statement due

to accounting difference between operating and capital expenditures.

4 Why Procurement must transform itself by 2020, Deloitte. 2013.

5 www.esourcingwiki.com/index.php/Cost_Reduction_and_Avoidance

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For instance, OPEX or operating expenses are typically recurring expenses and costs associated with

the day-to-day activities of the business such as research/development, sales and administration that

are critical to the operation of a business; essentially the money needed to turn inventory into

throughput. Since OPEX are shown in the income statement, procurement identifying savings in these

categories can become very visible if they are tracked properly and managed effectively through the

source-to-pay cycle.

CAPEX or capital expenditures, on the other hand, typically correspond to capital spending where the

initial impacts are represented on the cash flow statement and amortized over time on the balance

sheet. Generally only costs of repair or maintenance will be represented on the income statement as it

relates to CAPEX items. As a result, understanding and measuring the savings involved with CAPEX

items is possible to measure, but may be more difficult for procurement to trace their total impact for

having effectively sourced a CAPEX good or service.

Cost Avoidance

While hard cost savings are more tangible, much of a supply management’s efforts also result in cost

avoidance – essentially actions taken that may incur higher costs in the short run, but look to lower

costs over the course of time. Unless savings are recurring and can be tracked to a specific financial

budget, cost avoidance savings will never make it to the income statement. Moreover, soft cost savings

or cost avoidance is more difficult to define, but the suggested definitions from Iasta’s eSourcing Wiki 6

include:

Resisting or delaying a supplier’s increase

Purchase price that is lower than the original quoted price

Value of additional services at no cost such as free training

Long-term contract with price-protection provisions

(that for instance avoid issues such as price inflation)

Some of the common approaches to cost avoidance include:

Reduced ownership cost Competitive bidding of requirements

Avoidance of costs due to market changes Spot buy transaction negotiation

Improved total value Substitution or standardization

Strategic preferred contract relationships Negotiated better contract terms

6 www.esourcingwiki.com/index.php/Cost_Reduction_and_Avoidance

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While cost avoidance is not something that can be tracked to the bottom-line, Aberdeen research

shows that 66% of procurement organizations still look at both hard and soft cost savings in

understanding savings. In addition, an IBM study7 indicated 91% of the top performing chief

procurement officers (CPOs) placed high or very high importance on cost avoidances, compared with

only 54% of the emerging performers. These numbers demonstrate the value put on both types of

savings – cost reductions and cost avoidance as it relates to savings.8 Thus changing a company’s

perception of soft savings from not-impacting the bottom line to something tangible and adding value

is something that procurement must convey to other stakeholders to advance their cause.

Other Value Drivers to Savings

Finally, another area that cannot be measured in accounting terms is how procurement is able to

enhance purchasing decisions by incorporating a wider understanding of where savings can be applied.

In other words, a fanatical focus on better price realization and lower cost of procurement alone can

lead procurement down a rabbit hole by overly focusing on implementing more sophisticated ways of

improving procurement while neglecting more coordination within the wider organization.9

Hence, other aspects that make getting cost savings so difficult are the external global challenges that

encompass the modern procurement enterprise. These global challenges can be reflected in areas

such as through currency fluctuations, volume, and dynamic market movements. Immaturity in

managing savings can demonstrate procurement’s inability to improve and react to external aspects

that can directly impact spend. Even when driving costs from supply contracts will always be a central

tenant of procurement, many organizations may also look to procurement for extending their savings

activities proactively into wider core capabilities such as category management, supplier relationship

management and risk management.10

How Procurement Savings Gets Lost in Translation

Both finance and procurement would agree that hard dollar cost reductions are the shortest path to the

bottom line. However, establishing this lingua franca or working language that translates procurement

metrics into financial ones, without automating savings tracking and visibility remains one of the largest

hurdles for most companies today.

7 Chief Procurement Officer Study 2013, IBM, May 2013

8 Dynamic Procurement: The CPO as Collaborator, Innovator and Strategist. Aberdeen Group. August 2011.

9 Avoiding the Procurement Rabbit Hole. Booz & Co. 2007.

10 The Power of Procurement: A global survey of Procurement functions. KPMG. 2012.

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For instance, anyone reading financial statements such as an income statement, balance sheet, or cash

flow can clearly uncover core financial metrics that determine a company’s financial performance.

Commonly accepted measures such as gross margins, operating margins, or net profit margins are

monitored and well understood with the context of U.S. GAAP and/or other international accounting

standards used for financial reporting. Moreover, while industries vary in terms of the make-up of their

revenues, organizations can easily compare these metrics against their industry peers, competitors or

even other markets to understand how they performed related to profits and shareholder returns. As a

result, these metrics are easily or relatively transferable.

However, characteristics of procurement metrics such as spend under management, spend under

contract, or procurement cost savings typically are not measured with a high degree of consistency

from one organization to the next. Part of this difference resides in how an organization defines cost

savings that includes factors such as improvements in quality, service, delivery and increasingly

sustainability. Moreover, the focus on long-term factors that look at savings based on the total cost of

ownership (TCO) also creates the issue of putting both quantitative and qualitative factors on the total

benefits derived. Thus generating procurement standards and metric definitions is highly dependent on

the culture of procurement in each organization and frequently distinguished by the maturity of the

procurement organization. Given the lack of consistent metric definitions across organizations and the

absence of regulated bodies for measuring them, procurement metrics are less transferable than

financial metrics in understanding an organization’s performance.

Research even points to the fact that savings also becomes a function of the responsibilities within an

organization, where personal metrics, planning needs, and analytical skill sets for each part of the

business created the understanding what “savings” means.11 For example:

A sourcing or buying manager may interpret savings as the incremental discounts negotiated

from the supplier’s first quote or otherwise benchmarked market process across anticipated

purchase volumes.

A financial manager may look at it as the direct costs or expense reductions reflected as a

positive variance or working capital improvement in the “budget”.

Finally a CFO, controller or treasurer may interpret it as a something that impacts earning or

cash-flow plans including financing and global exchange implications.

Still, another challenge is the degree of credibility related to procurement’s ability to measure savings

due to not being adequately aligned with accounting. Finance organizations have often been 11

The CFO’s View of Procurement: Getting More to the Bottom Line. Aberdeen Group, 2005.

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confronted by procurement savings with the need to question their validity due to a number reasons

including:

carrying over savings from previous years

inconsistencies in establishing market benchmarks

assumptions with high inflation rates

mishandling of changes in unit price and quantity

overestimating savings assumptions due to process change

As a result of not speaking the same language, nothing gets interpreted easily between procurement

and finance. Research demonstrates this fact as well. According to a study by the Aberdeen Group,

32% of enterprises have no formal process to measure the savings generated by procurement, and

another 25% only calculate these measures on a case-by-case basis. Even more surprising, is that less

than a quarter use booked savings to acknowledge procurement’s performance.12

Ensuring Visibility to Savings Identification

While there are a number of ways procurement can improve its transparency from an accounting

framework, procurements organizations today must become more savvy and knowledgeable in how

expenditure types should be treated based on their stored data. In the end, procurement needs to

think hard and wide about how to document the complicated world of “savings”. And as one analyst

firm suggests, top-performing organizations are 40% more likely to hold visibility into booked savings

across the enterprise.13 Being more adept at identifying and reporting on savings visibility means

avoiding savings getting lost, which in part requires the right combination of both process and

technology.

As a result, Iasta recognizes that technology capabilities such as Iasta Savings Tracker tool can help

organizations better identify and eliminate threats and capitalize on opportunities that will enhance

business decisions and improve execution. The Savings Tracker tool provides procurement teams with

a centralized visibility into the status of key department metrics and corporate cost savings goals.

Moreover, through the use of technology, procurement organizations can streamline savings into pre-

built, user-specific data views, and templates that give decision makers the ability to monitor and

measure KPIs related to cost savings through identified negotiated, implemented, or bottom line

savings.

12

The CFO‘s View of Procurement: Work in Progress. The Aberdeen Group. 2009 13

Blog posting: http://cporising.com/2013/07/18/the-visibility-factor-another-best-in-class-advantage/

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But to improve procurement’s impact on identifying savings, a discussion also needs to take place

around the types of savings that are occurring within the organization such as project savings or cost

avoidance savings. With Iasta Savings Tracker organizations can obtain savings in a number of

different ways which includes:

Savings by Program Maturity Run Rate Savings

Savings by CapEx Cumulative Savings

Savings by OpEx Savings in Progress

Savings by Division Actual v. Forecasted

Figure 2: Screen Capture of Iasta Savings Tracker Dashboard

As illustrated above, Savings Tracker provides a graphical, analytic reporting tool with transaction level drilldown. The tool compiles <department level> <company level> <individual level> information on expenses, budgets, goals, risks and then calculates savings, cost avoidances, probabilities, and identifies trends for identified periods of time, specific groups, and classifications.

Improving procurement’s impact also requires a wider technology direction. For instance, in concert

with spend analytics for classifying and cleansing data, using advanced tools such as the Iasta strategic

sourcing, contract and supplier information and performance management applications, organizations

can better track spend. As a result, decision makers are provided with visibility into spend data within

and/or across categories, classifications, groups, individuals, or various combination of these elements.

By doing this, organizations can save time and increase productivity. Best of all, they can provide

intelligent decision making guidance supported by data to executive leadership to:

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Specifically pinpoint where savings are occurring from their source Identify findings that can help in forecasting and decision making for near and long-term goals Provide insights that can assist with managing both internal and supplier risk Simplify the aggregation and reporting on savings information through standardizations the end-to-

end process Automate the aggregation of data from multiple sources which tends to be a huge challenge for

most businesses

Finally, becoming a procurement team that delivers high value and impact requires the flexibility to manage the savings recognition in a dynamic and complex environment that faces change on a daily basis. Procurement professionals need the flexibility to:

Provide procurement management visibility into what they've done and justification for future Integrate market intelligence data into dashboard and reporting Integrate capabilities such as spend analytics, strategic sourcing and contract management Understand the needs of multiple currency environments to capture savings with multiple lot

currencies, converting project savings, maintaining exchange rates, and the ability to input custom exchange rate

A Call to Action for Procurement Savings

Based on the challenges outlined in this paper, it is clear that businesses today need a simplified,

automated way to consolidate their own disparate internal savings data and streamline it into pre-built,

user-specific data views and templates. As a result, decision makers in procurement, finance, and other

lines of business will need a better way to monitor and measure KPIs related to cost savings be it

identified, negotiated, implemented or bottom line savings. By using the Savings Tracker solution,

organizations are more prepared to identify and eliminate threats and capitalize on opportunities that

enhance business decisions and improve execution. What are your next steps?

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Step 1 – Establish consistent savings definitions and types

This starts by understanding the value that can be potentially provided from improved savings

recognition capabilities by improving the alignment of procurement metrics with the rest of the

organization. This includes -

Identifying the savings potential and base-lining both bottom line / non-bottom line impacts from

procurement activities

Aligning a common or standard definition of savings with Finance and other Executive stakeholders

so that everyone understands what savings means

Addressing the common external macro variables impacting cost (e.g. currency, industry,

environment, diversity) that can impact savings recognition approaches and interpreting their

effects

Step 2 – Assess Savings Maturity and Create IT Alignment

Being more consistent starts not only with multiple stakeholder alignment but understanding the

current state of things and the realm of possibilities now and in the future by -

Assessing current maturity in the savings recognition capabilities whether they be manual, semi-

automated or automated

Creating an improved IT alignment with procurement systems and tools that collect data impacted

by procurement such as spend, sourcing, product, or contract data

Integrating with external 3rd party for collecting additional factors that will impact savings

opportunities such as inflation, market trends or regulatory information

Step 3 – Drive for Savings recognition

Once definitions are aligned through the use of both process and automation, procurement

organizations can achieve a more consistent approach to driving savings recognition to the rest of the

organization by -

Using more conservative approaches to savings for establishing credibility (especially soft savings)

due to the lack of impact on income statement

Establishing a process of savings governance and repeatability with procurement systems and tools

that prevents a misinterpretation of what is meant by “savings”

Establishing heightened delivery and awareness savings recognition through the use of savings

reporting tools and executive-level dashboards

Are you ready to improve your team’s impact with enhanced visibility and better relationships with

Finance? Contact our sourcing experts today at [email protected] or visit www.iasta.com.

mailto:[email protected]

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About Iasta

Iasta is a team of dedicated sourcing and spend management experts who empower procurement to

expand their impact and influence across the organization. Our unmatched blend of software and

services allow companies to incorporate best in class purchasing practices through Iasta’s spend

analysis, supplier management, strategic sourcing, decision optimization, and contract management

solutions. We empower procurement organizations with the tools, business intelligence, and experience

needed to make responsible business decisions. Most importantly, the heart of Iasta's business model

is customer success. We believe that strong customer relationships drive user adoption, which

increases the ROI of our easy-to-use software and exceptional service offerings.

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Accelerating Procurement's Impact on the Bottom Line