Calculating Procurement SavingsPeter MorichovitisManager Supply

Olympic Dam

One of the major objectives a Procurement function is tasked with is generating Procurement Savings.

However, the process of quantifying and calculating Procurement Savings, legitimising them with internal stakeholders, and subsequently tracking them to the bottom line is often one of the Procurement department's greatest challenges…

IntroductionCalculating Procurement Savings…..

Topics

Introduction

Procurement Savings

What’s the problem?

The solution: Procurement Savings Protocol

• Savings Definitions

• Tracking and hardwiring Savings to the Bottom Line

3 years later…

Procurement Price Index

IntroductionOlympic Dam• A world class resource• Discovered in 1975• Fully integrated processing facility

from ore to concentrate to metal• Poly metallic orebody with 7.855Bt

resource – Copper, uranium, gold, silver

• Workforce of 3,200, majority residential in Roxby Downs

• World’s 4th largest copper deposit, largest uranium deposit, 5th largest gold deposit

Olympic Dam

Roxby Downs

IntroductionOlympic Dam Procurement

• 30 Procurement Staff, 26 Supply Chain Staff• $1,400M annual spend on goods and services (FY08)• 1,500 vendors• 40% of Spend with South Australian vendors• 300 contractual arrangements with vendors• 130,000 Purchase Orders p.a• 140,000 ‘invoice’ payments p.a

• Procurement Savings:FY08: $16.7MFY07: $18.5MFY06: $28.0M

Topics

Introduction

Procurement Savings

What’s the problem?

The solution: Procurement Savings Protocol

• Savings Definitions

• Tracking and hardwiring Savings to the Bottom Line

3 years later…

Procurement Price Index

• Must be able to demonstrate to stakeholders that Procurement is adding value and continuously improving

• Generating Procurement savings is seen as Procurement’s greatest value-add?• Procurement Savings calculations need to be viewed as “real” - real money,

real savings• Procurement Savings are difficult to track to the bottom-line?• And how do you lock them in so they are not spent elsewhere? It’s not

Procurement’s budget anyway?• What about cost mitigations, balance sheet improvements? These are other

ways Procurement adds value? Are they savings?• Its not as simple as just Price decreases, what about Volume? Who is

responsible for volume changes?• There needs to be alignment between Procurement, operations and Finance in

evaluating, and reporting benefits• Transparent data kept in a single system and key learning's shared with others• How do you then embed the changes into the operation?

What's the problem?....the business imperative…..

Topics

Introduction

Procurement Savings

What’s the problem?

The solution: Procurement Savings Protocol

• Savings Definitions

• Tracking and hardwiring Savings to the Bottom Line

3 years later…

Procurement Price Index

• Procurement Savings reported consistently, validated by Finance,approved by operations, in line with agreed Protocol and captured and shared in a transparent System

• Protocol approved by senior management. All Stakeholders trained in the Protocol. Institutionalised!

• Each Sourcing initiative viewed as an end-to-end process (and ‘Project’) with tollgates and stakeholder approval

The solution…Procurement Savings Protocol

3 months

Topics

Introduction

Procurement Savings

What’s the problem?

The solution: Procurement Savings Protocol

• Savings Definitions

• Tracking and hardwiring Savings to the Bottom Line

3 years later…

Procurement Price Index

Savings Definitions:Procurement Savings Types

1. Year-on-year Savings – decrease in the total cost of the good or service resulting from Procurement activity compared to baseline

2. Mitigation of Cost Increases – The avoidance of a cost increase which would have occurred, as a result of a Procurement initiative

3. Balance Sheet Savings: reduction in Capital expenditure or Inventory

4. Revenue: resulting from a Procurement activity

The consequence of actions taken during a Procurement Activity* which result in a change in Total Cost** of a good or service compared to a Cost Baseline***

Where*Procurement Activity includes:

• Strategic Sourcing• Purchasing activity, or• Contract Management

** Total Cost is: Unit Cost multiplied by annual actual or forecast usage

*** Cost Baseline is• The last unit price paid multiplied by annual/forecast usage, or• The Market Value of Purchases (a published MV or lowest initial

price in a complying tender)

Savings Definitions:1. Year-on-year Procurement Savings

Savings Definitions:2. Mitigation of Cost Increases

The avoidance of a cost increase which would have been incurred, but as a result of a Procurement initiative has been reduced or removed

• Avoidance/reduction of a proposed price increase by negotiation

• A negotiated reduction in the price of an item which increases on a set contracted pre-determined basis

• A negotiated reduction over the lowest conforming bid in a tender/RFP

Savings Definitions:3. Balance Sheet Savings

As Balance Sheet savings don’t ‘directly’ effect EBIT, they are treated separately

Generally comprise:• Decreases in capital expenditure through Procurement

activity• Reductions in inventory/working capital

Savings Definitions:4. Revenue

Revenue generated through a Procurement activity

eg. Selling off obsolete stock, plant

Generally One-off activities

• Savings Include but are not limited to:reductions in Unit Costimproved specification or product substitution reducing consumptionimproved product application practices reducing consumptionImprovements in the P2P Process reducing cost

• Savings may result from an action initiated by the:Procurement departmentSupplier the Customer

• Savings > $10,000 included• First 12 months of the savings only claimable• Usage: forecast volumes or historical (previous 12 months)

Savings Definitions:Other criteria within the Procurement Savings Protocol

Costs of Implementation • Costs of implementation are deducted from savings to

give a net result• Examples:

Expenditure to reconfigure plant and equipmentInventory expense either to increase holdings or write off redundant stockInstallation labourConsulting costs

Exclusions:• Foreign exchange movements• Taxes and other statutory charges• Non negotiable indices. Eg Platts, LME• Intercompany purchases

Savings Definitions:Other criteria within the Procurement Savings Protocol

Savings Examples

1. Reduced Operating Price• Base spend; 100,000 units @ $10 = $1,000,000 pa• Unit price reduction of 5% negotiated• New Price = $9.50/unit• Savings; 100,000 units @ $0.50 = $50,000

2. Reduced Usage• Base spend; 100,000 units @ $10 = $1,000,000 pa• Usage reduced by 5% due to waste control• New usage = 95,000 units• Saving; 5,000 units @ $10 = $50,000

3. Increased price offset by reduced usage• Base spend; 100,000 units @ $10 = $1,000,000 pa• New product price is 10% above old price• New Price = $11• Substitution will reduce usage by 20%• New Usage = 80,000 units• Cost to change is $100,000

Savings = Reduced Total Cost = Original Spend less New Spend less Cost to Change= $1,000,000 –($11@ 80,000 units) -$100,000= $1,000,000 -$880,000 -100,000= $20,000

Savings Examples

Topics

Introduction

Procurement Savings

What’s the problem?

The solution: Procurement Savings Protocol

• Savings Definitions

• Tracking and hardwiring Savings to the Bottom Line

3 years later…

Procurement Price Index

• Not easy, but possible!• Requires Management support

Tracking and Hardwiring the Savings to the Bottom Line

3 months

• Utilise 3 Month Control Period to ‘prove’ Savings• Hardwire Savings by getting Finance to decrease

area budget by savings amount – promptlyBudget

Topics

Introduction

Procurement Savings

What’s the problem?

The solution: Procurement Savings Protocol

• Savings Definitions

• Tracking and hardwiring Savings to the Bottom Line

3 years later…

Procurement Price Index

3 Years later…$$$ Savings

FY06 FY07 FY08

15.9$ 12.3$ 12.5$

9.5$ 5.6$ 4.0$

2.6$ 0.6$ 0.2$

28.0$ 18.5$ 16.7$ TOTAL ($M)

($M)

Year-on-Year

Mitigating

Balance Sheet

Procurement Savings Banked under the Procurement Savings Protocol

3 Years later…The verdict on Procurement Savings Protocol

• Has provided greater transparency of Procurement Savings• Has provided credibility to Procurement Savings

(Particularly when the distinction and separate quantification between Year-on-Year savings and Mitigated savings is understood)

• More Procurement Savings have reached the bottom-line• More Procurement Savings hardwired in budgets• Greater collaboration with operations regarding savings initiatives• Its simply Business Improvement• What about Price Increases?

Procurement Price Index

Next Steps:

Topics

Introduction

Procurement Savings

What’s the problem?

The solution: Procurement Savings Protocol

• Savings Definitions

• Tracking and hardwiring Savings to the Bottom Line

3 years later…

Procurement Price Index

UtilitiesUSD

1,660 M

LabourUSD

1,070 M

Fuel USD

1,265 M

Procurement Price Index (PPI)The next level

Fuel

Utilities

Labour

0

10

20

30

Q1 Q2 Q3 Q4

• Tool and standard framework used for capturing Procurement data • PPI methodology used is similar to that used to build a Consumer Price Index (CPI) for

a country • PPI includes algorithms that use unit cost and spend data inputs to calculate price

changes over time• Changes tracked on a quarterly basis for a basket of goods and services• Basket is customised and weighted to be representative of spend for the individual

operation

80

90

100

110

120

Q1 Q2 Q3 Q4

e.g. Spend weighting datae.g. Unit price data e.g. PPI MovementILLUSTRATIVE

PPI exampleThe PPI tool will provide a link between the budgeting process and actual purchase price movements for an Operation

ILLUSTRATIVE FOR AUSTRALIAN ASSET

12

3

3

1. Operation index developed from weighted category data

2. Relevant market indicator selected

3. Bands or targets selected for an operation, incorporated into budget setting and KPIs

ILLUSTRATIVE

Thank you and Questions?