The Challenge in Quantifying Savings from Supply Management

The number one mission of the procurement function, in general, is usually to reduce the cost of purchased goods and services, or perhaps to lower total supply chain costs through smart procurement strategies and negotiations.

There's just one problem: measuring the amount of those "savings" is devilishly hard to do.

P. Fraser Johnson and Michiel R. Leenders, of the University of West Ontario and the Richard Ivey School of Business, respectively, addressed that topic head on in a recent article for MIT's Sloan Management Review, with some excellent thoughts on both the challenges facing supply managers and how to overcome them.

"Both understatement and overstatement of supply savings gaps signal the wrong reality, leading to an overemphasis on low-yielding cost-saving initiatives, misdirected corporate resources and rewarding employees for the wrong behavior," Johnson and Leenders write. "Perhaps even more frustrating for managers is that supply savings gaps conceal the strategic contribution suppliers can provide."

Major Challenges in Quantifying Savings 

System Challenges: Accounting systems are simply not designed at present to well capture supply management "savings" - so, in general, procurement organizations define their own rules about what qualifies and what does not. These definitions can be arbitrary, and drive the wrong behavior. One company the authors studied exerted strong pressure to meet a minimum level of annual "savings," but little upside for going beyond that, leading procurement managers to "bank" savings for later periods and not pursue all savings opportunities.

Who Gets the Credit? Often, supply-based savings are not the result only from the efforts of a single procurement manager, but a team of others both inside and outside procurement. As a result, "Many supply managers look for savings opportunities that do not require the involvement of others, even if this means ignoring high-potential savings areas," the authors say.

One company Johnson and Leenders researched had an elaborate set of rules governing reportable savings. Though the goal was to make sure that savings were "provable beyond any doubt" during the current year and the result of supply effort alone, the approach led to under-reporting off procurement's value and short term versus long term thinking.

Things Change: Overall market pricing, technology, volumes, and number of other variables are all subject to dynamic change. If the supply organization achieves a cost breakthrough relative to competitors say for plastic resins, but then the price of oil spikes and the price of resins soars along with it - is that a "savings" or not? Even if the company is still paying less than competitors, it may be hard to for execs to accept there has been a savings as the price paid has increased perhaps 30%. Conversely, if technology or market forces drive the price of a component down dramatically, does that count as supply-based savings? All this makes year-over-year comparisons very hard.

Refusal to Account for Cumulative Savings: If the supply organization can set a baseline price with a supplier that gives the company a competitive advantage, those savings often continue over several years, even if the subsequent price rises basically in-line with overall price inflation in the category. The company is still paying below market rates, and the total savings to the company across purchased goods could be huge. But few companies account for or will accept these "multi-year" savings.

Incomplete Definition of Savings: In a sense, this category of challenge is in the supply organization's favor, as companies often focus on say the change in unit price that happens when there is a change in supplier, but rarely capture the other costs associated with the switch (qualification, risk, quality, etc.) that may accompany such a move. On the other hand, companies often do not consider "soft savings" or "cost avoidance" - such as the savvy supply organization that locks in prices right before a big swing upward in the commodity.

"In periods of rising prices, cost avoidance can be a major contributor to corporate competitiveness," Johnson and Leenders say.

Source: http://www.scdigest.com/