How to easily and accurately measure the P&L impact of indirect Procurement savings

I’m sorry, that title was just there to get your attention. The truth is you can’t. I’m sure there’ll be lots of comments from people asserting that they can and already do. I’d like to explain why I believe you can’t, but also why it doesn’t really matter.

I’ve spent far too much of my life trying to explain the subtleties of savings measures to CFO’s and CEO’s. Given it’s a subject I find incredibly dull I can only begin to imagine how tedious they must have found those conversations. Feel free to share this article with your CFO if you don’t want to go through the pain. 

There are lots of complicated reasons why you can’t accurately and easily measure the impact of indirect Procurement savings, but there are only two important reasons. For the sake of brevity I’m just going to focus on those.

1.     You can only accurately track the impact from one year to another on identical items purchased in identical quantities. 

The majority of indirect procurement spend varies in nature and quantity from year to year. In most cases the overwhelming majority changes. If all we bought was stationery, it would be awkward but possible to isolate the small changes in the ratio of pens to pencils purchased. Unfortunately, most indirect spend isn’t a simple unchanging product like stationery. It’s management consultants, marketing campaigns, software licences, outsourcing contracts, logistics, recruitment services. These things are services which change continually. You can draw an artificial baseline to give an indication of the saving, but it is only an indication. It is not an accurate measure which isolates the P&L impact.  

For example, even something as commoditised as utilities is problematic once you scratch the surface. Power is subject to market movements. While you could isolate the market movement to some extent to understand the impact of Procurement, you’re still left with the demand movements. What if your demand has fallen as a result of employees being more diligent in switching things off? If Procurement played a part in raising employee awareness then perhaps they should get credit for it. How big a part did they play? Did they print the posters and stick them up or just suggest the idea? Perhaps it would have happened anyway because people are generally more environmentally conscious. With the demand dropping the pricing may have gone up into a higher band, so not a saving at all anymore. Should Procurement be penalised? Perhaps the business is expanding and volume is actually increasing so pricing may drop to a lower band. Should Procurement get credit for that?  

The point is that even with a standard commodity, you have to choose between an easy and accurate measurement. You definitely can’t have both and you probably can’t have an accurate measure under any circumstances.

2.     Indirect Procurement doesn’t and cannot track every price movement

This is probably the most fundamental issue and the one most misunderstood outside of the function. Indirect Procurement teams negotiate or in some way intervene in a proportion of the total spend each year, not all of it. They report on their successes from that intervention. In my experience, the cumulative annual value of that intervention (or projects) typically runs at about one third of the total indirect spend. In theory, all of the spend gets some sort of review over the course of three years. Clearly, some spend gets reviewed more frequently and some less but the average has been broadly consistent at all the organisations I’ve seen. 

Time for some sums. If the one third ratio is true, it means that to generate a typical performance of between 3 & 5% savings across the entire spend, the average from the interventions would need to be between 9 and 15%. In my experience, that’s exactly what a average Procurement project delivers. Which funnily enough is curiously close to the magic 10% savings which most consultants are happy to commit to on their projects.  

In terms of P&L impact, there are two fundamental issues with this. Firstly, indirect Procurement teams report their impact on the third of the spend they are looking at each year. No one is tracking what’s happening to the other two thirds. Prices in the rest of the spend may have leapt up. The reason they’re not tracking it is because of the immense complexity involved in tracking the price movements on tens of thousands of transactions, let alone isolating all the variables.

The second issue, is a little more subtle. If you read carefully you will have spotted that I said “they report on their successes”. There aren’t many buyers out there who will include in their reporting a price increase they weren’t able to negotiate away. Some perhaps, but not many.

In summary, indirect Procurement savings have no meaningful basis to measure from, are subject to an enormous number of variables which Procurement have limited influence over, are reported on a minority of the spend and are self selected for success. Hardly a sound foundation for an accurate measure of P&L impact.

So if we can’t accurately measure the impact of indirect Procurement on the P&L should we pack up our bags and do something different?  Is indirect Procurement all smoke and mirrors or just an elaborate exercise in damage limitation? Have I just undermined the fundamental purpose of the Procurement function?

No. That would only be the case if it is necessary to isolate the P&L impact of a function to justify it’s existence. It isn't.

A business needs a marketing function to stimulate growth, a sales team to win business, a supply chain team to move product, a manufacturing team to make product, an IT team to build and manage infrastructure, an HR team to resource the organisation. You do not need to see the isolated P&L impact of any of these functions in order to believe in their purpose.

Does a Procurement function save money? Yes, amongst many other equally if not more important things. But we have, as a profession, over indexed on a single measure because it’s one which can be counted and it resonates with a Finance community we have become so closely aligned with. But it is a measure which is fundamentally flawed for the purposes which our friends in Finance would like it for.

Too often our response to challenge has been to attempt to prove the P&L impact. As a consultant, I once worked with a Procurement organisation who’s central reporting team was over 25% of the entire category management headcount. That’s one person reporting on what three are actually doing. I don’t think even the Stasi managed that kind of ratio. 

I accept that this creates a difficult conversation for us to have with our CFO’s, but I think it’s one we need to have. I think that also leaves us back where I started with the first article I wrote on Purpose, the difficult but necessary conversation about what we’re here to do.

On the call I mentioned earlier, someone rightly pointed out that actions speak louder than words. Perhaps then, this is our leadership challenge. To lead our teams to deliver a purpose which we believe in even if different from the expectations of our friends in Finance. But is it enough to “be the change” or do we need to confront the expectations as well?

This is fourth article in a series I’ve written during Covid lockdown, if you want read more:

Procurement – Why you need to look to HR to understand your purpose https://www.linkedin.com/pulse/procurement-why-you-need-look-hr-understand-your-paul-bestford-fcips/

How many Business Partners does it take to change a lightbulb https://www.linkedin.com/pulse/how-many-business-partners-does-take-change-light-paul-bestford-fcips/

The Procurement leaders guide to stamping out innovation https://www.linkedin.com/pulse/procurement-leaders-guide-stamping-out-innovation-paul-bestford-fcips/