As a procurement team, you’re expected to deliver savings. Hence one of your key activities at the beginning of the financial year is to forecast how much you shall achieve. This is where things get both tricky and diverse!
In our many years in the procurement industry, we’ve seen several approaches to this. Some procurement leaders devolve the task to the individual team members, a sensible move given they usually have knowledge of the intricate details.
Others simply apply a low percentage figure across their entire third-party spend, confident that in general the savings can be accomplished but not confident enough to suggest which spend categories specifically, believing that procurement is less of a science and more of an art form.
Whilst that may be true, in our view there are definitely scientific elements that can be incorporated into an activity as daunting as predicting your savings. So here are 5 key attributes you should quantify in order to banish gut feel in favour of calculated assumptions.
1) Influenceable spend: it may be tempting to prioritise your savings potential across the greatest spend areas. However, that is pursuing vanity over substance. Even though one spend area may be worth £100m per annum, it is important to establish how much of this spend can actually be influenced by procurement. Energy is a classic example. The majority of the spend consist of levies, wholesale prices and operating costs. All that you typically negotiate are the management fees and profit margins of the supplier, which can be very small percentages.
Contract end dates are also a major factor when considering what spend can be influenced. We’ve encountered clients with 30 year contracts. Without triggering the early termination clauses, contracts can result in large chunks of spend being omitted from your plans.
2) Key cost drivers: with any spend category, it is important to have at least a basic understanding of what influences the underlying costs. It may be currency fluctuations or raw material indices, employment rates, taxes, duties & levies, wholesale costs and so on. Therefore to accurately forecast your savings, it is important both to estimate how much of your spend is subject to cost driver movement and to what extent they have shifted since your last contract negotiation or spot-buy.
3) Negotiation history: it is unwise to predict future savings without understanding past achievements. For example, a contract that was recently penned after a scrupulous reverse auction process is highly unlikely to deliver further savings without changing the scope of the goods or service. However, a spend area that has been left unmanaged for a number of years can readily yield savings. Use historical performance to quantify what opportunities have been left on the table.
4) Market forces: ideally you’ll be procuring your goods and services from a fragmented supply market that has healthy levels of competition and motivated SMEs with an appetite for your business. This way you’re highly likely to be able to succeed with your negotiation outcomes to source that ideal supply partner. Analyse the market for each of your spend categories in order to accurately judge your savings potential.
5) Specifications: the devil is in the detail. Whilst you wouldn’t want to get bogged down during your budget planning with digging out CAD drawings, contract terms, SLAs and other specs. related materials, it is most certainly worth knowing conceptually how available and accurate such information may be. It would be unwise to pin a significant saving against a spend category that cannot be readied for negotiation, or even worse, may be cancelled mid-way through the tender due to poorly defined requirements.
€50m had to be spent on ‘shaving’ French train platforms that were too narrow to fit the new trains due to an oversight when preparing the spec.
There is a myriad of other factors that can weigh into your savings potential aside from those above. For example the prowess of your organisation’s brand or inter-linking your spend categories to ensure you leverage all of your spend with a particular supplier instead of focusing on each category in isolation. Therefore it isn’t an easy task but it can be simplified by adopting a robust methodology.
It is this methodology that enabled us to create our Category Dojo app to help organisations across the globe estimate their savings forecasts to within a few percentage points. If you’re curious, try it out to learn how it can be done.