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How to measure savings?

How to measure savings is always a hot topic for most purchasing departments. Unfortunately there doesn’t seem to be a perfect way which covers all scenarios. Still I would like to write down some of my own experiences on this topic and I hope that you will at least find some of them inspirational. 

Let’s start with a simple example:
During FY 2014 we bought 100 pencils for 1 Euro each. Due to savings initiatives and negotiation skills the new price for 2015 will be 50 cents for each pencil. During 2015 we are also expecting to buy 150 pencils. This would lead to a FY Cost reduction of 50 Euro for the first 100 pencils and a FY Cost avoidance of 25 Euros for the next 50 pencils.

Some companies could say that this takes care of it all, but this really is just the infamous top of the iceberg.

Let’s now consider some other aspects:

  • The new pencils only last half as long due to lesser quality.
  • Taking the market price into account it could be that the old pencils were somewhat overpriced and new price is exactly the market price at this moment. And if a negotiator is ‘only’ hitting the market price, you can even say that there is no saving at all (since most professional negotiators should be able to do better).
  • You can also decide to buy pens instead of pencils and even though these are slightly more expensive, they tend to last twice as long.
  • Not all purchases are actually according to the new contract (here enters the maverick spending which should always be regularly monitored and avoided).

To include these scenarios as well, the savings tracking should in fact include the following differentiations:

  1. Immediate savings (i.e. project related savings)
    Immediate spend savings must be based on budget, proposed spend, or market analysis since there should usually be no relative previous spend for comparison or a baseline. These should be measured up-front versus ongoing or at the end of the period.
  1. Recurring, ongoing or scheduled savings
    Ongoing spend can be based on previous spend as a baseline as well as the forecasted spend. Both of these figures have to be agreed upon by the Purchasing as well as Finance department. Ideally, the baseline spend is imported directly from your ERP. If your ERP has a good quality of data, this is easy. If the quality of the data is not up to spec, then you need to check directly on the invoices.

Now the types of savings. Most purchasers will be familiar with the terms Fiscal Year Cost Reduction and Fiscal Year Cost Avoidance. If all factors match (item, quality, quantity, and duration), this should be categorized as FY Cost Reduction. If not all factors are matching, this should be categorized as FY Cost Avoidance.

Read the guide: Ariba Strategic Sourcing in a nutshell

Within both of these primary categories, you can have sub categories such as credit received, rate reduction, rebate/bonus, and volume discounts.

And lastly the recurring, ongoing and scheduled savings must be linked to KPI’s which are aligned with the company’s goals in order to indicate whether it is meeting the expectations. And for these KPI’s to have value, you must be able to measure it as soon as possible. Otherwise, it may be too late to take action and the value of having a KPI is lost. As an example, having a KPI to tell you that our house has burnt down has little value compared to a fire-alarm KPI that tells you the house is on fire.

Curious to learn more about strategic sourcing ? Check out our White Paper Strategic procurement.

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