A universal truth in any organization despite size, industry, or strategic vision is this: “You can’t measure what you don’t know.” It seems like a fairly simple observation, yet many companies today lack a basic metric tracking and reporting process. One contributing factor is the intimidation of finding a place to start. In a data driven world filled with sophisticated metrics and dashboarding tools, it can seem like an investment just to get started. Fortunately, there are a few basic metrics that are fairly straightforward to implement and track, and the value they bring to the success and reputation of the procurement department is significant.
Metric 1: Cost Savings
What it is: There are many schools of thought around the most effective way to track cost savings, however for a novice procurement department the best approach is the simplest approach. Cost savings is a measure of the direct reduction in total cost of an item. This could be realized in the form of unit cost reduction, freight or ancillary cost reduction, or volume reduction related to a realized product efficiency.
Why you need it: Cost savings is the backbone of calculating the efficiency of a Procurement department. Without a measure of outputs, it is not possible to determine if the inputs are optimal.
Metric 2: Cost Avoidance
What it is: Cost avoidance is a close relative of cost savings, however it requires a more forward looking direction to calculate. Cost avoidance measures the cost increase that would have be incurred due to raw material price increases, supplier scheduled increases, or other market changes that is evaded by procurement through negotiation. In the case of cost avoidance, the total cost of ownership of the product remains stagnant, and the measure takes into consideration what the cost would have become without procurement intervention.
Why you need it: As savings efforts within a Procurement department continue overtime, returns will diminish. Achieving year over year cost savings in a rising commodity market is nearly impossible. Cost avoidance takes these factors into consideration and connects the efforts of Procurement to the current state of the market.
Metric 3: Procurement ROI
What it is: Simply put, Procurement ROI is the measure of the total cost of the procurement department in relation to realized cost savings/cost avoidance in a given time frame.
Why you need it: Procurement ROI is the backbone of the Procurement value narrative within an organization. It is a direct measure of the success of the department, and builds the business case for executive sponsorship and investment within the Procurement space. A strong ROI encourages stakeholders to actively utilize the services of the department, and eases resistance when collaborating on savings initiatives.
Metric 4: Spend Under Management
What it is: Spend Under Management (SUM) is the total amount of spend that is influenced by Procurement. There are multiple interpretations of SUM, but a fairly straightforward approach is the percentage of overall spend that is categorized and actively managed by procurement through savings optimization.
Why you need it: Spend under Management is a great tool in building a Procurement roadmap and forming metric goals. It gives direct insight into what is being influenced, and where there is opportunity to further leverage additional spend across the organization. It also gives insight into the possible need for a spend management tool to increase visibility in spend categorization and filter to the appropriate managerial parties within Procurement.
Metric 5: Spend Under Contract
What it is: A measure of total spend that is covered by an active contract, in comparison to all potential contractible spend.
Why you need it: Spend under contract is a good measure of Procurement’s ability to follow through with implementation. It is also an important metric to measure as non-contracted pricing is subject to fluctuation which can lead to savings leak. The greater the ratio of spend under contract, the more secure realized savings are, and the easier it will be to continue to audit price and service levels over the length of a supplier relationship.
With these in place, the path to more sophisticated metrics will become less treacherous. You now have an understanding of what is being managed, how efficiently it is being managed, and the opportunity that lies ahead. There is also irrefutable proof that Procurement is providing a valuable service, and will encourage future support and collaboration across the organization.
The implementation of metrics is an important step in evolving a tactical purchasing department to a Procurement Center of Excellence. Source One Management Services has years of expertise in advising on procurement transformation services and taking organizations from laggard to best in class.