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In my last post, I talked about how to define savings and the formula for calculating them. I believe that having this clearly defined is the foundation for effective collaboration between procurement and finance. It’s a process that should be lead by procurement, approved by finance and audit and then socialized to the business.
In the process of taking the agreed upon definition out to business leadership, the question inevitably arises: What happens to those savings? Do they go back to the business to fund additional needs? Do they go back to finance to reallocate to another department? Do they go straight to the bottom line? If there isn’t a clear answer, finding one may become part of the exercise of defining savings.
This is something that can get very political within organizations, and a rare example of a situation in my career where I stayed out of the fray. This is not a decision for procurement to make; it’s between the business leads and finance, and procurement needs to support whatever that decision is. But, this is important to procurement, and I do have an opinion.
The effectiveness of the procurement organization and the willingness on the part of the business units to bring them in is going to be driven by whether the savings gets pulled out of their budget, or retained and earmarked to be spent in a different way, or some other option.
If a business unit collaborates with procurement to save $100,000, will the CFO allow them to apply the savings to something else they want to buy? You can define savings, do your calculations and get everyone to agree on the savings realized, but if the money gets scraped back or moved somewhere else there’s not much incentive to work with procurement. It shouldn’t be that way, but it’s just human nature to prioritize what directly benefits your own cause.
It all about the units
That’s why I think the best thing to drive towards when defining savings is not just looking at money to be spent, but also units to be procured.
For example, if you're buying distributed technology—desktops, notebooks, etc.—you've got an existing price. If procurement comes in and negotiates, maybe you end up with a different product, or just a reduction in cost for the existing product. Whatever it is, if you were paying a dollar for it before and now you're paying $.90, the savings is $.10 per unit.
Everyone should be happy with that. The challenge, though, is that's not typically how people budget. If they budgeted a million dollars for distributed technology and procurement is able to reduce the price by 10% to $900,000, they still want the million dollars in their budget.
If you base budgeting and savings on units, people still get to buy what they wanted to buy and they really shouldn't care what happens to the savings. They wanted to buy X many units, they got to buy X many units. That makes it much less of an issue to give back the rest of the money to the organization.
Sounds simple enough, but it’s complicated by the fact that many times, organizations don't know how many units they're going to buy. It's not uncommon for everybody to know how about much money they want to spend, and throw a number at it. But they can't break it down into units that they want to buy.
If that is the case, you may have to address the way budgets are set as part of the process of defining savings. I've always found a zero-based budget is best. That means starting from zero each budgeting period and asking, "What are you going to do and what are each one of those things going to cost?” The numbers should be based on research and not a ball park estimate or percentage increase from the previous period.
Under this scenario, the IT organization says, "We're going to replace X number of desktops, notebooks, and servers next year. We budgeted Y number of dollars for each of those and we've done the math and we've come up with a budget of a million dollars.”
If procurement collaborates with IT to negotiate better unit pricing, there shouldn't be any debate around what happens with the money saved because the IT organization still gets the number of units they budgeted for.
This is harder to do and takes longer, but it gives budget owners a more powerful bargaining position. When somebody says, "Your budget is too high," they can respond with "Well, what is it you don't want me to do, because here's my plan and how much each one of those things is going to cost.”
I think that’s a win for everyone. While it’s true that what happens to the savings isn’t ultimately up to procurement, it does have an impact. A unit based-approach takes procurement, and even finance to some extent, out of departmental budget wrangling. That clears the way for procurement to do what they’re there for: buy for the company at the best value.