Is it Time for Procurement to Have a Spend Optimization Quota?
There are only two ways a company can increase profitability—make more money or save more, and the two are equally important. I've written previously about how one of the ways procurement can become more strategic is by thinking more like sales.
Salespeoples' sole job is to go out and bring in money. They forecast, they measure and salespeople get paid in part on their revenue contribution. Procurement needs to think like sales in that they need to make pursuit of the dollar saved the driving force behind all of their activities.
The other part of this is that salespeople have a quota to meet—a big fat KPI staring them in the face on the first of every month, and it’s not too difficult to measure their performance against that.
Naturally, they think and behave differently than people on the spend side because
they’re highly incentivized to do so. Isn’t it time that people in procurement, or expense management, or AP, or any other spending-related area create quotas and incentives for optimizing spend and thus savings?
We have the technology to do this, but the conversation on the spend side of the equation sounds a lot different. People talk about compliance, or maverick spending, or process improvement, or increasing spend under management.
All of these things are interesting, but what's most interesting is to be able to go to the CFO or CEO and say, “If you approve this solution or activity, I can assure you savings of X resulting in Y incremental improvement in profitability and thus Z improvement in stock performance or shareholder value.” That's interesting.
Now, it's pretty bold for procurement or finance to put a stake in the ground and say, I'm going to save so many dollars. But, it can be done, and this is what is done on the revenue side all the time. Do they always hit their revenue number? No. Welcome to sales. But they put a number out there, and hitting that number drives every activity and every decision.
To do it this on the spend side you need bravery (again, welcome to sales), and also you need to be able show a causal relationship between a solution or activity and the projected outcome. This can be challenging because very often it's not causal, but it's highly correlated. It’s the same with sales—putting more sales people on the ground doesn’t always cause more sales, but it’s highly correlated.
So, the question becomes, how strong is the correlation? If you could prove a 50%, 60%, 70% correlation between a solution or activity and a given result, then you’re well on your way to being able to put a stake in the ground.
Let’s look at a very simple spend management case. Let’s say you have 20% of your spend under management, and you're saving 10% versus what you would be spending if it wasn't under management. You’ve proven that when you bring spend under management, you save.
Now let’s say, with this tool or this change, you will get the other 80% under management. You are sure of it. That will mean a savings of 10% across that 80%. Apply that to your actual spend numbers, and show the impact on profitability. Let’s say for our purposes it’s $1.2 million in savings.
Now, the CEO will say—I would say--“Yeah, but just putting in this tool doesn't lead to $1.2 million in savings. It's not cause and effect because you still have to do a lot of things around it. You've got to implement, you've got to make sure that people use it, you've got to make sure that you get your categories in there, you've got to make sure that you hook up the suppliers. You've got to do a lot, so there's execution risk.”
It’s the same on the sales side. You can hire more sales people, but you have to hire the right people, and train them, and you have to make sure they have the right collateral and support, and all those other things.
You can factor all that in to your calculation: Assuming I can use the same methods that I used to bring the first 20% under management, if I then apply them to this next 80%, I could expect the same kind of results. There are all kinds of factors, so it's not causal. But you can probably look at the risk factors and say, I'm fifty percent confident. So you discount your forecast on how much incremental profitability you think you can achieve by fifty percent, down to $600,000.
So what does that $600,000 in incremental profitability mean to your stock price? It depends how big your company is, but that’s still a big number. That much profit is hard to come by.
I think a big misunderstanding in the world is that people think big companies make a lot of money. Yes, they make a lot of money relative to human beings, but if you look at some of the largest companies in the world, the amount of profitability they eke out of revenue isn't that much relatively speaking.
Look at the 2012 financial results from General Electric for example. It's worth $240 billion, and they had $147 billion dollars in revenue. Then you look down to the profit line, and how much did they take home? $13 billion. That’s a ton of money, but it represents about eight percent of sales dropping down to the bottom line, and this is a world-class company. Yeah, they make a lot of money, but they also spend a lot of money. So if you could tighten up even by 5 percent it could have a big impact.
To have this kind of impact, we need to approach the spend side the same way we approach the sales side: strategically. To be strategic, your initiatives must be tied to what matters to your executives--profits. Be bold, and be willing to work through the details to get to the value promise. Create an incentive structure around the goals and align your organization behind it.
Then go to your executive leadership. Clearly communicate the strategic value, a.k.a. the potential bottom line impact of your initiative. Quantify it for them because they're numbers people. Walk them through math. In the end it all comes down to simple math—one less dollar spent is one more dollar in profit.
Rob Bernshteyn is CEO of Coupa. A version of this article previously appeared in Spend Matters.