Leadership opportunity for procurement: Defining savings
As procurement becomes more strategic and manages a greater percentage of organizational spend, it's becoming more common for it to report to the finance organization. This makes sense. But I'm often surprised by how little procurement knows about finance and finance knows about procurement. It’s hard to work together well when the groups don’t understand each other.
Finance often doesn't understand how measure, manage, or evaluate procurement’s performance and effectiveness. They don’t know how to determine what value they’re adding, if any. If that’s the case, it’s likely that procurement lacks credibility within the organization, making it harder for them to partner with financeand with the business units as well as they could and deliver all the value they could. It’s a Catch-22.
A strong partnership between these two organizations has a lot of business benefit. So how can these two groups collaborate more effectively? The first step is for procurement and finance to agree on the definition of savings and how they are calculated and reported. If that is not clearly defined in your organization, start there.
Procurement can and should take the lead, but it must be done collaboratively. It’s a great opportunity for the organization to showcase their collaboration skills, and the outcome, the definition of savings, lays the groundwork for all future collaborations.
A leadership opportunity
Why is this so important? In many organizations, if you ask six people how they calculate savings, you'll probably get eight different ideas. For finance to support procurement performance measures, and for procurement to have the credibility it needs to be effective, both organizations need to be working from a definition and formula that has been agreed to by both, validated by audit and socialized to the business.
That way, whenever a savings number is positioned, everyone sees the real savings and how the number was reached. Where that definition doesn't exist, I will almost guarantee you won't see the level of collaboration and engagement between procurement and the various parts of the business that you should see.
When everything is well defined, and everybody agrees to the formula, nobody has any reason to get agitated. If nothing's defined and there are no rules, then when you get to the end of a transaction, everybody calculates a set of numbers based on their own formulas. You've got no consistency, and no confidence.
Unfortunately, this happens a lot. As a result, most of the time people don’t believe the savings numbers that they hear from procurement. Nobody makes a lot of noise over it. In fact, nobody even talks about it. People just roll their eyes, and that’s somewhat justified because savings is not clearly defined, reviewed, and audited. It is clearly a credibility challenge for procurement.
But it doesn’t have to stay this way – and it shouldn’t. CFOs intuitively know they should request this from procurement, but they don’t often do it. Procurement needs to be proactive about getting it done.
Begin with the end in mind
The goal is a single definition of savings across the entire organization. This will vary from company to company, but it should not vary within the company or its business units. It needs to be arrived at through a collaborative process not just between procurement and finance, but involving key stakeholders across the entire business.
This should not be an open-ended process where you go out and says, "Hey! We're going to come up with a definition of savings. What's your idea?"
Procurement needs to initiate the process with a well thought through definition and formula and examples.They need to hash out how to count the savings, Is it savings off of list price? Is it savings off of what you paid last time? How do you figure that out?
Once you have that, you create a straw man to take to finance and audit for them to test drive. Once they sign off, you go out and shop that process with the heads of the business units.
This is where it gets tricky. You’re not giving them the power to approve it because for the most part it’s already been approved by the CFO but you want their input.
You're engaging with them to let them know how the process works, what’s in it for them, and what's been thought through by finance, procurement, and audit based on their expertise. And that you're seeking their concurrence or their input to take back to the CFO with the caveat that it may or may not be adopted.
If input from the business heads results in a change to your proposal, so be it. If it stays the same, that’s fine too. It’s almost less important what the actual definition and formula is, because there are many valid definitions.
What’s more important is creating that collaborative framework, and getting to an agreement where people are engaged to support what they help create. That’s much easier when everybody's had the opportunity to kick the tires and have their say. It's really that circle that's important.
Why would business stakeholders care? Number one, they need to want to engage with the procurement organization. Part of this is also an opportunity to explain the role of procurement, how they can benefit and the terms of engagement.
As you go about this process, you might need to have a bit of a thick skin. If there’s no definition of savings in place, chances are good that procurement gets no respect. You might hear things like, “I didn't even know we had a procurement organization." Or they might roll their eyes.
The million dollar question
You also need to be prepared to answer the question, "What happens to the 'savings'?" That's something that most astute business groups are probably going to ask sooner or later, and it’s important to get into alignment with the CFO on this beforehand.
Most CFOs want to put any savings toward the bottom line. They don't really want to enable more spend because, they would argue, that in doing that there's really no savings to the organization.
It’s a philosophical decision, and not one that procurement gets to make. There are very few times in my career where I've stepped back from a situation and let people battle it out, but this frankly is one of them. I do have an opinion, but that’s a topic for another blog post.
Why step back? Procurement’s role is to buy goods and services at the best overall value for the organization. What happens with the savings is a discussion between the finance organization and the business units—the people that own the budgets. You need to stay out of that, but know where finance stands and be prepared to finesse this conversation with business stakeholders.
In the end, what we’re talking about is not that complicated but can be complex. The final definition and formula shouldn’t be more than a couple of pages long. The main challenge is that everybody is going to have an opinion and it's going to be time consuming to get concurrence. Allow time for it, because the process and the agreement is what matters most.
If you do it right, it eliminates all the yak-yak noise about, “are these savings real?” Everyone in the company has a clearer definition of what it is they're shooting for, and they can focus their energy on achieving it. And procurement comes away with a much better working relationship with finance, a lot more credibility within the company, and maybe even some new fans.