Procurement: generating savings or adding value?

Last week I had some interesting discussions with clients – procurement professionals – on the topic of reporting savings. It raised fundamental questions about the role of a procurement division in a company. We are witnessing some contradictory evolutions in corporate procurement practices nowadays. Some of our clients are still making the first steps in centralizing and professionalizing their procurement activities. Procurement tasks are taken away from local managers and a new corporate procurement team is set up at headquarters. But then we see other clients that have gone through this centralization a decade ago and now start to build down their centralized procurement divisions and push the responsibilities for buying goods and services back towards local site (procurement) managers. Is this a normal ‘ebb and tide’ phenomenon inherent to corporate life? Or is there something more going on? I believe that putting too much emphasis on the ‘savings’ made by procurement teams is responsible for this.

As a centralized team takes over the buying of certain categories of goods and services, they start to grab the ‘low hanging fruits’. The volume effects, the synergies and the professionalism of buying centralized often cause massive savings for different categories. It is obviously very tempting for procurement managers to make a lot of noise, “look how much money we have made for the company”. Moreover, setting up a large team of corporate buyers is very challenging in many industrial organizations. Especially when CEO’s have a background in production, they tend to be very skeptic about the value of large teams at headquarters, far from where the real value is created in the industrial processes. It is of course very tempting for the procurement manager to validate the decision that has just been taken to set up a corporate buying team by reporting the large savings made by the initial round of grabbing the low hanging fruit.

As energy procurement consultants, I recognize this temptation. One of the most gratifying aspects of our job is precisely this possibility of making cost reductions. Especially the savings that result from negotiations of contracts can give quite a kick. Last week, one of my colleagues was walking around with that recognizable big smile. He had reviewed the energy contract situation of a client with a large cogeneration unit and saved over a million euro per year with the negotiation of new contracts. It is of course very tempting to broadly “boast” about such savings. They obviously justify our consultancy fees. However, we try to resist that temptation, for a double reason. First of all, it is impossible to perpetuate such savings. They typically occur in the first year of working together with a client when the injection of energy market knowledge allows us to cure what went wrong in buying energy (the low hanging fruit). Secondly, however exciting they are, such savings by negotiations are just one aspect of the added value that we can create for our clients. Therefore, we have always preferred not to put too much emphasis on them. We don’t want to create the wrong expectation that we will make such savings every year and we want our clients to understand that buying energy is not just about making savings by negotiation.

I can only recommend corporate procurement managers to do the same thing. Making a big show of the initial ‘low hanging fruit’ savings round will create a pattern of expectation. The performance of the procurement division will be measured on measurable cost reductions only. You will find yourself struggling with an increasingly complex savings calculus. You will lose a lot of time in discussions with your buyers and with the financial manager over the realism of the reported savings. And especially if the savings reporting system is pushed all the way through to a bonus calculation for buyers, you will find out that it starts to live a life of its own. That your buyers are no longer doing what is best for the company, they do what is best in the (abstract) framework of the savings calculus. I have spent a large part of my professional life in the presence of corporate buyers. And at several occasions I witnessed buyers that “conspired” with the sales people to fake a saving. (For example: savings calculations that are based on differentials between initial, second best, average prices offered and the final price. Buyers ask the sales guy to make a first bid that is high enough. Don’t laugh, I’ve seen this happening before my eyes at least ten times.)

Too much emphasis on the savings reporting inevitably ends in the situation one of the clients I was discussing with this week told me about. He said: “a new CEO walked in and said, ‘I’m tired of procurement reporting astronomic savings of which I’ve never seen a penny in my bottom line’”. The client also told me that procurement in his company was now decentralized again and the corporate procurement team was scaled down. It happens too often that corporate buying teams are restructured because “the savings they generate are no longer justifying the costs”. As my client pointed out rightly: “why are they never asking the same questions about the corporate finance team?”, or corporate marketing? HRM? Because everybody acknowledges the value of doing such activities on a corporate level even if this value cannot be measured in exact ‘euros or dollars saved’.
Everybody will acknowledge that it is impossible to squeeze a lemon indefinitely. At some point, the low hanging fruit is gone. Reported savings inevitably decline (or they become increasingly ‘artificial’). That doesn’t mean that a central procurement team loses its added value for the company at that moment. Looking at procurement from the point of view of one category, namely energy, I see that in large international organizations, corporate buying generates the following added value:

1. Because of the smaller size of what they buy, site buyers will often buy a large number of categories. Corporate buyers can focus on one or more categories and become specialists in them. This inevitably leads to better decisions.

2. Companies shouldn’t just aim at making savings, they should aim at making savings “where possible”. That means that the buyers do all they can to “make the best possible deal, taking into account the market situation”. Professional buyers that are specialized in one or just a few categories are better at that. I observe again and again that local buyers or site managers sign sub-optimal contracts because they lack market knowledge.

3. Negotiating contracts is just one (albeit important) aspect of the procurement job. As they become specialists, corporate buyers can develop other aspects of their job and generate considerable added value with that. When they buy commodities, the procurement specialists can develop and implement the risk management and risk analysis tools that are necessary to protect the company against price volatility. And in products as well as services, buyers’ market knowledge can be an essential component of corporate supply chain management and quality control.

4. Even if cutting away the corporate procurement team is a direct cost saving, this will be compensated by the fact that buyers or site managers have to spend more time on procurement activities.

I recognize the need for metrics to judge a procurement division’s performance. But procurement professionals should avoid that the evaluation of their performance is reduced to savings reporting. They shouldn’t neglect the crucial role they play in the risk management, supply chain management and quality assurance of their company. Too much eye for savings is a dead end street. And moreover, too much emphasis on savings causes a regrettable neglect of other added values created by professional procurement, added values that are more difficult to measure. Everybody knows that reducing the role of the buyer to “the guy that comes in at the end to squeeze the lemon” is a farce. There are much more intelligent ways to do a procurement job and create a sustainable added value for the company. Management should judge their procurement teams on that broader added value.

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