THE REAL RISK OF FAKE SAVINGS
Are the savings you are reporting real or fake? How do you know?
Jonathan Dutton FCIPS explains in the fifth of his recent articles for the commercial aggregator, SUPPLY CLUSTERS.
Savings are important. Even though they are not the only measure of procurement contribution (far from it) they are still the opening justification for an investment in procurement. Savings are usually “our ticket to the ball game” …. and the most immediate way procurement is measured.
Until savings are being delivered, it is difficult to get traction on other benefits from professional procurement – improving compliance, reducing risk, building value. Never mind greater sustainability, farming innovation and driving competitive advantage from the supply side.
Yep, savings are important. Without them, procurement struggles to move on and deliver more. The stand-alone savings sheet, whether or not part of more sophisticated measurement reports (like a balanced scorecard), are a critical measure of procurement worth for many people and many organisations.
When is a saving an actual saving, or just cost-avoidance?
First, let’s just clarify what we actually mean by 'savings' –
DIRECT SAVINGS are those savings where we regularly paid a price of $X for something (goods or services) and in future, we pay less, say $X -10%. This is a direct saving of 10%. And usually a direct saving against the budget allocated for that user department.
Where we have been asked to pay for something (usually something new) at a price of $Y, and we agree a lower price of say $Y -10% or even pay nothing at all for some quantifiable benefit, this is COST AVOIDANCE.We were not paying this cost regularly, but for this purchase, we will ‘avoid’ paying it. Cost avoidance sometimes reduces the budgeted cost, but often it doesn’t – when we are paying for extras, unforeseen costs, upgrades or ‘bells & whistles” accessories; in effect wants not needs – a familiar trap for unwary businesses.
It is important, and usually demanded, that we differentiate these two core types of ‘saving’ on our procurement savings scorecard.
So, when do real savings become fake savings? In other words, when exactly are reported savings not real? Well, simply, fake savings are the savings reported but not actualised in the budget or. really, in the Profit & Loss accounts.
Basically, when the budget holders spend EITHER the direct savings or the cost avoidance on other things entirely:
Sometimes this is entirely explainable if unpalatable – extra compliance needs, delays, additional volume requirements, poor forecasting, waste, poorly thought out business cases or sloppy deal-making or even clear maverick spending.
Sometimes it is entirely reasonable and necessary – unforeseen costs, legitimate volume increases, events outside our control, unscoped work is required …
This net effect was christened by one consultant as "The Leaky Bucket” ….. the phenomenon of savings disappearing through a “budget-bucket with a hole in it.”
Even worse, sometimes, just sometimes, USERS go and deliberately blow the money saved from the budget on other needs entirely. Things that weren’t in the budget in the first place. Much lower business priorities. Probably things that were denied in the original budget-round discussion way back when … in other words, wants not needs.
This is where savings often 'disappear' in many organisations. In fact, so widespread is this problem that one salesman (for a procurement outsourcing company) exclaimed at the bar after one long annual PASA conference day that “procurement cannot actually make real savings, all they can do is build the value for every dollar they do spend.” In some ways, he has a point.
The CFO agrees …
One astute CFO was rather pointed in addressing this conundrum. He said:
“Our head of procurement has claimed tens of millions in cash savings over the last 2-3 years. But our cost base has risen by tens of millions too – broadly in line with volume. I cannot find his reported savings anywhere in our P&L and, if shareholders were to ask, I would say so.”
He articulated the ‘leaky bucket’ very well. Can you spot your reported savings in your organisations’ profit & loss account? Really?
How to save savings
The only way to save savings, to protect them, is to harvest them. When the saving is ‘claimed’ by procurement, and the client department has agreed them (signed them off on your Scorecard), the Financial Controller takes (withdraws) the equivalent monies from the user department’s budget into a convenient suspense account somewhere else. They restrict access to it. This prevents the users from simply spending-up the budget on other things – related or not to the project on which a saving has been recorded.
Of course, if the client department wants to ‘re-apply’ for extra budget release (now they know some is available, all of a sudden) then they always can. But it is the custodian’s decision in that organisation (CFO or delegate usually) that gets to make that decision on the strength of the ‘new’ business case offered. It is not the decision of the user department to spend savings.
A back-up device
Where the ‘budget harvesting’ approach is too difficult, either financially, operationally or culturally, then a second way to harvest savings is rebates. That is agreeing on any rebates earned from the preferred supplier are ‘collected’ by the supplier on the buyer’s behalf and returned quarterly (or annually) back through the procurement Department – but back into our suspense account, not the USER budget.
Aggregators often use rebates as a very quantifiable way to secure (and dramatize) savings. An old-fashioned bank cheque or just a plain old EFT each quarter can be very helpful. CFOs often designate them as reverse-cost (still into a suspense account, not a user budget) rather than designating them as revenue or even income.
In short-order such rebates quickly become part of the corporate profitability algorithm – and in this way savings always drop to the bottom line instead of dissipating in the multifarious expenses of the corporate P&L account.
Rebates are also a really viable way of incentivising spend centralisation, combating maverick USER spending and making more accurate spend estimates and forecasts.
The real secret to real savings.
Calculating savings potential is never easy. Surprisingly spend reports from typical Purchase-to-pay (P2P) systems are usually unfriendly, time-consuming to get and rarely accurate. There are too many reasons. Multiple data sources from legacy systems using different languages don’t help. Sloppy data input, human errors, duplications and capricious data links don’t help.
Ironically, suppliers often hold the best data on your spend. Salespeople are always sharp to track spend – for very obvious reasons. It is a good place to ask for “comparison data” … or to track your spend through an aggregator who almost always invest heavily in spend-tracking for obvious reasons if they get a cut, and have many members benefiting from the same deal.
Ultimately, therefore, your deal is only ever as good as the tracking of it. If that needs supplier help – so be it. Decent DATA is critical to good spend management nowadays. Indeed, a recent article on LinkedIn by Canadian consultant, Jean-Louis Moreau, argued that to succeed in future procurement has to become data-centric and no longer process-centric.
More savings ...
The direct benefit of becoming more DATA centric will be more savings – as well as more actionable insights into spend patterns and supply side dichotomies…
As we already know, savings are important. But a very real issue is that savings do tend to zero over time (there are only so many times you can go to tender for stationery supplies). Procurement teams that have oversold their ability to make continual savings are vulnerable. So whatever savings we can garner in a tightening market must surely be real and not fake savings.
Jonathan Dutton FCIPS is the former founding CEO of CIPSA until 2013 – the procurement peak body in this region. He now works as an independent management consultant specialising in procurement www.jdconsultancy.com.au and has a non-executive role at Supply Clusters www.supplyclusters.com.au