Cost Reduction and Cost Avoidance KPIs Deep Dive
Table of contents
Here's a quick rundown of the post in case you don't have time to read the whole article:
Every organization wants to be successful, yet success measuring methods differ significantly based on size, industry, company, or even individual department. To quantify success, key performance indicators (KPIs) can be used to help with rating employee performance and pinpoint which employees are actively contributing to the overall progress of the organization.
In terms of procurement, having the right KPIs in place is essential to determine the overall procurement performance. However, if it's calculating the wrong achievements, the procurement department can find itself at a serious disadvantage. For instance, measuring employee productivity through a per-employee spend may not be the most effective. Even though it's a common procurement KPI, the per-employee spend may not be as accurate since some employees may be managing many suppliers within the tail and may not be spending a lot of money in the process. Other employees, on the other hand, may be spending significantly larger amounts of money only on a few suppliers.
Even if a procurement organization is spending its whole year hitting quotas and exceeding standards, if they were operating on the wrong KPIs, their productive activity has, in reality, only accelerated the company's plunge into deficiency. In light of this potential outcome, procurement leaders need to establish the proper KPIs for their teams. In doing so, they will ensure that they will be getting actual business success for their organization.
The Focus on Cost Savings
While a comprehensive procurement strategy tackles several key areas, at the end of the day, reducing the operating cost is what procurement is all about. Why would one scrutinize the procurement process unless the end goal would be to acquire all the necessary goods and services for the lowest possible cost?
What separates a great procurement organization from a mediocre one is the cost saving benefits that it can achieve. Statistically speaking, effective procurement professionals will spend around 21% less money and employ around 29% fewer people than their less effective counterparts. The very best procurement strategy will devote itself to conserving financial resources.
There are a number of cost saving methods, as well as some cost reduction and cost avoidance KPIs that organizations need to take into consideration if they want to succeed in their procurement-saving strategy.
What are the Cost Reduction and Cost Avoidance KPIs?
By examining every key performance indicator listed below, your procurement team will be able to better focus on the areas that will have the greatest impact and maximize your cost savings.
The Procurement ROI differs from a regular return on investment, which is typically calculated based on the following formula ROI = (gain from the investment - the cost of investment) / the cost of investment. Many procurement professionals consider the procurement ROI as the most important procurement key performance indicator. That said, it's usually analyzed in combination with other metrics, in order to get a bigger picture.
Calculating the procurement ROI involves dividing the annual cost savings by the internal procurement cost. In general, this metric is best suited for your internal spend analysis and helps you determine the overall profitability, as well as the cost saving benefits of an investment or procurement function.
In most cases where there is minimal vendor competition, there will also be a chance for supplier monopoly. In time, this can lead to lower-quality services and fewer growth opportunities for your company. The focus of this KPI is put directly on shortlisting only those vendors that offer your organization a competitive advantage. In a sense, it measures vendor performance.
Similar to the procurement ROI, cost reduction is an important KPI in procurement management. It measures the hard savings that were achieved through various cost and procurement management techniques. This KPI can be measured by comparing old and new costs for the good or service. By keeping a constant eye on cost reduction, you can increase your efficiency over the long-term.
The cost avoidance metric looks at the actions taken to reduce future costs and expenses. By comparison to the hard savings measured through the cost reduction KPI, this metric tackles the so-called soft savings that don't appear directly in the company's bottom line in any direct, tangible, or quantifiable way.
Regardless, these soft savings can have a significant impact on the bottom line, even if they don't directly impact the income statement. These soft savings can include things such as various strategic investments that have no real comparisons. When combined with the cost reduction KPI, your procurement team can avoid future extra costs down the line.
Spend Under Management (SUM)
The spend under management (SUM) KPI is a percentage of procurement spending that is controlled by the management department. As the company's total spend increases, the potential for forecasting and cost optimization will also increase. The spend under management KPI is calculated by dividing the total approved spend by the Maverik spend.
How Prokuria Can Help
That said, it’s one thing to know about the existence of these cost saving KPIs and totally another to put them to good use. Luckily, however, this is precisely where Prokuria comes into play. Being applied at the most important phase of the funnel “the negotiated spend under management,” Prokuria will directly improve the KPIs related to cost reductions and price competitiveness. Below are some of the benefits of implementing Prokuria into your procurement strategy:
Empowering your Supplier Negotiation Capabilities with Actionable Data - By using Prokuria and what it has to offer, your organization can get a complete view of all of your suppliers. To achieve any real cost reductions in procurement, you will need to have real-time access to a consolidated and full view of all vendors and 3rd party suppliers. This type of comprehensive data will help your company better negotiate corporate prices and payment terms across the entirety of your organization. A supplier relationship management (SRM) platform such as Prokuria will allow you to uncover any existing hidden costs by connecting all supplier data into a single, centralized location.
Using sourcing RFQs, RFPs, and RFIs - Prokuria is also an excellent tool for discovering new suppliers, benchmarking existing ones, as well as gaining a better understanding of the market and its players. The SRM platform allows you to monitor your suppliers in real-time, provides you with powerful questionnaires with multiple types of questions for your Request for Information (RFIs), Request for Proposal (RFPs), and Request for Quote (RFQs). This way, you can finally compare all of your vendors and suppliers accurately. Lastly, Prokuria also provides a private webpage where suppliers can add their information quickly and efficiently, without having to set up their own account.
Using Reverse Auctions - As the final step in the selection process, reverse auctions help your organization by creating the highest possible level of competition between your suppliers. While e-auctions can be applied to pretty much every purchase your company makes, you are not obligated to do so every time. Between Dutch, British, Japanese, and other types of reverse auctions, you can also implement different types of other auctions in a creative way, as long as you are creating an environment where vendors are offering the highest payment term.