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Today's businesses look at their procurement teams as a means of driving value that goes beyond just cost-saving benefits. For this reason, as a procurement leader, you are under mounting pressure to increase the overall sustainability of your procurement processes. That said, experienced leaders will not look to make any major decisions without the right information readily available. To get a hold of this data, they will need to track several procurement key performance indicators (KPIs) as well as the metrics that go with them.
While the procurement KPI is a commonly used term in the industry, not everyone has a thorough understanding of what it actually represents. Almost every procurement key performance indicator means a different thing to different organizations. This lack of uniformity in terms can often lead to uncertainty within the procurement department, by not knowing what really counts as a KPI and what doesn't.
Yet, only by gaining the necessary understanding of these metrics and the relevant KPIs that your procurement team will be better positioned to track their performance and make more informed decisions.
What Are Procurement Key Performance Indicators?
A procurement KPI is a tool used to measure performance as well as monitor and evaluate the efficiency of a company's procurement management. These KPIs help businesses streamline and optimize their time, service quality, spending, and cost. In addition, procurement KPIs help companies keep in line with their business objectives, goals, and overarching procurement strategies.
Measuring the effectiveness of the procurement process is critical as it influences the supply chain in the event of economic downturns. Procurement performance is usually tied to the cost-saving benefits that it can provide. But aside from cost reduction, performance measurement can also help organizations by identifying areas of the business that need improvement, how well they stack against the competition, as well as determine whether they are growing and declining as a business.
Put simply, procurement key performance indicators provide a clear picture of the current performance level and help determine whether the company is where it needs to be. They improve decision-making and help reduce the complex nature of organizational performance by turning it into a series of manageable and actionable metrics.
Depending on their exact purpose, procurement KPIs can be divided into several categories such as quality, inventory management, delivery, and cost-saving KPIs. It is, however, important to keep in mind that none of these metric categories work in a vacuum, which means that focusing solely on one may negatively influence the others. There needs to be a careful balancing act that will provide all of the benefits that procurement management has to offer.
Compliance Rate - To ensure legal security, businesses need to be in contractual and policy compliance. If these compliance rates dip down, there is a high risk of increasing both indirect and maverick spending. To improve the compliance rate, businesses can turn to a foolproof purchasing contract that clearly outlines all penalties in the event of a breach. Some metrics to keep in mind here are the ratio of disputed invoices to total invoices, as well as the total difference between the paid and quoted prices.
Purchase Order Accuracy - A low purchase order accuracy will typically increase the company's operating costs. This specific metric will help organizations keep an eye on whether their suppliers are delivering the right orders and if these deliveries are on time. Tracking this metric revolves around the ratio of product/service delivered outside of the predefined service target. It's also indicated by the percentage of mistaken deliveries over the total number of purchase orders over a set period of time.
Supplier Defect Rate - The supplier defect rate is used to determine each supplier's individual quality. By measuring the supplier defect rate based on defect types, procurement professionals will be able to generate actionable insights regarding each supplier's overall trustworthiness. The supplier defect rate is a representation of the total number of substandard products over the total units tested.
Inventory Aging - An inventory aging report represents a list of all the items on hand that are grouped based on the period of time spent in inventory. This metric is used to identify which inventory is slow-moving, as well as determine the associated costs with storing and maintaining these items before they are sold. A high level of inventory aging is indicative of capital blockage in the form of inventory.
Inventory Turnover Ratio - This is the ratio between the inventory sold over the average inventory in a year. The higher the inventory turnover ratio, the better your inventory planning.
Inventory Carrying Cost - This KPI indicates the overall cost of holding inventory. It includes the cost of space in the form of rent, maintenance, wages, and other forms of overhead costs that place a burden on your organization.
Supplier Lead Times - This metric represents the amount of time spent between when a supplier receives an order and when that order has been shipped. The supplier lead times are typically measured in days and starts with the availability confirmation and order, and ends with the delivery.
Emergency Purchase Rate - Emergency purchases are unplanned orders that are made so as to avoid any product shortages. This KPI is measured by comparing the emergency purchases to the total number of purchases made over a given period of time. If they manage to lower their emergency purchase rate, businesses will also be able to improve their procurement function, reduce supply risks, save costs, and ensure operational continuity.
Vendor Availability - This metric is used to measure a vendor's ability to respond to any emergency demands. Vendor availability helps companies determine the overall reliability of a vendor and is calculated as the percentage of the number of items available with the vendor by the number of orders placed with the supplier.
Purchase Order Cycle Time - This procurement KPI is measured from the moment a purchase requisition is submitted to the time when it's sent to a vendor. This KPI covers the entire ordering process, which makes up the end-to-end purchase order cycle.
Procurement ROI - The Procurement ROI helps determine the overall profitability and the cost-saving benefits of a procurement function or investment. This KPI will be best suited for internal analysis and is a ratio between the annual cost savings and the annual procurement cost.
Cost Reduction - Cost reduction is a central procurement KPI and measures the tangible hard savings that were achieved over the years through cost management techniques. You can measure this KPI by comparing the old costs with the new costs for the same good or service. By monitoring the cost reduction over time, you will be able to increase it over the long-term.
Cost Avoidance - This procurement metric focuses on the actions taken to reduce future costs. Also known as "soft savings" these do not appear directly in the company's bottom line in any tangible or quantifiable way. Nevertheless, these can still have a positive impact, even if they don't directly impact the income statement. Cost avoidance often targets strategic spend such as new technologies or investments that have no terms for comparison. By combining it with the cost reduction KPI above, businesses can avoid future extra costs down the line.
Spend Under Management (SUM) - The SUM represents the percentage of procurement spending that is controlled by the management department. As the company's spend under management rises, the potential for cost-optimization and forecasting will also increase. The SUM represents the difference between the total approved spend such as direct, indirect, and service-related costs, and the Maverick spend.
Price Competitiveness - Minimal vendor competition will oftentimes lead to a supplier monopoly. Over the long-term, this can lead to lower-quality services and fewer growth opportunities. The focus is placed on shortlisting vendors that offer a competitive advantage. This KPI will also give you, as a procurement leader, the ability to create custom reports that include other metrics like the above-mentioned purchase order cycle time, emergency purchase rate, or procurement ROI.
Procurement metrics and KPIs have an important part to play in performance management. They can connect procurement professionals with key strategic points and provide enhanced visibility on the impact of every procurement function and improvement areas. The end result is an efficient and well-organized procurement team armed and capable of impacting the company's overall success. And while this list is not exhaustive, it is still comprehensive enough to cover all of the critical metrics and KPIs that need to be taken into consideration.