We live in a world of data overload. Data is everywhere and there is more than what one needs or wants. So the challenge is which data to look at, when and how. The challenge is not even data mining yet, it is simply forestry work; to see the trees through the forest….
The first step on the road to identifying the right data or KPIs (Key Performance Indicators) is to identify what are the objectives of your S2P (Source 2 Pay). If you are after savings, you would need to look at which kind of savings you are looking for: out-of-pocket, processing, bottom line, cost avoidance etc. Savings is a colloquial term not a mathematical one.
Here an illustration of what I mean; if you are looking at savings which affect your bottom line they require you following them all the way up … to, well, the bottom line. This might seem obvious, but there are many necessary iterations:
- savings from sourcing which might be the price differential between how much you purchased comparable services/goods over the past period and the price you have sourced competitively or through negotiation based on your spend baselined for the next = spend sourced/savings sourced over the period.
- you also need to look at what spend you have contracted for the upcoming period, is it above or below your baselined spend = spend contracted
- you need to look at what is the actual consumption of the contracted spend, this is what happens in operations = spend ordered then,
- you need to look at how suppliers under the contract (s) delivered against orders = spend delivered then,
- what spend has been invoiced, then,
- you finally reach the savings which will actually hit your bottom line…
In the meantime, you do need to make sure for everything to work out the way you intended it, to put in place certain operational indicators to ensure it will:
- that the contract(s) you put in place for the spend are actually available to operations = contracts published and available
- that operations use the contract(s) in place as a matter of priority and compliance = preferred suppliers/contract (s) for the type of spend,
- that the suppliers meet their commitments under the contract(s) = supplier performance monitoring and that their deficiencies do not lead users to order somewhere else…
- that there is no alternate demand out there to what you have contracted = demand management
- that invoices are processed in line with the contract terms
All these indicators play into you achieving your initial KPI of savings which hit bottom line.
- Spend/categories covered by contract
- Spend in so called Buying channels off contracts and compliance
- Supplier performance
- Demand or category management
- AP (Accounts Payables) compliance processing
All of a sudden, measuring savings becomes a multi-dimensional, multi-function and across a timeline exercise.
You may indeed skip all the intermediate measurement steps and move strictly to measure contracted vs. invoiced but it will not allow you to easily detect and remedy where the leakage occurred and possibly allow you to correct the course before the relevant savings measurement period has passed.
I also want to address a couple of key measurement errors or gaps through a few examples based on ‘ most frequent misconceptions’:
Compliance vs. Risk
- Measuring spend with qualified suppliers measures compliance while,
- Measuring spend with unqualified suppliers measures risk
Tail Spend vs. Maverick Spend
- Tail spend is spend which is necessary and not worth sourcing or contracting – it should be on P-card or spot buy, in that it could not have been compliant…within the existing contractual framework.
- Maverick spend is spend which has already been sourced and contracted but users do not use the contract provided to execute their needs – it could have been compliant but is not.
Another one, is measuring only savings which hit the bottom line:
- By not measuring cost avoidance, esp. in markets where prices are on an upward trend is not recognising the buyer’s contribution but equally importantly it does not recognise her/his contribution to improving the company’s competitive advantage positioning
- Comparatively, not measuring opportunity costs, which especially if missed, diminish the company’s competitive advantage positioning is equally suboptimal. E.g. the price of a commodity goes down significantly consistently, but the buyer has locked her/his self into a long term contract w/o a formula which allows to take advantage of the change in prices…
It is equally important to address the comparability of changes in demand, that is getting more value for the same amount of money, than before with no recognition under a savings to the bottom line kind of approach. This sometimes requires sophisticated calculations, which should be entertained to provide not only transparency, recognition but also a good estimate of ancillary financial benefits to come to a valid award decision. An illustration of this is a maintenance contract:
- Under an earlier contract, the ordinary maintenance, spare parts, extraordinary maintenance and the equipment were under different contract terms and possibly with different providers. The company was paying a fixed fee for ordinary maintenance, spare parts of a list price based on consumption, extraordinary maintenance based on request T& M (Time & Materials).
A new contract provides for:
- The machines being owned by the suppliers, maintained in functioning state by the suppliers and the company paying by usage e.g. Number of hours of production.
In this second scenario:
- Machines are off the company’s book – doing away with depreciation = working capital
- The risk to production is born by the suppliers – doing away with a need to have FTEs catering to the maintenance and can be offset by penalties or business continuity insurance born by the supplier contractually, if all goes sour (of course paid for through the contract)
- The need to hold essential/first intervention spare parts in the inventory is born by the supplier and thus there will be no excess stock or remnants (e.g. spare parts in stock but never used) at the company – working capital
- The replacement of the machines is decided by the supplier based on her/his knowledge of the lifecycle of his/her machines (the supplier is in the best position to know his machines/ IoT helps a lot here).
- There is also an opportunity cost which is not accounted for: surely, the ” all-in/pay per consumption” contract will be of a longer duration than the previous one and therefore opportunities for finding more competitively priced spare parts, or doing some of the maintenance in-house by otherwise available FTEs, or replacing the machines earlier for some production efficiency or later, will be foregone. The risk of relying on a supplier which might not be as reliable as one self and losing the relevant expertise about one’s own production process is also not to be discounted…
The new set-up requires a TCO (Total Cost of Ownership) calculation as well as a risk analysis. However, there are many categories where the risk is limited while the TCO calculation is very favourable, because the suppliers in the marketplace have as much to lose as their customers.
This pay per use model is already in place in e.g. car insurance/leases to some extent, whereby the premium depends on: the make and model of the car, the age of the driver, the length of time the driver has been driving, the maintenance of the vehicle, the kms driven, the accident record of the driver, the number of drivers, the geographical location, and other considerations which price the premiums.