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There is an old saying, “You can tell a lot about someone by the company they keep.” In the supply management world, you can tell a lot about an organization and their strategies (and, even, their likelihood for success) by what they measure.
Evidence of this fact came through in Aberdeen Group’s latest report, The CPO’s Strategic Agenda. The far-reaching study covered many aspects of supply management challenges and approaches. One of the most compelling sections focuses on the key performance indicators (KPIs) used to measure supply management efficiency and effectiveness.
According to Aberdeen, the Top 10 Procurement KPIs in use today ranked in order of priority are:
- Negotiated cost reduction savings
- Implemented cost reduction savings
- Percent of total spend under management
- Cost avoidance
- Procurement ROI (savings/operating costs)
- % of suppliers accounting for 80% of spending
- Supplier performance (price, delivery, quality, service, etc.)
- Contract compliance
- Requisition, PO, or invoice transaction volume
- Subjective feedback (structured, survey-based)
Report author, Vance Checketts, warns of the dangers of focusing too heavily or narrowly on specific metrics: “Unfortunately, negotiated cost savings is still more prevalent than implemented/realized cost savings. This is problematic because the former is at risk of never reaching the bottom line.” The challenge, writes Vance, is for the supply management organization to “take ownership of the savings” and ensure that they are fully realized.
The leakage that occurs between negotiated and implemented savings is quite dramatic. Aberdeen’s innagural CPO Agenda study reported that the typical company only implements about 70% of the savings it negotiates. Chief culprits of savings leakage include lack of communication of supplier contracts to requisitioners and insufficient policies and systems to enforce compliance.
The CPO at a global high-tech manufacturer summed it up best when we recently had lunch, “You only truly have spend under management when you are both applying strategic sourcing methods and standardized compliance methods to that spend.” In short: Procurement savings don’t count until they hit the bottom line.
Vance was also wise to question the absence of metrics on the list that link procurement to key financial performance metrics that are watched by CFOs, CEOs, and investors, such earnings per share (EPS) and Return on Invested Capital (ROIC). These points are well covered in Doug Smock’s book Straight to the Bottom Line as well as in his previous posts on Supply Excellence.
While Vance’s example focused on negotiated versus realized savings, his broader point should not be overlooked. No single metric defines supply management success. (Although, I personally believe that spend under management, as defined above, comes pretty darn close.)
I welcome Supply Excellence readers to share their own views on what are the right metrics to measure and balance supply management performance. Post your ideas in the comment section below or e-mail me directly at tminahan@supplyexcellence.com
8 responses so far ↓
1 Mark Usher // Dec 13, 2006 at 1:39 pm
Tim,
(I posted the comments below to Paul Martyn’s CombineNotes blog as well). Wanted to make sure you got my feedback on the report, which I think is excellent with just a few areas for follow-up I would say.
Mark
1. Very encouraging that 89% of respondents see procurement as more strategic. This improves the chances that the CPOs’ top 10 goals will get the senior executive sponsorship they need to be pushed through. Only 27% of best-in-class companies with CPOs reporting to CEO/President level, though - I’d like to see that move nearer to 50% over the next couple of years.
2. Although getting more spend under management is clearly a top concern, it seems like the best-in-class (early adopter) companies consider they’ve made good progress in getting increased spend under management and improved spend visibility and - although still considering those areas important - are starting to focus their attention on the softer/more strategic areas of procurement team skills and supplier development/collaboration.
3. Supply base rationalization is still a priority, even for 27% of best-in-class companies.
4. Great correlation between two of the top 10 goals - supply base rationalization & low cost country sourcing - and one of the top 5 pressure areas - supply risk. Not surprisingly the best-in-class companies recognize the supply risk threat more than the “others” - 32% compared to 19%. The BIC companies have just got themselves more educated in this area.
5. Staying on supply risk, a couple of critiques about the KPIs and PACE priorities in chapter 3. First, what about a supply risk KPI (or two)? Such as probability of supply disruption or shortage in next 12 months? Or some supply risk metric that is a weighted average of a number of individual probability-based metrics? Secondly, the actions/capabilities/enablers in the PACE table for #4 Supply Risk are a little too supplier-centric in my mind. What about supply market intelligence on price and availability? Or optimizing supply strategy-driven savings vs. increased risk? You get the idea - broader issues that impact supply risk over and above the (admittedly important) supplier and even supply chain factors.
Again, a great report.
2 David Rotor // Dec 18, 2006 at 2:24 pm
Hi Tim,
I agree with your comment:
“No single metric defines supply management success. (Although, I personally believe that spend under management, as defined above, comes pretty darn close.)”
I’ve been using “spend under management” as the leading indicator (metric) for indirect procurement department effectiveness for several years now. I’ve found it effective across several industries, and even in the public sector. I also often refer to it as our department’s “market share” as executives in other business units understand the language, and often intuitively accept that market share growth is “good”.
I measure procurement market share against two axis. First, from a category manager’s perspective, what’s the corporate-wide compliance with each of our category offerings. For example, “the compliance rate for our preferred cell phone carrier was 89% last quarter”. The second axis is from a customer perspective; what’s our market share for a given client department. For example, “our market share of the COO’s spend is 92%”.
The value of this approach is it provides feedback to allow the procurement department to understand what the rest of the organization values, and what it does not. It also enables discussions around client requirements “why is our market share so low on the east coast?”
Cheers,
David Rotor
3 Tim Minahan // Dec 19, 2006 at 9:30 am
David:
You bring out an excellent point. Spend Under Management is equal parts strategic sourcing and compliance standards.
Your two-pronged “market share” approach addresses the visibility and metric requirements of all constituents, allowing you to measure the effectiveness of specific spend categories (and the supply team that manages them) as well as the performance of individual functions and departments. Having these metrics in your arsenal can go a long way to secure senior support — particularly from the CFO — to drive compliance and demonstrate the value of having spend under management of the supply management group.
Other Supply Excellence readers would be wise to emulate your approach.
Thanks,
Tim
4 Top links this week #50 - Strategic Sourcing | Europe // Dec 19, 2006 at 7:32 pm
[...] Top 10 Supply KPI’s: Aberdeen view | Post from Tim Minahan [...]
5 Supply Excellence » The Only KPI that Matters // May 29, 2007 at 4:06 pm
[...] A common refrain I hear from procurement execs is ”What are the right key performance indicators (KPIs) to measure supply management success?” In a recent report, Aberdeen Group proffered a list of the Top 10 Procurement KPIs. But Chief Procurement Officers (CPOs) tend to have a more direct answer: it’s all about cost savings. [...]
6 Mike // Aug 1, 2007 at 1:59 pm
What good is spend under management if you are over-paying for all your goods & services? Isn’t it better to save $100M on 50% of spend than save nothing or over spend for 100%? This is an extreme example but it seems much of the KPI discussion is theoretical and not realistic.
7 Tim Minahan // Aug 1, 2007 at 2:37 pm
Mike:
Your point is well taken. Yet, the law of averages of negotiating and implementing even a small margin of savings on a larger portion of spending strong suggests that the more spend you have under management, the better return for your organization.
There is also the “success effect” that occurs when a supply management organization begins to get more spend under management. If the purchasing group hits the ball out of the park on savings for a a basic part or assembly, they save the company some money, but they are still not viewed as strategic. And they are still no affecting the majority of the company’s spending.
However, if the purchasing group does a very good job at sourcing and driving compliance for a number of direct and indirect categories, they not only drive greater realized savings for the company, but they also begin to be viewed as more strategic.
And this success breeds more success. As more business units and functions hear more about this success, they want to leverage purchasing to help negotiate and manage better savings for all types of categories — including those once deemed too unique or strategic for purchasing to touch, such as consulting services, printing, advertising, legal, benefits, etc.
To continue the baseball analogy, which is better, having a single player win the home run title or having the whole team win the pennant with base hits, good defense, and sacrifice flies?
8 Mike // Aug 1, 2007 at 4:54 pm
Thanks for the response (and quickly) Tim - points well articulated and taken.
The converse of the success factor is that any perceived bottleneck, extra burden, or less than positive experience can be detrimental to leveraging more spend. So the planning, communication and implementation aspects are critical to ensuring “success”.
For future benefit - do you distinguish between purchasing and strategic sourcing, where I consider the former to be more tactical and repetitive?
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