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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.
Case in point: at the Supply Management 2.0 Forum in New York last week, AllianceBerstein CPO Joanna Martinez told the audience that her group reports the ratio of the fully burdened cost of procurement operations (e.g., salaries, benefits, equipment, real estate) to the cost savings that procurement generates for the organization. (This is the core measure benchmarking firm Hackett Group uses to assess purchasing performance.)
National City Corp. CPO Jean-Jacques Beaussart was more direct in his answer: “When I talk with my CFO, cost reduction is the only thing that matters.”
Beaussart said hard-dollar supply savings are best calculated as follows:
Cost Delta (between previous costs and newly negotiated costs) X Purchase Volume = Savings
As one of the nation’s Top 10 banks, National City puts extra emphasis on aligning supply and finance goals. Beaussart says his team works directly with the CFO to validate and approve savings. Once approved by the Finance group, supply cost savings are removed directly from the businesses’ budgets.
To be fair, National City does track other measures, such as revenue generated for the bank through the use of purchasing cards (P-cards) and commercial cards used for travel purchases. But hard-dollar cost reduction is what matters most.
“We don’t count cost avoidance,” said Beaussart. “I think cost avoidance is a cancer on sourcing because it can be added and debated in so many different ways.”
Beaussart recommends that supply management groups develop a well-defined method for measuring actual versus projected cost savings, particularly for big projects. He also emphasizes the importance of communicating status of cost savings initiatives to all impacted stakeholders — particularly finance — through reports that reflect both progress towards goals and are tailored to the business user. “This procedures shows the business and your comapny that you have a disciplined approach to [cost savings] and that you are contributing to the goals of the business.”
9 responses so far ↓
1 Rick Fulk // May 24, 2007 at 10:17 am
I understand the difficulty in measuring cost avoidance. I compare it to insurance and we would be ignorant not to have insurance.
2 Seán O'Dwyer // May 24, 2007 at 10:45 am
While I understand the ‘bottom-line’ approach to cost savings it really is only part of the picture. To describe cost avoidence as a cancer is understandable but a bit of a cop out. In effect what this is saying is “I am not interested in cost reduction, I am interested in price reduction”. There needs to be some incentive for innovation and recognising and rewarding cost avoidance can often be that incentive.
3 Robert M. (Mike) Kanze, MBA, C.P.M., A.P.P. // May 24, 2007 at 1:17 pm
While a focus on cost reduction is hard to challenge, there are two, somewhat subtle problems in cost reduction being “the only thing that matters.”
About two years ago I wrote an article that included the following:
“Accounting Measures versus Strategic Measures.
“Understandably, we use accounting measures expressed in money units (dollars, euros, yen, etc.) as the near-universal scorekeeping language of performance measures, including supply chain performance. Unfortunately accounting measures are much more expository than predictive. Using accounting measures alone to gauge performance is a bit like driving a car by watching the road through the rear-view mirror: it is easy to see where we have been but much more difficult to determine if we are currently headed in the right direction. Further, accounting measures are better suited to monitoring operational and financial performance (return on assets, inventory turns, etc.) which is not necessarily the same thing as illuminating good strategic performance (brand rankings, “most admired” in an industry, etc.). Finally, accounting measures for supply chain performance have an almost exclusive focus on cost savings or cost avoidance. Savings and avoidances are certainly worthy, insofar as they improve the bottom line. Savings alone, however, do nothing to help us build the business while the right supply chain strategic measures can and often do so.
In the best-managed firms, strategic and accounting measures are used together, with a clear understanding of what each delivers to the area under evaluation. SCOR Level 1 metrics (for example) include both accounting or ‘internal-facing’ measures like supply chain management cost and cash-to-cash cycle time, and strategic or ‘customer-facing’ measures like perfect order fulfillment and upside supply chain flexibility.
“Strategic versus Tactical Measures.
“Earlier during the evolution of supply chain performance measurement, we focused on very granular, tactical metrics like cost per purchase order, Bill of Materials accuracy, and cost variances. As with accounting measures these tactical measures were expository. In addition, many lacked strategic significance because they focused on discrete transactions rather than the relationship from the supplier through to the end customer. An additional problem for these measures was their focus on functional excellence, which sometimes ran counter to organizational strategic goals and often regarded performance in isolation from the organization’s other parts.”
(A good example of this last point is a logistics objective to reduce less-than-truckload shipments that can conflict with a customer service objective of on-time deliveries.)
Organizations with an overriding focus on cost reduction as a KPI eventually find diminishing returns in this focus especially when strategic objectives are considered - as they must be eventually.
4 James V. Kelly, CPM // May 27, 2007 at 10:51 pm
The formula…
Cost Delta (between previous costs and newly negotiated costs) X Purchase Volume = Savings
…is missing two major components:
1) Utilization of any agreement (if only half the company uses the contract, then the projected savings will not be achieved)
2) A definitive budget reduction to keep the dollars from floating into another Expense Category.
At Dun & Bradstreet (as reported at last years Conference Board Purchasing Symposium in NYC), they created both compliance tracking using their Supplier Optimizer tool and also the budget link which moved the reinvestment of captured savings from potentially the lowest level of the organization to a reinvestment committee. This has worked well for them year over year and is strong example of a well executed plan for continued process improvement and cost reduction.
5 Supply Excellence » Killing the Messenger: What it Takes to Spark the Great KPI Debate // May 29, 2007 at 2:35 pm
[...] Last week’s post on CPO views of supply management metrics ignited a heated debate among Supply Excellence readers. The post cited comments from the CPOs of National City Corporation and AllianceBerstein stating that cost reduction was the chief metric for supply management performance. [...]
6 Tim Minahan // May 29, 2007 at 4:10 pm
Great and valid comments all!
Your passionate replies are exactly what I was hoping this post would ignite.
If cost savings is the only measure that defines supply management’s value to the organization, then our function will never be considered strategic. In fact, supply management organizations that myopically focus on costs are sentencing themselves to business purgatory, with their importance and support within the organization rising and falling with the economic cycles.
The only way to prove and SUSTAIN supply management’s strategic role is to quantify the function’s contribution to your company’s core objectives, such as developing innovative new products, increasing profits, penetrating new markets, and enhancing the corporate brand.
I have elaborated on your comments (and cleared up some misconceptions) in my latest post. Read all about it (and continue the dialogue) here:
http://www.supplyexcellence.com/blog/2007/05/29/killing-the-messenger-what-it-takes-to-spark-the-great-kpi-debate/
Many thanks,
Tim
7 Supply Excellence » Are You a Customer of Choice? // Jun 13, 2007 at 8:47 am
[...] At the final stop on the Supply Management 2.0 Forum in Houston last week, Hess Corporation Supply Chain Specialist Carl Tatum revived the lively debate over the right key performance indicators (KPIs) for supply management success. “We need something more than year-over-year cost reductions to prove our ROI,” Tatum told the audience of Houston area supply management executives. As Supply Excellence readers know, this statement contradicts comments from previous Forums panelists, including CPOs from National City Corporation and Alliance Bernstein. These top procurement execs argued that, in the eyes of the CFO, hard-dollar cost reductions is the only KPI that matters. Tatum countered this mindset by suggesting a more profound measure: “The only metric that matters is year-over-year profitability improvement. In addition to lowering costs, procurement must quantify its role in impacting revenues by avoiding risks of supply disruptions and contributing to the long-term sustainability of the business.” Responsible for supporting oil exploration and production activities for Hess, Tatum’s team is no stranger to risk management. New reports abound that the capital equipment and skills required to build new oil rigs and refinery capacity are in short supply, particularly in the far reaches of Africa or off the coast of Latin and South America. Competing for scarce drill bits or engineering and construction services to expand refinery capacity can be tougher than finding a Nintendo Wii at Christmas. (And, yes Virginia, there are oil companies trying to tap new sources and improve refinery capacity. More on that in a later post.) Such factors have prompted Hess’ supply chain squad to adopt a new goal: become the Customer of Choice to its suppliers. “A customer of choice consistently receives competitive preference for scarce resources across a critical mass of suppliers in its database,” said Tatum, citing a recent Procurement Strategy Council report found that suppliers rated only 5% of customers as “customers of choice.” At Hess, failure to attain this choice status could cost hundreds of millions of dollars a day in cost overruns and limit the company’s aggressive growth plans. The pillars of Hess’ Customer of Choice initiative include: [...]
8 Supply Excellence » Negotiations: It’s Not About You // Aug 1, 2007 at 9:02 am
[...] Many Supply Excellence readers might remember Martinez from the Supply Management 2.0 forum for her role in the great debate over measuring purchasing performance. This time, she turns her straight talking style to uncover the secrets to effective negotiations. [...]
9 Supply Excellence — CFO Magazine: Don’t just cut costs…Deliver value // Jul 15, 2009 at 9:28 am
[...] Supply Excellence posts have (with much controversy) documented CPOs reporting that hard cost savings is the “only KPI that matters” to their CFO. In the past year, this refrain has only crescendoed as the economy has made cutting [...]
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