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Purchasing Magazine’s recent advice that procurement market and sell its usefulness to internal stakeholders got me thinking: what are spend management organizations doing to serve their internal customers? And how are they measuring success?
When I first posed this question to two CPOs a while back, their answer was blunt: “When I talk with my CFO, cost reduction is the only thing that matters.” And, while I’m certain the current economic environment has more CFOs (and CPOs) thinking this way, procurement must differentiate its value based on more than just cost savings.
To find out what key performance indicators (KPIs) procurement groups were using to measure their service to internal customers, I turned to the fast-growing Sourcing and Procurement Group on LinkedIn. And I received some interesting responses from practitioners and consultants alike.
A Director of Purchasing at Sunburst Hospitality argued that “It is just as important to track KPIs for the internal customer as it is for the supplier. Setting up an evaluation form using key components from your scope and general conditions is a great place to start for the supplier deliverables. The [external] supplier can help set the KPI’s for the internal customer” based on their understanding of the product or service being delivered.
A Supply Chain Manager at a U.K.-based aerospace company went a step further and said his group has regular meetings to bring internal customers and external supplier representatives together to review performance and identify opportunities for improvement.
He also advises that procurement measures be aligned with the goals of the individual business functions: “Internal stakeholder KPIs can be a challenge as different functions are measured in different ways which in turn are reflected in their department strategies.” He suggests that Quality and On Time are a given and that “Responsiveness and Flexibility” are other areas upon which procurement should be measured by internal functions.
All respondents emphasized the importance of removing emotion or long-term biases from the discussion by basing metrics on fact-based data: ”Critical to the success of any agreed KPIs is a full understanding of data origin and accuracy by all parties.”
This echoes comments from spend management executives at Alliant Techsystems and H&R Block, both of which use the output of their spend analysis programs to drive compliance and performance discussions with their internal customers. At H&R Block the fact-based spend detail procurement provides has elevated the strategic role of the function within the company and with its franchisees.
Yet, my old pal, David Rotor at EDS offered the most intriguing advice: “Operational KPI’s such as cycle time and first time matching have their place in measuring performance, but owning responsibility for driving market share instead of measuring compliance seems to be more productive.”
Rotor recommends a three-tier approach for effective procurement organization:
- Client Team: “The Client team is measured on the ‘market share’ that they manage,” writes Rotor. “For example the client is ‘Chicago Manufacturing,’ and they spend 87% of their supplier dollars with the procurement department.”
- Category Team: “The Category team is measured by the market share their category has captured across the firm (for example the “Commercial Printing” category manager has 92% of all spend for commercial printing across the firm). “
- Analysis Team: “The Analysis team gets measured by total market share (client X category). “
Bottomline: the most successful procurement organizations are equally competent at selling as they are at sourcing. And, as ever good salesman knows, success requires you to align your solution or service to support what the customer needs.
Join the Sourcing and Procurement Group here and become part of the discussion.
10 responses so far ↓
1 Andrew Brightmore // Feb 24, 2009 at 6:07 am
Interesting piece. I am still surprised by the number of procurement teams / organisations that ignore the measurement of cost avoidance as a key contributer due to its complexity / vague nature. Capital buyers, that I know, can feel disengaged from their larger teams as they metrics can be less robust or demonstrable. I also know of one organisation that has a “introducing creative ideas” as part of the review brief - seems to work well.
2 Steve Balombini // Feb 24, 2009 at 8:24 am
As the CPO’s stated in the first of the article, cost reduction (and in some companies cost avoidance) are what matters at the end of the day. All the other fluff looks good on PowerPoint and may be a good talk at a conference; but the CFO/CEO want to know “what did you save me today!”. Answer that in the positive and you are a hero (and still employed) dispite the opinions of internal or external sources.
3 David Miller // Feb 24, 2009 at 12:31 pm
One needs to step back and recognize that KPI’s are to be measurements of progress toward fulfilling your KI’s (Key Imperatives). To bluntly ask what an organization’s KPI’s are without referring to the underlying KI’s, is like asking, “what color.” The answer is just not fully relevant. Growth industries will certainly have different objectives than non-growth industries, such as time to implementation vs. cash conservation. Just my two cents, which to some may be a good deal, to others may be overpriced.
4 Howard Richman // Feb 24, 2009 at 1:13 pm
Savings as a KPI is greatly misused because, as an outcome measure, it says nothing about the methods used to obtain it (and is it repeatable or sustainable), the ROI on the effort to generate the savings, and whether the organization actually used that savings to drive a strategic or competitive advantage.
KPI’s that truly measure performance and gain alignment and synergy with the business goals will drive the right behaviors, and lead to sustainable, repeatable outcomes. By cutting cycle time to run and implement a sourcing strategy, you improve the ROI and the “cost to procure” of the Procurement function while improving savings delivery, cash flow and time to market for your business strategy. That’s the real goal.
5 Tony Rudd // Feb 25, 2009 at 6:46 pm
In an evermoving economic climate the best measure of “savings” would be reduction in TCO. the measure is then balanced in a rising and falling economy. fixed measures like spend under contract, time to complete master data requests, reduction in vendor database, are probably what has been termed above as “fluff” but at the end of the day are you discussing internal customer satisfaction or kissing the CFO? In a project driven industry key measures for internal stakeholders are performance to budget. To win a single job you can simply quote low and beg for variations, to win the next job you needed to be on or underbudget on the last one. Efficient and accurate costing will win at the end of the day, if you drive your supplier base into the ground then sooner or later no will want to play.
6 Tim Minahan // Feb 26, 2009 at 6:35 am
Excellent points, all. Earning and retaining the trust and support of the business requires you to align your performance measures with the goals of the internal customers you support. While the predominant performance metric remains TCO — and to a lesser degree, cost avoidance — specific functions are also interested in what procurement can do to impact other key measures, like availability (can’t afford a stock out now), quality (…or a malfunctioning product), or responsiveness or cycle times (…or an unhappy customer). For example, the procurement group at one technology company recently designed its sourcing and supply risk plan to align with the CIO’s goal of winnowing its use of outsoured developers and balancing off-shore with onshore resources. Sure, cost savings was a key component of this strategy, but the real drivers were reduced risks, more consistent and better quality code, and faster development cycles.
7 Procurement KPIs: How Are YOU Measured? | Sourcing Excellence // Mar 2, 2009 at 2:47 pm
[...] be judged by the internal stakeholders I would urge you to read Tim Minahan’s post “Procurement KPIs: How Are YOU Measured?”. The bottomline quote sums it up for me the most successful procurement organizations are [...]
8 Pierre Mitchell // Mar 2, 2009 at 4:55 pm
Given I spend most of time on this topic, I thought I’d chime in. The metrics need to start with Procurement’s Value Proposition and what you’re trying to accomplish which itself should be derived from business goals. If assurance of supply is important - measure it! Many don’t/can’t. If you’re all about being the negotiator, then price reductions and cost avoidance are for you. If you’re like most though, you’re about hard dollar TCO reductions for the “Return” in “ROI” (with “I” being the Cost of Procurement). Let’s not get into “Mark to market” vs. year-over-year or new-vs.baseline here - that’s a whole discussion in its own right. But like Tim said, it’s not just about Procurement’s TCO savings, but about serving business objectives, of which cost is surely part, but so is cash liberation, brand protection, revenue uplift, etc. Internal Cust Sat is also used and is good to have as a good proxy measure for alignment. As much as many hate Procurement using a customer or client terminology, “Assurance of relationship” and alignment is key to assurance of supply / savings. Warning here though is that Procurement needs to elevate its game and its “completeness of vision” - not just “ability to execute” (to quote Gartner’s magic quadrant - except applied to Procurement as a “services vendor”). Otherwise, it’s like “Yeah, Procurement, you’re doing a great job…launching POs or doing last minute negotiations - keep up the great work!”
As Procurement gets to the level of “Value Management”, it becomes about maximizing value from spend (and supply/suppliers), which either means less spend or more utility from that spend and that is ROI as defined by the business. For example, if a slightly more expensive CRO can help a pharma company get better clinical outcomes and get to market 2x as fast, it’s ‘unfavorable PPV’, but hugely favorable business outcomes! Procurement needs to be tune its operating model (and change management approach) as such to deliver this value in context of the business. This leads to final thing to measure which is ‘capability’. We measure this primarily through best practices adoption (and somewhat through the customer stakeholder satisfaction survey process that we use in our benchmarking projects and advisory programs), but it means being able to measure those causal factors that will drive improved performance so that you can improve those capabilities - automation, alignment/partnering, knowledge/know-how, and process-specific techniques. If you want P2P automation - use a “hands-free” type metric. If you want to guage supply risk, create a profit-at-risk type metric. And so on.
The biggest thing to remember is that KPIs should be used as weapon to build capabilities and improve performance - and should be refined at least annually as part of the planning process. If your value prop and needed capabilities are to evolve, so does your scorecard and your performance management process that drives it.
Pierre Mitchell
Director - Procurement Research & Advisory
The Hackett Group
617-281-6185
9 Thomas Kase // Mar 3, 2009 at 5:25 pm
Price is what you pay - cost is not price.
Let’s say you’re a toy retailer, and I have a boatload of 52′ containers full of the latest children’s toys. 10,000 toys per container. I’m charging $20,000 per container - delivered to your warehouse. Easy equation, right?
The cost is $2 per toy you say?
No, the price is $2 per toy - the cost can be anything.
If those toys have lead paint on them - and your company gets hit with multi-million dollar lawsuits - possibly criminal charges - what’s your answer now?
Know your supply chain, know all aspects of what you are buying - only then can you start to see what the cost is.
As sourcing professionals we shouldn’t throw these words around lightly - how can we drive change if we can use words like this properly?
TCO is a tautology - cost is always total.
10 Pierre Mitchell // Mar 5, 2009 at 4:11 pm
Thomas,
Yes, I’m aware of the difference of cost and price and TCO, and the precision of words - and how to use them ‘properly’. At a Supply Chain World conference 7 years ago, I presented an entire presentation on why “Source” per SCOR model vs. “Source” per n-step sourcing methodology destroys a lot of value in the value chain. The lack of terminology is an industry problem. I won’t even touch “supply management”!
In my business, the terms must be very precise to collect accurate data in our benchmarks. So, let’s begin:
Spend = “Purchased Costs” = $ flowing to suppliers (except things like charitable donations, etc.). Purchased Costs include all-in costs such as third-party freight, handling, etc. - and it’s of course Price * Volume on the various elements of this (piece price per unit, truckload cost per container, etc.)
TCO = all other costs including cost of capital, cost of E&O, cost of quality, etc. This is where it obviously gets tricky when other stakeholders ‘own’ these costs (as does Procurement - welcome the fundamental issue on the dual-agency problem). Also, the TCO of supply includes the cost of managing that supply and that includes the cost of “Procurement” (the Function (i.e., collection of processes) - not the department).
We obviously understand this cost well because we essentially do bottoms-up activity based costing to allocate people’s time to various Procurement processes (even if they don’t report to Procurement - that’s part of how we get ‘apples to apples’ comparisons) and then look at the value that the company gets from those processes and also the best practices applied to those processes that help explain why (or why not) performance is being achieved. i.e., the usual “operating expense” measure used to measure the cost of procurement processes is not good because it measures the cost of those who report to Procurement (i.e., a management decision) and since that decision varies, so does the measure.
“Value” itself is another term thrown around. Value = Utility / Cost. So, Value of Spend = Utility of Spend divided by Spend [Magnitude] which we defined before. Spend = unit cost * volume.
Now, if we were going to have a REAL discussion on costs, we discuss cost pools, cost drivers, and activities which “consume costs” etc. - but I’ll leave that to the closet ABM folks (critical stuff - real Dr. Ellram’s report on it). Yet, I’ll give you another pragmatic example. The “Cost per PO” is NOT the cost of procurement divided by the number of POs!!! Why burden the poor PO with strategic sourcing and supplier management costs. It should be the activity-based cost of processing a PO. Think $5-20 here - not $50-150.
But, what is “Utility of Spend”? This simply means the “Bang” in “Bang for the Bucks”. Bucks = Spend. “Bang” means that what you spend gets converted into an explicit economic return for the company or an implicit return through brand building, market expansion, whatever. So, that’s why I use the example of a Pharma CRO that is higher in TCO, but also way higher in revenue uplift and industry advantage. This is why we call Level 5 in our Value Evolution model “Value Management”. You can read more about it here: http://www.iaccm.com/contractingexcellence.php?storyid=678
Anyway, I wholeheartedly agree on the value of precision in semantics and that it’s something that needs improving if we’re to make improvements. It’s just like SPC - you need good measurement and visibility first - otherwise you’re just “tampering”. Thanks for the comment - it’s a great topic!
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