Ways to Look Beyond Hard Cost Savings
When asked what their procurement goals are, most business executives will say they want to reduce the cost of goods and services.
When asked what their procurement goals are, most business executives will say they want to reduce the cost of goods and services. In other words, hard dollar cost savings. Executives will establish aggressive savings goals but will not necessarily have a clear direction on how those goals can be achieved. Meanwhile, focusing on hard dollar cost savings can actually have a negative impact on the bottom line in the long run, if they are executed without an understanding of soft dollar savings.
Hard dollar cost savings are easy to quantify. Here is a simple example: 100 widgets typically cost you $2 each, but your procurement department negotiated the price down to $1 each. By going from $2,000 for the widgets to $1,000, you were able to achieve a 50% savings. A soft cost saving, such as a reduction in lead-time, is harder to tie directly to a dollar amount.
Hard dollar cost savings allow upper management to track the impact of the savings on the bottom line. They also allow the procurement department to measure their ROI. However, problems can arise when hard dollar cost savings are the sole concern of procurement and soft dollar cost savings are ignored. Without taking soft dollar cost savings into consideration, the organization will not be able to ensure continuous improvement in procurement. No matter how efficient the procurement team is, it cannot achieve 5% savings year-after-year.
The potential for soft dollar savings should prompt procurement to look at things like the cost to process an invoice or execute a contract or the implication of extended payment terms. There are costs and value associated with these things and others like them.
Ask yourself this: what if the best price you can negotiate for an item is the exact same price as the one your competitor is paying? Where will your competitive advantage come from? It can be in areas like inventory control and being a priority customer so that when you need a product, you get it before others who also may need it.
When setting goals for your procurement department, make sure to consider things like process improvement, relationship building, supplier innovation and other factors that may not have a direct impact on the bottom line, but will still add value. In addition, reward procurement for achieving success in those soft areas just as you would for any hard dollar cost savings they are able to achieve.
When you do that, you will become best in class.