Here’s how you can show value.
A client of ours, who is a VP of Supply Chain Management, jokingly refers to the historic challenge that supply chain dollars are often viewed as being very different than REAL dollars. In a sentence, he captured one of the most fundamental challenges facing the procurement and supply chain profession. Just in case you’re not sure what I’m talking about here, take a look at the questions listed on page 4. Have you ever been asked some, or all, of these questions? If you’re typical of most supply-chain managers, these questions are very familiar.
• “Are these savings real?” • “Are these numbers net of inflation?” • “What are these compared against? What is the baseline?” • “Where are the savings? I can’t find them on my bottom line.” When I first moved from a CFO career track to heading up procurement and transportation at Bethlehem Steel (back in the mid-90s), I became acutely aware of the issue of showing hard value for our efforts. My new boss was the president and COO. In our first meeting after became head of procurement, he told me the following: “Your predecessor (who had just retired) kept telling me that procurement saves this company millions of dollars every year. I never could find those dollars on the income statement.” That simple statement caused us to focus heavily on creating a methodology and tracking system that met key design criteria—from the perspective of our internal clients. This is a subject that directly influences your credibility—so join us as we go through a short but important journey. Perhaps the single most important distinction you need to make is to separate cost reduction from cost avoidance. Why do I say that? It’s simple. Cost reduction in operating expenses can, generally, be tracked to changes in operating costs on the income statement. Cost avoidance doesn’t have the same ability. So, if you try to add cost avoidance to cost reduction, and then report your total “savings,” you’ve just created an apples and oranges amount that has absolutely no relevance to the P & L statement that your internal clients look at on a monthly basis. That’s not to say that you should not track cost avoidance. We work with clients to develop a robust tracking system that tracks operating cost reductions, capital cost reductions, and cost avoidance. Just never add them together, or you will lose P&L relevance. The importance of relevance to the P&L Statement cannot be overstated. If you report procurement results that can’t be found on the Income Statement, your credibility will suffer greatly. In fact, as a CPO, I literally banned the word “savings” from our practice. Either a result was cost reduction, or it was cost avoidance. But never was it labeled by the vague term “savings.” Investment recovery professionals should heed this advice: To have the best chance of credibility with your internal clients and senior management, you need to build a framework and tracking system that is P&L relevant—and that means tracking and reporting only cost reduction from operating costs. This framework was developed from the standpoint of supply chain operations and is one of the foundations for a credible approach to reporting the results from the efforts of your teams. One of the important design choices in building a credible cost reduction tracking system is what should we measure our cost reductions against. There are some basic choices:
• Costs of a baseline year (e.g., the year just before your efforts began) • Prior year costs (so-called “year-over-year reporting”) • Business plan (budget) for the current year • Market In the most advanced organizations, capabilities exist to do all of the above. What’s right for you will depend mainly on your company’s financial office and your internal clients. Another very useful technique is to track progress on individual projects from the initial “identified opportunity” through “on the table” (initial offers), to “final negotiated” results, to “realized benefits.” Best Practice. A simple and powerful best practice is to obtain stakeholder sign-off regarding the sourcing strategy as well as the methodology for calculating results. If you’ve kept your stakeholders informed and involved throughout your sourcing process, this should be a relatively simple task. The specific practice that we share with clients involves summarizing all key information on one page. As a result, your internal clients / stakeholders can quickly see and understand such things as: • Sourcing category • Baseline annual spend • Team leader • Team members • Sourcing strategy • Selected supplier(s) • Inception date and term of new contract • Key provisions • Estimated cost reduction by business division • Other quantifiable and nonquantifiable benefits • Method of calculating benefits, with an example • Investments needed (if any) • Team leader signature, and sign-off block for the stakeholders These elements can be built into a onepage format that serves as a template for all of your sourcing teams. Straight to the Bottom Line®. Very importantly, once you have the sign-off in hand, it can serve as a reminder to make budget adjustments to preserve the negotiated results—and ensure that they make it “straight to the bottom line®.” All too often, after a long and productive sourcing initiative, the team celebrates success when the new contract is finalized. The best efforts don’t end there. They continue with a welldeveloped implementation plan. And that plan includes—among a long list of actions— involving the finance and accounting folks in ensuring that negotiated benefits make it to the bottom line. Without a proactive approach on budget adjustments, this is what typically happens: The new contract creates favorable variances at the cost center level, and the individual cost center manager has the freedom to spend that favorable variance on other things. As a result, no one can “find” the benefits from the new contract on the bottom line. This is especially true with indirect materials and services. When I present at conferences and ISM dinner meetings, I sometimes ask whether companies regularly adjust budgets for new contracts. Most do not. If your company is in that category, you can improve your value-add, and your credibility, by starting now. Involve your finance and accounting partners—they have as much at stake as you do. 5 ASSET 2.0 Vol. 5: 2012 Robert A. Rudzki is a former Fortune 500 Senior Vice President and Chief Procurement Officer, who is now President of Greybeard Advisors LLC, a leading provider of advisory services for procurement transformation, strategic sourcing, and supply chain management. He can be reached via the company’s website: www.GreybeardAdvisors.com. “Straight to the Bottom Line®” is a registered trademark of Greybeard Advisors LLC.