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Suppliers can make a significant contribution to any organization’s success, both strategically and operationally. For most companies, the single largest cost category is the total spend with suppliers. Inevitably, supply represents a fertile area for cost improvement efforts, and most organizations expect it to deliver significant cost savings and profit improvements. However, figuring out how to identify the best areas for supply savings — and then how to measure and report them — presents major challenges.
The Leading Question
As companies strive to wring savings from their supply chains, how should managers measure the savings?
- Identifying gaps can point managers to competitive opportunities.
- Understatement of supply savings lowers the status of supply and reinforces the search for low-yielding initiatives.
- Overstatement undermines morale and rewards employees and suppliers for poor performance.
Both understatement and overstatement of supply savings gaps signal the wrong reality, leading to an overemphasis on low-yielding cost-saving initiatives, misdirected corporate resources and rewarding employees for the wrong behavior. Perhaps even more frustrating for managers is that supply savings gaps conceal the strategic contribution suppliers can provide. Nevertheless, our research on the supply management practices at 30 large companies located in North America and Europe shows that effective measurement and reporting of savings on purchased goods and services is easier said than done.
Measurement and Reporting Challenges
The pursuit of savings is at the core of every supply professional’s job and requires significant time and resources. At the start of any supply initiative, managers need to make a judgment call to identify the benefits they hope to achieve. Subsequently, they have to be prepared to evaluate the actual results versus the estimates and report accordingly. We have identified six major factors that prevent organizations from accurately measuring and capturing supply savings
1. Systems that don’t account for savings. Accounting does not generally get involved in auditing for supply savings. An organization’s own rules defining what does and does not qualify as a savings can be a major obstacle. Inappropriate rules drive inappropriate behavior. For example, at one company in our study, organizational pressure to meet the minimum annual savings target was so strong that buyers routinely banked savings opportunities to ensure their continued employment. The minimum was reached annually, but the maximum was never pursued.
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1. The price for West Texas intermediate crude oil declined from $145.29 per barrel on July 3, 2008 to $31.41 per barrel on December 22, 2008. On November 4, 2009, the price stood at $80.18 per barrel. “Spot Price Graph for West Texas Intermediate Crude Oil,” Bloomberg November 4, 2009.
2. “Spot Price Graph for Hot Rolled Steel Coils,” Bloomberg November 4, 2009.
3. For example, after the CEO at one company decided to use return on net assets as a new measure of supply performance, the supply organization was successful in moving hundreds of millions of dollars of inventory off its balance sheet by negotiating consignment inventory agreements with major suppliers. In freeing up cash, the company was able to reduce its high debt load and stave off bankruptcy.