Memo To CFOs: You Have A Procurement Problem

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Procurement departments are incentivized to ride an unproductive and P&L-damaging roller coaster. There’s a better way.

The management goal with every expense should be simple—find the optimal cost level and stay there. Something like this:

Negotiate a favorable deal, get what you signed up for, limit internal resources required to manage, and make incremental improvements over time.

Unfortunately, with complex indirect services, the typical output from your procurement department looks much more like the graph below. We’ve dubbed this the “nuisance expense” (or indirect services) roller coaster:

The unproductive routine goes like this: negotiate a new contract every few years, project year one savings that rarely materialize, collect bonuses based on those flawed projections, turn your attention to other projects as costs rise in ensuing years, and do it all over again every 3-5 years.

The dirty secret is that procurement departments are incentivized to “ride” this unproductive and P&L-damaging roller coaster. In fact, it is actually “bad” for procurement if they eliminate “low hanging fruit” by delivering real, lasting P&L impact. When costs rise between reportable “savings initiatives,” it makes the next initiative possible.

We see it time and again: year one projected savings is all that matters—as if the ensuing years of contractual obligations are meaningless. Savings goals or targets cause departments to stop pursuing additional savings if targets are met or they stagger savings over time instead of immediately getting to rock bottom.

How did we get here? There are a host of reasons starting with the simple fact that true world-class expense management is hard and only getting harder:

  • Let’s start with those flawed incentives. We have spoken about this extensively in a three-part series Procurement Incentive Plan Flaws: Part 1, Part 2, and Part 3.
  • The threat of lost business has been diminishing over time with fewer marketplace options and fewer internal resources to take on supplier transitions. As a result, there has been a gradual shift of power in the marketplace as many industries have consolidated and vendors have begun to deploy increasingly anti-competitive behaviors. Furthermore, as suppliers have been emboldened by the success of these strategies, we have seen less and less adherence to contractual obligations.
  • As you move to larger and larger organizations, even if you have good expense data, it is increasingly hard to coordinate multiple departments involved in expense management—we call this organizational disconnect. As the expenses get more complex, more departments are involved (procurement, operations, accounting, finance, quality, HR, sustainability, security, legal, etc.) and major coordination problems can get in the way of cost containment.
  • Furthermore, departmental turnover creates its own challenges to long-term success in various expense categories—see: The Revolving Door of Corporate Procurement.

So what can today’s bottom line-focused CFO do? Well, obviously, there are many challenges a company must successfully navigate to achieve best-in-class expense management—especially in complex expense categories.

Though this is clearly a complicated problem, I’ll leave you with a few high-level thoughts to get started on a path toward better expense management:

  1. Align procurement with actual P&L savings instead of single-year projected savings.
  2. To properly execute the overall goal in #1, you must get better measurement tools in place. You are in the dark ages if you don’t have sophisticated spend data. It is hard to track true baseline/normalized spend for all of your important expense categories, but not impossible—there are tools and services in the marketplace that can assist with this.
  3. Track true normalized savings for the life of contracts. With the better data from #2 and the right expert knowledge, this is possible.
  4. Consider a middle ground with payment terms. There are many unforeseen costs and problems with extended payment terms, including strained resources on both sides and diminished value of your business to your vendor.

Reorienting your procurement department to better align with the company’s bottom line won’t be an overnight fix, but the rewards for escaping the unproductive roller coaster will be significant and lasting. Furthermore, it will allow for incremental gains over time as lasting solutions become more prevalent instead of procurement “managing” the same issues over and over again.

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