“So, how much did that e-auction really save me?”
Quantifying savings after an e-auction is notoriously difficult. After all, a saving is an absence of spend; you won’t see a line in the P+L for savings. But savings are a key metric for buyers. So how to measure savings?
Steve Mallaband in CPO Agenda offers a useful approach, that can be applied in all sourcing projects, whether you are using an e-auction or not.
Think of the following scenario:
Current price: €100m
Facing a market price increase: €25m
Negotiate new price (based on forecast volume): -€31m
Actual new price: €94m
Is the saving €31m or €6m?
Mallaband argues forcefully that procurement, and the business, must distinguish between Annualised and Actual savings. Actual savings are the real € difference between what was spent last year and what was spent this year. In this case €100 – €94 = €6m. Annualised savings are a notional figure that takes into account market price increases. In this case the €31m. Mallaband argues that procurement must be measured by annualised savings rather than actual savings.
This means that it’s critical to build any price increases into the baseline against which you are measuring your annualised savings and to get buy-in from the business as to what baseline you are going to be measured against.
As Mallaband’s says: ‘The baseline is often not a “real” price but one obtained by adjusting the current price or by using the price bid by a supplier before further negotiation. This is why “procurement performance” does not give you real, touchable money. What it does give you is a good estimate of how well procurement is doing against the market.’
Using this approach, buyers will not find themselves talking about cost avoidance, since any market price increases will already have been built into the baseline before the supplier negotations begin.
Some more comments on annualised vs. actual savings in my next post.