"Don’t insult yourself, or your CFO, by reporting on cost avoidance". Do you agree?
"Costs that have been avoided simply don't count". Tania Seary made this controversial comment in her latest article on KPIs - what do you think? I know a few CPOs who would strongly disagree..
Ah, cost avoidance....
I take Tom’s point, and yours Tania and I’ve also struggled to get Finance colleagues to accept Cost Avoidance savings. However, let us not forget that cost avoidance is by its very definition money that has not been spent because of procurement intervention. Had it not been for us busy little bees, the business would have incurred cost, which it has not had to do. This is a good thing – right? We should not be afraid to count that and report it and be proud of it (caveat: lets make those numbers realistic, and not as big as we can make them though!).
Perhaps it’s a semantics argument. Let’s not call it cost avoidance – how about ‘Profit Enhancement’ (linking avoided costs directly to year end profit figures) or Loss Limitation (if your business/division is not making profit this year for whatever reason). Or, how about directly linking avoided costs to reductions/increases in the organisations Sales targets?
I completely agree with the need to develop a variety of KPIs which will help us all show off our professions capabilities. One I would suggest, particularly for smaller, less mature/developed procurement teams is a percentage (95+%) of goods, services and supplier relationships to been mapped in terms of ‘Portfolio Analysis’ and ‘Supplier Preferencing’ matrices, with 100% of ‘strategic’ goods/services/suppliers to have detailed sourcing strategies.
I’d also like to see ‘the business’ engagement being measured. So a KPI on percentage of budget holders who have ‘meaningfully’ engaged with procurement to develop and challenge their budgets going forward.
As with any metric, cost avoidance can be manipulated for whatever purpose the provider of the metric is looking to use it for. It really comes down to what is important for the organization and how the metric expresses the value of the procurement organization. I seen examples where a supplier comes in with an outrageous bid and procurement "negotiates" down to something acceptable. The bottom line, though, is that the original bid would never have been acceptable in the first place. Do you call that cost avoidance (the delta between the bids) and does that situation really go to procurement's value?
Personally I think the headline is very insulting - especially to CFO's. Cost avoidance, when defined as real price decreases over time due to a good contract clause or good negotiation should be measured. If the real cost of the good/service is decreasing then that should be a good thing, shouldn't it.
Cost avoidance as the result of global commodity prices falling is just luck - who would have predicted the fall in the oil price? I remember my days at Rio Tinto (post GFC) the fall in the commodity prices was unbelievable; but cost avoidance was measured and reported. This sort of reporting does not reflect well on the procurement function.
I have not seen Tanya's comment so I do not know the context in which it was given.
Cost Avoidance merely shows the success of negotiation, or lack of.
Don't get me wrong, it is something that should be recorded, and reported, but IMPO it cannot be a KPI of the department as there are too many variables to enable benchmarking or validation of the monetary effect. It also opens a whole can of worms for the reverse, which are costs you should have avoided, or reductions you should have attained
Be careful what you wish for and all that!
(Reposted from the LinkedIn ISM Group:) Ted Linklater: Excellent article that is very much thought provoking . The value proposition is certainly a topic for many procurement "talent" professionals who are frustrated in trying to explain the true benefits of what they provide to an organization.
On one point I would strongly disagree. In my opinion we should absolutely promote our efforts on cost avoidance. For many of us it may take a great deal of effort and negotiation to reduce a 20% price increase from our supplier down to a 15% increase. So yes the price has still increased by 15% overall and yes I understand the CFO only sees a price increase of 15% and not a savings of 5% but if we don't promote the effort and savings that have actually occurred then "in the eyes" of the CFO we are failing one of the main KPI's that we are measured on.
In my opinion, Cost Avoidance is legitimate and involves focussing on reducing or eliminating costs that were previously charged and paid for on a regular basis. Looking at examples of reducing costs I have recently identified areas such as improving logistics rates or finding alternative lower-cost carriers. Eliminating storage and carrying costs by incoporating JIT deliveries is another cost avoidance benefit. Reducing the Approval Workflow is a cost avoidance by streamlining the workflow process and removing unnecessary involvement of people charging time to a project. Improving Payment Terms particulary on progress payments allows the client to preserve their capital for a longer period of time. Cost Avoidance can be seen as an anticipated ongoing cost that is either reduced or eliminarted. The benefits can be accrued over the term of the year.
I do agree that cost avoidance should be measured and reported on as long as it is within reason. Using an over inflated starting point as the base is a no-no, as is using a price point the business would never buy at. To switch the subject a bit what are your thoughts on "value creation" as a metric? This was very popular to report and track when I was in Global Brand Building Purchases at Procter & Gamble. It was essentially the additional value created in the deal vs the original tender.
Cost avoidance does count, as long as it's properly defined. There are examples above of savings due to commodity prices changing or an overinflated initial cost. To this I would add the TCO argument - buying something on the cheap now that has the potential to add to the cost in three years' time is not cost avoidance. My own favourite form of cost avoidance is when somebody asks me to get something and I ask them why they can't use the one sat next to their desk - but of course, that's the everyday sort of saving that seldom gets recorded!
I believe it absolutely counts. I also agree with Justin that it shouldn't count in situations where it basically equates to smoke and mirrors. But if Procurement is actively negotiating cost out of the equation where the organization was spending in the past without that involvement - I don't understand why that shouldn't count.
To play devil's advocate, I understand why some - especially higher on the food chain - can be prickly about the idea. It's basically saying, "We weren't doing this very well before" and that makes some folks uncomfortable and/or defensive.
Cost Avoidance can be a very "squirrelly" metric, but I agree with Alan Haynes that "Cost Avoidance, when defined as real price decreases over time due to a good contract clause or good negotiation should be measured". I believe that there is a role for Cost Avoidance, but there needs to be very clear definition and agreement with Finance as to what is a "legitimate" Cost Avoidance that can pass the "smell test" and be applied towards the Savings objective/KPI for Procurement.
Yes, I agree 100% and would take it further that not only doesn't cost avoidance count but it is even bad for a procurement team to try to use it as it waters down hard savings and makes it harder to be credible with the executive level. The bottom line is that the C-level only cares about what has P&L impact. You can tell great success stories about the other things - and should - but don't mix it up with the year over year savings.
We've had three "disagrees" so far - does anyone agree that cost avoidance doesn't count? Let us know your thoughts!