Procurement Can Drive Value in an Inflationary Environment
As CPOs struggle to manage growing spend in the inflationary climate, cost avoidance may be the best metric to show their value, and CPO Live speaker Jane Thomson tells you how to make the shift
Inflation comes for all – from your favorite fast-food meal to fuel to labor. Costs for nearly all products and materials are rising faster than ever. Yet procurement is under pressure to deliver the same goods at the same prices or close as possible, even as the Producer Price Index continues to climb.
In this inflationary environment, it’s critical for procurement pros to help their organisations understand the value that procurement delivers to the organisation. During the 2008 economic turmoil, a new phrase emerged: Flat is the new up. That meant if you could keep revenues or costs flat, it was the equivalent of an improvement during more normal times. Take your wins when you can.
Flat is the new price cut?
At the Faculty’s 2022 CPO Forum, Jane Thomson from McKinsey & Company told participants that procurement leaders must mobilise their C-level colleagues and business partners to align expectations with the current environment. The organisation’s goal should be to protect margins by utilising a more comprehensive set of levers to address embedded costs. Without measuring these elements, it’s impossible to motivate the organisation to focus on the impact of inflation.
In the face of uncertainty, CPOs’ posture must move from a traditional procurement focus with a narrow role in enterprise value creation with responsibility for part of the cost of goods sold.
There’s an opportunity to expand the view of procurement as an agent of value creation as a critical lever to protect the enterprise’s margin.
Historically, procurement has been measured by expense reduction and cost control.
Cost avoidance was not a widely accepted metric for external consultancies (and some in-house procurement) because it’s possible to track the ROI. However, in this inflationary market, cost avoidance and cost reduction deliver tangible value and can be recognised by the organisation.
Procurement is about more than direct financial benefit through cost management. Procurement delivers value creation. Today, cost avoidance delivers value through collaboration and innovation with business partners. Stakeholder partners appreciate a procurement organisation that helps them innovate and compete.
If procurement can deliver a flat rate instead of an inflationary bump, it’s a big win. Flat is the new down. However, financial colleagues may see things differently. Cost avoidance isn’t necessarily a cost savings. It’s hard to track money that wasn’t spent. There’s not a direct P&L benefit from the finance viewpoint. But in the current climate, procurement teams can protect the P&L by mitigating cost impacts.
Given the current financial challenges—inflation, exchange and interest fluctuations, fuel costs—CPOs should make cost avoidance a more relatable metric for CFOs.
Cost avoidance has huge value. Particularly if you are working in an environment with significant change or transformation spending that isn’t in a traditional annual operating expense budget (e.g., financial services), the heavy technology and professional services spend means that not counting cost avoidance would result in a significant underplay of the value from procurement.
Cost avoidance is clearly different from “hard” savings but is still an added value brought by procurement to an organisation. This added value from procurement has often been overlooked because it’s not seen as impacting the bottom line.
Executives know inflation is a reality right now and understand that expenses will be higher. C-level leaders are looking for procurement to beat the market and the competition. Reducing spend relative to the competition gives your organisation a marketplace advantage.
Procurement leaders should communicate when they deliver cost reductions from a baseline. Be sure to count inflation offsets/avoidance and demand-based initiatives to protect margin and budget. These efforts underpin risk management and mitigation.
One key revelation over the past two years is that procurement should not be measured by a single KPI function. Maintaining supply continuity, mitigating risk, and facilitating supplier collaboration are critical value-adding procurement activities.
Add cost avoidance to the benefits procurement to showcase the benefits of good procurement policy and processes and capture the full impact on total spend. In these times of rampant inflation, procurement leaders should be bolder in promoting this added value to their organisation.
Value creation framework for procurement
- Focus on a broad range of levers: everything is in play, including product innovation
- Set targets based on all categories, including cost avoidance
- Dive into supply chain market dynamics to ensure supplier availability
- Procurement coordinates value creation with multiple cross-functional teams
- “Nerve center” for market intelligence used to prioritise risks and interventions
One critical factor that Jane Thomson highlighted is considering the total cost of ownership/operation for products. During the semiconductor shortage, procurement can collaborate in reengineering products to use available, less expensive semiconductors.
Digital solutions offer unprecedented levels of analytical insights. Forecasting tools with automated category level input cost and a dashboard for risk exposure can inform responses to tactical escalation requests.
Tools such as spend intelligence, parametric clean sheets, and rapid category reprioritisation can help limit cost escalations compared to the overall market.
In a recent CPO Live event, procurement consultant Jimmy Anklesaria cautioned against accepting vendors’ across-the-board price hikes based on the overall inflation rate. Costs for goods and commodities don’t move in lockstep, so procurement pros must dig into the current cost profile for the most significant categories. Even though fuel costs are rising, in some cases, that represents only a small portion of the overall cost of a product. Don’t accept a 30% price increase because fuel has risen 30%, for example.
As economic volatility becomes the norm, procurement leaders have the opportunity to provide leadership for their function as well as the organisation as a whole. Traditional procurement processes lack the appropriate strategy for the times. It’s time to build new capabilities for risk management and internal collaboration, implement digital tools for advanced analytics, and update the operating model to incorporate the value of cost avoidance.