THE chief procurement officer/chief financial officer relationship has always been a strained one. In some circles, it’s almost iconic – like that of a mother-in-law and her new son-in-law. They both have the best interest of the business – or family – at heart, but historically, can’t always agree on what ‘best’ looks like. This, of course, causes problems.
The main issue stems from both parties’ inability to agree on performance measurement. There is no direct link between purchasing performance and financial performance. A CPO might claim to have saved 15% on £1bn of spend in a year, yet the CFO may record savings of only 7% – and they would, in their own way, both be correct. In procurement, contrary to finance, savings are not an absolute term. There are four different stages of savings, and they are all important – to procurement.
Let’s say an organisation paid a supplier £1m for ten thousand units of goods last year. That organisation puts out request for quotation and finds three alternative suppliers for the upcoming year, the cheapest of which can offer the units for £700,000. They enter into negotiations with those three suppliers and eventually agree on the supplier that offers a higher price: £800,000. A contract is signed. By the end of that year, the organisation only ends up ordering five thousand units from this supplier and thus spends a total of £400,000.
We can see the different stages of savings in this scenario. There are identified savings of £300,000 (the savings to the organisation if they chose the lowest bidder), there are then negotiated and contracted savings of £200,000 (the savings to the organisation based on the contracted volume/price), and then there are realised savings of £100,000 (the savings to the organisation based on the actual usage).
Identifying and then achieving substantial negotiated or contracted savings takes a great deal of time, effort and skill from the procurement team yet in that whole process the CFO cares only about the last bit – the realised savings that can be tracked and measured at a P&L level. This is the point where the disconnect lies.
John Paterson, CPO at IBM, once called the CPO-CFO relationship “the most important relationship that exists or needs to exist within the enterprise” yet, based on a recent survey of Xchanging Procurement customers, only 28% of CPOs viewed procurement and finance as partners and more than a tenth (12%) said there is no working relationship between the functions at all. How do we bridge the gap? How can organisations turn this ‘he said/she said’ relationship into a cohesive partnership that benefits the business?
The measurement of procurement performance needs to become strongly linked to the company financial goals by tracing savings that are generated by the procurement function directly back to the financial statement of the company, in order to more measure the true value of the procurement function and hold it accountable.
Using supplier invoices to measure savings is the most direct way to link purchasing’s performance to savings that CFOs will recognise. It’s essentially going from theoretical savings to real ones. This type of reporting requires a great deal of analytical work to both clearly define how savings are calculated and to extract those savings from the invoices. When done correctly, it establishes a savings amount on which both procurement and finance can agree. Negotiated and contracted savings are important, but if they are never realised then they don’t actually help the business. Realised savings, ultimately, are the only savings that matter.
Licence to spend
But I would also argue that the other key lever of driving value from procurement is access to spend, and CFOs need to broker relationships with key budget stakeholders and help CPOs and their teams gain this access. “Best in class” procurement operations can achieve performance levels that are at a minimum two-to-three times higher than an average organisation, and companies have been able to achieve a 5% to 20% saving for each new pound brought under spend management. This can result in millions, or even tens of millions, that can be either reinvested or dropped to the bottom line as realised savings impacting EPS, operating profit and working capital.
Ultimately, by creating a system that gives visibility to realised savings made by procurement, and by broadening the scope from which procurement can achieve savings, CPOs and CFOs begin to talk the same language and the historic gap between the two can be distinctly narrowed.
Olivier Chalon is sales & marketing director, continental Europe, Xchanging