Battle inflation, risk, & uncertainty without compromising vendor relationships.
Finding ways to reduce costs and grow company savings remains a top priority for procurement leaders. As we are nearing 2024, the current challenges hitting them are clearly sticking around for the ride. These leaders will continue to fight inflation, supply and transport challenges, labor shortages, and a whole host of other uncertainties.
Ever-planning ahead and operating strategically, procurement teams hold the greatest potential to unlock massive procurement cost savings and optimize operational workflows for maximum profitability.
But how does procurement demonstrate the total scope of the savings they lockdown?
Especially when the procurement-finance relationship is often complex and procurement-driven savings can be difficult to see beyond the balance sheet. Each team interprets savings in different ways, and the procurement can often feel undervalued in their contributions.
That's why we're shedding light on the different kinds of procurement cost savings businesses can leverage for a successful 2024, and beyond.
Let's explore the many ways procurement teams unlock cost savings and how to build more understanding as they are reported to your finance counterparts.
Cost Reduction vs. Cost Avoidance
In financial terms, savings are measured through bottom-line reductions, and are often referred to as “hard savings.” But this definition rules out a whole category of business-critical cost avoidance initiatives that may not be directly visible in the profit and loss (P&L) account, yet hold great future value.
Achieving cost avoidance savings depends on the level of stakeholder engagement in contract compliance.
Cost savings come in many forms. In the procurement process, the top determinants include cost reduction and cost avoidance. These are not to be confused with cost cutting, a last-resort strategy that infers instability as companies look to cut costs when they're forced to undergo changes in order to save money.
Instead, cost reduction and avoidance initiatives are voluntary processes aimed at proactively enhancing productivity and profitability.
Cost reduction is realized through gained efficiency within the tangible current costs of doing business. This procurement KPI defines the reduction from a previous period's spend that immediately impacts the balance sheet (EBITDA). It involves adopting cost reduction strategies that enhance the organization's bottom line and profit margin, the ability to invest into other areas, and ultimately support future growth.
Cost savings coming from cost reduction strategies in procurement, are called “hard savings.”
Cost avoidance involves actions that avoid incurred costs in the future. In business, cost avoidance is an action that lowers potential increased expenses, thus decreasing a company's future costs. This procurement KPI is the difference between a lowered cost and the cost that would otherwise have been realized if the cost avoidance actions had not occurred. It supports the procurement process to work proactively, instead of reactively.
Cost-avoidance-driven initiatives are called “soft savings” because they don't show up on the balance sheet or impact EBITDA, therefore, they're often overlooked by finance leaders.
The relationship between finance and procurement can be one of the most powerful alliances in an organization. Establishing a common language around the full scope of cost savings is a crucial step towards establishing trust and aligning on goals.
So, let's now dive into cost reduction opportunities as part of the cost saving strategies in procurement.
Cost Reduction Strategies
The first step to a successful cost reduction strategy in the procurement process is cutting current unnecessary expenses to boost the bottom line and profit margin. Doing so is heavily dependent upon having the insight to identify opportunities in the first place, especially visibility into:
- Maverick spend
- Vendor performance
- Project progress
- Category level insights
- Risk management
There is a bigger picture aspect to effective cost reduction that requires focusing beyond today's problem and creating cost reduction strategies for lasting impact. Achieving the max value from external resources is a vital KPI to realizing larger organizational goals over time.
The following cost reduction strategies provide a direct and traceable path to measuring and achieving cost reduction throughout the procurement process:
1. End Value Leakage
Procurement teams put incredible time and effort into securing strong contracts that maximize value. But, how beneficial is a contract if it's not being enforced? If we can't see and measure compliance, we certainly can't correct it.
Lack of visibility and metrics likely means value is leaking through lost volume discounts, gaps between completion and invoice closeout that restrict access to working capital, compromised safety, lack of preventative maintenance, and contract term discrepancies.
Manual stare and compare tracking within vendor billing and contract compliance opens the door to costly errors. Furthermore, it's an ineffective use of human time, energy, and brain power.
To reduce procurement costs and avoid value leakage from contracts, organizations are rapidly adopting robust Vendor Relationship solutions, among other measures that help procurement leaders solve countless contract-related uncertainties, including these common concerns:
- How can we be sure the promised percentage of workers work on each specific WO, PO, or project at any given time?
- Have we got the right ratio of expertise across our projects?
- Are we paying each trade class the right rate?
- Are we overpaying for too many overqualified personnel or over-policing in areas where less seniority is needed?
- Is everyone starting and leaving work on time, and being compensated fairly?
- Are the project owners aware of holdback requirements to ensure work is completed at an acceptable level of quality?
Dropping manual methods for advanced solutions that auto-monitor contract compliance allows for instant flagging when the above instances occur. This way, they're corrected early, and procurement and finance professionals are both confident reporting is accurate.
Associates are then empowered to pay the correct amount sooner, and save countless hours of manual monitoring time.
2. End Cost Leakage
Outdated procurement systems and manual processes lead to cost leakage through over-billing. This is especially true when, as opposed to products purchased from catalogs, procurement is working with service providers that give an estimate for a future event. Vendors sending crews on-site present unique financial, safety, and compliance risks.
Unfortunately, using spreadsheets or relying on a small army of approvers to seek acceptable levels of compliance systematically creates errors that escalate fast. Some of the most common offenders include:
It's not uncommon for a vendor to accidentally send the same invoice more than once, or resubmit if payment takes longer than expected. During crunch times, it's not a surprise these double submissions are often paid twice.
These errors cost incredible admin time–if they're even discovered–creating headaches when calling back and reconciling duplicate payments.
Routine worker late-arrivals, early-exits, or “ghosts” on-site, while the vendor bills for the entire day, get expensive fast. This can cost an organization millions of dollars each year.
Living Out Allowance (LOA) billing
Not monitoring contractual obligations around LOA expenses costs more than is often realized. LOA errors most commonly seen include incorrectly applied LOA, such as for local workers; based on the wrong work classification, union, or contract agreement; or, LOA entered by the wrong unit–say hour versus day.
These seemingly small errors add up fast as they accumulate across workers and project days.
Workers who swipe out late are often mistakenly paid expensive overtime hourly rates. Across the vendor workforce, overtime rates, and project duration, this easily adds up to millions in annual spend. Also, it puts fatigue management, and ultimately safety, in jeopardy.
When vendors default to minimum billable increments–per quarter or half hour–billing rounds up in the worker's favor. Even staying one minute late could mean each worker is paid for an extra half hour each day.
Marked up billing
To keep their own businesses viable, vendors must strike a balance between bidding their best offer and covering their own overhead–trucks, tools, equipment, fuel, and admin costs–to retain a net profit at job completion.
But, there must be a way to measure and prove markups are fair on both sides to prevent vendors from taking liberties with markups.
The problem in all of these cost leakage occurrences is a lack of visibility to even identify them in the first place, never mind correct them.
High-performing procurement leaders are turning to advanced solutions that provide real-time insight into spend and performance while automated intelligence flags discrepancies so vendors can correct them without awkward human intervention.
3. Prevent Maverick Spending
Maverick spending involves unauthorized purchases that occur outside agreed-upon contracts; also known as neglecting proper procurement process. It often points to poor initial communication around decentralized procure-to-pay (P2P) processes or other gaps creating workplace cultures that foster unethical behavior.
At best, maverick spend is a one-off accident causing minor leakage and reducing the value you're receiving from your contract. At worst, it's an indication of uncontrolled, even rebellious, vendor spend behavior.
Make no mistake, maverick spend could be costing you millions annually. Experts estimate maverick spend can account for as high as 80% of vendor spend.
To eliminate it - or at least mitigate its risk - it's essential to have complete visibility into vendor spend, as well as to establish diligent process observance. After all, you cannot manage what you can't see or measure.
Get on top of maverick spending today with the following tips that all point to clarity as the solution:
- Establish effective onboarding processes that set a clear tone of responsibility and accountability as the foundation of your vendor partnerships.
- Communicate, communicate, communicate. Leverage company-wide events to present any updates in the procurement process.
- Embrace advanced technologies that give all employees a clear, accessible list of approved vendors. It should include their capabilities and historical performance metrics so you can impart the essential control measures.
4. Negotiate Collaboratively
Collaborative negotiation–a cooperative, mutually beneficial, and interest-aligned approach–places real value within the relationship, striving for fair and equal agreement when all is said and done.
The key principles to collaborative negotiation are transparency and trust. While it may not be possible or necessary to give away all of your information, there's little tolerance for deceptive practices in collaborative negotiation.
This is why automatically collected, and centrally stored data provides a better understanding of both sides' situations as well as sows a fertile ground for constructive conversations.
Here is a simple outline of the key steps to leveraging data for stronger negotiation strategies that achieve more collaboration and win-win results:
- Step 1: Get a single source of truth on vendor performance
- Step 2: Highlight areas for improvement
- Step 3: Rank vendors in order of competitive value and potential
- Step 4: Be transparent with your data. This isn't poker
- Step 5: Compare data year-over-year for continuous improvement
When both parties have the same visibility into performance data, it enables transparent and collaborative discussions on cost savings for a truly better way forward.
Now, let's explore cost avoidance as part of the cost saving strategies in procurement.
Cost Avoidance Strategies
Effective cost avoidance supports the bottom line by preventing future costs.
Often referred to as intangible cost savings since they don't hit the balance sheet, cost avoidance strategies still positively impact business profitability while protecting important relationships.
Procurement professionals achieve more valuable cost avoidance when they're empowered with better visibility for insight-driven preventative initiatives, including the following examples:
- Reducing a proposed vendor price increase
- Optimizing preventive equipment maintenance schedules to avoid downtime
- Having a roster of high-performing and loyal vendors to draw from
- Monitoring contract compliance to avoid worker fatigue and protect safety
- Identifying potential disputes at the early stage before they escalate out of control
There is a bigger picture aspect to effective cost avoidance that requires focusing beyond today's problem, creating strategies for lasting impact, and realizing larger organizational goals over time.
The following strategies provide key opportunities for procurement teams to drive organizational cost savings through cost avoidance:
5. Revisit Contract Terms
The vendor contracts secured by procurement professionals establish the foundation of the business partnership, outlining all terms and conditions in black and white to protect both sides.
However, the vendor contract is rarely a one-and-done because terms must keep up with constantly shifting economics, changes in operational costs, and other changing conditions.
Access to accurate data for regular assessment of both the inner workings of the business and the larger market environment is the effective route to cost savings for the future. Easy access to clean, detailed, real-time data supports you to confirm the following:
- Has pricing become uncompetitive and outdated?
- What's changing in the economic environment that should be accounted for?
- Can you apply market research and benchmarking to negotiate fair pricing?
- Where are there key opportunities based on past performance to highlight renegotiation opportunities?
6. Track Vendor Performance
One of the top risks when it comes to depending on an external workforce is the potential lack of control over daily performance, operational costs and issues, as well as any out-of-norm spend.
If there's no way to effectively monitor, track, and measure vendor performance, the risk of losing control is extremely high.
Conversely, advanced technologies can return control, helping leaders to retain accountable, reliable, high-quality vendors. Turning manual monitoring and flagging of discrepancies over to an automated solution minimizes the reliance on human intervention. Disputes are diminished, costs are reduced, internal-external communication is enhanced, and valuable time is returned to all.
7. Improve Risk Management
Vendor and employee satisfaction is a key strategic asset, especially as labor shortage impacts all industries across the globe. Risk management strategies that ensure proper management controls and mitigation plans are in place are central to avoiding the danger of depending on limited suppliers for essential items or services.
Smart procurement leaders are working to adopt collaborative approaches to risk management that allow for positive discussions and results that benefit all parties.
The first step to establishing that collaborative foundation is a well-designed contract. As projects progress, automated monitoring of contract compliance and vendor activity will ensure discrepancies and non-compliance are flagged instantly. This way, vendors can take corrective action early, or project managers can intervene before smaller issues escalate into larger problems.
This transformation fosters a culture of trust and accountability where ethical vendors and their workers feel safe, secure, and satisfied.
8. Automate the Incurred-to-Pay (I-2-P) Process
As competition for quality vendors continues to increase, paying them on time, and correctly, for their services is critical. Unfortunately, manual paper-based incurred-to-pay processes can take a month or more and are prone to error.
Meanwhile, digitizing and automating the process cuts payment down to mere days and ensures it's the right amount.
When payments don't happen efficiently, frustration grows quickly; late or erroneous payments put vendor relationships in harm's way.
If you haven't already automated your I-2-P process, here's why you should:
- Added visibility into project progress, vendor performance, and payment process equips procurement and other leaders with the insight needed to make informed, time-sensitive decisions
- Automating the payment process creates more efficient use of administrative resources and allows for efficient workflow
- Having a single source of truth removes the need for additional documentation beyond what's held in the centralized system
- Real-time performance monitoring avoids expensive emergency actions
- Automated collection and interpretation of specific data sets available in dynamic views make way for a practical application for constant process improvement
9. End Cost Overruns
For too long, project managers have accepted that are part and parcel of doing business. In this increasingly competitive and transparent world, it's no longer a sustainable way to operate.
Cost overruns are an open invitation to time-consuming, frustrating audits. All those eyes on vendor submissions, internal processes, and compliance tend to result in a failed audit that impacts the organization both internally and externally.
Failed audits expose internal teams to time-stealing, tedious work. They also unveil any vulnerabilities in people and processes.
A failed audit means erroneous vendor payments are called back, creating tension and disputes that compromise these important relationships. In many cases, public trust and reputations may be harmed.
In avoiding a cost overrun, real-time visibility into project spend and vendor performance allows for early intervention, correction, or at least mitigation that lessens the impact of a potential cost overrun. Automated solutions empower internal teams to end cost overruns altogether as people continuously improve by leveraging these technologies.
10. Retain your Best People
Securing the best talent in vendors, workers, and employees is now a survival requirement, particularly given the global labor shortage. As more organizations depend on external workers for on-demand service, it becomes more difficult to attract them at those critical times they're needed.
When able to work more proactively than reactively, procurement professionals can help retain the best people in the following ways:
- Understand performance at the vendor and worker level to identify potential and areas for improvement
- Up-skill workers with training that supports them to make better decisions
- Familiarize people with technology so they're confident and get max value from it
- Remove administrative burden by automating repetitive manual tasks
- Align everyone in terms of vision, direction, objectives, and values.
- Foster a culture of trust, transparency, and collaboration
It's people that are a company's best resource and external workers hold massive potential to achieve cost avoidance savings. Cost savings procurement strategies aimed at retaining good people today are critical to maintaining a future-proof operation.
Focusing Solely on Cost Savings is Dangerous
Procurement strategy is about so much more than procurement cost savings. Measuring these professionals on that single basis is an outdated mentality that can negatively impact their potential.
Procurement leaders have a direct hand in, and deserve to be recognized for, value-add activities, such as:
- Improving ESG performance and metrics
- Driving revenue by discovering the best partners and technologies while leading strategic transformation projects
- Creating supply chain resilience
- Strengthening mission-critical vendor relationships
In this sweeping mission to drive industries forward, effective procurement leaders are finding ways to use their cost savings KPIs for constant improvement that–on top of securing cost savings–protects production quantity and quality, operational efficiency, and safety, all while supporting their people through change.
Crush Your 2024 Cost Savings KPIs
The margin for error within cost and value leakage is shrinking fast in an increasingly uncertain and competitive environment. Procurement teams have their hands full in the pursuit of securing cost savings. But they're also working to set the foundation for mutually beneficial relationships that stand the test of time.
We have an incredible respect for these professionals and the daily effort it takes to lead an organization into a more sustainable and profitable future.
PayShepherd was born out of a boots-on-the-ground understanding of the downfalls of manual vendor monitoring. We know how much time and money it wastes, and it's our strong desire to help people reimagine a better way forward.
How can we transform your vendor management to unlock huge cost savings without compromising relationships?