The Ultimate Guide to the Perfect Time and Materials Contract
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Finding savings remains top priority for procurement leaders. As we enter 2023, 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 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 procurement can often feel undervalued in their contributions.
That’s why we’re shedding light into the different kinds of cost savings businesses can leverage for a successful 2023, 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.
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 procurement, 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.
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 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 initiatives 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 procurement 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 strategies.
The first step to cost reduction at the procurement level 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:
There is a bigger picture aspect to effective cost reduction that requires focusing beyond today’s problem and creating strategies for lasting impact. Achieving the max value from external resources is a vital KPI to realizing larger organizational goals over time.
The following strategies provide a direct and traceable path to measuring and achieving cost reduction throughout the procurement process:
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 avoid value leakage from contracts, organizations are rapidly adopting robust Vendor Relationship solutions, among other measures that help procurement leaders to solve for countless contract-related uncertainties, including these common concerns:
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.
Outdated 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 provide 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:
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.
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:
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 better understanding around both sides’ situation 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:
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 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:
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:
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 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:
One of the top risks in depending on an external workforce is the potential lack of control over daily performance, operational issues, and 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.
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.
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:
For too long, project managers have accepted that cost overruns 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.
Internal consequences. Failed audits expose internal teams to time-stealing, tedious work. They also unveil any vulnerabilities in people and processes.
External consequences. 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 allow 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.
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:
It’s people that are a company’s best resource and external workers hold massive potential to achieve cost avoidance savings. Strategies aimed at retaining good people today are critical to maintaining a future-proof operation.
Procurement strategy is about so much more than 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:
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.
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 around 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?
Find out today. Let’s talk.