PROACTIS Blog

Boardroom Chatter: Cost Reduction (Part 4 - Purchase Authorisation)

Charlotte Sutton
Charlotte Sutton,
PROACTIS
Following another Board meeting where ‘how do we reduce costs?’ was discussed for the umpteenth time… the CEO, CFO & CPO of a large corporation stop for a few moments to discuss the specific subject brought up at the end of the meeting – how to better control what is being spent on purchased goods and services across the organisation.
“Even though we have written policies for pre-authorisation of purchases, we all know people skirt those left and right,” says the CEO.  Turning to the CFO and CPO, he asks: “What do you think that’s actually costing us?”  
 
The CFO answers immediately: “It’s hard to know the exact amount, but we can easily do a quick estimate.”  Thinking out loud…
  • $100m is our rough annual non-payroll spend
  • 75% of that is ‘discretionary’, meaning above and beyond things like utilities and so forth
  • 10% of that amount could surely be avoided if managers always had the opportunity to approve or not based on how necessary the purchase really is, whether or not that item is already available somewhere in the company, their current standing against budget, etc.
“That’s $7.5 million a year,” she states with a frown on her face.
 
“But that’s just part of the story,” picks up the CPO. “Much of that money is spent with suppliers with whom we do not have price agreements. So the discounts we’ve negotiated are completely wasted.  I can take a swag at what that amounts to…”
  • $75,000,000 in addressable spend (“just using Mary’s number, but I’m sure it’s close”)
  • A good 20% of that is unnecessarily spent ‘off contract’, meaning spent with sources other than ones where we have supplier agreements in place for the type of item purchased
  • 10 – 15% more (let’s say 12%) is my conservative estimate of how much addressable spend we could negotiate spot agreements on if certain types of requests were routed to us to get competitive bids 
  • 17% average savings opportunity lost on all those off-contract and non-bid purchases – that’s our typical savings when we negotiate agreements
“Making a quick mental calculation, that’s another $4+ million in savings.”  
 
“So let’s see…” The CEO adds it up: 
  • Over $7 million per year savings by avoiding unnecessary purchases, plus 
  • Over $4 million per year savings from increased buying against negotiated supplier agreements
“… that equals over $11 million a year in total savings.”
 
“We could add over $11 million straight to our BOTTOM LINE – we’d need to increase sales by $55 – 75 million to get that same impact.” says the CEO quietly.  He then adds with a little grin: “But clearly we CAN get those savings by just gaining better control of how we go about buying things. (pause) I think this is well worth pursuing.”  
 
Needless to say, the team proceeds to ask around about why so much is being purchased ‘outside the system’. What they find is a little startling, but in retrospect, pretty predictable:
 
From employees:
  • “The requisition process just takes too long – the business moves much faster than the paper. Even with e-mail, managers are often out so requests just sit.”
  • “I don’t even know what the proper procedure is…”
  • “If I actually waited to get official approval before I took action, I’d probably lose my job.”
  • “Who knows what suppliers we have discounts with – I can’t keep up with memos and e-mails saying I should by from this supplier or that.  Those e-mails never show up exactly the day I need to buy something.”  
From managers:
  • “Requests come at me willy-nilly – it’s very hard to focus on making a good decision sometimes.”
  • “I can’t get a handle on my current budget position because I don’t know what purchases have been made. We are frequently over-budget.”
  • “People tell me all the time that they’ve found a better deal than what the procurement people have – I just don’t know and don’t have time to run that down.  I just say OK when I think that person is at least trying to be cost-conscious.”
“This seems like a problem we can actually do something about,” says the CEO when the executive team re-convenes.  “Let’s outline what we would need to do to get 90+% of purchases going through the right process.”  As usual, it’s Mary who takes the marker and stands to record the team’s thoughts on a flip chart:
  • Remove paper from the equation - make the entire process electronic (Standardize the way all purchases are made, eliminate communication lag time and capture a history of all activity)
  • Build authorization policies and the approval hierarchy into the system so people don’t need to know the details – the right process is always followed by default
  • Save everybody time by automatically approving purchases that are obviously OK based on specific criteria such as value, supplier, requestor, etc.  
  • Give managers full visibility of previous and in-process expenditures vs. budget in order to make better decisions; give them control over when they focus on purchase requests (e.g. end of each day); automatically route requests to the right stand-in when a manager is out
  • Make supplier agreements very visible to people at the time of purchase – make them impossible to miss
  • Give people the ability to shop and compare multiple sources from “within” the system; automatically route appropriate requests to procurement for competitive bid assistance
  • Make the system extremely easy to use; accessible anywhere (office, home, or on the road); and always available so it becomes the fastest, easiest way for everyone to get what they need 
“You know…” say the CFO and CPO almost simultaneously, “In addition to saving the $11 million we already identified, if we put that type of system in place, we have the framework to do lot of other good things as well.” Mary then lists on the board with everyone’s input:
  • Reduce the real cost of each PO by taking less of everyone’s time
  • Automate the invoice matching process in AP   
  • Perform more thorough spend analysis
  • Gain better visibility of the overall ‘cost pipeline’
  • And more!  
So… the CFO and CPO agree to jointly lead an effort to put such a situation in place as soon as possible.  The team leaves the CEO’s office happy for once, knowing this was something they could do in a matter of months that would have a noticeable impact on the bottom line.
 
 
 
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