Communication failures can be a key cause of challenges and conflicts found in business, as well as in social and political settings. One source of communication breakdowns can be as basic as the language and terminology used by participating parties. When these are not aligned, frustration builds and time is wasted. The following is a brief look at developing a common savings language for Procurement.
Capgemini consistently encourages Procurement organizations to communicate their value proposition and key successes to their internal business customers. This builds credibility and establishes trust with business partners. However, communicating these successes is not always straightforward. In our experience, we have seen a wide-variety of savings terms and definitions and disagreement about how to track and verify savings. To confront this problem head on, I have compiled a list of savings definitions for Procurement organizations to consider.
Savings Life-Cycle Definitions:
Projected Savings: Expressed as a dollar value or percentage, savings resulting from category analysis using spend analytics and opportunity assessment tools
Identified Savings: Expressed as a dollar value or percentage, savings resulting from a sourcing activity and/or negotiations
Captured Savings: Expressed as a dollar value or percentage, savings resulting from a sourcing activity and/or negotiations that are memorialized in an executed contract
Realized Savings: Expressed as a dollar value or percentage, savings that occur overtime, tracked through invoices and payments as actual against an executed contract
These savings definitions can be integrated into any sourcing process. Below is an illustration of the terminology applied to Capgemini Consulting’s sourcing methodology. The arrows indicate where a savings dollar($) number or percentage would be a likely output from the process.
Figure 1: Capgemini Consulting Sourcing Methodology
Financial Definitions: Related to the financial impact of savings
Cost Savings: Reduction in year over year (YoY) pricing or equivalent total cost of ownership for a specific good or service. This savings is directly traceable to the P&L
- Example: In 2012, widget A had a unit cost of $100. Following a competitive event, widget A now costs $90 for 2013. Per unit “Cost Savings” is $10
Cost Avoidance: Elimination of a proposed cost increase YoY or cost differences in bids for a one time project or unique service. This savings is NOT directly traceable to the P&L
Note: There are many possible scenarios for cost avoidance. I have listed two quick examples.
- Example 1: Company X is sourcing through an RFP a unique one-time project for which it receives 5 bids from various vendors. The bids range from $1M – $3M. The average is $1.8M. The “Cost Avoidance” is $0.8M, the difference between the average bid and the lowest bid or selected bid
- Example 2: An existing supplier has proposed a 5% increase to their current rates of $200/hr. Through negotiations, the increase is reduced to 2%. Initial proposal $210/hr. Post negotiation proposal $204/hr. “Cost Avoidance” of $6/hr
Savings terminology derives its value from its ability to create agreement and accountability among internal organizations. Procurement must secure the consent of both internal Finance and its business customers to define and consistently measure savings. Having definitions that only Procurement understands or agrees with does little to build credibility among peers.
For Procurement organizations embarking on a transformational journey or those well on their way, establishing a common language can provide a strong foundation of communication to support building and sustaining growth and maturity.