The challenge with buyer performance measurement and some pitfalls to avoid.

by

I recently read a good article made by Charles Dominick at Next Level Purchasing regarding some of the mistakes surrounded the area of buyer performance. It is a tricky area for sure and it is worthwhile repeating some of the commonly made mistakes and to reflect a bit over them.

Here they are:

Mistake #1 – Having Cost Savings Be The Lone Metric. One of the most important metrics a purchasing department can share with top management is cost savings. But just because it is one of the most important metrics doesn’t mean it should be the only metric.

If you only measure buyer performance on cost savings it could incent buyers to sacrifice quality, on-time delivery, and/or supplier service for lower prices. So a cost savings metric should be balanced by measuring these other aspects of purchasing performance to produce a clear assessment of the buyer’s impact on total cost and overall company performance.

Sure, most of us won’t disagree to this and it is important to have other metrics as well. However, savings is and will always be an important indicator of the buyer performance regardless if we like it or not. A more balanced approach is certainly desired and the target must be to switch the performance indicator to a market relative indicator i.e. to secure that the price level always is optimized from time to time. This may include to accept a price increase if market conditions are difficult.

Mistake #2 – Not Using Net Cost Savings As A Metric. When calculating cost savings, price increases should be deducted from price reductions to produce a “net” cost savings number. One reason for doing this is that top management expects reported cost savings to equal actual profit improvement.

But also consider buyer motivations. By counting only gross cost savings, buyers may be inclined to ignore opportunities to minimize price increases on large spend categories while focusing their time on less critical categories where price reductions are possible, resulting in an overall lower positive impact on profit.

Yes, this is very true and is exactly how savings are reported within automotive industry. Secondly, the total spend is measured in a similar way implying that no room for individual creativity is allowed, which I think is an important aspect. Thirdly, no snowball effect is allowed. Only the year when the saving is achieved, is reported. The latter was a specialty performed to perfection by Ignacio Lopez when reporting huge savings result to management.

Mistake #3 – Not Taking Markets Into Account When Setting Goals. When some purchasing managers set cost savings goals, they look to “last year’s numbers” or some other arbitrary figure to determine the targets for the next year. This can set buyers up for failure.

In the last few years, there has been cost volatility in many markets. If the purchasing department promises year-over-year price reductions in markets where prices are rapidly rising industry-wide, top management will likely be disappointed when actual performance is compared with those goals. So give consideration to market conditions when setting buyer goals.

That isn’t to say that price increases should be readily accepted just because that’s the direction of the market, but rather that goals should estimate how much an aggressive effort can offset market price increases.

This is exactly what I mean as being outlined in point no.1 above i.e. to set a market relative indicator. The moral is that only looking at archeology when setting your targets will lead you to wrong assumptions.

About these ads

Tags:

3 Responses to “The challenge with buyer performance measurement and some pitfalls to avoid.”

  1. procureinsights Says:

    Hello Christer:

    Here is an excerpt from an article I wrote earlier this year based on a reader question regarding performance/results measurement.

    Once you read the article your will most certainly realize why there is a tremendous shift in the way courses are now be structured to extend beyond the confines of traditional purchasing metrics.

    Member Question:

    I’m establishing my own suggested goals for a company performance-based bonus based on my work as the Procurement Manager for a manufacturing division; we’re running Epicor Vantage ERP software to manage the business.

    Houston, Texas

    My Answer:

    The following is an excerpt from an article I wrote on January 31, 2008 that should serve has a cautionary beacon to any purchasing professional contemplating the establishment of performance metrics.

    Bridging the Communications Gap Between Finance and Purchasing

    A May 4th, 2006 article titled How to Speak Like a CFO stressed that “Too often, finance executives in Corporate America simply don’t believe that purchasing departments are really bringing in the savings they claim. That may be because finance and purchasing don’t speak the same language.”

    For example, the finance department isn’t interested in cost avoidance. They are interested in hard cost savings. This is perhaps one of the main reasons why a recent study revealed that of the 11.9% of average identified savings presented by the purchasing department, only 3.2% actually gets booked by the finance department – a difference of 73% from identification to realization.

    Here are some additional findings from the Aberdeen study that may surprise you:

    – Less than 20% of CFOs consider the work of CPOs and their staffs as having a very positive impact on competitiveness.

    – On average only 46% of CFOs feel that the procurement team has contributed to enterprise growth.

    – Only 57% of CFOs feel that procurement contributes to enterprise profitability.

    Against this backdrop of miscommunication and misunderstanding, it is therefore imperative for the purchasing professional to both recognize and understand the financial objectives of the finance department as these will almost always reflect the primary interests of senior management.

    Along theses lines, and according to Robert Rudzki, president of Greybeard Advisors and co-author of Straight to the bottom line, here are the five critical finance terms:

    1. ROIC (Return on Invested Capital): earnings divided by the total capital invested in the business (long term debt plus stockholder equity)

    2. Cost of Capital: the weighted average “cost” of debt and equity. It represents what you must earn to, minimally, cover the expectations of your debt holders and stock holders

    3. EVA (Economic Value Add): if ROIC is greater than Cost of Capital, then EVA is positive (you are adding value to the organization). If ROIC is less than Cost of Capital, then value is being destroyed and – absent substantial corrective action – the demise of the enterprise is just a matter of time

    4. EPS (Earnings per Share): the net income divided by the # of common shares outstanding. Typically calculated on a quarterly and annual basis.

    5. P/E Ratio: The ratio of the common stock price to the annual earnings per share. Companies/industries typically “enjoy” certain P/E ratios, therefore, increasing the E (earnings) often directly equates to a higher stock price.

    The two “biggees,” says Rudzki, are ROIC and EPS. Those two concepts drive C-level because they are what Wall Street and bankers are interested in. ROIC and EPS are the ultimate “report card” of senior management.

    My suggestion would be to meet with your organization’s CFO and collaborate on a program that will make sense from an enterprise wide perspective. This kind of dialogue will also open up important avenues of communication that can only help to further both your profile and career.

    (Note: If you would like further information on the research material I used for the article send me an e-mail at jwhansen@sympatico.ca with “Finance Articles” in the subject line.)

  2. floor jack Says:

    It’s the first time I commented here and I should say you give us genuine, and quality information for other bloggers! Great job.
    p.s. You have a very good template . Where have you got it from?

  3. Stephen Malakasuka Says:

    Time delivery is the most aspect to be considered, because we are buying for resale and if we can deliver late it means nothing, for both quality and cost saving. For me the most challenge is to deliver on time, then other factors to be well thought-out.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s


Follow

Get every new post delivered to your Inbox.

%d bloggers like this: