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.