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Rethinking Procurement: Shifting from Cost to Value for Greater Success

image of Ngaire Guzzetti Ngaire Guzzetti
Ngaire Guzzetti 5 Oct 2023 Time to read: 

Traditional procurement methods have long emphasised cost as the primary factor for awarding contracts, with other considerations given limited importance based on the organisation's preferences.

However, this approach is outdated and needs to evolve to align with modern and progressive ways of working. Aspects like environmental, social, and governance (ESG) factors are increasingly becoming integral parts of tenders, and new legislation in Germany is making them mandatory for certain companies. Despite these changes, procurement targets have been slow to adapt. Currently, procurement teams are primarily evaluated based on year-on-year profit and loss (P&L) savings, rather than the value they bring. 

Using this conventional approach to assess procurement's success comes with several risks. It discourages procurement teams from driving value through new requirements, as any savings they negotiate won't contribute to their cost-saving targets. In some cases, this may lead to a focus on renewals to achieve P&L benefits or even unethical practices where inflated prices are allowed in the first year to meet future savings targets. This serves individual success rather than benefiting both the company and its procurement efforts. 

The common practice of considering savings upon contract signatory overlooks the true costs involved. Factors like resource allocation during the tender process, unanticipated costs due to miscommunication, or service level credits for the seller are often ignored. Business cases are rarely revisited during or after the engagement to evaluate whether the original goals were achieved. Contracts are frequently put aside until expiration or renewal without reviewing them against the initial business case. 

Internal stakeholders may hesitate to engage with procurement if they believe that reduced prices will result in budget cuts, which isn't aligned with the company's best interests. They may also worry that cost savings come at the expense of value and quality. Evaluating procurement solely based on cost savings leads to undesirable behaviours and can result in lower product or service quality, ultimately harming the organisation. Opting for the "cheapest price" can prove to be a false economy if it leads to minimal service or the need for managing underperforming suppliers or replacing faulty products. 

When procurement is solely evaluated based on price reduction, and suppliers are judged on their ability to maximise prices, it sets an adversarial tone to the relationship. Focusing on cost savings contradicts the idea of mutually beneficial supplier relationships advocated by current academia. By pitting the two parties against each other, the focus becomes a zero-sum game where one's gain is the other's loss. Forcing suppliers to cut costs to slim profit margins can lead to negative perceptions and diminished service. 

To optimise value gains from relationships, organisations must consider various elements. It's important to understand that if you want a Ferrari, you can't expect to pay Skoda prices. However, it's equally crucial to explore whether a Skoda would meet the requirements or if a car is even necessary. Perhaps a bike would suffice. Regardless of the sourcing needs, it's time to evaluate procurement success based on value, speed to market, contribution to the wider company strategy, and innovation. Moving away from purely bottom-line savings is essential for the industry's growth and to maximise value from supplier relationships.

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