Operations Management: Find Your Edge
Now you see it, now you don’t. That’s the feeling many leadership teams have when the head of procurement touts substantial savings. All too often, it seems, the benefits disappear before reaching the company’s bottom line. Bain & Company research shows companies often realize only 60% of their identified savings.
What happens behind the scenes isn’t so mysterious. The way companies manage spending makes it appear as if procurement savings have disappeared. In fact, someone often has spent them.
How does this budgetary sleight of hand happen? Procurement offices calculate savings based on categories, but business unit leaders spend based on their budgets. The savings are lost in translation. So when the procurement team scores some gains, say by negotiating a lower price for computer equipment, typically business unit leaders use it to plug a hole elsewhere or fund a priority project.
Companies with best-in-class operations have a strong competitive edge. Bain's insights on operational excellence help leadership teams transform supply chains, procurement spending, and manufacturing capabilities into strategic weapons.
Successful companies track procurement savings rigorously and capture them before they disappear. They make sure the heads of procurement, financial planning and accounting as well as budget owners are all seeing the same numbers. As soon as the procurement savings are booked, they reduce business unit budgets accordingly. We call this a closed-loop process. With procurement savings visible to all, leadership teams can determine the best use of the savings—whether it should fill budget gaps, fund new investments or bolster the bottom line.
How do companies set up a closed-loop process? A major airline company launched a process to capture savings that started with procurement category managers filling out a standard savings form for each initiative. The form detailed targeted gains and whether those costs were included in budgets. Each week, senior procurement managers met with financial planning and accounting teams to validate the savings. The finance managers then called in business unit leaders to flag the reduction in their budgets, based on procurement gains. In a preliminary phase, the company’s closed-loop process helped the company deliver 8% in savings, allowing the leadership team to reach its target on bringing down cost-per-seat mile.
A business and financial software company went one step further, creating a “procurement savings leadership team” including executives from procurement, financial planning and accounting. The group’s goal was to validate savings and adjust budgets as early as possible, based on completed procurement initiatives. The group then quickly channeled the savings into a CEO fund. Within two years, the group captured $80 million in procurement savings, allowing the CEO to fund 14 new investment priorities, including a marketing campaign and a project to build artificial intelligence and machine learning capabilities. In prior years, business unit leaders had simply spent most of the savings.
True, no business unit leader will be thrilled to hear halfway through the year that his or her budget is being cut. P&L owners are used to having the flexibility to deploy savings in one area to offset higher costs elsewhere. In our experience, the most effective approach is to anticipate procurement savings in advance and incorporate them when the budget is being set up. That provides an incentive for business unit leaders to work closely with the procurement team throughout the year to achieve targeted savings.
Companies that want a more systematic approach to cost control, of course, are turning to zero-based budgeting, a process that reviews annually all decisions on spending. They may also create budgets by category. But for companies that don’t have zero-based-budgeting, closing the procurement savings loop can deliver a big improvement in transparency and performance.
It’s not surprising that procurement savings disappear into thin air, given the way companies are structured. Skilled leaders bridge the communication gap between procurement, finance and business unit managers by creating a closed-loop system to track and capture those gains. The benefits are compelling: increased efficiency and new opportunities to reinvest gains in strategic priorities.
David Schannon and Chuck Miller are partners with Bain & Company's Performance Improvement practice. David is based in the firm’s Silicon Valley office, and Chuck is based in the Boston office.