I hope that you have enjoyed the PurchTips article “Defending A Procurement Business Case.”
PurchTips is always in a very concise format, so I didn’t have much room to include examples. But I will do so here.
I’m just going to pull numbers out of the air here, so don’t take the numbers themselves literally. Focus on the methods.
Let’s say that you are going to propose to the president of your company the idea of investing in an eSourcing system with optimization capabilities at a cost of $100,000. You expect the system to enable your department to conduct 50 sourcing projects a year instead of 40. In addition, you expect the optimization capabilities to enable your department to identify twice the amount of annual savings you had in the past (20% of sourced spend vs. 10% of sourced spend). The average spend per project is $200,000.
This means that, without the system, you would be sourcing $8 million worth of spend per year (40 x $200,000) and achieving savings of $800,000 per year ($8 million x 10%). With the system, you would be sourcing $10 million worth of spend per year (50 x $200,000) and achieving savings of $2 million per year ($10 million x 20%).
The net financial benefit of implementing your business plan, therefore, is $1.2 million: $2 million in savings with the new system less the $800,000 you’d save without it. Now, let’s walk through the four things from the article that you need to know to defend your business case…
1. Your alternatives with a fraction of the funding. So, if your management only authorized you to spend $70,000 instead of the $100,000, what would you accomplish? You couldn’t buy the system you wanted to buy. So does that mean it would be a bigger waste to spend that $70,000 on a less-optimal solution? You better know the answer!
Let’s say that with $70,000 you would be able to afford an eSourcing system without optimization capabilities. How would that impact your savings? Well, maybe your average savings would only be 15% instead of 20%. Then, your annual savings would be $1.5 million ($10 million x 15%). You’d be sacrificing $500,000 in cost savings to avoid spending $30,000. Does that seem worth it? Unless you defend your procurement business case with this type of analysis, your management may not know.
2. The timeframe in which benefits will accrue. The easy way out is just to say that you’ll save $1.2 million more over 12 months so you will save $100,000 per month and the system will “pay for itself” in 30 days.
Be careful. There is likely some lag time between agreeing to buy the system and when it will start showing tangible benefits. Be realistic.
Maybe it will take you 30 days to implement the system and train users before it can be used in a real souricng project. Maybe the first sourcing project will take 90 days to conduct and conclude. And, spreading that $200,000 in spend over a year from that point forward (as well as spreading that $20,000 in additional savings over a year), you may only really achieve $1,667 per month from that first sourcing initiative. If you only did that one sourcing initiative in the 12 months following your purchase of the system (and you subtracted the 120 days of implementation and sourcing), the benefit of the system in the first year would be a mere $13,333 ($1,667 additional savings per month x 8 months).
So, go to this level of detail to identify what projects you will be utilizing your investment on, any lag time associated with those projects, and when the real money will drop to the bottom line.
3. The importance of timing. Here, you answer the question: “What happens if we put this off?” Fortunately, it is quantifiable. Let’s say that, as per point #2 above, you determine that there will be a 4 month lag time before contracts are signed that result in the additional savings from using the system. That gives you 8 months – or 2/3 of a year – to accrue benefit. Two-thirds of your additional annual savings of $1.2 million is $800,000. You can say that putting off investment will cost your organization $800,000 in higher prices in this year alone.
Pretty powerful stuff when put this way, eh?
4. Multiple options for success. In this case, you might compare the eSourcing with optimization vs. the eSourcing without optimization alternatives that I discussed in point #1 above. Or you may show what the costs and benefits would be if you hired a consultancy to do your 10 extra projects vs. buying the system that would improve your department’s productivity. Or you may show two or three options of any variety. When presenting a procurement business case for approval, the worst thing you can do is to relegate the decision to a “go” or “no go” decision.
All too often, the “no go” decision looks more attractive to executives. Give them a “choice of yeses” as they say in marketingspeak.
It’s not enough to put together a business case. You must anticipate what your audience (i.e., senior management) will be thinking. I hope that these tips help you get your investments in improvement procurement approved.
To Your Career,
Charles Dominick, SPSM
President & Chief Procurement Officer
Next Level Purchasing, Inc.
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