In this introduction to KPIs and related considerations, we’ll examine not only which KPIs matter, but also how to use them and expand them to support procurement’s broadening role — and also how certain KPI approaches can mislead.
This two-part brief is available to readers as part of SIG and Spend Matters' ongoing partnership.
Procurement leaders know that managing spend (what you pay) and supply (what you get) is much more than tactical efficiency improvements and short-lived price reduction efforts. Enabling this procurement evolution requires a balanced scorecard to measure procurement contribution and key performance indicators (KPIs) that quantify the return on investment (ROI) of current procurement processes and also new and improved processes that are increasingly powered by emerging digital capabilities.
In this introduction to KPIs and related considerations, we’ll examine not only which KPIs matter but also how to use and expand them to support procurement’s broadening role — and also how certain KPI approaches can mislead.
What’s the problem with KPIs?
When measuring procurement’s value contribution to the business, the first questions to raise are these: (i) What KPIs should I use (ii) and why?
Although year-on-year purchased cost reduction has been a key historical value proposition of procurement, companies can't "save their way to zero." As businesses are evolving and digitally transforming, procurement organizations must also transform their KPIs to not just measure legacy procurement processes (or procurement services), but to also guide the transformation efforts themselves and build better procurement scorecards that reflect how procurement can enable broader business objectives.
Traditionally, procurement has been focused on these two tactical and operational KPIs:
- Purchase Price Reduction (PPR), which is a favorable purchase price variance (PPV). This isn’t a great metric for the long-term (and doesn’t benchmark to supply market conditions), but finance folks educated in standard costing methodologies can’t seem to wean themselves off it!
- Operating Expense (OpEx) of a procurement function that gets treated as a back-office cost center rather than a form of profit center (and transformation center).
Beyond these two, the metrics vary wildly: supplier performance, supplier diversity, procurement cycle times, compliance rates and various meaningless volume numbers: number of POs, suppliers, etc. The problem is that the "Big 2" listed above end up creating a procurement operating model that essentially becomes a "sourcing factory" to drive price-reducing deals that then get thrown over the wall to a transactional purchase-to-pay process measured by headcount and OpEx. And what the business perceives is procurement as a function seeking to reduce prices (and business unit/function budgets) at the expense of broader business goals. This is the old procurement status quo.
The procurement scorecard, therefore, fails to provide the perspective of the voice of the customer (business units, partner functions and external customer) and the "voice of the supplier," and the relentless focus on price reductions will eventually harm these two critical stakeholders.
Is There a Better Way?
Finding metrics that track the contribution of broader added value for the end stakeholder will bring much more recognition for procurement as a valued business partner rather than just a negotiator and/or transactor and "firefighter."
Metrics are key enablers and key destroyers of aligning procurement to the business objectives such as revenue uplift, working capital improvement, innovation, sustainability and risk mitigation — areas that are easily overlooked in favor of more tactical and siloed metrics.
What we’ve seen from progressive organizations is procurement creating a broader balanced scorecard of supply to lower spending (not just costs), but also get more value from the supply chain. If procurement is interested only in improving year-over-year cost reductions because of its vested interest, it loses its ability to become a valued and objective business partner. We say to focus on "supply performance management" if you want to tackle procurement performance management. This term means two things:
- Managing and improving the performance of supply in a balanced way beyond just the unit price of that supply (e.g., reliability, quality, responsiveness, flexibility, etc.)
- Improving the performance of supply management (the part-and-parcel of spend management), which is not a term to rename an old-school purchasing function, but a term to focus on improving supply/spend outcomes for stakeholder benefit.
Let’s turn our attention to innovation as a basis for additional KPIs. Many procurement organizations are engaging suppliers in supplier innovation activities to unleash supplier creativity to add value to end-users in a way that adds total economic value to the firm. Tracking your KPIs here (e.g., you can measure what percentage of new products/services were derived from formal supplier innovation programs/processes) can show how procurement is supporting business growth. Measuring early procurement involvement in strategic business initiatives such as product/service development, mergers and acquisitions (M&A) and other areas is a critical leading KPI (versus a lagging KPI such as cost savings) area. And based on a 2019 survey of 450 CPOs that Spend Matters helped develop, there’s a lot of improvement needed for earlier procurement influence (see Figure 5 of the study here).
Watch Out: KPIs and Benchmarks Can Also Mislead
KPIs and benchmarks can create adverse behaviors (and they can also be manipulated), so handle with care. For example, consider the following:
- If market pricing dropped 15% in a year, but you saved only 5%, is that 5% savings good? What if the market pricing went up 15%? Either way, the +/- 10% PPV tells an incomplete story.
- What is the right number of suppliers per $B of spend? Too many is bad, but very often, too few are equally as bad because of supplier power and lack of an alternative.
- How far should you stretch days payable outstanding (DPO)? Finance may want to maximize it, but there are downsides too (e.g., supplier risk). See our webinar here for more on this Procurement-Finance alignment topic.
The answers are, of course, situational to each business and involve trade-offs. The bottom line here is not to take a KPI at face value: Understand the context of the metric, the impact on the business and the success of your stakeholders. Then you can help them make trade-offs and run scenarios in a way that helps optimize supply arrangements to that balanced scorecard that satisfies the business, procurement and the suppliers. You need all three.
Stay tuned for Part 2 of this KPI series from Spend Matters.
Pierre leads procurement research and IP development at Spend Matters, and is the chief architect of the firm's industry leading SolutionMapSM framework. He has 30 years of industry, advisory, and research experience and is a recognized digital procurement transformation expert specializing in advanced supply processes, practices, metrics, and enabling digital tools and services. Previously, Pierre led procurement research at The Hackett Group, and also coined the term "guided buying" in his role as the industry's first procurement technology market analyst at AMR Research (now part of Gartner Group).