I start by doing a bold statement; Forecast is by far the most powerful tool for Procurement, when communicating with Business. Why?! Let me try to explain.
First of all I want to make it clear that the same rules in this context don’t apply for Indirect (spend not directly connected to end products, like travel, office supplies etc.) and Direct (raw and packaging materials, sold services etc.) categories, because they differ significantly from each other looking from the business point of view, at least from my own experience in the FMCG industry. I want to highlight this from two different perspectives.
First, let’s take a look on this from the end product perspective. I use as an example my previous experience with the retail in Finland and Sweden, which is very centralized to a few big players. It means that they have a lot of negotiation power towards suppliers. I guess this is the case in many other industries as well.
If you need to increase prices, it is always a tough negotiation with the customer where you need to present good arguments for the increase. If the price increase is accepted by the customer, it can depend mainly on two different factors; raw material price- (equals direct categories) and wage changes (if remarkable changes in logistics or energy, they also might impact some). The fact that you have decided to put more money to marketing campaigns or sent your personnel to nice trainings abroad does not interest the customer and is not an argument to increase end product prices. Direct counts, not indirect.
Secondly, direct categories are managed from process and cost perspective by the Procurement Category Manager while indirect categories are managed from process-, but not from cost perspective by the Category Manager. What do I mean by this?
I use a real life example. A few years back, I was negotiating data connections together with our IT department. We had a good co-operation, and the results from the negotiations were very promising. Costs for the current setup could be reduced significantly. But instead of taking that cost benefit and save the money, IT decided with that same money to increase the connection speed. Result: no direct P&L effect but probably happier end users with faster connections.
Indirect cost savings tend to vanish in the company. I know some of our clients are quite good in actually reducing the cost center/profit center budgets if new contracts with lower prices have been negotiated. But in many companies the money is not saved but used elsewhere (more or better quality)
In direct categories on the other hand, the category manager is “the king of the castle”, and if material price reductions are negotiated, they go straight to company’s P&L, and forecasts/budgets can be reduced accordingly.
SAVINGS, SPEND, CATEGORY MANAGEMENT… – I DON’T REALLY CARE!
In this light, the primary focus for the business should be on direct category development because it can be used as an argument in end product pricing decisions. At least for me it was. After I left Procurement and worked as a Business Head, my questions to Procurement were always the following;
1. Are the raw material prices going up or down?
2. If yes, in which categories and why?
3. How much does the change impact the end product prices?
Based on this information, we did make the decision to change or not to change the end product prices also taking into consideration the market situation (demand, competition etc.)
Business is not interested in spend and category savings. Sometimes they don’t even know exactly what these terms mean. It is Procurement internal teminology. The category development needs to be translated into forecasts and arguments behind the cost development, and even better, end product price forecasts. This is the language that the business understands and appreciates.
I have been slightly amazed, how little our customers have been so far interested in developing their category forecasting process. Maybe it is because Finance is responsible for the whole Cost Of Goods Sold calculation (wages, other overheads) and Procurement only for some part in that equation (raw materials). Or then the organisations are not mature enough to go for this kind of forecasting process. It requires strong leadership I can tell you. But I believe that this is one of the future trends in Procurement, that they together with Finance translate savings and category spend developments into end product forecasts and bring real value add to the business decisions.