How to calculate procurement ROI?

Procurement Performance & Development

Procurement ROI and Operational Procurement Performance

Jasmiina Toikka Nov 17, 2021

Procurement performance measurement

Procurement performance measurement (PPM) is the systematic process of measuring the effectiveness, efficiency and spend of procurement teams with the continuous ambition of improving value of procurement to business. Selecting the most relevant Key Performance Indicators (KPIs) depends on business strategy, organizational structure, size and location of the business and budget. The metrics most widely tracked to measure procurement performance are cost savings, operational KPIs, spend under management, supplier performance, employee deliverables and costs. Such procurement performance measures can include procurement cycle time, compliance rate, material defect rate, material availability, rate of emergency orders, procurement service level, customer satisfaction, PO or invoice accuracy, and cost per PO or invoice.

CPOs are constantly looking for ways to improve procurement performance of both people and processes. The CPO's responsibility is to prove the value of procurement to the business and stakeholders. In this blog post we will walk you through how to measure and systematically improve your procurement performance and calculate your Procurement ROI.

 

Don't stop with KPIs: learn how to take insights from Procurement Analytics to drive organizational value.

 

Why should you monitor procurement performance?

Procurement performance measurement is important because of procurements critical role for the financial performance, quality, resilience, and risk management of the whole company. By measuring the efficiency of their processes, organizations can establish to what extent there are fulfilling their mandate. Managing procurement performance can provide the following benefits:

  • Improved management of the team
  • Effective allocation of resources
  • Improved productivity and steering of performance
  • Greater strategic sourcing impact on business
  • Ability to communicate results in numeric terms
  • Demonstrating value of procurement to business

 

What are operational KPIs in procurement?

Operational KPIs can provide insights into the performance of the procurement function. Operational KPIs are those that track what is happening in the day-to-day business of procurement to identify areas of improvement. Operational KPIs can help CPOs answer important questions like:

  • Are our procurement processes efficient?
  • How do categories compare with one another?
  • How do we compare with other organizations?
  • Are there bottlenecks in our processes?
  • What needs to be improved in our operations?
  • Are we improving or declining in our service levels?
  • Are stakeholders satisfied with the speed and service delivery?

Procurement cycle times are key measures of procurement process efficiency. Cycle time tracks how long a certain task or activity takes to complete. The least amount of time a person takes to process an invoice, execute a sourcing project, or sign a contract means that not only savings but also better products and services can be made available sooner. Minimizing transaction time also means cost reduction. Mitigating time spent on manual activities, such as POs, PRs and invoice management, frees up team resources to focus on strategic sourcing and development.

 

Procure-to-pay cycle time

The Procure-to-Pay (P2P) cycle consists of many steps, some of which are definite bottlenecks. For example, purchase order (PO) cycle time is measured in days (could be hours!) from the time a purchase requisition (PR) is submitted until the PO is sent to the supplier. Common KPIs are time-from PR-to-PO and the average cost-per-purchase order. One of the main bottlenecks is the delay in approving PRs. Delays may occur due to category specific approvers’ unavailability e.g. during unexpected leaves or overlapping responsibilities.

 

From a Purchase Requisition (PR) to Purchase Order (PO) Requisition to order process

 

From a Purchase Order (PO) to Invoice payment

Order to Pay process

Another main bottleneck is invoice cycle time - matching the invoice to the PO, a process that can be automated. A useful KPI is PO coverage, meaning the % of invoices or spend with no PO. Non-PO invoices require substantial manual effort and cause frustration as well as delays in payment if there may be no pre-approved budget to cover the invoice. Implications of slow invoice payment include missing out on discounts for prompt payments, incurring penalties for late payments, additional costs of manual handling activities, and unhappy supplier relationships. By interrogating the payment process, a procurement organization can find ways of reducing processing time. Automating the purchase-to-pay process reduces opportunities for fraud and ensures that suppliers are paid on time with correct price. Paper invoices should be eliminated or at least reduced to very minimum.

 

The sourcing cycle time

Selecting the right KPIs for managing the sourcing process depends on the size and organization of the procurement function. In large and mid-size companies where strategic sourcing activities are conducted in category groups, one KPI may be designed to track number-of-projects-per-person. Too many sourcing projects may lead to longer tender and RFP turnaround times or a drop in project delivery quality. Too many projects may eventually lead to a review of procurement resourcing or outsourcing some of the tender projects to specialized consultants. Alternative way to measure tender efficiency is to calculate the average time to complete the steps in the sourcing process and the average cost of a tender. Another KPI used to evaluate procurement impact in tenders is the difference in the first bid price and the actual price contracted.

More and more procurement organizations have started to implement performance measures for sourcing value add in opposite to hard KPIs. Procurement value delivery in sourcing is dependent on tender project objectives and business KPIs. Sourcing value related measures could be related to customer experience, quality, reliability, or sustainability for instance.

 

How do you evaluate procurement ROI?

Procurement’s return on investment (ROI) is used to determine the profitability and cost-effectiveness of the money spent on operating a procurement function. One accepted measure is:

               Procurement ROI = Annual cost savings / Annual procurement cost

However, procurement value delivery is more than just cost savings. Additional procurement value is generated in strategic sourcing, category development and supplier relationships. One interesting perspective is the view of seeing procurement as driver for possible new revenue streams through supplier collaboration, innovations and transforming existing business models. Value-driven alternative for measuring procurement ROI could look something like this:

               Value-oriented procurement ROI = (Annual cost savings incl. cost avoidance + Procurement value delivery incl. revenue impact) / Annual procurement cost

 

Stages of procurement maturity

Phases of procurement maturity development and increased ROI delivery follow the stages of i) having the license to operate ii) developing best practices in procurement to iii) becoming a strategic partner to business and fostering value-driven collaboration. Early stages of maturity focus on ensuring steady supply of products and services as well as gaining visibility on spend and categories. Developed procurement organizations optimize their total cost of ownership (TCO) on category level, continuously identify opportunities for savings and develop their capabilities. Mature procurement organizations drive competitive advantage, identify opportunities for value and build win-win relationships with business and category suppliers. Mature procurement organizations not only use spend data to assess current performance, but predict future spend and take action based on data-driven insights.

Procurement ROI stages of maturity-1

 

Spend analytics enables procurement performance improvement

Every company requires insights into where it is spending its money. Spend visibility tools can highlight areas with low visibility, irregularities, process optimization potential, non-adherence to negotiated contract terms, areas not covered by PO and contracts, and excessive cycle times that may speak for resourcing or compliance challenges. With only manual methods of analysis, it is not clear who is approving PRs and invoice payments and how long each transaction is taking. Spend analysis provide greater visibility that is a must for continuous improvement and tracing performance improvement opportunities back to the smallest detail.

To level up procurement performance, organizations need to make the most out of analytical tools available. Spend analytics solution enables tracking and benchmarking of all agreed procurement KPIs from a centralized dashboard. Performance data from all P2P processes is gathered, stored, and analyzed with minimal manual effort. Data provides common language and understanding, and a starting point for improvement.

 

Cover picture by Hert Niks (unsplash.com)

SA101 Mockup

Begin your Procurement Analytics journey now!

Get your procurement analytics journey going with our free Spend Analysis 101 eBook. No matter if you're a Procurement Analytics Pro or a beginner in the field, this book will help you develop and improve the procurement analytics within your procurement organization.

Never miss news from Sievo

Get updates straight to your inbox