Procurement KPIs (Part 1) – Foundational KPIs Every CPO, Supply Manager and Buyer Needs to Know

This research brief is intended as an aspirational piece for more transaction-focused procurement team members who aim to add value to procurement and the business beyond mere efficiency improvements and price reduction efforts. This series is not a compendium of financial metrics to convince your CFO about the value of procurement. It will leave you with a laundry list of prioritized ideas, open your mind to the qualitative side of the business and give you ways in which you can begin to measure procurement contribution and key performance indicators (KPIs) to quantify the return of the various activities you’re up to.

We begin with an introduction to KPIs and related considerations, examining why KPIs matter and how to use them and discussing basic procurement metrics, the role of innovation in setting measurement variables and how certain KPI approaches can mislead.

Let’s start by asking perhaps the most important question of all: Why use KPIs at all?

Why do we bother with KPIs?

This is the first question to raise when measuring procurement’s value contribution. Although year-on-year purchase cost reduction is the legacy value of procurement, you cannot save your way to zero. The more important aspect of this is year-on-year improvement. Another phrase for year-on-year improvement is “continuous improvement,” a phrase we most often think of as applied to quality improvements in manufacturing and the supply chain rather than in the broader realm of corporate spend management. In short, if we have no KPIs, whether qualitative or quantitative, how can we define today’s baseline and where we want to be tomorrow? Performance measurement is useless unless you use it to control the process and further improve it.

The next question then becomes what to look at, what to track and what to improve.

Traditionally, procurement has been focused on many relatively tactical and operational KPIs, as these examples show.

Cost management KPIs, which all too often are merely input prices, include:

• Purchase price reductions (PPR).
• Purchase price variance (PPV). Favorable PPV is the same as PPR.
• Cost reductions (year-over-year), beyond just price reductions. It can include freight, handling, quality, capital costs and many other non-price cost elements.

Delivery KPIs include:

• On-time delivery. Perfect order rate is a good example, although it incorporates product quality and invoice data quality. On-time in full is a narrower metric often used here.
• Variance. Fill rate is one form of this. Many manufacturers also use delivery variances to help size raw material buffer sizes. In other words, they use the data to improve their physical operations. We’ll return to this idea later.

Performance or quality KPIs include:

• Percentages (e.g., defect rate or its inverse: acceptance rate).
• Customer satisfaction (e.g., net promoter score or equivalent).

Service-level KPIs include:

• Ease of engagement.
• Timeliness in response.
• Flexibility in meeting unforeseen buyer requirements.
• Innovation (although this can also be a separate measurement category).

Unfortunately, aside from price and cost reduction, most metrics are not typically found on the formal procurement scorecard, especially when finance is the scorekeeper. Therefore, the procurement scorecard fails to provide the end user’s perspective of the product or service. Furthermore, a relentless focus on price reductions will eventually impact quality and delivery performance.

Is there a better way?

Finding metrics that track the added value for the actual end user will bring an order of magnitude more recognition for procurement, if implemented and managed, through the positive business impact.

Metrics are both key enablers and obstacles when it comes to aligning procurement with the company’s overall strategy. While procurement will probably need to keep track of basic KPIs like the above, it needs to expand its horizons to remain viable as a business function capable of delivering increasing value. This journey can take procurement to influencing and impacting sales efforts, profitability and market share growth, areas that are easily overlooked in favor of more tactical and siloed metrics.

What we are advocating is procurement becoming the champion and facilitator of a “balanced scorecard of supply” in the eyes and metrics of the stakeholders themselves. If procurement is only interested in improving year-over-year price or cost reductions, it loses its ability to become a valued and objective business partner. This is why we say to focus on supply performance management if you want to tackle procurement performance management.

To get more specific here, let’s turn our attention to innovation as a basis for additional KPIs.

Look to innovation for advanced KPIs

Consider the following case example of how a South African firm drove both innovation and value by understanding its clients.

In South Africa, mining is an important industry. In the gold mining business, one way of extracting the ore is to dig deeper and deeper holes in the ground, insert explosives, blow up a part of the mountain underneath the earth, excavate the rubble and extract gold from this. The efforts start vertically and later expand horizontally, tracking the gold vein.

In the process of extracting gold, the industry uses eucalyptus tree logs to support the excavation and keep workers safe as the tunnelling progresses, specifically to provide controlled collapses as the explosives are detonated. The tree logs provide critical collapse control by letting the rubble fall in a controlled fashion, without which the shock waves could become so violent that other areas could collapse, potentially resulting in lives lost, as workers remain underground during demolition and extraction.

The logs are just about the only thing combustible below ground, and the supplier of the logs in our example took it upon itself to research chemicals to fireproof the logs. After several trials, an inexpensive chemical and process was developed to add fire retardant to the logs at an added $3 per metric ton. This product became even more valuable and eventually became the dominant provider of logs in South Africa’s gold mining industry when a mine experienced a fire and lost 50 workers. The supplier also eventually became so strategically important that one of its mining company customers acquired it.

Had the firm been solely focused on traditional performance KPIs to reduce input prices and maintain quality and performance levels, the added value would not have been created, and the company might even have been displaced by a competitor creating the improved logs. This case study illustrates why so many procurement organizations are engaging suppliers in supplier innovation activities to unleash supplier creativity that adds value to end users and increases total economic value to the firm.

Watch out! – KPIs can also mislead

It is important to understand why KPIs, as a given metric, can fall at different extremes of a range for different firms but still be considered excellent for those companies. Take the frequent KPI of inventory turns, for example. This is an operational measure that looks at the number of times per year inventory is depleted and replenished. It can be as high as 50 times (essentially a weekly cycle), twice or even fewer (maybe not even once per year).

But what is the correct number? The answer depends on the business. Is the company delivering goods where high availability is critical, such as medical supplies, in which case ample inventory on hand is a literally vital KPI. Or is the organization in an industry with rapid obsolescence, such as computer components, where innovation and Moore’s Law combine to force companies to both have as little inventory as possible, yet be responsive to demand? Is it a high-margin product with low variable production cost, such as a patented proprietary drug made from common chemicals? Or how about a high-cost product that ties up extensive operating capital?

Do not take a KPI at face value. Understand its context and its impact on your business and your end users’ success. Then you can help them make trade-offs and run scenarios to optimize supply arrangements and that balanced scorecard to satisfy the business, procurement and the suppliers.