Procurement KPIs (Part 2) – Are KPIs Balanced or Obsolete?

To continue our analysis of procurement key performance indicators (KPIs), we turn to additional metrics for measuring procurement performance, including supply base development and spend under management (SUM). This piece also examines how to discover whether organizational procurement KPIs are off balance, favor one area over another or the strategic over the tactical, or if they are just right.

While intended for everyone from buyers to chief procurement officers, this series on procurement KPIs is particularly suited for individuals and organizations looking to put in place the right measurement foundation to change how procurement is viewed by the business from a function that only reduces input prices and “keeps the production line running” to one that brings new areas of value, from supply chain risk reduction to creativity and innovation.

KPIs: You become what you measure

The phrase “You become what you measure” may sound trite, and it is by no means new. As Lord Kelvin said, “If you cannot measure it, you cannot improve it.” And, as demonstrated by the Hawthorne Effect, performance will improve when those performing the process know they are getting measured on it. If you repeat an activity enough times, it becomes a habit. Whether good or bad, you have now learned something that takes a lot of effort to unlearn. This is the main driver of the perpetual need for change management and procurement transformation efforts in just about all organizations. You must change the measurement system to be SMART (specific, measurable, achievable, relevant and time-bound) if you want to keep it relevant and aligned to changing business conditions.

Not only does spending too much time on the wrong things create bad habits, but it also makes measuring procurement’s value a painful experience. For example, do you really want to only be expected to deliver on tactical basics like:

• Purchase price reductions (PPR)
• Invoice to PO match rates
• Cost to process a PO

Wouldn’t you also prefer a strategic aspect to your line of work, something that really raises the organization’s long-term performance? More metrics toward:

• Total cost of ownership (TCO) for an item, category, supplier, etc.
• Total economic value added (i.e., factor in top-line performance, asset productivity, etc.).
• Percentage of strategic/critical suppliers (not just based on spend) that are influenced and managed deeply.

Frankly, some kind of metric that measures or at least ranks the mix of strategic and tactical activities is worthwhile for maintaining a balanced workload and attracting new hires who want a way to really contribute to an organization. Let’s now turn our attention to seeing whether your procurement KPIs are well-balanced and segue to some of the most important foundational KPIs to get right.

The KPI balance often is a tradeoff between strategic and tactical goals. Think of the classical accounts payable (AP) example of taking a requisition to a PO and later matching this with received goods and related invoices. Done properly, this is a highly transactional activity with little direct value-add. In other words, this is a process that is at the very top of the list of things to automate.

A procurement team that confines its role to activities like this will be relegated to the function that, as one CPO said, “is the place where people go to die” in their careers. The tactical and operational certainly have their place, but they cannot be the sole focus of the function. A procurement team also cannot focus exclusively on identifying the greatest opportunities through strategic sourcing, go through a bidding process, arrive at a negotiated deal and then think its job is done. This “drive-by sourcing” keeps procurement locked in the box of, per another CPO, “doing deals and paying bills.”

Savings have to be implemented to deliver value, which brings us to our next KPI.

KPI: Spend under management

Spend under management is an important and vexing KPI — or set of KPIs. It is both underestimated and misunderstood. One of its challenges is that the addressable spend and SUM concepts are interpreted differently across organizations. But, based on our experience and that of practitioners who use the metric, here is the basic definition. SUM is the percentage of annual truly addressable supplier spending correctly disbursed against preferred suppliers’ contracts.

The definition contains 14 simple words, but their meaning and implications are what matter. First off, let’s examine the term “addressable.” True addressable spending means all cash disbursed to suppliers, not just the spend deemed touchable/influenceable by procurement. Next, we are talking about spend that is pegged to contracts that can be measured with proper spend analytics. This is how you get visibility of maverick spending happening for whatever reason and the data you can use for continuous improvement.

Most importantly, the contracts are associated with preferred suppliers that themselves are established via a procurement-led strategic sourcing process, i.e., a “center-led,” procurement-designed process that can have distributed resources in execution. This is different from approving suppliers that might have been set up properly with AP controls, but not with procurement controls. This is why most firms make their CPOs the global process owners for procure-to-pay (P2P) and why procurement must sign off on every new supplier added to the supplier master.

Finally, we say “correctly disbursed” because spend is only under management if the execution systems in P2P are purchasing and paying the preferred vendors with the correct transactional “pathways,” such as three-way match, ERS and recurring invoices.

SUM is not a perfect metric because it measures the quantity of spend influenced/managed by procurement, not the quality of spend influenced/managed (i.e., earlier, more deeply and on an ongoing basis). For example, you can have 100% SUM through rigorous policy enforcement that requires procurement’s involvement in contract negotiations, but if procurement is brought in too late to exert meaningful influence, that spend is not getting managed properly. There are different ways to measure the quality of influence, and it goes beyond the scope of this piece. We do recommend, however, that you base it more on adoption of best practices, e.g., involvement during planning and budgeting, than the percent of effort reporting up to procurement or the exact RACI model you’re using.

Finally, SUM tends to be very sourcing-centric, though it has also been implicitly extended to supplier management. And while there is no real “SUSM” metric (spend under supplier management), the benefits of supplier management programs and processes are no less real, and they become even more important to drive value within ongoing relationships, especially strategic ones. Supplier management is also an area that lights up many metrics because it is multi-faceted, such as including risk management, regulatory compliance, performance management, etc., and it also highlights the complexity of “supply base management” that involves measuring supply base segments like these shown in the spend/supply management framework:

• Supply base demographics show the attributes of your supply base overall (e.g., measuring strategic supply base concentration via the metric of percentage of suppliers representing 80% of spend) or certain criteria, such as diversity criteria.
• Spend categories from low-level sub-categories/commodities up to “super categories,” such as contingent labor and services spend, direct vs. indirect and others. The power of good supplier information (which itself is part of supplier management) and a common category taxonomy helps to enable scorecarding at any of these levels.
• SRM segmentation, such as strategic, critical, A/B/C, preferred, under-performing, etc., and risk segmentation, which is based on risk values of various risk types or scoring by NGOs, e.g., CSR ratings. Of course, this all assumes that you have the data here to report, and if you do not, that is also a key driver to getting such insights.

Tier-2 supplier metrics can also be added to the list for firms with critical tier-2 suppliers to measure and manage (directly or via the tier-1 supplier). Another example is that some companies measure supplier diversity at tier-2 level.

Another finding from more advanced practitioners is to standardize the “palette” of KPIs (including their definitions and calculation methods) so that these types of metrics can scale up from a supplier level (and even down to a contract level where the KPIs become performance SLAs) up to the end-to-end supply chain level.

KPI: Should we consider only ‘the Efficient’ or also ‘the Effective’?

This is another example that appears semantic at first, much like SUM. Consider the requisition-to-PO to the invoice-to-matching process – as much as accurate and fast sounds good, how about effective? Effectiveness is about doing the right things. Efficiency is about doing things the right way to maximize output given a set of inputs.

Consider: What if the wrong item is being ordered? Are you buying older technology that is already obsolete, such as approved laptops that are both dated and expensive? Maybe the product has the wrong specs, or the spend is not leveraged, so your purchasing terms aren’t what they could be. Or it is from a contract that has not been competitively sourced in many years, or ever. There are many reasons why the tactical metrics alone could be misleading.

As much as we need to be efficient, being effective is more important. Doing the right thing trumps doing things the right way. However, these two are not actually conflicting if you dig a little deeper. All processes have both efficiency and effectiveness dimensions, and you need efficiency to help “fund” effectiveness so you can do more of the right things with limited inputs. The trick is to shift your “mix” of procurement services from more tactical to more strategic and to use efficiency gains to “fund” that reallocation.