Calculating
Procurement’s
Value
NAEP Ad Hoc Committee on
Defining & Calculating Cost
Savings:
April 8, 2008
Brian Rounsavill, Princeton University (Co-Chair)
Chris Mihok, Yale University (Co-Chair)
Jim Hine, University of California, San Francisco
Judy Smith, University of Michigan
John Riley, Arizona State University
Kevin Lyons, Rutgers University
Michael LaPointe, University of Illinois
Agenda
• Introduction, Overview & Background
• Cost Savings & Benefits
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Sourcing Savings
Usage, Supplier Incentives Savings
Process Efficiency Improvement
Compliance & Risk Reduction
Reporting Cost Savings & Benefits
Responding to the Campus Community
Critical Success Factors & Conclusions
Q & A - Panel Discussion
2
Cost Savings & Benefits
The “Bull’s Eye”
Requisitions
Purchasing
Tools:
•POs
•Credit Cards
•E-Commerce
Campus
Departments
Orders
Vendors
Contracts / Strategic
Supplier Relationships
Campus Training /
Information Exchange
Procurement
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Cost Savings & Benefits
Core Assumptions
• Procurement = Purchasing + Accounts Payable
• Hard and soft savings are equally beneficial and valued
(savings = savings)
• Cost savings and cost avoidance are equally valued
(savings = avoided cost)
• As Ben Franklin said….
“A penny saved is a
penny earned”
4
Sourcing Savings
• Achieved through the actions taken by
Procurement
• Reduction in the purchase price of goods /
services
• Examples include:
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Competitive bidding
Negotiated quantity discounts
Negotiated tiered discounts
Identification of alternate sources of supply
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The Role of Market
Competition
• Essential in balancing supply and demand and
achieving sourcing savings
• Ensures that a reasonable price is paid
• Snapshot of the current market for a specific
commodity at a specific time (i.e. the market
basket approach)
Key Point:
The moment competitive bids are obtained, the “last
buy” price no longer applies since the economic
elements of a perfect market are in play
6
Calculating Multiple Bid
Savings
Definition:
• When multiple bids can be obtained, the savings shall
be the difference between the awarded bid (what you
will pay) and the average of the non-awarded bids (what
you would have paid elsewhere in the market)
Formula:
(Average of Non-Awarded Bids - Awarded Bid) = Savings
Percentage
=
Savings
Average of Non-Awarded Bids
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Calculating Competitive Bid
Savings
Example:
• Bid results obtained for a widget were: $1.57, $1.15 and
$0.87
• The contract was awarded to the low bidder ($0.87)
$ 1.57
Bids
$ 1.15
$ 1.36
$ .87
Bidder
1
Bidder
2
Avg. of 1
Bidder 3
and 2 (Low Bidder)
8
$0.49 savings (36%)
The Role of “Last Buy Price”
• In the absence of competition (i.e. single bid / sole source),
the “last buy” price is the starting point to determine a
reasonable price for the specific commodity
Key Point: The use of a list price will dramatically over-inflate savings
• To bring the “last buy” price current, use the generally
accepted index measure to account for inflation and/or new
market conditions (CPI, PPI, etc.) www.bls.gov/cpi/
• The “last buy” price is multiplied by the % change in index
measure to bring it forward to the current time period
– In situations where a contract is several years old, this is required for
each year the contract has been in place
– Key Point: Losses occur if the price increase exceeds the index
• A tool for monitoring whether the supplier is trying to gain
back initial price concessions, or an indicator of market
conditions
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Calculating Single Bid Savings
Definition:
• When no competitive bids can be obtained, the cost savings
shall be calculated as the difference between the new
awarded price and the last buy price adjusted for inflation
(i.e., CPI / PPI)
Formula:
[Last Buy Price x (1 + % ∆ CPI) ] - Awarded Price = Savings
Percentage
=
Savings
Last Buy Price x (1 + CPI)
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Calculating Single Bid Savings
Example:
• The new bid price is $1.53
• The last buy price for this product was $1.40
• The change in CPI is 3.5%
$1.53
Prices/
Bids
$ 1.40
Last Buy
$ 1.45
Last Buy
Adj. for CPI
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New Bid
- $.08 savings/loss (-5.52%)
Calculating Total Sourcing
Savings
1. Days Active:
The contract begin/end date range is compared against the
specified date range to determine the actual number of
days within the specified period the contract was active
Note:
Some contracts will contain two entries, which indicates that the contract
expired and was renewed within the specified period. The cost savings
associated with each entry will be different, which reflects both the previous
and renegotiated contracts
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Calculating Total Sourcing
Savings
2. Total Spend:
Run total vendor spend reports for all contracts that were
active at any time within the specified period to calculate
the total discounted spend with each vendor for the
specified date range
Note:
Total vendor spend is calculated from a combination of: e-commerce
transactions, purchase orders, credit card transactions, and other AP
distributions (i.e. all payments to a vendor)
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Calculating Total Sourcing
Savings
3. Cost Savings
The individual contract cost savings percentages are
calculated as we have outlined in the previous slides
Competitive Bids:
(Average of Non-Awarded Bids - Awarded Bid) = Savings
Sole Source:
[Last Buy Price x (1 + % ∆ CPI)] - Awarded Price = Savings
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Calculating Total Sourcing
Savings
4. Total Savings:
A weighted-average approach is used to approximate the
total savings associated with each contract over the actual
valid dates of each contract to achieve an approximation of
total savings over the entire specified period
Note:
This methodology associates specific savings with each contract for specific
dates to account for the fact that vendors may have more than one valid
contract during the period with differing savings percentages (i.e. the contract
was renegotiated during the year)
* For multiple year contracts, this concept holds true in that pricing was held firm for the
entire term, or may include price increases, each of which are recorded for specified
periods over the life of the contract
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Calculating Total Sourcing
Savings
4. Total Savings: The following total savings calculation is
used to approximate the pre-discounted spend with a
vendor for the number of active days in the specified
period, which is then multiplied by the contract cost
savings to achieve a weighted-average total savings
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Calculating Total Sourcing
Savings
Example:
• The following three contracts were renegotiated during
the fiscal year beginning on July 1 and ending on June
30. You are asked to provide data on the total sourcing
savings achieved for this period:
Contract
Date Range (Days Active)
% Savings
FY Spend
Contract A
Aug 1- Dec 31 (152)
10%
$100,000
Contract B
Jan 1 – Dec 31 (181)
5%
$250,000
Contract C
Jul 1 – Jun 30 (365)
-3%
-$125,000
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Calculating Total Sourcing
Savings
Answer:
Using the total savings calculation, the individual weightedaverage total savings are calculated for each contract and
added together, which estimates the total sourcing savings
achieved for the period:
Contract
Days
Active
Spend
% Savings
$ Savings
Contract A
[(152/365) *
$100,000 /
(1-.10)] * 1.0
=
$4,627.09
Contract B
[(181/365) *
$250,000 /
(1-.05)] * .05
=
$6,524.87
Contract C
[(365/365) *
$125,000 /
(1+.03)] *( -.03)
=
-$3,640.78
Total Savings for Period = $7,511.18
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Other Hard Benefits: Usage
• Item Specification Savings
– Convert to lower lifecycle cost specifications
– Benefits: [(old specification cost) - (new specification cost)] * usage
• Consumption/Usage Savings
– Identifying/eliminating overuse/waste/expired product
– Benefits: historic costs vs. revised costs
• Inventory Savings
– SKU consolidation, inventory sharing, vendor managed inventory,
JIT, surplus and auctions
– Benefits:
• Inventory work-down: avoided procurement cost during work-down
• Lower carry cost: value of space, manpower, obsolescence savings
• Revenues from asset sales/recovery
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Specifications Savings
Example:
• Requirement = 1,900 cases of usable gloves
Company A
Price/Cast
Yield
Implied Cases Required
Total Cost
Company B
$10.86
$10.97
95%
97.5%
2,000
1950
$21,720
$21,391.50
$328.50
(1.5%)
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Inventory Drawdown
Example:
Due to improved vendor delivery, able to work down
stocked inventory of expensed gloves by 500 cases
from 2,000 to 1,500
$21, 391.50
Inventory
Value
$15,906.50
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$5,485 one-time
savings
Other Hard Benefits:
Supplier Paid Incentives
• This category can include a variety of incentives derived
directly from suppliers:
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P-card rebates
Catalog fees
Electronic transaction fees (i.e. EDI)
Prompt Payment Discounts (i.e. 2/10 net 30)
Volume-based patronage/earned incentives
Retroactive supplier payments
Signing bonuses
• In most cases, these incentives can be used to help
fund centrally-driven improvement efforts
Tip:
Negotiate price first, then additional incentives to prevent suppliers from
merely increasing their unit prices to cover the costs of these incentives
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Additional Benefits:
Process Efficiency
Example:
Implement eProcurement - increase efficiency, reduce nonvalue added and reconciliation tasks frees substantial
capacity.
600
500
Annual
FTE’s
Spent On
P2P
400
Purchasing
Accounts
Payable
>100 FTE’s (> 20%)
300
Departments
200
100
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Additional Benefits:
Compliance and Risk Reduction
• Tighter, more automated procurement and sourcing
processes can substantially reduce key risks and improve
compliance:
– Increased small, diverse business sourcing for federal/state funded
research grants
– Reduced risk of use of unqualified/debarred suppliers through
comprehensive supplier tracking
– Increased SAS 112 compliance and reduced fraud risk through
automated closed loop processes (approvals, 3-way matching,
exception monitoring etc.)
– Increased supplier compliance to contract and reduction in risk of
double payments
• Though hard to attach monetary value, keeping key
stakeholders out of the newspaper can bolster any
business case
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Reporting Cost Savings &
Benefits
• By using the methodologies outlined in this presentation,
total savings can be fairly measured for the contracts or
sourcing transactions during the reporting period in
question
• In the absence of a market analysis (competitive bidding),
existing active/valid contracts are included in the total
measurements because they are still actively saving the
institution money
Note:
There has been a great deal of discussion concerning whether savings should
be reported for multiple year contracts. Some institutions have chosen to report
cost savings in the first year only, while others have reported cost savings over
the entire contract term. Regardless, any total savings calculation should be
viewed as a tool for institutions to apply as necessary and appropriate within
their own environments
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Reporting Cost Savings &
Benefits
“The Bottom Line”
This approach does the following:
– Approximates the total savings and benefits
– For each active contract or sourcing transaction
– For their specific valid date ranges
– To estimate a measurement of total savings for the
reporting period in question
Tip:
Electronic databases or spreadsheets can allow the total savings calculation to
be adjusted for any date range at any point in time
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Responding to the Campus
Community
• In order for a cost savings and benefits program to have
endorsement, the campus community must understand
and agree with the methodology
• Campus departments typically view “savings” from what
they actually paid last year
• The campus must be educated on what would have been
paid if there was no Procurement intervention (i.e. current
market price / conditions, effects of inflation, etc.)
The Litmus Test: “What would it have been?”
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Critical Success Factors
• Documentation
– The file should contain competitive bids and other documentation necessary
to establish price reasonableness and justify the reported savings/benefits
• Data-Driven
– Cost savings and benefits must be linked to actual supplier spend for the
date ranges over which the savings are projected
• Price Point of Comparison
– The use of competitive bidding or the “last buy” price adjusted for inflation are
standard methods that provide process, analysis and details to substantiate
price point comparisons
• Report Losses and Savings
– Both savings and losses should be reported
• Be Conservative
– The credibility of your entire Procurement program can be undermined if
exaggerations, errors, or discrepancies are found
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Conclusions
•
A reasonable approach and generally-accepted definitions
have been defined by this Committee
•
A basic set of tools have been developed that can be
applied to different and changing institutional procurement
environments
•
A structured program will provide relevant information to
departments and demonstrate the value provided by
Procurement
•
When Procurement can adapt to changing environments
and demonstrate a return on investment; sourcing and
savings results will continue to validate Procurement’s
efforts and solidify Procurement’s credibility and necessity
within any organization
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Conclusions
Campus’ view of Procurement
“The speed bump between me and a Nobel Prize?”
Or
“My strategic partner who delivers value.”
Show me the money.
Appendix
• The complete White Paper that formed the basis for this
presentation has been published as an NAEP
monograph and was distributed to all session attendees
and is also available on the NAEP website
(www.naepnet.org)
• Excerpts from this article have been published in the
December 2007 and March 2008 issues of the NAEP
Journal
• The Ad Hoc Committee on Defining & Calculating Cost
Savings wishes to thank the NAEP for the opportunity to
present at this session and work on developing
standards for this important industry topic
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Q & A – Panel Discussion
NAEP Ad Hoc Committee on Defining &
Calculating Cost Savings:
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Brian Rounsavill, Princeton University (Co-Chair)
Chris Mihok, Yale University (Co-Chair)
Jim Hine, University of California, San Francisco
Judy Smith, University of Michigan
John Riley, Arizona State University
Kevin Lyons, Rutgers University
Michael LaPointe, University of Illinois
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