Management
improvement. Low-cost retailers routinely invest in their procurement organisation to reduce purchase prices in order to cut retail prices, creating improved turnover and customer loyalty leading to improved market share and further reinvestment in the cycle.
Achieve lasting change
In all these ways, procurement can become a lever for fundamental and lasting changes in an organisation’s performance, but how can these benefits be achieved?
First, bymanaging expectations. Pro-activemanagement is
essential if all the benefits of an otherwise excellent procurement project are to be delivered and secured in the long-term.
Secondly, it is long-term improvements in earnings that can
lead to higher valuation by the market. Third, to deliver and retain these benefits, it is essential to
invest in systems, processes and people capabilities. The first phase is to identify and target the opportunities that can be achieved, which in itself can be costly if the technology is not in place to identify spend/opportunities accurately.
Fourth, once these targets have been identified it is essential
that they are executed using effective processes based on clear understanding of strategic sourcing approaches, tools and techniques, and, importantly, pan-organisational compliance to these approaches.
Fifth, there must be effective contract and supplier
performance and relationship management tools that track obligations, performance, risk, price variances, off-contract spend and measures savings to plan, and if necessary, prompt corrective action.
How it works
When it comes to improving competitive advantage and organisational economics, investment in procurement
capabilities and tools often leads to sustainable long term benefits and can contribute to the company’s bottom line. The result: dramatic improvement in valuation and share price.
The dynamics of transforming business value through
procurement can be explored in a simple example. Take an organisation with a £100m turnover delivering an average 10 per cent annual net profit of £10m.
It would be an impressive achievement if the CEO could add
10 per cent to the top line resulting in £10m in revenue, but its impact on the bottom line would only be about £1m. If we assume however that third-party spend is 50 per cent of revenue, reducing procurement costs by 10 per cent could deliver a direct increase in profitability of roughly the same amount saved – about £5m.
This is because there would be few additional costs and most
of the savings would fall to the purchasing and logistics bottom line. In our scenario this would produce about £5m on the bottom line, equivalent to five times the benefit of adding 10 per cent to the top line.
The effect may actually be even more dramatic in private
sector/listed companies, where increased profitability could lead to a direct increase in the company’s earnings. If our organisation trades at a Price Earnings (PE) ratio of 10, then the subsequent impact on its market value could be an incremental £50m - a staggering 10 times the original saving.
Of course, factors such as differing cost structures, the
investment required, capital costs and corporate tax could dilute this number, but even if you halve the number above, the dynamic remains where the pound reduced from procurement costs still has an impact on the company’s net profit/earnings/valuation of about five times that of a pound added to top-line revenue growth.
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26 | September 2011
www.electronics-sourcing.co.uk
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