Procurement ROI (Return on Investment) is a critical metric that measures the value that the procurement department delivers to the organization. In this blog post, we will explore what procurement ROI is, how it is calculated, and why it is essential for procurement departments.
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The procurement department plays a crucial role in any organization. It is responsible for acquiring goods and services necessary for the company’s operations, ensuring that these acquisitions are cost-effective and of high quality. The primary aim of procurement is not only to save costs but also to contribute to the overall value creation for the company.
What is Procurement ROI?
Procurement ROI measures the financial return on the investments made by the procurement department, such as the implementation of procurement technology, training programs, and hiring additional staff. It also takes into account the cost savings, improved supplier performance, and other benefits that procurement initiatives deliver to the organization.
Evaluating Procurement Performance
A key metric for assessing the performance of a procurement department is comparing the cost reduction or customer value created against the operating costs of the department. This comparison helps in understanding the efficiency and effectiveness of the procurement process.
The 10 Times Value Generation Benchmark
Successful procurement departments are often characterized by their ability to generate value that is significantly higher than their operational costs. A commonly used benchmark is that a high-performing procurement department should be able to generate 10 times more value than its running costs.
- Cost Reduction: This refers to the direct savings achieved through negotiating better prices, finding more cost-effective suppliers, or optimizing supply chain processes. The cost reduction should be substantial enough to justify the expenses incurred in maintaining the procurement department.
- Customer Value Creation: Beyond cost-saving, procurement can add value by improving product quality, ensuring timely delivery, and fostering innovation through supplier relationships. This enhancement in value directly contributes to customer satisfaction and potentially to increased sales.
- Calculating the Ratio: To calculate the ratio, divide the total value generated (cost savings plus customer value creation) by the total cost of running the procurement department. A ratio greater than 10 indicates that the procurement department is successfully adding more value than its cost.
How is Procurement ROI Calculated?
ROI is calculated by subtracting the total cost of procurement investments from the total benefits delivered by those investments and dividing the result by the total cost of investments. The formula for ROI is:
( Total Benefits – Total Cost of Investments ) / Total Cost of Investments x 100
For example, if a company invests $100,000 in a procurement initiative and generates $150,000 in cost savings and other benefits, the ROI would be:
( $150,000 – $100,000 ) / $100,000 x 100 = 50%
Why is Procurement ROI Essential for Procurement Departments?
ROI is essential for procurement departments for several reasons. First, it helps procurement departments to demonstrate their value to the organization and justify investments in procurement technology, staff, and training programs. By measuring the financial return on procurement initiatives, procurement departments can demonstrate the impact that they have on the organization’s bottom line.
Second, ROI can help procurement departments to prioritize investments and initiatives that deliver the highest ROI. By focusing on projects and initiatives that deliver the highest financial return, procurement departments can optimize their resources and deliver the most value to the organization.
Third, ROI can help procurement departments to align their goals with those of the organization. By measuring the financial impact of procurement initiatives, procurement departments can ensure that their goals and objectives are aligned with the organization’s strategic priorities.
Examples of supporting KPI
Cost Savings
Cost savings are one of the most critical procurement KPIs, as they measure the department’s ability to reduce costs and maximize value. Procurement departments can measure cost savings by comparing the actual cost of goods or services with the estimated cost or the cost of previous purchases. This KPI can help procurement departments to identify cost-saving opportunities, negotiate better deals with suppliers, and optimize the procurement process to reduce costs.
Supplier Performance
Supplier performance is another critical KPI that measures the effectiveness of the procurement department’s relationship with suppliers. Procurement departments can measure supplier performance by tracking metrics such as on-time delivery, quality of goods or services, and compliance with contracts and policies. This KPI can help procurement departments to identify areas where suppliers are performing well and areas where improvements are needed, allowing them to work with suppliers to address any issues and improve performance.
Procurement Cycle Time
Procurement cycle time measures the length of time it takes for the procurement process to be completed, from the identification of a need to the delivery of goods or services. This KPI can help procurement departments to identify bottlenecks in the procurement process, streamline processes, and reduce the time and resources required to complete each procurement cycle.
Purchase Order Accuracy
Purchase order accuracy measures the percentage of purchase orders that are accurate and complete, with no errors or omissions. This KPI can help procurement departments to ensure that orders are processed efficiently, reduce the risk of errors and disputes with suppliers, and maintain compliance with contracts and policies.
Conclusion
Procurement ROI is a critical metric that measures the financial return on procurement investments and the value that procurement delivers to the organization. By calculating procurement ROI, procurement departments can demonstrate their value, prioritize investments, and align their goals with those of the organization. Procurement ROI is an essential tool for procurement departments seeking to optimize their resources and drive success in the procurement process.
Learn more in the EFFSO course about Sourcing KPIs
Note: Illustration created with Chat-GPT on Dec 27, 2023.
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