The manner in which a business carries out its procurement can contribute a great deal to the growth of the company, both in the immediate and in the long term. Thus, companies are always on the lookout for ways that could improve their procurement process. Improvements can take place by implementing new technology or changing vendors and other strategies.
However, these potential improvements come at a price that can sometimes result in companies having to undertake a substantial financial risk. For this reason, before actually implementing these changes, a company takes a step back to determine if the changes being brought in are worth the revenue. In other words, they evaluate if the implementation of these strategies will bring in a significant return on investment.
What is Procurement ROI?
Before expanding on the aspects that are required to evaluate the procurement ROI, one must know what procurement ROI entails. Procurement ROI is a common key performance indicator or KPI. Procurement teams utilize this indicator as a standard of measurement to determine the efficiency of the current process of procurement.
To calculate procurement ROI, employees will have to think beyond just the revenue that is going into procurement. Rather, they will be required to compare department costs with the total savings that are brought in.
Mathematically, the process of calculating the procurement ROI involves the following formula:
Procurement ROI = Cost savings annually / Annual cost of procurement
Evaluating procurement ROI and working towards increasing it has provided significant benefits to companies. According to some studies, by basing the company’s procurement strategy on maximizing procurement ROI, companies were able to reduce their procurement spending by around 8-12% while also accomplishing an annual savings of 2-3%.
Why is it Important to Maximize Procurement ROI?
As mentioned before, evaluating the procurement ROI is a great way to ensure that the company is benefiting while procuring the goods they need or not. In addition to this, procurement teams look to maximize their procurement ROI in an effort to improve the relationship between the company and its stakeholders.
Companies are also in a better position to determine the value of implementing procurement software and applications into the procurement process.
While evaluating strategies to maximize procurement ROI, companies can analyze and further improve upon the following areas:
- Streamline Approval Workflows
Every procurement process consists of several junctions at which approvals are required from the several parties that are involved in the process. During these approvals, a company will make it a point to determine if the requisitions and the orders being made are within the predetermined budget.
Therefore, the company will be able to meet the desired budget and ensure that the company is not partaking in rogue spending. In addition to this, by streamlining the approval workflow, the company is capable of reducing the procurement cycle significantly and making it more efficient.
- Analysis of Spending
Companies also utilize state-of-the-art data analytics tools and artificial intelligence to determine where the revenue is going in the current procurement system. Aspects like prices of goods from the current vendor will undergo scrutiny as the company will look to choose a vendor that provides the best goods at a reasonable price. Thus, the company can focus on cutting costs while preserving the quality of the goods and services they provide to their customers.
The procurement system can sometimes be a convoluted process that causes significant confusion among the employees involved in it. This confusion can result in the company experiencing loss either financially or operationally. Therefore, the team will have better internal control over the procurement process. By accomplishing this, the company can manage the spending better and increase the efficiency of the process as well.
- Utilization of Workforce
A problem that was seen with outdated procurement processes was that a major portion of an employee’s time involved carrying out monotonous manual tasks. Therefore, the employees are unable to devote their time to strategic sourcing that will improve the procurement system and increase the revenue of the company.
- Accessibility of Technology
The introduction of technology can also contribute to the improvement of the procurement system in an operational capacity. At present, most procurement software makes it possible for users to track the procurement system in real-time. Therefore, Companies can monitor aspects like the inventory levels of goods across various locations and get a more comprehensive look at what goods are required.
Strategies to Maximize Procurement ROI
Now that it is clear why maximizing procurement ROI is important for the financial and operational improvement of a company, it is time to delve into how a procurement team can go about maximizing it. While implementing a new strategy in the procurement process, it would be advisable to improve and track the following metrics first:
- Duration of Purchase Cycle
A purchase cycle is defined as the duration between the issuing of a purchase order and the processing of payment for said order. In order to decrease this time, a company will have to determine what aspects of the cycle are causing delays. Reducing this time would mean that the company can function more efficiently and, therefore, provide more goods and services to their customers. As a result, the company can make more sales and receive a significant procurement ROI.
- Percentage of Rebates Obtained
Rebates refer to refunds or discounts that are usually given to an enterprise by a vendor. Therefore, a company should keep an eye on potential opportunities to obtain rebates as it brings a surprising amount of savings in the long run. Procurement teams can also devote their time to altering their agreements with vendors in an effort to obtain the most number of rebates.
- Cost Per Invoice
The measurement of this metric takes place by determining the ratio between the complete cost of accounts payable to the total by the total number of invoices. The process of generating invoices can also be an expensive one as time passes. The reason for this cost is that paper invoices require typing, scanning, mailing, and more.
A company can analyze how much spending is taking place with the generation of every invoice and look to decrease these costs with technological innovations like automation. The introduction of automation in the generation of invoices results in the creation of electronic invoices, which means that there is no need for the aforementioned expenses.
- Amount of E-Invoices
Usually, this metric is calculated by obtaining the ratio of the number of digital invoices generated to the total number of invoices generated. By increasing the number of digital invoices, a company can not only decrease the cost per invoice but document every purchase. In other words, improving this metric will mean that the company is capable of putting a better system of documentation in place. Therefore, audits can take place easily when it is required. That is, companies can analyze their spending better.
Therefore, by keeping track of these metrics periodically, a company can effectively direct its efforts towards maximizing the procurement ROI.
Procurement teams can create extremely effective procurement strategies when they look to maximize the procurement ROI. In almost little to no time, an enterprise can achieve better control, efficiency and reduce procurement risks in their quest to maximize their procurement ROI. Thus, companies will be able to create strategies that improve operational aspects of the company as well.