Securing Organisational Cost Effectiveness

Failing to regularly analyse how an organisation uses finances to purchase products, services, or works may result in increased prices being paid that are 7 – 9% per annum higher than the open market. To be cost-effective, an organisation must regularly review what it spends.

The analysis is essential to understand how an organisation spends its financial resources before taking the necessary steps to ensure that the resources are spent effectively. Purchasing more by spending less is crucial to maximising the efficiency and effectiveness of an organisation’s financial spend.

Traditionally, it has come under the remit of a procurement function to assist organisations in increasing their cost-effectiveness. However, within low-performing organisations, Procurement is seen as a reactive function as they wait for budget managers to request assistance.

The procurement function will take a more initiative-taking stance within high-performing organisations by regularly providing spend reports to budget managers. This provides budget managers with information on where and how the organisation's financial resources are spent.

By presenting budget managers with regular spending reports, a proactive procurement function can meet with budget managers regularly to review their areas of spend. This will increase the budget managers’ understanding of how financial resources are used by the organisation, especially within the budget managers’ area of responsibility.

Meeting regularly with budget managers allows a procurement function to ensure a financial risk assessment is conducted for all spend areas across the organisation. It provides opportunities to engage periodically with budget managers to suggest potential areas that should be renegotiated or tendered.

A procurement spend report is more detailed than a traditional financial budget report in which organisations manage their budgets. A budget report may contain information on up to sixty areas of spend. A spend report drawn up by procurement aims to provide a more detailed analysis of an organisation’s spending.

The number of defined areas of spend, or “spend categories” as they are better known, will increase and can total more than five hundred. A spending report aims to provide more meaningful data upon which budget managers can base their tender or negotiation decisions.

An organisational-wide commercial plan, usually of two to four years duration, must be formulated to ensure that all areas of an organisation’s spending are regularly reviewed and formally tendered or negotiated as appropriate.

The aim of the commercial plan must be to reduce the bottlenecks in people’s time to undertake tenders or negotiations whilst timing these to coincide with the start/end of current supply contracts.

Ensuring that financial resource use efficiency is maximised can be broken down into several crucial steps. It is essential to take a logical approach to develop a commercial plan to reduce costs. The success of a commercial plan will depend on being able to engage with stakeholders to undertake the appropriate negotiations.

The spend report aims to provide stakeholders and budget managers with relevant, accurate and understandable information to conduct a financial review for their area of responsibility. The information provided will be crucial to obtaining the support of budget managers in undertaking the actions required to increase the effectiveness of organisational spending to reduce costs.

Analysing how financial resources are used is crucial as a starting point to understand how finances are used. The ideal place to start is a list of Supplier Invoices for the last 24 months to ensure that all regular and irregular spending is captured.

The next stage in the financial review is to assign spend categories to each area of Supplier spend. The assignment must accurately depict what the Supplier’s spend is used for. However, where a Suppliers spend is used for purchasing assorted products and services, the spend Category must be assigned to the highest financial value of the various products and services.

The analysis of an organisation’s spend will need to split the spending into different groups and descending levels of priorities, for example:

• Strategic Items?(High Value + High Market Complexity/Supply Risk)
• Leverage Items?(High Value + Low Market Complexity/Supply Risk)
• Bottleneck Items?(Low Value + High Market Complexity/Supply Risk)
• Non-Critical Items?(Low Value + Low Market Complexity/Supply Risk)

It is essential to prioritise the tendering or negotiation of spend categories based on the size of the potential benefit of the outcome of the tender or negotiation. However, it is equally essential to ensure that the risks of legal and health and safety compliance are considered in prioritising the tendering or negotiation of spend categories.

An organisation faces an extremely high risk if they fail to mitigate the commercial failure risks of Supplier purchased products and services. They must ensure that the risk is transferred back to suppliers by having the appropriate customer/supplier contracts in place.

Risk management is concerned with identifying, assessing, and controlling the risks arising from operational supply factors and making decisions that balance the severity of the risk with offsetting the benefits.

Risk management is a systematic approach used to identify, evaluate, and reduce or eliminate the possibility of an unfavourable deviation from an expected outcome. The more common risks to consider are:

• Financial: These can range from an unexpected or unfavourable exchange rate change to a supplier’s bankruptcy. Some financial risks include budget overruns, limitation findings, constructive changes, and missed milestones requiring additional funding.
• Legal and Contractual: These are often related to disputes, interpretations of contractual obligations, or not meeting the Supplier’s terms and conditions requirements. Use or misuse of intellectual property can also be considered a legal
• Health and Safety: is one of the most critical areas of risk management. An organisation must protect its staff, customers, and members of the public from harm and ill health when conducting business activities. Hazard identification and management are essential when selling products but never more critical than when purchasing Supplier services on behalf of customers.

In most organisations, financial and spend management is vested in budget managers; centralising the coordination and control of tendering and negotiation activities is a significant change project. ?

Organisational change is a difficult concept to understand; it is the process by which an organisation changes its structure, strategies, operational methods, or culture. An average of 70% of all change initiatives fail. Change is a fundamental part of an organisation’s evolution.

From a significant project perspective, organisational change has become increasingly prevalent in the past few years as organisations evolve in response to the challenging economic climate. The following can support and sustain the change, not only for the coordination and control of tendering and negotiation activities but for all the major change projects an organisation needs:

• Support: Leaders are influential as they guide direction, course, action, and opinion. To ensure that organisational change efforts have a chance, it is essential to review whether the organisation’s leadership supports the cause. They need “to be” the change they want to see and function as change agents as they lead by example, making others more likely to support the change.
• Engagement: Organisations do not change; their people do. It is essential to involve them in the change process, which is crucial to the success of the change project. Sharing the proposed change's sense of urgency and ownership will increase staff participation and acceptance of the change, making positive shifts to the organisational change culture.
• Education: Managing change through authority is a short-term solution. Education and training provide a solid foundation to carry through organisational change. Training is hugely beneficial to change implementation. Getting people to understand the reasons for the change will benefit the facilitation of change.

As organisations face ever-increasing cost management issues, it is essential that they review their current and future spend requirements. Not carrying out a financial review will invariably increase costs by 7 – 9% per annum, higher than the open market.

Assisting budget managers to understand where and how they spend an organisation’s financial resources will facilitate their ability to set tendering or negotiation priorities to maximise the reductions in costs for their current and future anticipated spending.

However, this requires organisations to become increasingly proactive in reviewing and coordinating their tendering and negotiating activities, which are reliant on having as accurate spend data as possible. Procurement in low-performing organisations wait for budget managers to ask for assistance. In high-performing organisations, procurement provides the spend data for budget managers to become proactive in their tendering and negotiating activities.

More articles can be found at?Procurement and Supply Chain Management Made Simple. A look at procurement and supply chain management issues to assist organisations and people in increasing the quality, efficiency, and effectiveness in the supply of their products and services to customers' delight. ??? Simon Callier. All rights reserved.

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