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July 26, 2016

Savings Trades One Opportunity for Another (Series 4 of 5)

When I first started this series of posts, I mentioned that it was in response to the thoughts Kelly Barner shared on procurement’s hierarchy of needs: first savings, then compliance, moving on to risk and finally — collaboration. So, for procurement, savings is the most fundamental need. No other goals or objectives can realistically be addressed unless the organization’s spend is being efficiently negotiated and managed.

Now, before you start working on an angry comment to me in response to my thoughts (that’s for the procurement folks who happened to have checked in to see what a CFO thinks about savings…), let me be perfectly clear:

I, John Nolan, want to go on the record as a CFO stating that finance knows procurement is essential to realizing far more than just savings. Finance’s primary need is compliance and, I’d like to believe, following that line we are capable of moving on to risk, savings and collaboration.

Okay? Let’s move on.

The key point to make about finance’s perspective on savings is that there is more than one kind of savings — and we’re not equally interested in them all.

From our perspective, the best savings are what I describe as “structural.” This means that they are related to expense categories that will continue to generate savings over time as opposed to just generating a one-time reduction in costs through spend avoidance.

For instance, depending upon your industry and what your company produces, redefining specifications so that they require less customization, substituting a less expensive material for a commonly used component or rationalizing service levels — these sorts of changes shift the cost model that drives how we price our products as well as the profit margins we are able to generate.

To that point, finance is concerned with the top line, the bottom line and all of the lines in between. And, as I’ve mentioned in previous posts, time is a key element in finance. We understand that structural savings often involve longer-term contracts, commitments or investments. That is one way of looking at savings. When you move away from what you have to spend in order to save, and look at the same decision in terms of resource allocation, the context of the choice changes.

The flip side of what our company has to spend in order to save is identifying the cost of the associated commitment. Each commitment comes with both a savings opportunity and an opportunity cost. Both opportunities have to make sense for finance to view the deal favorably. In some cases, the opportunity cost is hard to express in straight dollars. The cost may be better expressed in terms of the flexibility the company has to trade to secure the lower pricing that seems so appealing in the short term. And the further towards the investment horizon finance has to look in order to assess the value of an agreement, the less confident we will be that the promise of savings outweighs the total cost.

Generally speaking, taking costs out of a category is always better—it’s another way to look at savings; but we can never allow ourselves to lose sight of the top line. Creating shareholder value requires a firm grasp on both revenue growth and profitability, or the top and bottom lines. Each time procurement has to weigh in on a decision with savings impact, finance must take a category-specific view as well as one that recognizes all of the other investment opportunities currently at hand.

* Get the big picture from a CFO’s perspective. Check out our previous blogs in which we’ve discussed the importance of timing, compliance and risk. And stay tuned for our next blog on collaboration.

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