Of course, for many organisations, in some situations, and for some goods or services, it is an appropriate strategy. But much of what is bought, by most organisations today, is not the simple, repetitive purchases where a basic cost reduction strategy might be the best idea.
In this research paper, we look at the concept that procurement must be prepared to spend more on occasion, because that is what will create the most value for our organisations. Indeed, slavishly following cost reduction strategies leads to perverse outcomes in many cases.
That requires a change of mindset for some people and organisations, as procurement is often still mired in a mindset of cost reduction and savings reporting. Even those functions that talk about value, rather than savings, will often still admit that the key metric on which they are judged is “savings”, however imprecisely that is measured, and however little the “savings” really matter ultimately to shareholder value.
If we think about it for a moment, then it must be value rather than savings that is key. For any organisation, spending with third parties is about obtaining value rather than the simple amount spent. No doubt a buyer somewhere reported impressive ‘savings’ numbers when they purchased suspiciously cheap ‘beef’, that turned out on further analysis to be horsemeat, costing their businesses millions in lost revenues, not to mention lost reputation. Or consider ‘cheap deals’ on software development or on running a marketing campaign – low cost but ineffective suppliers could lead to huge internal inefficiencies, customer dissatisfaction or loss of reputation.
So the obvious conclusion is that it will be appropriate at times to spend more money buying particular goods or services than we have to – it is the right decision not to buy the lowest cost option. Every experienced procurement practitioner will agree with that; and yet behaviours and indeed measures of procurement success do not always reflect that!
In this paper, we look at three specific situations where it makes perfect sense to spend more rather than less, starting with the basic issue of whole life costs then moving into more complex cases. The paper provides some of the theoretical economic underpinning of this argument for the more complex cases, where the benefit of spending more is not so direct, but does have a consequential effect on shareholder value.
As an example, the paper looks at buying marketing services, and explores how the “return curve” leads to interesting conclusions about when it is right to spend more, and even suggests what should be done with savings created from better buying. That gives an answer to the old question – if we find a way of saving money from the marketing director’s budget, should he or she be allowed to re-invest that, or should it be returned to the CFO? The paper answers that, given certain assumptions, based on analysis rather than “feel”.
The paper is free to download here (requires simple registration).