Procurement Leaders Don't Know The ROI of Spend Analysis...But Do They Really Need To Anyway?

I know I'm going to blog about an article when I feel my blood pressure go up while reading it. Such was the case when I came across the article entitled "Majority of Procurement Leaders Unable to Determine ROI of Spend Analysis, Survey Shows" on Supply & Demand Chain Executive's Web site.

This article is based on a survey that shows, among other things, that "51 percent of respondents were unable to determine the return on investment for spend analysis." The survey data, compiled interestingly enough by a spend analysis vendor, was used in a manner to take a stab at that vendor's competition.

The CEO of that vendor was quoted as saying "The findings from our survey reveal that spend analysis vendors are taking advantage of procurement leaders who, confidentially, admit that they do not know when they should realize a return on investment...Spend analysis is such an important business-critical tool for organizations that [our company] challenges vendors to become more accountable to customers, including transparently stating when their solutions will deliver returns on investment."

OK. So more than half of all respondents can't determine the ROI for spend analysis. That sounds like a bad thing. But, my question is "do they need to?"

Those of you who know me may be surprised that I, of all people, would ask such a question. You know that I am a big advocate of putting together businesses cases and that I stress the need to think like a CFO.

But, in some cases, I say that it is absolutely OK to not know or try to calculate spend analysis ROI.

Think about it this way...

You know those self-checkout machines that have popped up in grocery and other retail stores over the past decade? Why do those retailers buy those machines?

Simple - ROI. By adding those machines, they need fewer employees, so they reduce their expenditures on labor such that, over a period of probably a few years, they spent less on the machine than they would have spent on the labor that the machine replaced.

Now, do you think that the retailers crack open those machines and ask what the ROI of each component is? Unlikely. What matters is the overall ROI of the group of machines.

So see your procurement department as the group of machines and spend analysis as just one component of the machines. That component cannot replace cashiers on its own. But without that component, the machines are not going to be able to function.

Spend analysis, on its own, does not generate cash flow improvements. It allows a procurement department to better identify opportunities to generate cash flow improvements. Therefore, spend analysis does not generate ROI in isolation. If you did a world-class job of analyzing spend, but never sourced, or addressed non-compliance, or rationalized the supply base, spend analysis is worthless.

So what matters (or what should matter) is the ROI of the entire procurement department budget (including salaries, benefits, equipment, facilities, and technology), not the ROI of one component. The procurement leader should have an ROI goal for the department (comprised of a cost savings goal and an expenditure maximum) and the flexibility to choose how to make those expenditures to best position the department to meet or exceed the ROI goal. The procurement leader is likely to view spend analysis as a means of getting the intelligence necessary to maximize cost savings contributions and, on that basis, the investment in spend analysis is justified.

So this type of situation is most likely in the case of a procurement transformation initiative with a new leader. The new leader says "I will improve profits by $x. And I need $y in resources."

Another scenario where ROI may be more easily calculable involves an existing leader trying to make improvements - not necessarily a total transformation. I think back to my days in procurement in the late '90's when spend analytics programs were just starting to develop in the wake of the reverse auction buzz.

My team extracted data from our accounting system and crunched it in Excel spreadsheets and Access databases to turn it into intelligence. The team was actually quite good at it. But we did spend a lot of time on it.

If you found yourself in this situation, you could calculate the amount of time (and, therefore, money) that would be saved from using a spend analysis solution rather than the clunky accounting system data imported into an Access database by a well-paid analyst. If you could replace one or more of the analysts who laboriously manipulated the data, you could calculate a true return on investment. Or, if you had data on savings for a couple of years doing spend analysis the "old way," you could compare your post-spend analysis savings against your pre-spend analysis savings (which would, theoretically, be less) and attribute a certain percentage of the difference to doing spend analysis.

Finally, you could look at some benchmark work that some of the analyst and advisory firms have done regarding spend analysis' impact on cost savings results, although that is not a guarantee that you will achieve the same.

My advice? Spend analysis is a useful tool. It gives procurement teams better quality data, faster. These advantages really assist procurement teams in delivering better results, but they don't produce ROI on their own. So measure the ROI of the entire procurement department (the machine), not of just one technology tool (a component).

For a related method of calculating procurement ROI, please download our FREE whitepaper entitled "Procurement Skills & Profit: The Correlation."

To Your Career,
Charles Dominick, SPSM
President & Chief Procurement Officer
Next Level Purchasing, Inc.
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