Most Procurement teams are measured on the value of the cost savings they can secure. Yet many run into challenges when baselining the budget or calculating the savings that have been secured. 

There are some basic guidelines that you can use to baseline your budget (even if you do not have a formal budget in place) and to show how you can calculate a auditable savings figure. 

Baselining the budget 

For existing requirements (e.g. replacing a contract like for like) this is relatively easy. The total of the previous annual budget can be used to show the budget for the full contract. For example, if the previous service was £200,000 per year and you wish to introduce a new 5-year contract, your budget is 5 * £200,000 = £1,000,000. The total value of the contract you are then negotiating will be subtracted from this to indicate your cost saving. 

For new requirements that have no attached budget, there are a variety of ways to establish one:

1. A business case or sign off process to allow the project to proceed may well have included high level costings agreed by Finance. This can be used as the budget baseline. 
2. When quotes or bids are submitted for the project, remove any outlying cost of more than 20% above the next highest quote and average the remaining quotes. If there are no outlying quotes, take the average of the total quotes as your baseline. 
3. In a single source situation, the baseline can be taken as the list price or the price at which procurement are involved to continue the negotiation. 

Once you have a baseline, this needs to be signed off by your key customer and crucially, whoever is signing off the auditable savings at the end of the process, usually Finance. 

Calculating the saving

Calculating and reporting savings delivered is equally important as establishing the baseline. It can provide a basic measure for the effectiveness of the Procurement team, contributes to how you measure the performance of your business and aids in risk management. A clear method of calculating and reporting savings is needed to secure these benefits. 

Situation  

A 2-year contract is renewed at £326,000 per year started on 1 August 2021. The previous contract cost £350,000 per year. This generates a saving of £48,000 across the 2-year period (£350,000 - £326,000 = £24,000 x 2 years = £48,000). 

One way of recording this saving is to aggregate it as a total saving and report it as a single figure. This shows the overall savings from a single contract and overall impact on the budget.  

However, it can also be reported as savings made in the year they are realised from the budget. 

Using the same example, a contract commencing on 1 August 2021, for a 2-year term, gives a span of 3 financial years: 2021-22, 2022-23 and 2023-24. The in-year saving for each year is calculated as follows: 

In-year saving = Total saving x (months in financial year/contract duration in months)

The total saving is the same but reporting savings in this way enables the ability to track the reduction in budget year on year more accurately and gives Finance the option to reduce annual budgets based on audited and approved savings and deliver cash back to the bottom line.

It may also give the option for a central pot that can be used to fund projects or contracts that had not been budgeted for but are now affordable due to the savings made in other areas.

When linking Procurement savings to Budgets, be very careful to have a collaborative and agreed process in place across Finance, Procurement and business operations. Linking savings to Budgets is the optimal outcome for transparency, credibility and real savings - but the process to do so can be fraught with complexity, sensitivity and process to implement and maintain, so learn from others before enacting this initiative.

Whether or not you use savings as a KPI to measure your Procurement team, it is critical that you understand where your savings are coming from and when and how they will affect budgets. This gives you the power to make informed decisions about the future of your business and provides a financial metric for overall business performance.   

As an example, below is a list of just a few examples of Procurement saving calculations, across sectors and industries, to determine a benchmark or saving metric:

“Savings” are typically condensed to two types: Hard Savings and Soft Savings. Hard savings based on tangible reduction in internal or external costs and Soft Savings recognised as additional value from related services or goods.

• New Price vs last year price
• New price vs index price
• New price vs spot price
• New price vs should cost modelling
• New price vs 6 month rolling average
• Benchmark vs competition
• Baseline price reduction
• Waste reduction
• Rebates
• Demand reduction
• Reduction in inventory
• Invoice error reduction
• Reduction vs quote
• Volume based discount
• Logistics efficiency gain
• End of life asset recovery
• Reduction in life cycle cost
• Reduction in maverick spend
• Working capital/payment terms improvement
• Performance based contracts
• Reduction in transaction costs
• Cost avoidance
• Reduction in total cost of ownership
• Savings from standardised components

If you are not sure how to start tracking your savings, or your savings methodology needs reviewing, 7 Step Solutions would be happy to help.