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Inventory: The Link Between Negotiated and Realized Savings

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Historically, procurement has been measured on our ability to negotiate savings. Conceptually, this makes perfect sense as it aligns with our primary reason for existing (which is to manage costs before they are incurred) as well as the focus of the time we spend working with suppliers before agreements are in place.

The trouble with negotiated savings is that they are just projections. They are a best guess on bottom line impact that combines a known price with a guess on demand quantities into something of a fuzzy number. And the more time procurement spends working with – and in some cases for – finance, the clearer it becomes that even the best projections do not equal results. There is so much that happens between contract signature and expiration, and although procurement has less and less responsibility for the act of buying, those purchasing decisions are what create the final measure of our actual performance.

Depending on what industry you work in, many of the ‘happenings’ during the life of a contract are represented by inventory. The metrics associated with inventory - how much is ordered, how much is paid, whether it arrives on time, if it gets used, and if projections were accurate – might as well be a direct explanation for the delta (whether positive or negative) between negotiated and realized savings. How procurement chooses to manage inventory, and all of the processes that bring it into the company, ultimately determine our control over the savings delta and our measurable impact on the bottom line.

Procurement doesn’t usually have sole responsibility for inventory management, but as available technology becomes more advanced and increasingly analytical, we must be prepared to look for the direct connections between inventory management and our own objectives.

 

Looking Beyond Price to Managed Spend

When procurement manages a category, we are usually so focused on collecting historical prices and quantities for the sake of sourcing and negotiation that we do not stop to question if the quantities being ordered are appropriate. For instance, what percent of the spend in each category is associated with safety stock as opposed to inventory that will almost certainly end up in a client’s hands? If too much of the spend on each item is associated with safety stock, it is absolutely within procurement’s purview to ask why. The answer may be poor forecasts, unpredictable demand, or less predictable suppliers, but procurement can get involved to address the problem and ensure that the total spend is based on actual need. Any over commitment of company resources to inventory, especially when the root cause of the inflated demand is related to process or quality issues, is inefficient and may unnecessarily jeopardize the working capital strategy or cash position of the organization.

 

(Artificial) Intelligence Can Be Genuinely Smart

The key to effective inventory management is precision: in demand estimation, in replenishment timing, and in order requirements. Falling short in any of these categories can either add costs or delay production in ways that are most certainly at odds with procurement’s efficiency mandate. Achieving precision is the perfect opportunity to introduce technology designed to track data and enforce ordering constraints based on pre-determined rules and requirements. And that doesn’t have to mean turning over inventory management to the robots. This intelligence is about putting relevant facts in front of the person placing an order in the moment they are placing it so that decisions are made based on fact rather than shaky estimates or intuition.

 

Fixed v. In Flux Factors

Compounding the difficulty associated with achieving precision is the fact that inventory demand drivers are dynamic. While order requirements are likely to be static during the course of a contract, many of the factors influencing demand are constantly in flux. In these cases, having the ability to consult cost-optimized order fulfillment proposals will not only speed up the decision making process, it will also improve the decisions that are made. Any opportunity procurement gets to manage the total cost of a category, which has to include costs associated with inefficient ordering, puts us one step closer to the increased realized savings we seek.

 

Closing the Loop on Supplier Performance

The most natural reason for procurement to increase our involvement in inventory management is the data that supports evaluations of supplier performance. Punctuality and quality are two measures of performance that do not require a complex legal reading of contract terms and conditions. Usually a supplier is either meeting expectations or they are not, and this is most clearly evidenced in the data associated with their delivery performance. Better yet, don’t try to explain; show the supplier their own performance record through reporting that allows them to identify and resolve problems and then protect the business they worked so hard to win.

Focusing too much on negotiated savings has created a disconnect between procurement’s performance metrics and our ability to build influence in the organization. When negotiated savings can not be tracked or tied to the bottom line, every document referencing them hurts our credibility and introduces questions about the effectiveness of our processes.

Inventory driven businesses should count themselves fortunate that they have a physical representation of procurement’s impact in addition to a whole range of ways to drive realized savings. With intelligent automation, more accurate forecasts, and reduced data maintenance there is no disputing the fact that better inventory management means more of those negotiated savings make the transition to realized savings.

 

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