Focus on the value contribution of purchasing, especially in tough economic times

Due to a volatile market environment and increasing competitive pressure, many companies are once again turning their attention to purchasing initiatives.

Designing and acting in purchasing requires usable transparency in figures, data, and facts. In a purchasing study entitled “What really matters to the CFO – Expectations of purchasing” by Horvath & Partners, the overriding expectation is, not for the first time, “Achieving savings that have an impact on the bottom line.” So far, so familiar. However, although over 90% of CFOs say this is a priority issue, only 50% say it has been implemented to any significant extent. Where does this discrepancy come from? In more than 25 years of project experience, we have yet to meet a purchasing manager who does not have savings at the top of their agenda, so it seems reasonable to assume that part of this discrepancy lies in the communication between purchasing and the CFO.

The term “savings” as commonly used in purchasing does not necessarily include savings that affect the income statement. Process savings, cost avoidance, or savings compared to offers are part of the purchasing manager’s repertoire, but often have no effect on the income statement and are nevertheless classified as “savings.” If, on top of that, the purchasing department excludes price increases based on exchange rate fluctuations, raw material indices, or technical changes from the reported material cost analysis, even though these naturally influence the company’s results, it is no wonder that the “savings world” of purchasing is often not understood or accepted at management level. Therefore, the transparency so often demanded by purchasing must first refer to the definition of what is meant by savings that affect the income statement.

Breakdown of material costs

Everything that happens in purchasing is reflected in figures and has an impact on the company’s targets: P&L, liquidity, budget, or working capital. These value-related effects must be reported accurately, based on accounting entries. This means that every price increase must first be recognized by purchasing as such and reported as a change in material costs, rather than being deducted in advance as “not influenced by purchasing.” Taking the next step and breaking down the determined material cost development into its influencing factors greatly expands the scope for action available to purchasers. The existing figures available to purchasing from invoices, orders, and master data enable this splitting of figures in almost every ERP system. This paves the way for precisely tracking the extent to which raw material surcharges, technical changes, special freight charges, currency fluctuations, single sourcing, scheduling behavior, and quantity dependencies influence invoice prices and thus changes in material costs. This breakdown of material costs, which is a milestone for any ambitious purchasing department, enables purchasing managers to leverage their control function in a value-adding way.

For a precise view of the future

The procedure described here considers the purchasing-related development of material costs, as the purchasing effect is given when the invoice is posted, but not yet the effect on the income statement. The effect on the income statement is only realized when the material is removed from stock, over which purchasing has no influence. Therefore, inventory and withdrawal cycles must be incorporated into this calculation in order to actually determine the transfer of purchasing activities to the income statement. As much as many companies are working on measuring purchasing success in order to calculate the impact of past purchasing activities on today’s income statement, a CFO expects no less emphasis on looking ahead:

  • Where are future risks in price development, which factors influencing material costs are controllable, and which are very difficult to control?
  • How high is the fixed purchasing volume and what capacities are secured?

In addition to the natural uncertainties surrounding price, currency, and market developments, purchasing also has to contend with the problem of volume uncertainty. Accurate forecasts of future volumes for purchased components are the exception rather than the rule. Most purchasers have to make do with the quantities of the last twelve months, even though it is not that difficult to determine secondary requirements based on the breakdown of parts lists and planned sales quantities.

Focus on the end product

The solution to inherent uncertainty lies in the use of simulation variants. This approach is considered unfeasible in most purchasing departments due to the large amounts of data involved. However, modern analysis software is able to quickly and effectively use planning frameworks for simulation purposes. The result is not a single planning point, but a value range that is highly likely to accurately cover price developments, liquidity developments, market indices, budgets, and other influencing factors. Combined with a quarterly review of existing plans, supplemented by new market insights and price agreements, and a regular comparison of actual and target prices, quantities, and quotas, including a meaningful machine forecast, purchasing planning becomes a proactive supporter of agile action in purchasing. Anyone in purchasing who wants to translate transparent analysis values of their past actions and planning targets into activities, monitor and control them, will inevitably have to deal with the topic of initiative management. In purchasing practice, Excel is usually used for this purpose, which naturally quickly reaches its limits. Since there is generally no integration of content and values into existing analysis and reporting systems, much of the work has to be searched for and stored manually. The requirement for purchasing in this regard is a helpful connection to the existing data world that enables communication with suppliers and internally with project participants. This allows milestones to be defined, degrees of difficulty to be tracked, planned measures to be compared with actual values, and EBIT effectiveness and carry-over effects to be displayed. The much-vaunted agility of purchasing is made comprehensible and reportable for every third party in the form of informative dashboards that are available at the touch of a button, thus serving as a genuine control lever.

Essential for purchasing in the future

In the hustle and bustle of everyday life, it is often forgotten that all purchasing activities should be focused on the products sold.

  • How do market price changes affect which products?
  • What product cost reductions are possible if alternative sources of supply are sought?
  • How should target prices be evaluated from a purchasing perspective?
  • How should the interaction between technical changes and price changes over time be assessed?

As a software provider, we encounter all these questions more and more frequently, and the solutions we offer expand the horizons of purchasing. For every purchaser, this means learning new things and making better use of their market and technical knowledge in the product environment. The more difficult the market environment becomes for a company, the more purchasing is expected to play an even greater role as an active value driver within the company.

“Everything that happens in purchasing is reflected in figures and has an impact on the company’s targets for profit and loss, liquidity, budget, and working capital. These value-related effects must be reported accurately, based on accounting entries.”

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