While supply management has elevated its status as a strategic business partner during the coronavirus pandemic, conveying the function’s value to company executives and other stakeholders has traditionally been a challenge for practitioners.
For procurement organizations that can relate, The Monthly Metric has valuable data, courtesy of the annual The Metrics of Supply Management (Cross-Industry) Report by CAPS Research, the Tempe, Arizona-based program in strategic partnership with Institute for Supply Management® (ISM®) and Arizona State University. Consider that the average 10-year stock market return is 9.2 percent, with the S&P 500 a little better as of late, with an average annual return of 13.6 percent between 2010 and 2020.
Those figures generally indicate a sound investment — and provide a compelling comparison when discussing this month’s analytic, supply management ROI. According to CAPS Research’s 2021 metrics report, the average annual supply management ROI (when counting cost reduction and avoidance savings) across all industries is 635.9 percent.
So, for every dollar that a company invests in supply management operating expense, $6.36 comes back. “And that could be the best way to look at it, by turning it into dollars or savings to the company for every dollar invested in the function,” says Geoff Zwemke, Director of Product at CAPS Research. “Supply management ROI may not prominently appear on a performance dashboard, but we’ve heard that this metric helps supply management practitioners communicate value in a language that aligns with the business.
“When you think about the average return on the S&P 500 with dividends reinvested, a return of 636 percent looks really good when you compare expenses to savings.”
Meaning of the Metric
The best way to measure ROI is a simple fraction: Supply management cost savings divided by the function’s operating expense. CAPS Research defines supply management operating expense as all salaries and payroll-related expenses (for example, FICA and benefits), allocated expenses like office space, utilities and information technology, and such unallocated, controllable expenses as travel, training, materials and supplies.
This space has discussed ROI before, detailing that a shortcoming is that it can be adjusted to make procurement look better — primarily through the inclusion of cost avoidance, which some executives and finance departments don’t count as savings.
The Metrics of Supply Management (Cross-Industry) Report addresses such concerns, offering supply management ROI benchmark data with cost avoidance savings, and without. “Many CFOs do not count avoided savings; they want to see hard-dollar reduction savings versus expenses,” Zwemke says. “So, we do offer those benchmarks as well. We’ve found that a company can use the reduction-plus-avoidance for internal benchmarking while publicly reporting ROI with only reduction cost savings.”
In the 2017 CAPS Research report, supply management ROI with cost avoidance was 723.5 percent across industries. With only cost reduction, it was 509.9 percent.
The discrete manufacturing sector tends to have a lower ROI; in the 2017 report, the figure (cost reduction and avoidance) was 304 percent, compared to 891.5 percent for the process manufacturing sector (oil and gas, engineering and construction, food and agriculture, pharmaceuticals, chemical products, utilities and the like) and 838 percent for services businesses. However, a lower ROI does not always indicate a less-mature supply management function. In some cases, Zwemke says, it’s the opposite.
“Discrete manufacturing companies were some of the first to look at supply management as a strategic function, and so some of those organizations began their maturity journey sooner,” he says. “An industry like aerospace and defense has been around for lot of years and in often has to comply with government regulations. They’ve been at this game much longer and the big savings projects that maybe were a one-off or the low-hanging fruit have already been addressed.”
Among selected industries in 2017, ROI (reduction and avoidance) was 231.7 percent in aerospace and defense, 897.8 percent in financial services, 288.6 percent in industrial manufacturing and 1,101.6 percent in utilities. Without cost avoidance, the biggest ROI change was by utilities (to 642.9 percent); the smallest was by industrial manufacturing (246.8 percent).
Lowering Returns, Increasing Expectations
After the one-year reductions and low-hanging fruit are addressed, the law of diminishing returns can set in: As procurement organizations get better at savings, year-over-year percentages level off, and even world-class organizations experience a drop in their ability to reduce spend over time.
What’s more, many supply management activities, including protecting the company from supply-base risk and supporting M&A activity, generate value that doesn’t always translate into cost savings. However, Zwemke says, expectations on procurement to deliver value that is expressed on a balance sheet will never diminish — even if returns do. For example, strategic supplier relationship management can result in more efficient product design and materials, leading to lower commodity and production costs.
In the era of COVID-19, companies have realized, perhaps more than ever, the critical importance of investing in the supply management function. And the ROI metric indicates that allocating those resources is smart business.
“It becomes more of a challenge every year, so a lot of ROI might come through innovation,” he says. “More mature supply management groups start to look at innovation, from supply-based strategic partnerships to engaging suppliers on the front end of new product and service development. Supply management will always have to show tangible savings and value, and mature organizations are always looking for ways to generate it.”
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