Your company’s new year’s resolution – on your behalf – will be clear this year. Procurement needs to produce more savings than last year! More people will adopt sophisticated TCO (total cost of ownership) models to analyse, improve and measure costs. And if not now, you will be incentivised on reductions achieved. Being paid for savings achieved. Is that really such a good thing?

Many buyers have said: “If only I could only be paid a percentage of what we save … If sales people get paid on revenue why can’t we get a percentage of profits created”.
Upon which the accounts department would say wisely “But its your job! You’re getting paid to do it.” They also make that comment about sales people. Experienced MD’s will know that to pay sales people a good basic with no or a small incentive is a good recipe for reducing sales. (At which time they’ll have to downsize the accounts department. This is called what goes around, comes around!) Most sales people just perform much better when rewarded well.
So what would happen if buyers were obscenely rewarded? How much more profit would the company achieve? Only you can answer that question. But I have a suspicion it might be cause “slight” improvement on the bottom line.

How she got her cut of the action
Why isn’t this done more often? I know it does happen though. I met a very shrewd procurement negotiator in her sixties while lecturing on strategic sourcing a while ago. She negotiated a deal where she gets 10% of savings achieved on the spend under her control. (Warren Buffet likes to say that “You can’t teach a new dog old tricks”. Maybe the younger, more sophisticated crowd can learn from the old trick generation!
How does she get measured? By the size of the rebate that she collects on behalf of the company. And thats a good deal that works for that specific, smaller company where she is close to the MD.
In larger companies everyone will have a reason why you can’t claim the savings.”Its my budget to start with. DUH?” And also” if I make a decision that reduces cost how can you possibly lay claim to it.”
And the simple mechanism of rebates only work on some specific commodities in some companies.
So one of the key reasons why incentives couldn’t work in the past is beacuse of measurement and agreeing who was responsible for the benefit.

The great equaliser: Modeling TCO
Using TCO Models to calculate total cost now and even years from now when certain drivers (e.g. Inflation or commodity prices) would have changed, give the company the ability to track performance. If developed before a new sourcing strategy, there will be no abiguity about whether or not the savings are valid. And whether or not purchasing can lay claim to the savings. Which is a good thing.
But some of our readers will know that after a year or two on this programme, it becomes a “bit” more difficult to extract more savings. Especially when last year’s savings become the bencmark that needs to be maintained and any new savings is over and above last years performance. Even if last year resulted in a saving for this year.

Over time this becomes a race to the bottom – Relevance Lost?
Although it takes a while, procurement people, at some point, will experience a conflict between the need to reduce costs (what they are being measured on) and the needs of the business (what the other departments are being measured on) and even the needs of the local area / country in which your company is based. (see article on preferential procurement vs TCO)
An interesting example of this dynamic is currently being experienced in the South African Forestry industry. As a result of some shrewd maneuvering a large US Based company together with local partners have cornered a substantial part of the local Pine (soft wood) supply market. This has resulted in smaller companies having to buy pine at up to 100% more. Many of the smaller sawmills are closing since

a. they can’t get wood or
b. their customers won’t pay for the more expensive end product.
A small sawmill employs about 200 rural people who in turn support about 1200 dependents.
This strategy obviously has tremendous advantages from a TCO perspective for the larger players and significant bonusses will be paid as a result.
But the effect on the local population and the areas involved will be serious.

A balanced incentive programme needed – at the commodity level
In 2006 it would be a good idea if forward thinking companies start rewarding purchasing based on achieving strategic objectives of which TCO will be one. And depending on the commodity it might not even be the major consideration.Other targets should include whatever is important for the company to achieve. Items such as innovation, quality, preferential procurement, cycle time etc.
Even strategic issues such as tying up a key supplier, finding new / alternative sources of supply or reducing risk.
Out of a hundred points the objectives for measuring the commodity (depending on the type of item or service) could look like this:

Comodity team measurement framework
TCO – 40 points
Preferential procurement – 10 points
Reducing risk – 20 points
Innovation – 20 Points
Reducing cycle time – 10 points
Total: 100 points

The commodity team can then come up with a strategy that, while empasizing TCO, also contributes the larger picture.
If you haven’t received my best wishes for 2006 yet, please have a look at the new years contract!