Let’s get straight to it: annualized savings is a vanity metric.
It feels great to save the business millions in spend year-on-year. It looks great to see the annualized savings bar rise above the target line.
But annualized savings is a root cause to many common procurement issues…
The case against annualized savings
To make an impact on an annualized savings metric, you go for the biggest savings pot. Easy, right?
So, you focus on getting your $4 million logistics saving initiative signed off this year. It is by far the biggest opportunity and ensures you deliver against your target, even if it seems to be complex to implement. It dwarves all other initiatives, including an $800k saving in software licenses delivered by simply changing vendors, which has dropped a long way down in priority order.
They are presented to finance like this and signed-off:
But once we have promised these savings, the gap between procurement and the rest of the business starts to emerge.
In an annualized savings world, both projects above can be compared without having to worry about when the savings are delivered. In fact, according to annualized savings, the logistics initiative has the exact same delivery date as the software license switch-over. It also doesn’t matter that we know the logistics project has a longer ramp-up and is higher risk to implement. We simply explain them both as single figures.
When the finance team attempts to add up those annualized savings and verify it has been delivered, they inevitably get a number they cannot find in the P&L at any point in time. They are looking for $4.8 million but cannot find it because both projects are actually delivering savings at different rates and start at different points in time.
Annualized savings has masked this entirely. Finance feels confused - and no wonder.
It is likely that savings are already leaking from the logistics initiative completely unknown to either procurement or finance. As changing buying processes take time to embed and new suppliers are learning the level of service/quality demanded, there is a likelihood that non-compliant spend creeps in. How can we remedy this?
Close the gap by forecasting savings over time
Now let’s be honest with ourselves: we knew these initiatives didn’t look the same when we started them. We knew they wouldn’t both immediately deliver 100% of possible savings, with zero chance of leakage.
What we hid by using annualized savings in our hypothetical scenario was any sense of time.
By adding time into our metric, we can see that the two projects look substantially different:
A totally different picture.
In year 1, the software licenses initiative is expected to substantially outperform the logistics initiative – the ramp-up is short, as it is a simple change in billing, while the logistics initiative is slow to start up.
In fact, by the end of year 2, software license savings makes up 60% of the total savings to date – a stark contrast to when we looked only at annualized savings, which suggested savings in logistics would significantly outperform those in software licenses.
Now show this to finance, and they can start to see the true picture. When they look for the savings in 12 months-time they are much more likely to find a total of $900k, compared to the $4.8 million annualized savings promised to them.
Imagine how much easier the conversation between finance and procurement can be now both sides are working in the same language for savings.
Go further, address leakage by measuring savings over time
Once you have a time dimension, you can begin to measure the savings you are delivering and actively address any leakage that may be occurring.
Forecasting savings at month level allows you to retrospect whether you are achieving as expected and take actions that sustain your expected savings. It is a small amount of extra work to add in detail that elevates the capability you have as procurement to ensure you are delivering real, measurable value.
At Efficio, we focus on ensuring our savings can be tracked. We use our proprietary project lifecycle management tool, Pulse, to forecast at the right level of detail and set up tracking for each initiative. The resulting visibility helps to ensure that our savings do hit the bottom line, as seen at MEC3, and closes that gap between procurement and finance
So, consider stepping away from the trap of annualized savings, forecast your projects across months and years, and begin to bridge the gap between procurement and the rest of the business.