Quick and dirty financial model: Efficient RFT processes v. contract management: Part 1
I've noticed that companies with under-resourced procurement departments are often so overwhelmed with day-to-day vendor management issues that they roll-over contracts rather than go to market. I've decided to do a quick and dirty model showing the cost of not going to market.
The assumptions in the model below are that the procurement department manages $100 in annual spend. If they manage contracts poorly, their year-on-year costs will increase by 1% (Poor CM column). If they manage contracts well, initially their year on year costs will decrease by 4%, but over time, as they mature as a purchasing group, their year on year cost decreases will drop to 1% (Good CM column).
The "Poor CM" column shows the company will spend $1,281 over 12 years if they never go to market and do a poor job of managing their suppliers.
The "Good CM" column shows the company will spend $988 (23% savings over Poor CM) over 12 years if they never go to market but do a good job of managing their suppliers and achieving year on year cost reductions. A fiction, I know, but a convenient one for the purposes of the model.
The "Periodic RFT" column shows the company will spend $1,035 (19% savings over Poor CM) over 12 years if they go to market every three years and achieve the same reduction as the "Good CM" column, but do a poor job of managing their contracts and experience the same annual year on year increases as the "Poor CM" column.
This indicates that an under-resourced procurement department who cannot focus on contract management can achieve significant results simply through efficient and regular tendering.
Interestingly, if the procurement department goes to market every six years instead of every three years, the savings drop from 19% down to 14%.
Send me an email if you'd like a copy of the spreadsheet.
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Hi Dave,
This is an interesting model you created. I did a post on PurchaseRealm to alert my readers that you came up with this.
It is so easy for Buyers to just allow those contracts to renew or just go month to month. (Thank goodness for auto-renewal clauses, right?) You’ve made a good case as to why that is not the best option.
One solution to being overwhelmed by the day-to-day volume of work problem would be to have some Buyers who are responsible at the contract level while others are responsible on the tactical level. That way, the contract would be seen as equally important, rather than a chore lower on the priority list.
Hi Matthew; You’re right. It’s critical to separate tactical purchasing from strategic sourcing. The two activities require entirely different approaches. Purchasing is all about the “now” whilst sourcing is about the “then”. When combined, the immediacy of tactical purchasing tends to overwhelm the remoteness of strategic sourcing. By the way, it’s Doug, not Dave
Does anyone know where I can find information on how to set up a vendor management office? What I mean is “what are the actual steps you would take” I am sure step 1 is identify vendors that will be part of this new initiative, Thanks for the help.