How to Bridge the Gap between Contracted Sourcing Net Savings and Actual Realized Savings

Abstract

Background
Many companies today spend more than half of their sales turnover on purchased parts and services. One dollar saved in purchasing costs contributes straight to the bottom line of the company in theory. Besides from accounting, sourcing and purchasing activities contribute to risk management and value improvement. (Van Weele, 2014) Still, many practical challenges of implementing balanced performance measurement remain within sourcing and accounting-based information remains to play an important role in strategic planning and monitoring. (Holmberg, 2000; Monczka et al, 2010)

Problem Description
Currently reported savings from the sourcing department at Sandvik can deviate from the key financial figures a business controller analyzes. In other words, one dollar saved in sourcing costs does not necessarily correlate directly with one dollar saved in EBIT, earnings before interest and taxes.

The problem of a gap between reported sourcing net savings in contracts and realized savings seen in EBIT, is not specific for Sandvik. On average, less than 50 percent of the reported savings from sourcing departments are able to be analyzed by management executives in companies. (Artur D. Little, 2009).

Purpose
The purpose of this study is to the describe characteristics of the gap between contracted sourcing net savings and actual realized savings hitting the bottom line, map potential reasons behind the gap at Sandvik and give recommendations to Sandvik about how the gap can be bridged.

Method
A focused interview study at five companies with inspiration from case study research combined with a literature review, provided a foundation for the work at Sandvik to fulfill the purpose.

Theoretical Framework
The gap is characterized by that finance are questioning the reported savings from sourcing, which deviates from savings seen in EBIT.

Potential reasons for the gap are non-compliance, time lagging, non-alignment between business plan and sourcing strategy, standard cost, market factors and different definitions of net savings.

In order to bridge the gap, theory suggests measure compliance and present market factors.

Conclusions
The gap between contracted sourcing net savings and actual realized savings hitting the bottom line seems to be characterized by that it is discussed by finance and sourcing at several companies. It seems to be more discussed in tougher market situations, when sourcing is pressured to achieve savings. The gap seems to reflect that it is hard to capture the real savings; since it is challenging to connect the real savings with the real spend at most companies. The gap seems to exist less at successful companies in competitive industries with mature purchasing organizations.

Potential reasons for the gap at Sandvik seems to be cost increases due to various root causes (some can be affected by sourcing and the order function, while others require cross-functional work), time lagging (takes time before a realized savings is visible in EBIT), a difference between estimated and actual purchased volume (the quality of the reported net savings), and standard cost (associated with accounting)

Bridging activities for all potential reasons were not found, such as time lagging and standard cost. Instead, recommended bridging activities for Sandvik concern controlling the spend, which is avoid cost increases on purchased material by sourcing and the order functions continuing to identify reasons for cost increases and defining actions to be taken, but also expand this work to include other departments. Improve the quality of the reported net savings by sourcing updating the net savings more frequently with actual volume, report cost increases more often, align the update frequency with business controllers, and continue the validations of net savings with business controllers. Finally, follow up the implementation of net savings by enabling time for sourcing and the order functions to align more on a daily basis, continue to track average purchasing prices for direct material on local site level and awareness should be taken that measuring drives administration, requiring time and resources.

Popular Abstract

Master Thesis Title: How to Bridge the Gap between Sourcing Net Savings and Actual Realized Savings
Author: Alexandra Wikström
Department of Industrial Management and Logistics, Faculty of Engineering, Lund University

Purchasing and sourcing activities contribute and influence the financial performance of companies to a high extent, since many companies today spend more than half of their sales turnover on purchased parts and services. In theory, one dollar saved in purchasing costs is one dollar saved in the company result. However, the study in the master thesis indicates that this is not the case in practice at several companies.

The purpose of the master thesis was to describe characteristics of a gap between reported sourcing savings and actual savings seen in the company result, map potential reasons for it and give recommendations about how the gap can be bridged. The method used in the master thesis was a focused interview study inspired from case study research at several companies.

The study in the master thesis showed that the gap seems to be discussed by the finance and sourcing departments at several companies and it seems to be more discussed in tougher market situations (when sourcing departments are pressured to achieve savings). The gap seems to reflect that it is hard to capture the real savings; since it is challenging to connect the real savings with the real spend at most companies. The gap seems to exist less at successful companies in competitive industries with mature purchasing and sourcing organizations.

There does not seem to be one set of potential reasons for the gap at all interviewed companies. However, it seems like the major potential reason is cost increases on purchased material due to various underlying reasons. Some underlying reasons can be affected by sourcing like non-compliance (not ordering from preferred supplier), approved and non-approved cost increases from suppliers, while other require cross-functional actions. Other potential reasons for the gap seems to be time delay (time lagging) for a reported net saving to be visible in the company result, a difference between estimated and actual purchased volume and standard cost associated with estimated cost used in accounting.

Actions for bridging all potential reasons were not found. Time lagging and standard cost did not have any suggested bridging activities. The following actions (addressing cost increases and difference in reported and actual volume) were recommended in the master thesis to bridge the gap:

- Improve the quality of the reported sourcing savings
- Follow up that the sourcing savings are implemented
- Control the spend in terms of avoiding cost increases on purchased material

• author: Wikström, Alexandra
• supervisor: Andreas Norrman
• organization: Engineering Logistics
• course: MTT820 20161
• year: 2016
• type: H2 - Master's Degree (Two Years)
• subject: Technology and Engineering
• keywords: Bottom line, EBIT, Sourcing net savings, Financial sourcing key performance indicators, Purchasing development, Cost increases, Non-compliance
• report number: 5806
• language: English
• id: 8881671
• date added to LUP: 2016-06-15 14:28:10
• date last changed: 2016-06-15 14:28:10