How to Conduct a Procurement ROI Analysis

Ah, don’t you love metrics?

They are a certain way to know if things are working out or not, and for procurement purposes that’s a big deal. 

Recently we discussed the importance of procurement performance measurement and learned that it’s indeed possible and recommended to keep an eye on the performance of your procurement activities so you can take action if needed.

Today’s mission?

Go to the next level and focus now on procurement return on investment results. 

But how can you measure the ROI of your procurement processes? 

That’s what procurement ROI analysis is for

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What’s Procurement ROI?

To define what’s procurement ROI, let’s remember what ROI is.

In simple terms, the return on investment metrics let you know how much profit you obtain from a certain investment in numbers. 

Moving to the procurement side of things it quantifies the financial and strategic benefits of your procurement efforts

Calculating your procurement ROI allows you to discover if your procurement activities are bringing the results your company expects or if there’s something that must be done to achieve those goals. 

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Components of Procurement ROI Analysis

• Cost Savings: This assesses the amount of money you saved through negotiated contracts, bulk purchasing, or strategic sourcing. Cost savings are one of the key fundaments of procurement ROI.
• Efficiency Gains: Allows you to measure improvements in procurement cycle times like reduced administrative workloads, or streamlined approval processes.
• Supplier Performance:  This one is to discover how well your suppliers meet quality, delivery, and compliance standards. Keep in mind that high-performing suppliers contribute to better ROI.
• Risk Mitigation: Consider how procurement practices reduce risks related to non-compliance, supplier defaults, or market fluctuations.
• Value Creation: Account for added value like innovation, sustainability initiatives, or improved supplier relationships that promote your business’s long-term goals.

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Okay, all of this sounds really positive, but how can I know exactly what my procurement ROI is

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How to Measure Procurement ROI

Define your goals

Why are you measuring your operations? What’s the end goal? Start by outlining the specific objectives you aim to achieve through procurement. These could include cost reduction, improved supplier relationships, or perhaps having more process efficiency.

Identify relevant metrics

You have the goals, now it’s time to determine the metrics that align with your said targets Examples include total cost savings, procurement cycle times, supplier compliance rates, and spending under management.

Gather data

This step is super important, you won’t get accurate results if your data is not updated or precise so be sure to collect relevant data from your procurement processes, contracts, and supplier records. It’s the only way you can obtain a reliable ROI analysis so consider using procurement software.

Calculate ROI

Use this formula:

Procurement ROI = (Benefits - Costs) / Costs x 100

Here, the benefits are cost savings, value creation, and efficiency gains, while costs encompass procurement salaries, technology investments, and any other operational expenses.

Analyze results

You got the numbers

Now what?

Compare the calculated ROI against industry benchmarks or your historical performance. Identify areas where your procurement processes are excelling or underperforming.

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Use the results to refine your procurement strategies. For instance, if supplier performance is not what you expected, you might focus on improving vendor management practices.

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Challenges in Procurement ROI

Data accuracy

This is a common problem in many procurement situations, having the certainty that your data is indeed accurate can be difficult, especially if you’re working with multiple systems or manual processes. Without reliable information, how can you know that the outcome of the analysis is correct?

Intangible benefits

ROI works with numbers so what about the things that are hard to quantify? Like non-financial benefits such as improved supplier relationships or innovation. Finding the right metric for each one is but is crucial for a full ROI analysis.

Complex supply chains

For businesses with diverse supply chains, consolidating data and tracking performance across multiple suppliers can be a logistical pain, working with procurement software can alleviate the burden.

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Procurement KPIs Related to ROI

Cost Savings: This KPI tracks the direct savings achieved through negotiated contracts, bulk purchasing, and vendor discounts. It is a really important metric that feeds directly into procurement ROI calculations.

Spend Under Management: Useful if you want to measure the percentage of total spend managed by your procurement team. A higher percentage indicates better control over expenditures and strategic procurement practices.

Procurement Cycle Time: You’ll want to go over this one to learn the time it takes to complete the procurement process, from requisition to payment. Faster cycle times often reflect improved efficiency and contribute to ROI.

Supplier Performance: Monitoring supplier delivery times, quality standards, and compliance ensures that vendor relationships positively impact procurement value.

Compliance Rate: This measures adherence to internal procurement policies and external regulatory requirements. A higher compliance rate reduces risks and enhances ROI.

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Trends for Procurement ROI Analysis

Sustainability metrics

As businesses and let’s be honest, the whole world prioritizes sustainability, procurement ROI now includes metrics related to environmental impact and social responsibility.

AI and predictive analytics

Advanced technologies are helping businesses predict ROI outcomes based on historical data and current market trends.

Strategic sourcing

Businesses are shifting from transactional purchasing to strategic sourcing, which emphasizes long-term supplier relationships and value creation.

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