Procurement: Delivering Improved Company Valuation

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Procurement: Delivering Improved Company Valuation

Procurement: Delivering Improved Company ValuationImproving an organisation’s procurement brings benefitsfar beyond saving money or raising quality standards. It candramatically improve the valuation of the organisationas a whole.

AuthorDaniel QuinnSenior Account DirectorBravoSolutionJuly 2011


Improving an organisation’s procurement brings benefits far beyond saving money or raising quality standards. It can dramatically improve the valuation of the organisation as a whole

At a time when many companies are facing tough times, procurement is becoming recognised as an essential component of corporate strategy for leading organisations. It is well understood by CEOs and CFOs that buying more efficiently can bring big cash savings and more revenue through improved quality of goods and services as well as more reliable supply chains, but its strategic impact is now starting to elevate CPOs up the corporate agenda.

Procurement projects are traditionally aimed at reducing the purchase price of goods and services and improving on the value delivered, through for example, increased functionality or increased quality of service. They often produce very quick wins which can amount to millions of pounds of value for larger organisations.Cashable savings can often be identified for a wide range of categories including indirect items (office supplies, telecoms, facilities for example), direct categories (raw materials, front line services etc) and now even to very complex categories like transportation or construction, traditionally considered extremely difficult to manage. At the same time, the supplier base can be streamlined and procurement processes rationalised, producing further immediate benefits in terms of lower transaction and administration costs.

Longer term benefitsA systematic drive to improve procurement skills, process and infrastructure can deliver much more far-reaching benefits to customers and investors. There are further economic and strategic prizes to be won, whether you work in private, public or not-for-profit sectors. They may not be so immediately obvious, however they are likely to be of far greater value in the longer term. In fact, analysts have seen that the right blend of skills, process, and technology improves a company’s financial performance by 30 pence on every pound spent. Source: AMR/Gartner; Reaching Sourcing Excellence, Part 1: How To Keep 30 Cents of Every Dollar Spent.

Saving money on third-party spend and streamlining procurement processes can often deliver savings to an organisation’s Profit and Loss (P&L) “bottom line” far more quickly and effectively than improving the top line by increasing sales. By saving money through the traditional procurement tactics of aggregation (bundling spend together), rationalisation (reducing the number of suppliers) and negotiation (re-structuring or renegotiating contracts), profitability can be improved dramatically.

Buying into the benefits

The dynamics of transforming business value through procurement can be explored in a simple example. Take an organisation with a £100m turnover delivering an average 10 per cent annual net profit of £10m.

It would be an impressive achievement if the CEO could add 10 per cent to the top line (i.e. £10m in revenue), especially in mature industries and those that are impacted heavily by the economic cycle. But its impact on the bottom line (bearing in mind its average 10 per cent net margin) would only be about £1m.

However, if for simplicity we assume third-party spend is 50 per cent of revenue, reducing these procurement costs by 10 per cent could deliver a direct increase in profitability of roughly the same amount saved – about £5m.

This is because there would be few additional costs and most of the savings could therefore fall to the P&L bottom line, assuming the exercise was well managed. In our scenario this would produce about £5m on the bottom line – five times the benefit of adding 10 per cent (£10m) to the top line.

The effect may actually be even more dramatic in private sector/listed companies. This increase in profitability could lead to a direct increase in the company’s earnings and, if maintained, its subsequent market valuation.

If we continue our simplified example and our organisation trades at a Price Earnings (PE) ratioof 10 (i.e. its market value is 10 times its annual earnings, or to look at it another way, investors are prepared to pay £10 for each £1 of earnings delivered), then the subsequent impact on its market value could be an incremental £50m, a staggering 10 times the original saving.

Technically it would be less than this because of factors including differing cost structures, the investment required, the cost of capital, corporate tax and so on which will serve to dilute this number.

But importantly, even if you are cynical and halve the number above, the dynamic remains where the pound reduced from procurement costs still has an impact on the company’s net profit/earnings/valuation of about five times that of a pound added to top-line revenue growth.

In reality, the actual long-run average PE Ratio in the FTSE 100 is almost 20 (19.9 cyclically adjusted 1993-2010 – Source: Datastream.)


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The real effect is that an increase in profitability could lead to a direct rise in the company’s earnings and, if maintained, its subsequent market valuation. Factors including differing cost structures, the amount of investment required, cost of capital, corporate tax and so on must be taken into account. But on a simple calculation, a pound cut from procurement costs can have an impact on the company’s net valuation equivalent to about five times that of a pound added to top-line revenue growth (see sidebar on page 1).

In addition, improved procurement and organisational economics can create competitive advantage. Lower prices and improved value and quality in the goods and services on offer, especially if they are embedded and sustainable, can lead to the organisation differentiating itself from the competition. This can in turn lead to a better reputation in the marketplace, growing customer loyalty and improved sales.

These benefits can then produce further strengthening of the company’s reputation, often driving a virtuous cycle of overall improvement. Low-cost retailers routinely invest in their procurement organisations to reduce purchase prices in order to cut retail prices, creating improved turnover and customer loyalty leading to improved market share and further reinvestment in the cycle.

Achieving lasting changesIn all these ways, procurement can become a lever for fundamental and lasting changes in an organisation’s performance.

How can these benefits be achieved?

First, let us manage expectations; identifying savings can be difficult and purely theoretical until delivered. Pro-active management is essential if all the benefits of an otherwise excellent procurement project are to be delivered and secured in the long-term.

Secondly, it is long-term improvements in earnings that can lead to higher valuation by the market, so it is vital to lock themin. Unfortunately hard-earned savings often erode over time if

the procurement team does not have the proper motivation, skills and tools to pro-actively manage the budget, contract lifecycle and eventual contract renewal.

Third, to deliver and retain these benefits, investment in systems, processes and people capabilities must be establishedto ensure that they comply with best practice and are designed to produce long-term benefits. The first phase of a programme, broadly speaking, is to identify and target the opportunities that can be achieved. This can itself be a costly undertaking if the technology is not in place to identify spend/opportunities accurately and help managers “see the wood for the trees”.

Fourth, once these targets have been identified, however, it is essential that they are executed through the establishmentof effective processes based on clear understanding of best practice modern strategic sourcing approaches, tools and


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techniques, and, importantly, pan-organisational compliance to these approaches.

Fifth, there must be effective contract and supplier performance and relationship management tools that track obligations, performance, risk, price variances, off-contract spend and measures savings to plan, and if necessary, prompt corrective action.

This may mean, for example, initiating a programme of education and change within the organisation to build capabilities, upskill resources and ensure that procurement’s objectives are clear to all, and reflected within personal targets/objectives and reward systems.

Finally, it is crucial that the organisation’s top management is fully signed up to the programme’s objectives and provides visible, tangible and, if required, financial support to the build the long-term capability. The boardroom must understand that procurement is a strategic function engaged in critical work of value to the organisation as a whole, and be prepared to exercise their leadership to invest in procurement’s success.

SummaryIt is well known to CPOs that procurement can deliver results quickly in terms of savings and better value for money. When it comes to investing in improving competitive advantage

and organisational economics, CEOs, strategists and senior managers looking to make a significant impact in their organisation’s economics should understand that investments made in procurement capabilities and tools often lead to sustainable long term benefits and contribute significantly to the company’s bottom line. For organisations this can mean dramatic improvement in valuation and share price.

About BravoSolutionBravoSolution is an international leader in Supply Management solutions, uniquely positioned to significantly enhance the performance of a company’s entire sourcing cycle.

Our solutions interlink to provide cohesion between robust technology and professional services expertise, a combination that guarantees businesses will receive optimal support in achieving their strategic procurement objectives.

As of today, over 400 companies in the private and public sector, 40,000 procurement professionals in 60 countries are benefiting from BravoSolution’s technology and services, unlocking tangible benefits including of increased process efficiency, decision support, cost reduction, improved process governance, greater quality relationships with vendors and the ability to share, understand and act upon the wealth of sourcing-related data held within their organisation.

About the AuthorDaniel QuinnSenior Account DirectorBravoSolution

Dan has over 10 years professional procurement and management experience across various private and public sector organisations. He is an MBA and has category strategy, business planning and project management qualifications and experience. He is currently a Senior Account Director with BravoSolution in the UK advising private sector and government organisations worldwide on the strategic deployment of sourcing solutions.


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Procurement: Delivering Improved Company Valuation

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