The elusive "value-for-money"

Cost management is a mainstay challenge for businesses. According to an EY report on the top 10 risks and opportunities from the Chief Operating Officer’s perspective, pricing and cost pressures continue to be of concern.

Companies are driven to look at cost management, and part of that includes the procurement of cheaper goods and services. In fact, a survey by the Singapore Business Federation and American Express in October 2014 found sourcing for cheaper suppliers as among the cost-cutting measures that Singapore companies take as they deal with rising business costs.

Cost management does not necessarily mean cost reduction. Companies should consider a higher order objective of value creation.

Therefore, is cheap necessarily good? While the proposition that cheap products can be as good as expensive ones is attractive, the reality is that there will always be sacrifices in some areas.

Today's procurement teams wrestle with a range of performance metrics such as variances between actual and targeted cost savings, addressable spend, and quantifiable measures of value to justify their procurement decisions.

The third metric is arguably the most challenging: qualifying and quantifying what "value-for-money" is. After all, value is a matter of perception – what a company deems as good value may not be so to the customer.

Measuring "value-for money"

Value-for-money is about determining whether the purchase is well worth the money spent in the eyes of the purchaser. More than just about price, value-for-money must be evaluated throughout the entire decision loop, including setting expectations, planning, inputs, processes, outputs, and outcomes geared towards the achievement of specific business goals.

Prior to procurement, companies need to look into the goods and services that they intend to buy and how the organisation will be affected at different levels.

For small item goods, the impact may be negligible. For large service outsourcing contracts, the implications may extend to front, mid, and back offices as well as risk management functions. This assessment is vital and could surface potential unintended consequences in areas where value is perceived to be unmet.

Some other key considerations prior to the purchase or outsourcing of services include whether the service provider has well-trained and qualified employees to undertake the task; if their systems and processes satisfy regulatory requirements; third-party risk management; and cost savings achieved through procured services compared to managing the tasks internally.

Another value indicator is the efficiency and economy of the processes and resources involved. Can you get the same level of output with lesser inputs, or higher quality or quantity of outputs?

Further, in assessing the short-term results of the procurement and the long-term impact or outcomes, companies should consider both internal and external reviews of the product or service procured, particularly from major customers.

Sometimes, the outcomes of the procurement decision may not align with the expectations. That is why it is important to, where possible, set clear expectations with the seller when making a procurement decision, for example, through service level agreements.

The challenge in evaluating what is value-for-money lies in setting quantifiable metrics. Moreover, what is value-for-money today may not be compellingly so in future, thus making periodic assessment of the sourced product or service necessary.

If procurement was to be based purely on price, the role of the Chief Procurement Officer would have been redundant. However, the reverse is true today. Procurement is an integral part of business operations. It requires strategic integrated thinking, and will only become increasingly so.
 

The views reflected in this article are the views of the authors and do not necessarily reflect the views of the global EY organisation or its member firms.