Focus on estimating e-procurement cost

While cost savings are commonly cited as the key benefit of e-procurement, more than half the companies in the Tranmit (1999) survey (54 per cent) did not know the procurement costs of their organization! This suggests that calculating costs is not straightforward, but it is clearly an important part of the cost-justification of introducing an e-procurement system.

The general approach to estimating procurement costs is straightforward. First, we calcu­late the average procurement cost per item, then we multiply by the average number of requisitions. The Tranmit (1999) report provides some illustrations – typical medium-to- large companies issue between 1,000 and 5,000 requisitions a month and are spending between £600,000 and £3 million annually on the procurement process, based on the £50 median cost per item. In exceptional cases, the number of requisitions was between 30,000 and 40,000 per month. In these cases, the annual cost of procurement could be between £18 million and £43 million!

To calculate cost savings from e-procurement we perform the following calculation:

Savings = No. of requisitions X (Original cost – New cost)

For Cambridge Consultants (Case Study 7.1) cost savings from orders placed with RS Com­ponents alone are as follows:

Savings = 1300 X (£90 -£10) = £104,000

These are relative to a typical order value of £70, i.e. savings of £104,000 on purchase item costs of £91,000.

The impact of cost savings on profitability

The study by Kluge (1997) referred to above suggested that cost savings achieved through e-procurement may have a significant effect on profitability. Activity 7.2 illustrates how the sav­ings will vary between companies according to their buying characteristics. The largest savings and impact on profitability will typically be for manufacturing companies in which procure­ment is a major cost element and there are many requisitions for relatively low-value items. Service industries have lower potential for savings. The consequence for this is that there will be a wide variation in potential savings according to industry, as illustrated in Table 7.3.

To conclude this Focus on topic, a note of caution should be struck. Many of the models used to calculate savings and return on investment are, of course, only as good as the assumptions they use. Refer to Activity 7.4, Purchasing ROI myths to review why savings may be lower than those pre­dicted by models.

Source: Dave Chaffey (2010), E-Business and E-Commerce Management: Strategy, Implementation and Practice, Prentice Hall (4th Edition).