Blog
Aug 9, 2023
A practical guide to demonstrating the Return on Investment of Category Management
7
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The financial concept of demonstrating a positive Return on Investment (ROI) is deeply ingrained in most investment discussions, no matter how big or small they are. And rightly so. No organization should ‘waste’ money by spending it on something that doesn’t provide additional value to the organization.
And while this concept is, in theory, universally and easily applicable in all investment decisions, everybody who ever had to justify investment decisions that were not directly impacting production costs or sales knows better.
This is especially frustrating as a lot of time and resources (think waste) are invested to justify something financially that is logical to everybody feeling the pain. What’s worse is that the ROI is a big discussion before an investment but receives little attention afterward.
Our clients keep telling us about the importance of just getting started with developing category strategies. But our ‘clients to be’ are eager to learn about the Return on Investment of working with Cirtuo before making a decision. We have therefore interviewed customers and partners during the recent Cirtuo Procurement Forum to provide an actionable guide for demonstrating the Return on Investment of digital category strategy based on their insights and experiences.
The classic financial formula for calculating the Return on Investment divides the added value or benefits through the costs (investment), both measured in the same ‘currency’, to understand the payback (return), expressed as a multiplier.
While the actual investment can be easily identified and the calculation for the return only requires basic math skills, defining the perceived and real value can sometimes feel like rocket science.
The reason is that the term value is a canvas that can be filled in a million ways. The definition of value is unique to the company, its objectives, and the investment at hand. That’s what makes it difficult to define it generically.
Ganga Siebertz, VP Customer Success Cirtuo, pointed out that “every business has different needs. Some care about costs, but the business group responsible for diversity or innovation will value that more than cost.”
“It depends on the pain point you’re trying to solve and who you are selling the solution to – the budget owner. They may have their own perspective as to what ROI is and how it is defined, because they have their specific pain point or objective,” added Travis Johnson, Sr. Director ISM Walmart.
This is what makes it a great analogy for category strategies as well. The world of procurement has grown into a highly complex environment in which structure and guidance are needed more than ever. Category Management and strategies help Procurement make sense of this complexity and derive holistic decisions in line with business requirements.
The ROI aims to do the same. Simplify investment decisions based on objective facts. But as in developing category strategies, the world is rarely black and white. A guided process and structure can therefore help identify the common themes that create value.
In our discussions, we have found that many organizations recognize three dimensions of value: cost savings, efficiency improvements, and non-tangible, or soft benefits.
The first dimension of value is cost savings. The concept of savings is universally understood by procurement and finance teams, even if the actual calculation and recognition might be very individual to their respective organizations.
“The current state of Category Management” (2022) by Future Purchasing and the Henley Business School suggest an average saving opportunity of 7-8% for category strategies on previously unmanaged spend. The calculation would, therefore, simply be Spend covered*0.08=savings. Based on our interviews with customers, the saving % would go down to 1-2% for categories that were already well managed. Asked for the rationale for the achieved savings, they mostly mentioned pulling previously untapped strategic levers as the main savings driver.
The second dimension of value is efficiency improvements. Efficiency improvements, or productivity gains, are also well understood. If we can free up resources by simplifying or eliminating non-value-adding processes and tasks, we can express the accumulated time savings as Full-Time Equivalents (FTEs) and use an average salary to calculate the achieved value.
If every Category Manager saves 20 hours per year on creating or refreshing their category strategy and we have 100 category managers with an average cost per FTE of $100’000 at 2000 hours/year, the calculation is as follows: Efficiency savings=(100 CM*20h)/2000h)*$100’000=$100’000. This impact was mentioned multiple times during a panel discussion on the ROI of Category Management at the Cirtuo Procurement Forum 2023. Customers were able to cut the time for developing a category strategy by 50% compared to manual approaches, with further reductions on consecutive strategies.
The third dimension of value is ‘non-tangible’ benefits. Non-tangible benefits are all the improvements we can achieve for procurement teams or stakeholders but struggle to put a price tag on. For some because they are subjective, for others because we just don’t know the numbers or must work with hypotheses to calculate them.
Andrew Speck, VP Cirtuo North America, highlighted that “One of the common themes I’ve noticed working with many organizations is that we talk about all these great value levers, new opportunities, and how we’re delivering value for the business. But at the end of the day, they always come back to us and ask what the savings are going to be because that is what they must report.” This observation demonstrates that especially non-tangible benefits need to be communicated in a compelling way.
To take a more holistic view on benefits, we need to create an understanding of the variety of benefits that can be relevant to an organization. Some of them are more tangible, others almost impossible to quantify.
The ones that are more easily calculated include improved governance and guidance on how to spend money and who to spend it with. Strategies provide guidance on the right suppliers that offer preferable commercial terms. More spend under strategy can therefore lead to increased rebates and more efficient purchasing processes. Both of those benefits can be expressed in monetary terms.
Other benefits are much harder to quantify. Breno Jung, VP Digitalization at Corning highlighted the importance of resilience in the current business environment. “We have to be resilient. The world is shaking, it’ll shake us. But with proper category management, with a clear strategy, we can react better. I see a very strong connection between having proper category strategies in place and the overall organizational resilience.”
The same could be said about achieving ESG goals. Category strategies provide the structure and consistency required to embed business goals around sustainability or supplier diversity across all spend categories. This drives increased strategic alignment of Procurement with the business.
“We usually see CFOs that will value Return on Investment, where the return is going to generate value and savings and the investment is my money and my time”, explained Travis Johnson, Sr. Director ISM Walmart International. “It’s hard to put a number on people experiencing less stress, feeling less anxious or being more comfortable within their job because they have the right tools. I think we need to look at this as well because the cost of not doing it might mean higher turnover and frustrated employees because they don’t feel empowered to do their job well,” he concluded.
To demonstrate a positive Return on Investment, all three value dimensions should be considered. This way, a more holistic perspective on the potential impact of digital category strategies emerges.
Firstly, a clear understanding of the current baseline, spend coverage through category strategies, performance, as well as the desired future state, are required to properly calculate the ROI of Category Management.
Secondly, a clear expectation towards value delivery needs to be established. A ROI of 1 is by default positive, but not necessarily good enough to jump on the opportunity. Every organization needs to determine if a multiplier of 1, 2, or 20 is most appropriate for demonstrating a positive return and building a convincing business case. A general agreement on the expected value early on in the decision process ensures the investment discussion doesn’t stall the process down the road.
Lastly, including a Finance Business Partner in the decision process ensures internal expectations are well understood and appropriately weighted. This way, Finance gains a full understanding of the business requirements and can provide guidance for evaluating or validating the required hypothesis and calculations.
Establishing a baseline requires a sound understanding of the value levers accepted or valued by the business. By defining KPIs with stakeholders and Finance, the expected value becomes more easily understood by them. Especially in situations where clear targets exist across the organization, this approach will help demonstrate a clear path to action.
In an increasingly complex world, Procurement teams are pushed to deliver more with less. This increases the cost of not doing anything further, as a lack of focus in category teams or the inability to question information critically might result in wrong strategic decisions – a big business risk.
Based on our discussions and interviews, we have therefore created an easy-to-use calculator to support you in building your business case for a digital category strategy development solution. The calculator helps you capture inputs across the three dimensions of savings, efficiency gains, and intangible benefits and can be easily adapted to your specific situation.
Please contact us below or reach out to sales@cirtuo.com to get access to our business case calculator and learn more about Cirtuo or how guided strategies can help you develop more holistic category strategies. We are here to help you.
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