Stopping Contract Leakage

You've invested countless hours and completed your strategic sourcing process. The resulting award will deliver significant and important savings to your company's bottom line. You're a hero, at least for now. But how do you ensure that the award is implemented as contracted so that the savings, in fact, accrue? And how will you know?

Contract leakage is your enemy. It includes things like:

• Buying from a non-contract source.
• Buying non-contracted items.
• Buying through the wrong channel (in store purchase or retail website versus "punch out" catalog)
• Paying a total delivered price different from the contract (including payment terms, freight, duty, etc.),
• Incorrect or missing contract reference which results in non-contract billing.
• Not getting rebates or other volume price reductions.

Most sourcing professionals face these challenges and have a difficult time plugging all the holes. This is particularly true for today's awards which often span vast geographical regions and numerous business units. Aberdeen Group reports average leakage rates of 21% as Purchasing strives to implement its sourcing decisions. Best In Class companies experience about 14% leakage whereas All Others see 24% leakage ⁽¹⁾. Small companies experience up to 40% savings leakage ⁽²⁾. The risk and the opportunity are huge!

To address this challenge, one needs to do the following for each potential leakage point:

1. Measure the leakage rate.
2. Understand the root cause.
3. Fix the problem – either the user behavior, vendor behavior or change the definition of "right".
   Most people don't even try to do #1, don't understand #2 and, therefore, are in no position to fix the problem. Let's examine each point in a bit more detail.

1. Measure The Leakage Rate
There is an axiom among business gurus that states: "What gets measured, gets done." So if it's important that our award gets implemented correctly, then we first need a way to track actual purchases and get visibility into all of the potential leakage points listed above. Also, measurement must occur on a timely basis so that any required corrections can be made before additional savings are lost, perhaps forever. You wouldn't drive your car by looking in the rear view mirror. You can't effectively manage your expenditures that way either. Fortunately, today's spend analysis solutions provide the functionality we need to efficiently monitor the various components of our business awards so that we can take the necessary action to forestall contract leakage.

For this purpose, it is critical that data be refreshed very frequently – at least monthly. A quarterly data extract leaves erroneous spend unchecked for 3 months draining savings that may never be recovered. Monthly extracts are actually more efficient. Once the queries are defined, they get put into a monthly schedule and can happen automatically. They become part of the routine. A monthly review becomes part of the sourcing manager's routine as well. With an effective spend analysis solution, he/she can quickly review contract performance. Some tools (such as BIQ) provide an interactive tool that facilitates period-to-period comparisons and highlights outages by magnitude. This makes it easy for the buyer to prioritize efforts to reign in maverick spend.

2. Understand The Root Cause
Now that you've identified the outages, what do you do? First, you need to understand the root cause(s). As stated in the article above "Making Sourcing Savings Stick", there can be several reasons including: communication, inconvenience, fear of the unknown, lack of trust and others. Quality tools such as "5 Whys" or a Fishbone Diagram can help you get to the root. Fixing symptoms alone results in unnecessary rework.

3. Fix The Problem
After identifying the root cause(s) you want to develop a correction plan. The plan should address management support and must involve stakeholders. It should include detailed actions with names and dates and, importantly, a means of accountability.

Accountability is key but can be tricky, particularly in situations where purchasing is seen as more of a support organization rather than a leader on the path to improved profitability. You must re-double your effort to sell your sourcing plan to corporate management as well as to internal customers. To do that effectively you must:

• Understand and explain the link to business objectives. How will contract adherence help stakeholders achieve their goals?
• Refine business processes to make doing the right thing easiest. Human nature follows the path of least resistance. How can you make it easy to comply?
• Speak like a CEO. The language of management is numbers. What is the impact of leakage on profitability and other financial goals?
• Be opportunistic. Look for "pain" you can relieve. What short or long term pain can be alleviated through compliance?

The preferred approach is the "carrot". Convince your constituency that compliance is in their best interest. Reward positive behavior. Publicize successes and share the glory! However, you must also be prepared to escalate if necessary. As Teddy Roosevelt advised: "Speak softly and carry a big stick". Most importantly, don't get discouraged. You must continually monitor the situation through your monthly reviews, and seek continuous improvement over time.

As sourcing professionals, our job is not done when the contract is signed. We must continually monitor and measure actual spend, identify root causes of leakage and implement effective fixes so that we don't leak 15% to 40% or our hard-earned savings. Spend Analysis solutions provide an effective and efficient means to achieve this.

¹ Aberdeen Group. "The Advanced Sourcing & Negotiation Benchmark Report. January, 2007.
² Aberdeen Group. "Sourcing Challenges for SMB". August, 2007.