How to Calculate Procurement ROI

Returns on investment are critical for any business. Every organization must regularly assess profit-effectiveness to optimize the business’s resources. 

High ROI leads to improved cash flow, efficient operations, and better profit margins. When it comes to procurement ROI, it showcases the profitability and cost-effectiveness of investments in procurement, allowing decision-makers to optimize the spending and budgeting further.  

Thus, it is fundamental to calculate procurement ROI rates to understand what aspects need more optimization and improvements to achieve higher operational efficiency. Throughout this guide, we will cover everything regarding procurement ROI, from its importance to a practical guide on how to measure it. Thus, let’s dive into it! 

Importance of Calculating Procurement ROI 

ROI for procurement is one of the most critical measures of the organization's success. Procurement ROI shows that the procurement department is providing enough value and fulfills its purpose when it comes to building strategic partnerships with the suppliers, handling inventory management, and making sure the organization has all the supplies needed for efficient operations. 

Calculating procurement ROI allows you to evaluate the profitability of the investments. According to Forbes, procurement ROI is the best KPI that can be measured.

How to Measure Procurement ROI? 

Unlike traditional ROI, which is calculated solely based on revenue, procurement ROI is measured by comparing the department’s costs with the savings generated (financially and operationally) for the whole organization. 

The procurement ROI formula is:

Procurement ROI = ((total cost savings - total cost of procurement) / total cost of procurement) x 100%.  

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However, everything is not that simple. To calculate everything more effectively, make sure to collaborate closely with the executive leadership and finance team. It will be quite useful to implement tracking methods to track savings and spending (e.g., a software solution). 

Further, in this guide, we will look into key components to consider when calculating procurement ROI, common challenges faced, and a step-by-step guide on how to calculate procurement ROI. All of these aim to equip you with a broad understanding of the efficient calculation of ROI rates when it comes to procurement. 

Key Components of Procurement ROI 

Before diving further into the practical side of the article, let’s understand the key components of procurement ROI. These key areas and components include spend analysis, approval workflows, team productivity, visibility levels, and even access to technology. 

Spend Analysis 

The first area to consider when it comes to measuring procurement ROI is spend analysis. Analyzing spend allows you to identify ways and areas to reduce costs and reach maximum efficiency. Also, spend analysis helps to identify trends and cost-saving opportunities. 

Approval Workflows and Team Productivity 

Approval workflows might not be the first thing that comes to mind when calculating procurement ROI; however, according to Forbes, it is another key aspect. Automated workflows are easier to manage, which makes the overall process easier for the team. For instance, by allowing to automate administrative tasks, employees gain more time for more strategic business initiatives. 

Technology 

Technology allows you to gain more transparency and visibility into the process, automatically ensuring more control over the procurement process. Also, cloud-based solutions allow one to store and access all the information from one database on any device and at any time. It greatly contributes to improved accessibility and productivity levels. 

Procure-to-Pay Cycle Time 

In a perfect world, the P2P cycle time should be quite fast. The cycle has many stages affecting its speed. For instance, the PO cycle time (time between making a purchase requisition until it is approved for placing a purchase order) itself can increase the overall time spent to complete the P2P cycle. 

The goal of the procurement department is to minimize cycle times and reach maximum speed and efficiency. So, when calculating ROI on procurement, make sure to take into consideration P2P and PO cycle times. 

Sourcing Cycle Time 

Another important component of procurement ROI is sourcing cycle time. Sourcing cycle time is the duration of the sourcing process (starting from identifying a need to finalizing the contract with the supplier). Faster sourcing cycles lead to a more efficient and quicker procurement process, contributing to lower costs by reducing delays in deliveries. 

Essentially, faster sourcing time improved procurement ROI by enhancing efficiency and responsiveness. 

Compliance Rate 

The compliance rate is a key performance indicator and an important metric to take into consideration when calculating procurement ROI. The compliance rate is vital for both external and internal business processes, such as employee compliance with the set policies and supplier compliance with the set regulations and contract terms. Essentially, this is a KPI that measures how well a company is able to follow legal obligations and negotiated terms. 

Supplier Lead Time

Supplier lead time refers to the time a supplier takes to deliver products to a business. Shorter lead times are beneficial for organizations in multiple ways. For instance, they reduce inventory costs, ensuring timely order deliveries, which contribute to the overall process efficiency and increase procurement ROI. 

Supplier Defect Rate 

When talking about suppliers and their role in calculating procurement ROI, let’s not forget about an important metric, such as supplier defect rate. Defect rate refers to the number of products that are defective in an order delivered by the supplier. This number indicates the quality of the supplier on a unit-to-unit basis. 

Vendor Availability 

One more important metric is vendor availability, which is used to measure the capacity of the vendor to respond to emergency demands. This KPI allows organizations to evaluate the vendors' degree of reliability and responsiveness. 

Reliable suppliers minimize risks associated with supply chain disruptions. 

Common Challenges in Calculating Procurement ROI 

Calculating procurement ROI is not the easiest task due to the multidimensional nature of the procurement process. For instance, it can be quite challenging to quantify process efficiency, cost avoidance, and risk mitigation. Yet, these are critical factors that determine the success of procurement. 

Other challenges revolve around diverse metrics and their strategic alignment. Every organization prioritizes different sets of metrics and KPIs when it comes to procurement. For some, the top priorities are compliance and risk mitigation, while for others, the top priority is saving. 

Steps on Calculating Procurement ROI 

To calculate procurement, it’s important to take into consideration a few keys to success, such as alignment with the finance department, consistent communication, and setting specific KPIs/ROI goals. 

Align Metrics 

To successfully calculate procurement ROI, make sure to align metrics, goals, and other expectations with the key stakeholders, finance department, and overall organizational goals. It will help to work toward shared KPIs and evaluate reports more accurately. 

Communicate Results Consistently 

Communication is key to success, especially when it comes to measuring procurement ROI. The achieved results should be consistently shared across departments and key stakeholders. 

For instance, you can develop a communication plan that includes regular updates and meetings, quarterly and monthly reports, etc. 

Also, when it comes to consistent communication, you should consider incorporating measures to enhance the transparency of the procurement process to build trusted relationships. 

Set and Commit to Specific ROI Goals 

To quantify and efficiently measure results. You need to set and commit to specific ROI goals. Make sure the goals are attainable and are tied to specific KPIs. Also, when it comes to goals, do not forget to review and adjust them regularly. Periodic reviews allow organizations to ensure that procurement goals are consistently aligned with organizational objectives and KPIs are efficiently met.

Best Practices for Maximizing Procurement ROI 

When you are done with the calculations, you might start wondering about what can be done to maximize procurement ROI. Well, it is time to review the top-notch industry practices in more detail. 

Supplier Relationship Management 

To maximize returns on investments, pay attention to supplier management aspects and strategic sourcing. Building quality partnerships with the suppliers will allow us to ensure quality products and timely deliveries, contributing to reducing cycle times. 

Continuous Risk Management 

It is important to assess risks and develop risk mitigation strategies regularly. Good risk mitigation strategies will allow you to save time and resources on potentially costly business mistakes. 

Incorporate the Right Technology 

To maximize procurement ROI, you need to keep in mind three goals: maximize efficiency, reduce cycle time, and track results. All of these become possible with quality procurement software. 

E-procurement tools allow for the management of every aspect of procurement from one single place, from supplier performance tracking and inventory management to spend analysis and automation. 

Pay especially close attention to automation, as it will greatly reduce cycle times and manual errors while increasing efficiency and productivity. 

Maximize Procurement ROI with Tradogram 

If you are looking for the best e-procurement solution to manage your procurement and maximize ROI efficiently, then you are in the right place. Tradogram is an all-in-one procurement platform that comes in handy with all the features necessary to scale. 

The platform offers features for automating procurement processes, managing inventory, tracking and managing supplier relationships, and gaining 100% spend visibility. To find out more about how Tradogram can help your procurement department get more returns on investments, schedule a demo with us.