Rethinking Procurement Incentives for Long-Term P&L Impact

The topic of our recent roundtable discussion with a dozen Procurement Foundry community members—exploring potential flaws in procurement incentive plans—was one that we anticipated would generate a lively debate…and we were not wrong!

It’s Fine Tune’s position that awareness is spreading around the fact that far too often, incentive plans handed to procurement departments are not healthily aligned with the P&L and do not promote optimal long-term P&L performance.

That said, it’s not procurement’s fault—most of the systemic flaws discussed in the roundtable were not created by procurement.

However, there are myriad issues with incentive plans. Chief among them and discussed during the roundtable were:

1. Departments have defined “savings” in accordance with the flawed incentive plans they have been handed, spurring a range of unproductive behaviors. An outsized, often exclusive focus on the first 12 months of any savings initiative has rendered longer-term protection of the P&L nearly worthless in many departments. This results in a bad tradeoff, with modest short-term relief favored over longer-term costs. Sound strategies and common-sense defense mechanisms against supplier cost escalations are not “counted” as meeting the departmental definition of “savings,” and thus such strategies are often cast aside.
   
   
2. Rewards for “savings” tend to be doled out based on projections rather than actual results. Often, this yields a situation in which procurement is stripped of any incentive to ensure their initiatives pan out as intended. Flaws in deal analysis as well as overstated savings projections tend to go undiscovered, as the credit is awarded before the savings actually occurs. Making matters worse, suppliers have noticed these flaws and for years have been developing myriad strategies that grow their margins after contracts get signed—once attention and resources have been incentivized away to other categories and tasks—further widening the negotiation-execution gap.
   
   
3. Incentive plans tend to count only the “good.” Category managers are credited with savings initiatives (before they actually materialize), but they are not usually penalized for lost ground and spend escalation. This flaw further strips away the incentive to defend the P&L after contracts go live.
   
   
4. Incentives, KPIs, and rewards can actually encourage counterproductive For example, items such as lengthy payment terms, onerous invoicing processes, etc., can actually hurt procurement’s ability to optimize P&L impact—and optimizing P&L impact should be the primary focus in negotiations.

As discussed with the Procurement Foundry members, all this “doom and gloom” provides opportunities for new waves of leadership.

We all came away from the discussion in agreement that leaders within corporate procurement (along with their peers outside the department who have a hand in crafting incentive plans—CFOs, VPs of Operations, etc.) need to first recognize the flaws in their incentive structures and then re-work their incentives to promote more common-sense, ownership-minded behavior.

Do you agree?