How to Identify Savings Opportunities: Transaction Costs
Last updated Jan 30, 2022 - 4 min read
- Table of Content
Procurement teams continuously focus on minimizing transaction costs and costs related to the purchase-to-pay (P2P) process. Although the trend is moving towards automated and self-guided P2P processes, there still might be some opportunities to explore.
Minimizing Your Transaction Costs
When we talk about purchase-to-pay, we often refer to it as operational procurement. While strategic procurement relates to identifying and creating value through upstream activities, operational procurement focuses on sustaining value through downstream activities. P2P reflects all aspects of purchasing the goods to the payment of suppliers, including downstream activities such as cataloging, requisitioning, ordering, invoicing, and payments.
Even though your organization should always seek to minimize P2P (or transaction) costs and optimize the processes, it is still essential to be aware of the following:
Reducing transaction costs, in some cases, will not always result in direct savings that improves the bottom line but rather "gains" or "efficiency improvements" in the form of time spent.
For realizing savings that influence profitability and costs, the changes must affect the underlying cost drivers. As people often are the most significant driver for transaction costs, such as manual processing of orders and invoices, you should look to automation for cost and risk reduction. Simultaneously, implementing selected measures (e.g. better facilitating e-commerce) may result in indirect or actual savings due to improved contract utilization or reduced consumption.
Let's look at some examples of how you can utilize procurement analytics to identify transaction costs opportunities.
Spend Through E-commerce Solutions
Guiding your organization and buyers in the right direction during the purchasing process can be beneficial. One way to do this is to implement e-commerce solutions with cataloged products from your preferred and contracted suppliers.
If your company utilizes e-commerce solutions, tracking the share of spend made through the system (and outside it) should be a priority. The example below shows you how the ratio is developing over time, here measured by months.
Many companies incur unnecessarily high transaction costs throughout the purchasing phase itself. A Danish survey found that the costs associated with one purchasing order are significantly lower when using e-commerce solutions:
- E-commerce: DKK 119 (~USD 19)
- Mail / telephone: DKK 231 (~USD 38)
- Physical in-store: DKK 436 (~USD 71)
Although the figures can't be generalized across all industries and companies, they indicate the savings opportunities (or gains) inherent in utilizing e-commerce solutions.
Note that you should also consider analyzing the e-commerce spend across the business, such as by cost centers, departments, companies, or business units. These kinds of drill-down analytics will support benchmarking and identifying areas for improvement internally. Also, the underlying PO or invoice data will help you estimate realized and potential gains.
E-commerce Utilization by Suppliers
For all the suppliers (and products) you have set up and included in the e-commerce solution, you should track utilization at the supplier level.
The above analysis shows the share of total spend flowing through the e-commerce system by suppliers. Ensuring that the organization utilizes the preferred suppliers (and products) is key to realizing efficiencies and cost reductions. And, of course, identifying any unwanted actions and deviations internally.
Again, the analysis should also be broken down into other available business data parameters, if available.
Number of Invoices and Average Invoice Amount by Suppliers
Manual processing of invoices drives processing and transaction costs. Depending on your business, the cost of processing a supplier invoice can range from NOK 150-500 (~USD 18-60). Keeping an eye on the total number of invoices (bars) and the average invoice amount (line) across your supplier base could highlight some quick wins.
A large number of invoices from your suppliers may indicate opportunities for cost reductions, which the analysis above can help identify. Looking at the data, you might want to ask yourself:
- Why does the supplier annually send us, for example, 4,000-5,000 invoices with an average invoice value of NOK 100?
- How are these invoices being processed internally?
- Do we pay any fees related to the invoices?
Assuming that the answers to the questions above are neither sensible nor desirable, you should reach out to the supplier and promote fewer invoices (e.g. monthly ones).
Number and Share of Electronic (and Manual) Invoices
Using electronic invoices can result in significantly lower transaction costs for your business. It isn't uncommon for processing costs to be reduced by between 25-50% per invoice. Many organizations increasingly facilitate electronic invoicing from their suppliers. However, numerous also fail to do so, or at least, in a systematic manner.
The first analysis (left-hand side) shows the share of electronic invoices developing over time, while the second showcases the total number of electronic and manual invoices. These insights, combined with the know-how of unit processing costs (cost drivers), will provide you with estimates of any potential savings or gains.
Tracking these kinds of metrics is also essential to ensure appropriate follow-up in your quest to digitize the invoicing process.
Disclaimer. The insights provided above are merely indications and don't always give you the full picture. For example, you might want to validate the analyzes with qualitative and other relevant insights.