Value of Procurement and Cost Management

4C Associates

Value of Procurement and Cost Management

2

1. Ensuring value for money and savings delivered to the business1. A good team should be able to deliver incremental savings of between 3 and 10 times their cost2. Ensuring that the prices are value for money3. Ensuring that the service is specified well and fit for purpose

2. Ensuring Compliance, procurement should ensure that all of your suppliers are compliant with relevant legislation including:

1. Tax2. Bribery and corruption3. Health and safety4. Ethics and child labour

3. Minimising business risk1. Ensuring liability for problems is documented and clear2. Ensuring the supplier base has the appropriate flexibility, for example termination3. Ensuring continuity of supply where required4. Identifying and elimination of other risks

4. Ensuring optimal cost structure and maximising share price1. Margin is a key driver of share price and good procurement can help manage margin

The value of Procurement and cost management falls into four main areas.

High level benchmarks

3

Organisations with mature purchasing organisations have a spend per person in their procurement team between £18m and £25m and generate savings of between £0.5m and £2.0m per person

Source: 4C Procurement survey

1 2 3 4 50

5

10

15

20

25

30

Average company spend per person in procurement (£m)

Benchmark Company

1 2 3 4 50.0

0.5

1.0

1.5

2.0

Average savings per person in procurement (£m)

Benchmark Company

Impact of Cost Management/Procurement on share price

4

• 4C research has shown that there is a strong collation between margin and PE ratio (e.g share price)- Increasing margin increases PE ratio, this is seen both across companies and in time series data for

companies- There is a disproportionate increase in PE ratio for the highest value company in the sector

• Maintaining margin is therefore a critical component of maintaining share price, being able to increase or maintain margin will have more of an impact on share price than simply the expected increase in profit.

• There is also the risk that expansion, if it reduces margin, will not increase overall share price, margin must be maintained, also if margin drops below the level of competitors this will have a disproportionate impact on value

• A focus of procurement on maintaining margin will therefore be high value to the company.• In addition, communicating margin or cost targets to the market has been shown to have a positive

impact on share price.- For example BG Group, have ‘Top Quartile Costs’ as a strategic objective- AstraZeneca communicates a margin target and then gives detailed updates on how it is meeting

these objectives

Relationship between margin and share price : High Street Gaming example

5

There is a strong correlation between margin and share price…

Source 4C research and analysis

14% 16% 18% 20% 22% 24% 26%0

5

10

15

20

25

Margin

PE ratio

Ladbrokes

William Hill

Paddy Power

10 15 20 25 30 350

5

10

15

20

25

LadbrokesWilliam HillPaddy Power

Margin

PE ratio

Among competitors at a point in time… ..and for an individual company over time

Procurement and cost management is a key lever to managing value

PE Ratio and Margin2010

PE Ratio and Margin2007-2010

Market Communication

6

Leading companies are setting clear cost or margin targets to the market in investor presentations, then link these back to procurement and cost management. There is evidence that this approach is rewarded with a higher share price

4C Research and analysis

BG Group AstraZeneca

• BG Group, a FTSE 100, oil and gas exploration company, sets and measures a ‘Top quartile cost’ objective as one of its strategic objectives.

• They are able to demonstrate clearly demonstrate meeting this objective through an output based benchmarking approach

• AstraZeneca, a pharmaceuticals company, has ‘Business Shape’ as one of its four strategic objectives. The key Shape objective is a core operating margin measure

• AstraZeneca provides detail in its investor presentation and also in Q&A on its procurement activity