Back on September 9, we learned that Kraft Heinz Corporation (KHC) had paid a $62 million fine for what Anita Pandey, director of the SEC’s Law Enforcement Division, called “…improper expense management practices that spanned many years and included numerous From misleading transactions, millions in False cost savings and a widespread breakdown in accounting controls.”
The SEC complaint cites among its complaints that Kraft Heinz employees negotiated a set of new supplier agreements laden with initial and short-term benefits tied to future commitments and thus “…prematurely and incorrectly recognizing (d) expense savings” .
This revelation caught my attention because for several years I have been writing and speaking about the pervasive phenomenon that I have called “phantom savings,” and the fundamental problems with purchasing department incentive plans that perpetuate them.
This phenomenon is especially prevalent in the field of indirect services, where there are many more complex expenses. Here’s what we saw in the field: Rotting procurement departments—weakened and trapped by their indirect suppliers—reported savings initiative after thrift initiative, only for those same initiatives that weren’t implemented properly to begin with and then quickly eroded after category managers moved on to other projects.
If you’re a procurement professional, your “Fake Savings” episode shouldn’t express KHC as a story about corrupt practices in someone else’s organization. Instead, it should serve as a warning to the entire purchasing organization that if your output isn’t real, the consequences will follow, whether in the form of multi-million dollar fines or simply in the loss of credibility and prestige within the organization.
Now, let me be clear: The “phantom savings” I have been writing and talking about are, in fairness, less heinous than the kinds of blatant misrepresentations cited in the SEC’s complaint against KHC (and it should be said, apparently has been Kingdom Holding has used a number of corrective measures since the crimes occurred.)
I would argue, however, that the pattern of reported ‘savings initiatives’ that fail to fully materialize in P&L – and thus consistently fail to stick with the intended form – are just a few blocks away from the phenomena at the heart of the KHC issue. And while “false savings” types are considered crimes by the SEC may be They are relatively rare, the kind of “false savings” I’m talking about is not only common, It’s the rule in many indirect complex classes.
The rules of the game (flawed)
It would be easy to say that the main problem responsible for creating “fake savings” is the lack of resources. Fair enough, thinness is a reality — and no one is likely to change any time soon. This fact does create weaknesses in the ongoing natural “dueling” between seller and buyer, but it is a fixable problem. In 2021, the market provides many opportunities for procurement resources to augment internal resources with external solutions to drive results and efficiencies, and hold suppliers to account.
No, the main problem is Game rules-Incentive plans delivered to purchasing departments, the ways in which credit and rewards are provided—and the behaviors these rules reinforce.
The most important ones:
1. Rewards before results To be frank, it doesn’t make sense that purchase-led “savings initiatives” should be credited and rewarded for most firms before one dollar of supposed savings reaches profit and loss. In many categories, the list of factors that threaten to make intended savings “fake” is long, and purchasing resources are usually poorly equipped to defend against these threats.
Now, measure what actually happen (especially in more complex expense categories) in a landscape that inevitably changes over time is no easy task. But it’s also not impossible. Developing an understanding of specific problematic expenditures and access to appropriate measurement systems – including normalization mechanisms based on the changing landscape – is a thing It can and should have priority Through smart companies. Once these measurement systems are in place, the company has set the stage for measuring—and rewarding—procurement efforts based on actual results, not theoretical and often flawed expectations.
Without doing the work required to measure the true impact of profits and losses rather than expectations of savings, procurement departments will be judged to continue to disburse credit for ‘pseudo savings’.
2. Count only the good The “Pat the Buyer” has $100 million in overheads and receives a 5% expectation of “reportable savings” each year across these expenses. At most companies, reaching this 5% comes from scheduling the expected dollar value of approved savings initiatives during that fiscal year. Pat will not typically lead initiatives in all of her categories in a given year, so if Pat has 10 categories, each representing $10 million in annual spending, her $5 million reportable savings will likely come from initiatives in half of those categories Just one tenth (or 10% average savings across five categories totaling $50 million).
Here’s the flaw: if the other five pat categories are experiencing cost increases beyond their intended spending levels (in fact, spending levels are often the product of prior years’ reported initiatives), This has no bearing on Pat getting her “numbers” for the year.
This tendency not to hold procurement resources responsible for defective savings expectations or erosion of savings due to a myriad of factors (many of which are predictable and can be controlled) Lies the definition of the phrase Category management. Moreover, this imbalance actively promotes “phantom savings”. If category managers are required to net cost escalation in other categories with reported savings initiatives for the current year, “phantom savings” will be significantly reduced because procurement resources will prioritize the impact of profit and loss in a manner Generally not required in 2021.
3. Overvaluing the short-run (and undervaluing the long-run) The dollar in your hand today is already more valuable than the dollar in your hand three years from now. As I write, the dollar today is about 10% to 15% more valuable than the October 2024 dollar. But looking at the buying landscape in 2021, you might think that the 2024 dollar was almost worthless – and this promotes irrational and counterproductive decisions.
The specific reason in this context is the tendency to view all expenses – even those where multi-year supplier commitments are the norm – through an annual perspective.
Let’s say the last five-year hazardous waste contract signed by ABC Widgets resulted in a $20 million five-year spending, and as that deal drew to a close, Pat found a way to pay 20% of those costs through effective negotiation (and then figured out a way to Category management to ensure savings stays). It’s hard to argue that Pat didn’t add $4 million in value to ABC Widgets in this scenario. However, in nearly every purchasing department, the rules of the game don’t assign any value to the impact that Pat’s work had in the second to fifth years of this decade.
Netting these three deep flaws in corporate procurement plan structures is not just a lack of incentive to manage expenses effectively and advance the company’s long-term interests—but actually often discouraged To do these activities which are obvious to any entrepreneur with a royal mindset. With incentive structures across many departments, Pat can do a good job of introducing a series of “savings initiatives” that take short-term gains in exchange for long-term sacrifices, which never reach profit and loss as intended and quickly erode from there, making It leads to the “hanging fruit” to do so again in a few years.
It is completely unproductive and widespread.
The real lessons of the KHC . story
Going directly to procurement professionals, I say this, directing my inner Robin Williams: It’s not your fault.
First, you are overburdened and understaffed. All of you are required to do two to three people. Second, it is difficult to ask humans to choose more productive behaviors if the easier and less productive behaviors may directly serve their personal financial interests. Far from fading you, the rules of the game in your departments drive the phenomenon of “phantom savings” more than anything else.
However, there is some good news in all of this. These common issues in the 2021 procurement landscape provide opportunities for new waves of leadership to emerge and to employ more ownership-focused strategies to make a lasting impact on profits and losses and advance the company’s long-term interests. Identifying flaws in the system and taking charge of reforms is, after all, something good leaders do.
Fixing the flaws of the buy-in incentive plan and the “false savings” they promote is no small challenge, but one that needs to be addressed. Good reforms in this area will raise the bar for the profession and make practitioners feel better about their roles and their reputation in their companies.