A procurement programme reports savings against budget, a buyer values EBITDA against last year, and the difference is usually half the headline.
Procurement savings reach EBITDA only as the fall in the price actually paid against last year's price, on spend the company can genuinely renegotiate, after the leakage that follows any contract. On an illustrative programme reporting 4.87 of savings against budget, the hard saving against last year is 2.91 and the run-rate EBITDA after 15 per cent leakage is 2.47, about 51 per cent of the headline. At a 9.0x exit that is 22.3 of value, not 43.8.
Worked in full in The Private Equity Operating Partner by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Procurement is often the first lever an operating partner pulls, because it needs no customer to say yes. It is also the lever whose reported number is furthest from what a buyer will pay for. The gap comes from three places: the baseline the saving is measured against, the spend it is measured on, and what happens after the contract is signed.
| Category | Annual spend | Saving vs budget | Inflation in budget |
|---|---|---|---|
| Direct materials | 40.0 | 5% | 4% |
| Logistics | 12.0 | 8% | 3% |
| Indirect (IT, facilities, services) | 18.0 | 10% | 0% |
| Addressable spend | 70.0 | ||
| Not addressable (leases, utilities, taxes) | 40.0 |
Other assumptions: 15 per cent leakage after signature, half the run-rate realised in year one as contracts roll, a one-off cost to achieve of 1.2 and an exit multiple of 9.0x.
Reported saving = spend × (1 + budgeted inflation) × saving vs budget
Hard saving = spend × [1 − (1 + budgeted inflation) × (1 − saving vs budget)]
Run-rate EBITDA = Σ hard saving × (1 − leakage)
In Excel, per category: =Spend*(1-(1+Budget_Inflation)*(1-Saving_vs_Budget))
Step 1, the reported number. The budget carries last year's volumes at budgeted prices: 41.60 for materials, 12.36 for logistics and 18.00 for indirect. Savings of 5%, 8% and 10% on those give 2.08 + 0.99 + 1.80 = 4.87, or 7.0 per cent of addressable spend and 16.2 per cent of EBITDA. This is the figure the procurement workstream presents, measured against budget.
Step 2, against last year's price. The materials budget already carried 4 per cent inflation, so a price 5 per cent below budget is 1.04 × 0.95 = 0.988 of last year's: a fall of only 1.20 per cent, worth 0.48. Logistics falls 5.24 per cent, worth 0.63. Indirect was budgeted flat, so its 10 per cent is a genuine 1.80.
| Category | Reported | Price vs last year | Hard saving | Cost avoidance |
|---|---|---|---|---|
| Direct materials | 2.08 | −1.20% | 0.48 | 1.60 |
| Logistics | 0.99 | −5.24% | 0.63 | 0.36 |
| Indirect | 1.80 | −10.00% | 1.80 | 0.00 |
| Total | 4.87 | 2.91 | 1.96 |
Step 3, leakage. Off-contract purchases and suppliers drifting back to list price erode signed savings. At 15 per cent, 2.91 becomes 2.47 of run-rate EBITDA, 8.2 per cent of EBITDA, lifting the margin from 15.0 to 16.2 per cent.
Step 4, timing and value. With contracts rolling through the year, year one shows 1.24 in the accounts and year two the full 2.47. Capitalised at 9.0x the run-rate is worth 22.3, or 21.1 after the 1.2 cost to achieve. The headline 4.87 at the same multiple would claim 43.8, overstating value by 21.6. For how a recurring gain of this kind converts into money multiple, see how much one point of EBITDA margin is worth; this programme adds 1.2 points.
Cost avoidance is real, but it is not EBITDA growth. Without the negotiation, prices would have risen by the 1.96 the budget allowed for, so the 1.96 is exactly the budgeted inflation. That protects the plan against inflation; it does not add a line to a bridge that starts from last year's actual EBITDA, which is the bridge a buyer reads.
A buyer's quality of earnings team will test the figure the same way. It takes the largest categories, compares the unit prices in the last twelve months of invoices with the prior year at constant volumes, and accepts only what shows up there. Savings that sit in signed contracts but not yet in invoices are treated as run-rate adjustments and discounted. Building the bridge on that basis during the hold avoids having it rebuilt, less generously, by someone else at exit.
| Inflation built into budget | Price vs last year | Hard saving |
|---|---|---|
| 0% | −5.00% | 2.00 |
| 2% | −3.10% | 1.24 |
| 4% | −1.20% | 0.48 |
| 6% | +0.70% | −0.28 |
At 6 per cent budgeted inflation, a "5 per cent saving" is a price rise: EBITDA falls by 0.28 while the programme reports 2.12. The higher the inflation in the budget, the more of the reported number is avoidance. Leakage works more gently: across the whole programme, 0 per cent leakage gives 2.91 of run-rate (26.2 at 9.0x), and 30 per cent gives 2.04 (18.3).
Report procurement in three columns: against budget, against last year's price, and after leakage. In this case they read 4.87, 2.91 and 2.47, and only the last is worth a multiple. The value creation plan template in the free working documents for this book includes a gross-to-net reconciliation for exactly this reason. For a cash lever that does not touch EBITDA at all, see how much cash reducing DSO releases.
Hard savings lower the price paid against last year's actual price and show up in EBITDA. Cost avoidance lowers the price against a budget or a supplier's requested increase. A 5 per cent saving against a budget that assumed 4 per cent inflation on 40.0 of materials is 2.08 reported but only 0.48 of hard saving, because the price still fell just 1.20 per cent.
The part of third-party spend that the company can realistically renegotiate within the hold: materials, logistics and indirect categories, but not rent under long leases, regulated utilities, taxes or insurance placed by the sponsor. In the illustrative case 70.0 of 110.0 of third-party spend is addressable, 63.6 per cent. Applying a 5 per cent target to all 110.0 would promise 5.50.
It depends on purchasing compliance, so measure it rather than assume it. Leakage comes from off-contract buying, maverick spend and suppliers drifting back to list price. In the illustrative case a 15 per cent leakage assumption cuts 2.91 of hard savings to 2.47 of run-rate EBITDA; at 30 per cent it is 2.04, worth 18.3 at 9.0x.
This article is one calculation from The Private Equity Operating Partner. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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