Analysing indirect spend part two – the direct way to increase your profits and your success
In part two of this short series of guest posts from REL Consultancy, manager Michael Wydra takes a closer look at how, once an indirect spend analysis is complete the insights gained can be turned to procurement’s advantage.
After analysing indirect spend on an aggregated level (see part one), the next step is to go into detail by gaining insight into the specific spend categories. Subcategories should be defined to reasonably group category spend. It can also make sense to capture certain supplier characteristics, such as region, spend contracted and contract expiration date.
Even where there is a valid contract, the business may not be actually buying according to the negotiated conditions. A catalogue with negotiated items and prices may be available but not used. Maverick spend, or purchases executed outside the boundaries of a contract, can be a reason for high purchasing costs as well as increased transaction costs. Ideally, an organisation should evaluate the percentage of targeted or negotiated cost savings lost because contracted rates from preferred suppliers were not used during the purchasing process. This is particularly a problem in indirect spending categories, where, on average, 12 percent is lost. Other opportunities include investigating lower-cost markets rather than sourcing locally. Measuring compliance is not easy but necessary to point out process weaknesses.
Further insights into spend categories come from conducting interviews with management and operational staff responsible for the respective category. The company may need to reconsider previously made decisions. It is also common for companies to define categories of spend according to the way the categories are managed internally, rather than according to the supply markets from which the product is bought. The main issue that internally aligned category definitions can cause is that companies will run a request for proposal (RFP) for only a portion of the spend, rather than all of the spend that a group of suppliers can supply. Take a category of spend sourced as a product family, such as screws. It might be that screws are traditionally bought from fastener suppliers. By examining the total spend data, a company may find out that screws account for about 60 percent of the total spend value of fasteners.
Running an RFP for the newly defined “fasteners” family would permit consolidating a greater level of spend volume and the supply base. In such cases, purchase costs savings in excess of 25 percent plus the additional value from process and transactional efficiency that comes from supplier consolidation is achievable. This example also shows plainly that it is necessary to go into detail and understand what exactly is being sourced, literally right down to the last screw.
Benefits of spend analysis
In the end, a spend analysis programme should point out opportunities for cost reductions that are sustainable and that facilitate monitoring spend, improve supplier relations, lower transaction costs and align service levels. Reducing spend has a positive effect on working capital as well, since less cash is required to maintain daily operations. Use of purchasing cards and standardised payment terms for a smaller supplier base further improve days payable outstanding (DPO). In order to ensure sustainability, a spend analysis should be conducted on a regular basis. That means your system needs to be automated to give you the required information as accurately and efficiently as possible.
Even though indirect spend is a significant contributor to the health of a company, it often falls outside the focus of interest, becoming neglected and unprofessionally managed.
World-class companies have on average 45 percent lower indirect procurement process costs than their peers. Furthermore, top performers achieve annual savings of 0.6 to 1.53 as a percentage of revenue in indirect spend categories only, which leads to a savings opportunity between €2.7 million and €8.6 million per €1 billion of revenue (Figure 3).
Figure 3: Annual incremental indirect spend savings opportunity gap between median and top performers.
|Industry||Annual incremental indirect spend savings opportunity per €1 billion in revenue|
|Biotech and pharmaceuticals||€7,136,665|
|Energy / resources / chemicals||€2,874,644|
|Government, nonprofit, and health care delivery||€3,163,202|
|Telecommunication services and utilities||€2,756,296|
Do you know how your company is performing?
REL can be found on twitter @RELConsultancy