Introduction to Spend Management and Spend Analytics

Value for money continues to be the focus of procurement teams. Solution providers have deployed various strategies and procurement efficiency levers to contain costs. Demand aggregation is a key efficiency lever which improves buying power for the purchasing organization and results in higher discounts and more cost savings.

Years ago people went to different stores to buy groceries, household items, and various other essentials. As years passed, all these items became available in a supermarket where we could not only buy everything under one roof but also choose from a wide variety of brands, volumes, and prices.

As a shopper, you could evaluate, choose, pay, and check out in no time. This not only cut down travel time between different stores but offered shoppers volume-based discounts, a plethora of choices, and improved the frequency of buying.

Are we still buying in the same manner at present? Though we still have supermarkets, the current landscape is now a combination of supermarkets and virtual marketplaces like Amazon and Flipkart. The virtual marketplaces are taking over, which gives the consumer better pricing, the convenience of buying from home, and offers a superior shopping experience.

As this selling model evolved, the buyer is naturally drawn to considering the benefits the new model offers. In most cases that means being cost-effective, convenient, time-efficient, and relevant. When we look back and analyze how the model has evolved over time, technology has played a vital role by catering to our changing lifestyle and demographics. Virtual marketplaces have cut down the divide between rural and urban buyers, bringing improved accessibility. Technology has also been instrumental in improving the overall shopping experience irrespective of the channel.

Similarly, on the B2B side, the buying models have evolved too. Value for money continues to be the focus of procurement teams. B2B brands are deploying various strategies and procurement efficiency levers to contain costs. Demand aggregation is a key efficiency lever which leads to higher buying power for the purchasing organization and results in higher discounts and more cost savings.

Aggregation is an established method of driving larger economies of scale. This not only results in reduced costs or greater value from suppliers, but also reduces the cost of operations by reducing buying or sourcing events. Additionally, aggregation encourages standardization which leads to inherent efficiencies.

Demand Aggregation could be simply at an organization level or even beyond the organization boundaries.

Aggregation of demand from multiple businesses who buy the same products or services, probably from the same supplier may not have not been able to achieve the benefits of volume pricing or centralized delivery, even though they all probably need it in the same time period. Despite the advantages – businesses still grapple to aggregate demand outside their organization. Perhaps what’s stopping them is the absence of a compliance layer or channel which aggregates and fulfills the demand as per the policies and procedures of their Procurement organization in the way that Amazon or Walmart would in the retail world.

Many emerging startups over the last few years like Uber, Airbnb and OYO have focused on the creation of mobile/ tech-enabled customer facing marketplaces. This helps in aggregating customer demands efficiently. In the B2B scenario, too many businesses have deployed strategies to aggregate the demand and consolidate the supply base. The result is many suppliers are restructuring or expanding their business offerings to function as aggregators like Grainger in the MRO space, Staples in the Office Supply space, or managed service providers to meet the demand of their clients for a breadth of service / product portfolio offerings.

The Procurement service providers so far have been concentrating on improving the efficiency and compliance of the process through technology, outsourcing, or automation. This has enabled them to change the game altogether and concentrate where the future value will come from. Alternative buying models leveraging collaborative buying is an emerging opportunity where modern Procurement service providers can play a significant role.

Issues like taxation laws, logistics, and IP legislation – across and sometimes within borders – can add multiple layers of complexity and often acts as a deterrent to demand aggregation. However, demand aggregators and collaborative partners that invest time, effort, and money to define and resolve the differences and establish a universally adaptable model will be well situated to succeed.

 

Vendor Consolidation

Vendor consolidation is a supply chain management strategy in which organizations or procurement departments reduce the number of vendors they work with to just a few partners. When using this strategy, businesses focus their resources on a single partner or a small group of reliable vendors per spend category as opposed to a wide array of companies. The ultimate aim of this approach is to maximize profitability while reducing time spent on managing vendor relationships. 

For example, instead of sourcing 1,000 units of a particular product from 10 vendors, after consolidation the purchasing company may choose to source the same products from two or three suppliers instead. This is true for goods as well as service providers.

Why Vendor Consolidation is Important

As businesses grow, their demands grow in parallel. As a result, they may start to work with more vendors to satisfy their needs. Further growth results in even more vendor acquisitions, which can eventually lead to an excessive number of suppliers.

Different business units or different geographical locations may require the organization to quickly identify partners to support their local needs if a mature, robust, and centralized procurement or strategic sourcing department has not yet been developed at the same maturation as the business growth.

Since each supplier needs to be managed individually, companies can find themselves spending significant resources on vendor management. Vendor consolidation addresses this issue by selectively reducing the number of suppliers to a few trusted partners. 

Benefits of Vendor Consolidation

Vendor consolidation offers a wide range of benefits to companies with significant outsourcing needs including:

• Increased purchasing power – Consolidation allows companies to award higher order volumes to a smaller number of suppliers. This strategy can lead to reduced per-unit costs due to bulk discounts. As an added benefit, the company can then pass on these cost savings to the end consumer in the form of lower-priced goods and services, helping drive greater top line revenue.
• Reduced shipping costs – Shipping a large volume of products from fewer vendors can cost considerably less than numerous shipments from several vendors. Savings on freight costs can be further improved by choosing vendors from nearby locations. Lower shipping costs can lead to reduced cost of goods sold (COGS) and, thus, increased sales profit. 
• Time savings – Vendor management requires valuable company resources. Fewer vendors mean less vendor management and less consumption of company time. Since less time is spent on managing vendors, companies can direct their resources toward more value-added business functions.
• Stronger partnerships – One of the most significant benefits of vendor consolidation is the ability to build strong and lasting connections with vendors. Working with fewer vendors allows companies to liaise with them more effectively on an individual level, which can lead to beneficial supplier collaboration. This is extremely helpful as companies look for vendors to help assist in designing and developing their products, their store/office build out locations, their internal employee service offerings, and their external business offerings.
• Improved vendor acquisition processes – By consolidating vendor databases, companies can simplify their acquisition criteria for new vendors. Companies that perform vendor consolidation can develop a better understanding of the Total Cost of Ownership (TCO) of the goods or services that include pricing, freight, service, and quality required for future orders.

Vendor consolidation ultimately reduces supply chain management requirements. To make the most of this strategy, companies should narrow down their suppliers, not just based on price but also using other criteria such as location (freight costs) and quality of service.

 

Tail Spend Management

Tail spend refers to any business purchases (such as IT software or hardware, office supplies, MRO or professional services) that fall outside the typical ongoing and large purchases an organization makes.

These purchases are often too small to go through the procurement buying policy process, don’t happen often enough to be included in approved “buying channels,” or are simply done by organizations without strict internal purchasing policies. Typically you’ll see this as the 80/20 rule, where 80% of the suppliers make up 20% of an organizations’ spend.

The most difficult part of managing tail spend is the lack of data visibility. This is typically the result of procurement and contract management running on separate systems, silos within the organization that may be using the same vendors and other resources, a high number of suppliers, and operating under decentralized policies.  

The first key is to identify the Tail/Maverick/Rough Spend.

Tail spend can include anything from misclassified purchases to maverick spend. That’s why it’s important to define tail spend (the definition can and does tend to vary slightly depending on the organization) and determine where it’s happening. To start, you’ll need to retrieve your spend data from all available sources and then analyze it. 

From there, you’ll define tail spend as it relates to your company. Then, you’ll calculate your tail spend based on that definition. At this point, you’ll segment tail spend commodities, and start to look for savings opportunities – in the form of both cost reduction and cost avoidance – at both the transaction level and the spend level. Most commonly, organizations approach analyzing tail spend by calculating the ratio of spend to suppliers – classifying tail spend as “all purchasing with vendors other than the 20% with whom they have the highest spend.”

Hidden Tail: This is the segment where the company’s biggest suppliers are, and these are generally dealt with as a part of strategically managed spend, where there are professionally negotiated and monitored contracts in place. However, some of the spend with big suppliers isn’t always covered by contracts since those contracts don’t always cover the specific materials or services being purchased, or due to non-compliant spend.

The below graph shows the different elements of Tail Spend

 

 

Head of the Tail:  In this segment, you’ll find the spend that isn’t strategically managed, though the spend supplier could be anywhere from $50,000 or > per year.

Middle of the Tail:  In this segment, you’ll have purchases that include a large number of suppliers that may be in the $2,000 to $200,000 range per supplier. The middle of the tail isn’t strategically managed because the spend per supplier is too small

Tail of the Tail:  This segment contains suppliers with less than $2,000 of spend. The spend is highly fragmented and transactional due to many one-off purchases with a large number of suppliers.

Companies across all market sectors are aggressively looking to reduce cost on all their indirect and direct purchases and to establish effective cash flow management. Declining market demand and over-capacity drives finished product manufacturers to put price pressure on their suppliers. This forces the latter to renegotiate contracts with their suppliers, thus impacting entire supply chains down to the raw materials.

Regardless of where your firm holds contracts or negotiations within a given supply chain, it’s crucial to extract important price concessions from suppliers fast, yet without harming the long-term prospects of vital suppliers. Given the brutal nature of the current economic crisis and still undetermined recovery timeframe, the traditional procurement approach is ill-suited to that challenge. It relies too much on the negotiation skills of individual buyers, leads to adversarial relations with suppliers, and, most importantly, does not achieve the best price-performance results in the timeframe necessitated by our current economic pressures.

The following 5 guidelines will help your organization achieve excellence in procurement and accelerate savings to your bottom line:

1. Create competition between your suppliers. Even if you already have alternative suppliers, expand the range of suppliers from which you are able to invite bids. Make your alternative suppliers and the switching options visible for your most important materials.
2. Use total-value-of-ownership to compare suppliers’ offerings. Start with the initial prices quoted by your suppliers. Then deduct a premium as a function of the performance of the supplier on your evaluation criteria, with the magnitude of the premium depending on the value of the performance to your business.
3. Empower the procurement department to both negotiate and decide. Allow the procurement department to decide about switching suppliers even during a negotiation, as long as they stay within boundaries prescribed by the total-value-of-ownership framework.  This allows quicker utilization of the lowest TCO supplier and the quickest impact to the bottom line.
4. Choose the negotiation and decision mechanism that is best suited to the bidding situation. Instead of relying on the personal negotiation skills of buyers, prescribe upfront which formal negotiation mechanism (English auction, Dutch auction, etc.) you will use as a function of the competitive characteristics of each specific situation.  The use of best of breed eRFx tools can accelerate the quantity of scopes of work being negotiated and drive the greatest return in the shortest amount of time.
5. Use the negotiation and decision process systematically. Be transparent toward suppliers about the negotiation and decision mechanism that will be applied, and stick to it as much as possible. Revise and adapt the prescribed mechanism only by exception.

 

Additional Details for the Procurement Organization

1.     Create Competition Between Your Suppliers

The first rule is to create competition between your suppliers. Even if you already have alternative suppliers, it does no harm to expand the range of suppliers from which you are able to invite bids. The “competition matrix” is an important tool for evaluating your alternative suppliers and the switching options visible for your most important materials.

Switching or replacing suppliers can be a very political decision, often characterised by internal power struggles. If your purchasing process is structured in such a way that higher levels of approval are required for more important purchases, this could require intervention by the executive board.  As your data and insights are driving a prioritization of opportunities, utilize a decision matrix for the levels needed for approval for switching suppliers verses a one-size-fits-all policy

2.     Use Total Cost/Value of Ownership (TCO/TVO) to Compare Supplier Offerings

Once all the potential suppliers for a given product are identified, you can compare their offerings. The complication is that for all but the simplest components you cannot compare on the basis of price alone. You need a way to bring into the picture all aspects that determine the performance of the offerings of your suppliers. The total-value- of-ownership (TVO) framework allows you to do so.

With the TVO framework, you start with the initial prices quoted by your suppliers. You then deduct a premium from (or add a penalty to) the initial price as a function of the performance of the supplier on your supplier evaluation criteria.

The magnitude of the premium or penalty depends on the value of the performance to your business. For example, if you expect a delivery lead-time of 10 days and every day gained represents a value of $1 to you, a supplier who can deliver in eight days gets a premium of $2.  Conversely, if every day lost represents a loss of $2 to you, a supplier who can only deliver in 11 days gets a penalty of $2. By extracting all the premiums and adding all the penalties, you can generate a comparison price (see Table 2). When you start negotiating with your suppliers, they can improve not only their prices but also the factors that determine their premiums and penalties.

Several benefits can be realized using this approach

• Leads to selection of suppliers with the best price-performance ratio,
• Creates more intense competition that lends itself to the use of powerful negotiation techniques (covered later in guideline 4),
• Present the potential for win-win scenarios, as suppliers have an incentive to improve their overall performance to win your business,
• Improves business relations with suppliers, allowing for difficult but fair negotiations,
• Creates internal transparency about supplier selection decisions

3. Empower the Procurement Department to Both Negotiate & Decide

The combined use of the competition matrix and the TVO framework enables you to let price negotiations go hand-in-hand with potential supplier switching discussions. The TVO framework in particular shows all preferences and decision criteria for all of the suppliers concerned.

Furthermore, the use of an approved TVO framework allows you to empower the procurement department to decide about switching suppliers even during a negotiation. No other argument will bestow as much negotiating power on the procurement department as this mandate to make decisions. Only when a supplier is certain that a concession granted during negotiation will decide the deal in his or her favor will they be prepared to offer their best price.

4. Choose the Negotiation & Decision Mechanism Best Suited to the Bidding Situation

Having established “comparison prices” with the TVO framework, you can start negotiating with your suppliers in an effort to lower prices and/or improve performance. A diverse range of effective eRFx negotiation mechanisms exist.

Which particular mechanism is most appropriate depends on the competitive characteristics of the situation. Explaining which mechanism (ie Dutch, English, Reverse, Japanese, etc. e-auction) is optimal for every situation is difficult given varying circumstances. Factors that play a role in making the choice of mechanism include the number of bidders, the bidders’ aversion to risk, the cost level of the bidders, the likelihood of collusion among bidders, the bidders’ history with auctions, and the level of product complexity.

As an example, 2 suppliers are active suppliers who might take over each other’s business.  You could use an all-or-nothing strategy as a negotiation tool and run a traditional eAuction event.  A real potential risk may arise and lead to nothing happening if both suppliers act defensively and find it more important to retain the status quo than to compete for more business. Neither of the two will lower their prices (or at best, by a tiny bit) and both will retain their business.

With this scenario you are taking the uncertain economic climate into consideration, you may conclude the risk of the two suppliers employing defensive strategies extremely high. Given this assessment, you may determine to deploy a Dutch auction and give target pricing for 100% of the business until one of the suppliers takes the price target.

5. Use the Negotiation & Decision Process Systematically

Applying the negotiation mechanisms described in guideline 4 below, it looks like a straightforward process. Unfortunately, unexpected challenges often occur. For instance, a supposedly aggressive supplier suddenly appears to lose interest in a deal, or vice versa. In such situations it’s up to the negotiator’s skill to adapt and interpret the mechanism prescribed.

In these cases it’s important to stick to once-communicated decision mechanisms as far as possible. A reputation for reliable decision mechanisms means your suppliers know when they have to reduce prices in order to influence your decision. Consistently applying guidelines 1-4 (below) creates sustainable negotiation power.

The benefits of applying the above five guidelines systematically rather than using a traditional procurement approach are better, faster, and more sustainable results (see the following table for comparison).

 

How Procurement Optimization Adds Value

The procurement function is often misunderstood and disregarded (unfortunately!) in an organization. However, as companies are looking for immediate ways to reduce costs, retain cash, or mitigate cash outflow, procurement optimization can produce a host of benefits and add tremendous value to the organization as a whole.

From a business perspective, the most obvious benefits of effective procurement optimization are financial. Productively managing procurement – and by extension purchasing – will allow an organization to realize immediate upfront cost savings by procuring items, services, and contracts at the best price available.

Additionally, a company will be able to properly take advantage of any warranties or discounts that are often forgotten, leading to routinely neglected, yet critical, back-end savings which an optimized and data-driven procurement organization can harvest. A fully functional purchasing process will also allow for better visibility into company spending and budgets, enabling proactive cash flow management discussions.

A strong understanding of company spending allows organizations to negotiate better contracts with vendors, enabling a company to take full advantage of discounts that might have previously appeared unavailable to them. Visibility into spending patterns and budgets will also allow organizations the option to leverage additional cash flow by extending payment terms and forecasting for the future.

Many view the procurement cycle as a one-dimensional process within an organization. However, when it is adopted widely within an organization, this cycle often leads to greater efficiency and provides for a better match with desired goods or services. An optimized purchasing process will lead to more efficient sourcing and more quality goods and services delivered on time.

A data driven procurement process will also ensure that an organization’s supply chain is able to capably navigate any unforeseen roadblocks (pandemics, financial problems, natural disasters, labor shortage/surplus, economic volatility, etc.).  When optimized, an efficient procurement organization/process will also help in distinguishing between successful vendors from underachieving vendors.

Being able to distinguish between quality vendors will not only improve your supply chain overall but may lead to compensation from the low-quality vendors for failing to deliver within agreed parameters.

An effective procurement process improves an organization’s bottom line and increases efficiency. But, the evolution of the procurement function does not happen in a vacuum. Providing your team with the right procurement tools to enable them to improve upon the current procurement process is critical.

 

How Procurement can Accelerate Savings, Protect EBITDA and Help Manage Cash Flow

As a significant number of business sectors are facing difficult times right now, procurement is one of the most strategic levers a CEO can pull to improve cash flows, salvage profits, or to soften unexpected losses. When growth and new sales are hard (if not impossible) to come by, any option that reduces costs and helps manage cash flow ultimately may save jobs and should be pursued aggressively.

The following 5 strategy execution suggestions are opportunity areas where Procurement organizations can focus to drive immediate impact.

 

Crisis Quick Hits: 

1. Negotiate improvements to existing contracts in pricing and terms and aligning disparate pricing across similar goods/services
2. Aggressively renegotiating payment terms through opportunity mapping of their T&C’s
3. Performing quick-hit strategic sourcing in obvious opportunity areas that push out payments in return for longer term contract renewal terms
4. Elimination of volume related penalties or price changes
5. Give more stability to your supply chain in an unpredictable environment

 

Advanced Sourcing

Addressing core areas of spend with a more robust analytics and insights platform and process will yield additional savings

Many of their suppliers have invested in BoB solution platforms that put the Sourcing team at a data-driven disadvantage. Investing in data analytics and insights solutions provide the organizations a greater advantage in negotiations and enables you to capture the lowest TCO and best ROI for that particular solution.

 

No Stone Unturned

In the most advanced environments, strategic sourcing and other techniques are being applied with great success to categories that historically were viewed as off-limits or too nuanced. 

Construction, Maintenance and Repair, Legal fees, regulated energy costs, advertising, and many more categories are yielding big savings and may be virgin territory in some companies.

Experience from the 2009 recession shows companies that failed to ask for cost concessions in these areas unknowingly subsidized those that did.

 

Make Actual Savings Equal Projections

A significant percentage of savings is lost when internal stakeholders use the wrong suppliers.  This undermines future negotiating leverage with current suppliers and mitigates the gains from prior sourcing events.

Being able to identify and manage preferred vendors enables you to lock down noncompliance across the business using a combination of laser-sharp spend visibility, insights, and policy.

 

Capture an Additional 10%-20% Savings through Demand Management 

Companies that deployed aggressive strategic sourcing discipline and realized significant cost reduction by reducing price, lost track of the quantity.

Business lines saw leftover budget and spent to budget levels with goods at the new price point with a use-it-or-lose-it mentality.

As prices have gone down, consumption has often gone up at a faster rate than organizational growth.

If spend equals “Price x Quantity,” many organizations spend a disproportionate time on the price side of the equation, neglecting the quantity or demand side. Organizations can optimize buyer behavior but need good data to do so. Advanced category analytics is a key to locking down this compliance process Establishing KPIs and Tracking Results

In procurement, ROI has a different definition than the common formula. It’s not just based on monetary returns, but rather on overall improvements, both financially and operationally. Here are 4 key questions to ask when evaluating your procurement ROI:

1. Spend Cost Reduction– has our cost of goods and services been reduced?
2. Budget Control Through Workflow– is our team spending within budget resulting in increased savings?
3. People Cost Savings– are we saving time and resources by decreasing manual purchase processes and eliminating paper-based invoices and management systems?
4. Spend Visibility– have we gained more insight and control resulting in better analysis and identification of after-the-fact savings?

If the answer to those questions are yes, then your procurement function is delivering. There are many procurement-specific KPIs that can be calculated and analyzed to improve your procurement ROI. Here are a few you can use to measure the effectiveness:

• PO Spend Percentage- Shows you how much spend is PO-based and your pre-approved vs. total spend. Insight into the PO process improves spend controls and increases visibility into where money is being spent, by who and with what suppliers.
• Purchase Adoption Percentage. To calculate this, divide the spend on your procurement platform by your total spend on goods and services. This gives you your total spend under management and tells you if a boost in user adoption is needed.
• Percentage of eInvoices. This is the number of invoices received digitally divided by the total number of all invoices (including paper). By identifying this number, you can determine your ability to eliminate work associated with manual methods (like typing invoices) which leads to a reduction in AP staff cost by better reallocating their time.
• Straight Thru Processing Percentage. This is the number of invoices that go from receipt to ok2pay without AP needing to get involved. Calculating this number tells you where efficiencies can be created by further automating core processes.

Percentage Spend from Approved Vendors. This drives savings and reduces risk by telling you the amount your organization spends under contract. When employees are buying from pre-approved suppliers, they are taking advantage of pre-negotiated discounts and reducing the overall price of purchased goods and services by reducing maverick buying.

Suplari is the pioneering Spend Accountability and Financial Performance system, indispensable for enterprise procurement and finance teams looking to optimize the cost-risk-compliance trifecta.

CFOs, COOs, CPOs, and other business leaders alike rely on Suplari’s powerful tools to gain better insights into spend visibility and operational agility, enabling cost optimization, compliance, and a reduction in fraud and other risks.

Users are delighted with Suplari’s modern and fluid user experience, advanced analytics, and AI-persistent Insights algorithms – helping teams consolidate vendors, aggregate demand, negotiate contracts, and manage supplier performance.