The effectiveness of a strategic sourcing program can rise or fall on the quality of the spend analysis. Is your company ready?
In today's economy, spend analysis is gaining respect as a potent weapon in the battle to squeeze new savings out of corporate procurement processes. Currently over 90 percent of the Fortune 100 companies are implementing strategic sourcing programs, and with it they are able to determine precisely what they pay for materials, products and services, when they pay for it, and with whom. Islands of spending data must be extracted and aggregated from multiple enterprise systems in order to generate a single uniform view of enterprise-wide expenditures that can identify cost-cutting opportunities as well as reveal critical differences among suppliers.
Some organizations that have adopted spend management initiatives are reaping big savings. One consumer products company has reported slashing certain bids by as much as 90 percent after consolidating and analyzing over $30 billion worth of purchases from 50 different accounts payable (A/P) systems. A cutting tools manufacturer saved over $1 million on $800 million in "quick hit" negotiations by applying the lessons learned after merging A/P, purchase order (PO) and purchase card (p-card) data. A cabinetry manufacturer lowered the costs of purchased materials with a projected year-over-year savings of 2 to 4 percent by consolidating spend data across five divisions.
In fact, analysts estimate that an effective, ongoing spend analysis program can produce net savings of 7 to 10 percent in the cost of goods sold, with additional savings elsewhere. But most companies fail to realize these savings because they use a short-term SWAT team approach rather than making spend analysis a permanent component of their cost-policing arsenal.
One way to realize the full benefits of spend analysis is by tracking and studying spending patterns on a continuing basis. A commitment to systems that can automate the process of aggregating spend data from all sources, standardizing it according to a granular coding system, and performing multidimensional data analysis to unlock trends perennially obscured by company size and structure, is one method of doing so. The resulting ongoing scrutiny can enable purchasing managers and corporate executives to obtain the actionable data needed to optimize sourcing decisions in the face of changing market demand, corporate requirements and supplier performance.
Once Is Not Enough
In its most common implementation, spend analysis is a one-time project that takes too long, yields incomplete and/or inaccurate results, and cannot be replicated without reinventing the wheel. The culprits: lack of adequate tools and dirty data.
Consultants have to use semi-manual methods to consolidate, clean and classify spend data from across different departments, disparate enterprise systems and multiple corporate locations. Differences in style and terminology must be reconciled (for example, "kilogram" and "kg"), and products must be classified down to very granular levels to permit precise searches on given spending categories ("cap screw" or "laser printer"). The effort can last many months, and the sheer volume of data and limitations of the methodology make it difficult to arrive at a thorough understanding of the complete spend profile.
More significantly, the one-time analysis yields only a one-time benefit. Repeated analysis is often required to identify changes in enterprise spend, by commodity and supplier both, incorporate projected demand as well as historical data into the spending picture, and monitor progressive spend against established contracts to ensure that anticipated value is delivered. How can you make it easier? By implementing automated tools dedicated to such functionality.
Taking the Plunge
Successful spend analysis needs a sustained application of resources; a commitment to refreshability; the sponsorship of one or more high-level executives such as the CEO, chief financial officer (CFO) or chief purchasing officer (CPO): and the participation of all relevant stakeholders. It also necessitates the adoption of the proper systems and processes to repeat the expenditure review on a regular basis, making it possible to uncover monthly, quarterly or year-over-year differences that can spark new cost-saving initiatives.
Whether using a license-based model requiring in-house installation of application hardware and software or an external solution hosted by an application service provider (ASP), implementation of a comprehensive spend analysis program involves five components. These include:
* Spend data capture software to gather and consolidate spending data from across A/P, PO and p-card systems, data business units and geographies
* Normalization software to eliminate discrepancies among supplier names, addresses, currencies, dates and other data compiled from multiple sources
* Classification software to code all products and services according to a uniform scheme to ensure commonality for the same or similar items
* Analytical and reporting tools typically interactive OLAP (OnLine Analytical Processing) systems with flexible reporting outputs
* A data warehouse to act as a central repository for data collected from all relevant enterprise systems
Spend analysis can be used by companies that are doing paper-based purchasing as well as those that have embraced e-procurement, but an enterprise using paper-based systems must also convert its paper data into electronic format. This is an extra step, but it offers an incentive to make the inevitable transition to electronic purchasing.
Once the infrastructure is in place, managers must implement proper procedures to ensure consistency across the enterprise, as well as comprehensive results. Processes must be standardized across all business units; the system must be configured to look at both past spending patterns and projected demand, typically one to three years in the future; software must be customized to generate the precise metrics the organization needs; and so on. Then the system can analyze corporate spend along dimensions such as commodity, class, part, part level, parametric attributes, supplier and division.
The Importance of Classification
The success of a spend analysis effort will be closely tied to the classification scheme employed. Granular, hierarchical classification of data is essential, not only to ensure successful standardization across the procurement environment, but also to aid search precision and permit aggregation and drill-down to any level of analysis.
With a common set of product identifiers that are part of a hierarchical taxonomy, individual purchases can be identified by highly specific descriptors ("safety glasses") or rolled up into more generic categories ("shop supplies" or "industrial supplies"). This allows users to evaluate expenditures at exactly the level most useful to their business or their purpose, including the identification of families of products that can be combined into contractible groups to negotiate a single source of supply and volume discounts.
The classification system that appears to be emerging as the universal standard is the United Nations Standard Products and Services Code (UNSPSC), the first global coding convention for products and services. Developed by the United Nations in association with business information provider D&B, the UNSPSC system arranges the entire universe of products and services into more than 13,000 hierarchical categories according to a five-level numbering system. This hierarchical structure and depth of detail make it possible to achieve the level of specificity required to effectively pinpoint a given product set, as well as to create meaningful product groupings.
Under the antenna category, for example, the UNSPSC assigns unique codes to communications, radio, automotive, satellite, aircraft, broadcast, microwave, television and radar antennas, enabling users to zero in on the precise product of interest. All antenna types share the same segment, family and class codes, facilitating search analysis and roll-up. The fifth level of the UNSPSC coding system allows for customization within the organization, tailoring the categorization hierarchy to user requirements.
Another advantage of the UNSPSC's numbering system is that it allows for unambiguous translation of a particular item's description into any language. This is a key benefit for multinational companies that want to analyze spending on a worldwide basis. While a given commodity will have different names in different languages, the UNSPSC system unites them all under a single unique number. Other coding systems lack this ability as well as UNSPSC's hierarchical organization and granular categorization.
"There are other codes available, but the United Nations Standard Products and Services Code is the one we rely on to support our strategic sourcing process," says Gary Reiner, senior vice president and chief information officer of General Electric. "The UNSPSC effectively gives us the means to capture a uniform, enterprise-wide view of our spending."
When all the numbers have been crunched, the resulting metrics will shine a light on potential savings in particular spending categories. Depending on the specific findings, purchasing managers may then be able to cut costs through the use of alternative products, supplier consolidation, merging products previously purchased separately into contractible groups, price reductions achieved through contract buying, improved contract compliance, the aggregation of purchases across divisions, reductions in maverick spending, and other means.
If a given analysis reveals that an enterprise is purchasing a particular part from 10 vendors at $100 each, for example, procurement officers can attempt to reduce expenditures on that item by narrowing the field to two vendors willing to provide price concessions in return for greater sales volume.
Without spend analysis, it is difficult if not impossible to spot these savings opportunities. Consider, for example, a Purchasing Magazine study of the procurement practices of the 250 U.S. companies with the largest procurement expenditures. The study found that only one in four companies were leveraging spending volumes across multiple divisions. In fact, the companies examined estimated that only 57 percent of their spending volumes have been fully leveraged. As the magazine noted, "U.S. companies are leaving billions of dollars on the table each year by not having sufficient insight into spending information to queue up and optimize their strategic sourcing engagements."
At the end of the day, the ROI of spend analysis can be considerable. For manufacturers, as mentioned earlier, industry experts estimate a potential net savings of 7 to 10 percent in the cost of goods sold, with anecdotal instances as high as 20 percent. This translates to the Holy Grail of higher gross margins. Both manufacturing and non-manufacturing enterprises can achieve additional savings on items ranging from office supplies to temporary staffing, contractors and consulting services.
Two telling statistics from Tim Minahan of the Aberdeen Group express the ROI story particularly well. Minhan notes that a 5 percent reduction in spending can have the same impact on bottom-line profits as a 30 percent increase in sales. He also estimates that nearly 75 percent of the savings opportunities in procurement stem from strategic sourcing. Pierre Mitchell, research principal at AMR Research, puts it another way. "A company that is spending, say, $50 million on everything from corporate supplies to IT to telecom services can save $5 million annually, which easily pays for a $1 million (e-procurement) application."
Spend analysis also yields tangible and intangible benefits in evaluating suppliers and vendors. It can measure price variations, on-time delivery, price/service ratio and incidences of quantity overages or shortages; help users choose between higher-priced vendors with on-time delivery and lower-priced vendors with late delivery; root out non-performing suppliers; and help boost contract compliance by continually monitoring pricing. Supplier scorecards aid these efforts by capturing both subjective and objective metrics that evaluate supplier performance.
Other advantages of spend analysis include faster sourcing cycles, reduced inventory and assistance in economic forecasting and long-term planning. It provides a realistic picture of future spend requirements based on forecasted planning data (for example, a company expecting 10 percent revenue growth in the next year can use spend analysis to determine what its expenses will be), and even makes it possible to assess the risk of a supplier facing bankruptcy or political unrest.
All of these advantages are maximized when spend analysis is used in conjunction with e-procurement. The Aberdeen Group estimates that companies can cut purchasing costs by 10 to 50 percent, and slash the costs of processing a purchase requisition from $107 to $25 or $30, by migrating to electronic purchasing.
Ready for Action
The effectiveness of a strategic sourcing program can rise or fall on the quality of the spend analysis. It contains the keys to the right suppliers, the right number of suppliers and the right allocation of spend. It provides the actionable data on which strategic sourcing decisions can be made. Without a comprehensive profile of enterprise spending, sourcing decisions may be sub-optimal or even wrong.
Automated spend analysis is certainly an avenue to pursue for any organization that is serious about strategic sourcing; the better the analysis, the greater the potential savings. For enterprises determined to leave no stone unturned to continually trim costs, that is good news indeed.
About the Author: Aatish Dedhia is CEO of Zycus Inc., a provider of artificial intelligence-based automated spend analysis and product content management solutions.