Within the larger process of strategic sourcing, a spend analysis is the necessary first step in identifying savings opportunities and providing a baseline for improvement. But surely before having a formal spend analysis (and undertaking a sourcing initiative), companies can already have particular savings opportunities in mind, such as changing to a preferred national or regional supplier. But pre-ordaining a particular course of action, before you have the analysis to back it up, you could set yourself up to achieve inferior results – or at least, not the best results you could possibly get.
In a recent Harvard Business Review article, finance keynote speaker Joe Knight noted, “most people use [return on investment] analysis as a way to justify something they really want to do anyway.” He recounted how, in a previous job as a CFO, the company’s owner asked him to do an analysis to justify purchasing a $100k 3-D printer. The idea was that the printer would reduce instances of rework in the fabrication of component parts, because often the translation of CAD data into a real-life object revealed issues in dimensions. Knight provided a quick projection based on five years of operating and associated costs. He suggested that the analysis might conclude that it’d be more cost-effective to make due with occasional scrap parts and rework rather than invest $100k plus ongoing maintenance.
Ultimately, the owner went ahead with the purchase, saying that Knight’s analysis was wrong. This way of operating is not just for equipment purchases, but mergers and acquisitions as well. Knight notes, “Even large companies make investments such as acquisitions based on irrational projections. The CEO negotiates with a company he or she wants to acquire. If the numbers don’t work, the CFO is told to revise the projections so that they do.”
Due diligence exists as a mechanism to identify risk and, plainly speaking, not do risky things. Aspirations are great, but you need the numbers to back it up. As we learn in elementary school studying the Scientific Method, we start with a hypothesis as the basis for experiment – but we have to accept that our hypothesis can be disproved. If, after repeat experiments, your results indicate that your hypothesis was incorrect, then you need a new hypothesis.
When undertaking a cost savings initiative, companies must keep an open mind to what the spend analysis will reveal. Maybe migrating to one national supplier, for example, looks attractive on paper, and could cut down on the number of invoices to manage, or the number of line items in the ledger. But does migrating to one supplier produce the most practical savings opportunity? Does it ensure sustainable cost savings? Source One Associate Director and Spend Consultant, Jennifer Ulrich, will speak at La Salle University’s Business Systems & Analytics Club this week, covering how a solid spend analysis will provide the best visibility for decision support – not only for sourcing initiatives but also for any spending course of action.
Image courtesy of LexisNexis