A few weeks ago, on June 7th, I had the privilege of speaking at the 2017 Plastics Financials Summit here in Chicago, not far from Source One's office. My talk was about the importance of Indirect Spend Management in strengthening your company's bottom line. Here's what we discussed at the conference!
Indirect spend, though often neglected, can range between 20% and 50% of a company’s expenditures, depending on the core business and industries it operates in. Although there are particular nuances to this spend category, the approach should be much the same as direct spend: strategize, standardize, and streamline the sourcing process to align with business initiatives. Effective indirect spend management drives greater efficiency across the enterprise and maximizes savings opportunities, resulting in future financial management success that will directly impact your bottom line, and elevate your business to the next level of success.
What is Indirect spend
It is important to first understand the notion of Indirect spend in order to properly sort your suppliers out and define the impactable spend of a future indirect spend sourcing initiative. As opposed to Direct Spend, which includes all purchases of goods and services that are directly incorporated into a manufactured product (raw material, manufacturing services, etc.), Indirect Spend encompasses all of the supporting materials and services that do not end up in products or services directly delivered to the customer. Generally, Indirect Spend can be broken down into two major categories: MRO supplies and Indirect Goods & Services. MRO supplies include all spare parts and repair services necessary to keep production equipment up and running. Indirect Goods & Services include all the support tools and services necessary to run a business, such as office supplies, IT hardware and software, travel, and advertising.
From a purely financial standpoint, Indirect spend is what CFO look at in the SG&A (Selling, General & Admin) or GNFR (Goods Not For Resale) line items on their balance sheet, depending on the nature of your business. In a more detailed approach, Indirect spend is generally low-value goods or services (I.e: not the most important source of cost for certain industries, especially General Manufacturing) or items purchased through Purchasing Cards (for example any type of office supplies, travels, other general expenses). Indirect Spend can also sometimes be embedded into direct spend, such as transportation fees included in the overall price of supply of raw materials.
From a pure spend analysis and supply chain management standpoint, Indirect Spend can be a good place to look at for cost reduction initiatives. What the financial definition of Indirect Spend given above means from a procurement operation standpoint is that when not managed properly, it can lead to decentralize procurement practices, which ultimately leads to maverick spend or in other words non -budgeted costs due to lack of compliance control over pre-negotiated purchasing policies or agreement with suppliers.
How to address Indirect spend from a strategic sourcing perspective
Managing Indirect spend is a team effort involving both Financial and Procurement department. Efforts must be focused on bringing control over your entire source to pay processes (3 components described below) for the targeted spend categories. This initiative overall goal will have a different definition from a CFO or a CPO point of view; Spend Control by CPO, Budget Control by CFO - but it will have a common positive result on your bottom line by bringing savings to your organization. There is 5 key steps to undertake to bring your organization’s procurement department to the next level:
Accountability and Sponsorship
Before to undertake such initiatives, it is mandatory to create or define a structured team that will be responsible for such projects. Building the team is not as easy as it can sound. Projects team members must understand the organization’s objectives and, most importantly, must be accountable for achieving them. This means that such projects must be sponsored by the highest level of the company’s management, and grant the team leader (who will report under the sponsors) with a strong decision-making power. This will facilitate communication among all stakeholders from different departments of an organization (such as finance, legal, operation, etc.) that will be involved in the initiative, and ensure its success.
Data collection – Company Procurement Operation Processes assessment and Spend Profile Analysis
The key to a successful Indirect Spend strategic sourcing initiative is to first get a clear picture of your organization’s procurement profile. It is essential to get a good visibility on your spend structure and your current control over it as well as your procurement operation processes and associated technology. Indeed, it will ultimately allow you to identified maverick spend and its associated financial impact and assess the gaps in your source-to-pay processes (technological, human or others). The best practice in terms of spend analysis is to focus on your top spend categories and associated suppliers first and tackle the remaining suppliers if need be, following the 80/20 rule. From this analysis, the team assigned to this initiative will establish a spend and a process/technology baseline. It will not only provide you with a better understanding of your entire supply chain management profile, but also provide guidance on which strategies to apply to what spend category (supplier spend reallocation, internal efforts to ensure contracts compliance, etc.).
Objectives definition and ROI projection
Once your baselines are established, you can set your objectives and build your initiative roadmap. This step must be used to answer questions such as what spend category will be included in the cost savings initiative, how much savings is your organization planning on realizing (while being realistic at the same time), what will be your internal costs to achieve these objectives, and how the overall return on investment is going to be leveraged across your organization. Answering these questions will allow your company to set the overall expectations of such initiative, at a C-suit level, which is essential in the sponsorship role expected from the highest level of management as described above. From simply cutting costs to using realized savings in order to extend investments current budgets in areas such as R&D, IT support, or even company expansion/acquisitions, it is essential to clearly define the line your organization wants to take, and properly communicate it to the team member(s) accountable for achieving your objectives.
Strategizing & Execution
Once the data collection process is completed and the initiative roadmap developed, it is time to strategize and go to market. Before exploring the different tools available for going to market, let’s take a look at what strategies could be applied specifically for Indirect Spend initiative. Some of the most common strategies that apply to decentralized Indirect Spend procurement practices are supplier consolidation, spend consolidation (consortium), and benchmarking and direct negotiation with incumbent suppliers. There are several points to take into consideration before choosing which strategy to go with, such as the impact it would have on the relationship with incumbent suppliers or the time and resources needed versus what’s available. These points of consideration should help you select the appropriate strategy to apply in order to maximize your results.
Some of the tools that can be used to support these strategies are RFx, Reverse auctions, consortiums, etc. RFx is one of the most straightforward processes that enables suppliers to gain access to the full scope of work a business is looking for, and that will enable your organization to collect valuable data about the market state of a specific Indirect Spend category (suppliers competitiveness, quality of services, etc.). Reverse auctions can be an efficient way to capture savings quickly, but will most likely not end up with a long-term, sustainable solution like a RFx will provide. Smaller companies who want to leverage volume to get better pricing can explore the Consortium option. It can be applied to health care plans, office services, etc. Contracts, existing or not, can be seen as tools to use for your direct negotiation approach, and can result in quick savings as well! Payment terms or extension of your contract duration term are points of discussion that can be leveraged to qualify your company for an immediate discount program.
Building control over your Indirect Spend categories goes beyond the strategic sourcing initiative your organization will conduct and the team you will assign to support it. Controlling your Indirect Spend also means being able to ensure compliance and track performance. As obvious as it sounds, the proper mix of human and technological resources is the key to ensuring that the full source-to-pay process is under control. That being said, your teams accountable for compliance and performance tracking have to be equipped with the proper tools! Technological resources must be carefully selected to fit your company’s profile and enable your source-to-pay process to become one continuous flow. Supplier enablement is critical and can be achieved by adopting systems that will ease the ordering and invoice processes. Investing in an intranet based electronic platform can be an excellent long-term solution as well; it will enable better control and tracking of purchasesand will facilitate any future sourcing initiative to be carried out. These are just examples of what can be applied to ensure proper control.
Indirect Spend sourcing initiatives follow the same logic as any Direct Spend sourcing initiative. However, it is not given the same focus, leading to decentralized procurement practices and maverick spend. Allocating the proper resources, both human and technological, is mandatory to the long-term success of any Indirect Spend sourcing initiative and to ensure the projected savings will be realized.