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CPO’s Guide to managing indirect spend
In our previous article, we highlighted the difference of spend from expenses. While expenses stated in financial statements contain accounting entries such as depreciation and inventory write-off, spend reflects the actual money paid by an organisation to external parties, regardless of whether they are used to pay for services, products or assets.
In this article, we leave the detailed definition of spend and analysis methods behind for a while, and start to look at the key performance metrics that are relevant to Procurement.
Ardent Partners – CPO Rising
One of the most respected research reports is published by Ardent Partners. This research is conducted annually, and uses results of a global survey to form a clear and comprehensive view on the “state of Procurement” expressed by procurement professionals.
The first report under such a survey was published in 2008 under the Aberdeen Group, before Ardent Partners was formed. In the latest instalment titled “CPO Rising 2016: The Art and Science of Procurement”, data from 331 respondents with 89% working in procurement across 25 industries were used. Some 30 interviews were conducted with CPOs to complement the survey data. While every research effort has its own weaknesses at some point, all Procurement functions will benefit from the rich knowledge and data covered in Ardent Partners’ research.
The 2016 Procurement Benchmarks
The following are the benchmarks published in CPO Rising 2016 report:
The following is the author’s interpretation of the first few benchmarks, illustrated with examples where appropriate.
Spend Under Management
Mathematically, this benchmark can be expressed as the ratio of spend managed by Procurement to total spend expressed in percentage terms. Using the example of an organisation with design, manufacture and distribution activities from the previous article, we have the following breakdown of the company’s spend, arranged in descending order of spend value:
If a new indirect Procurement function was to be established in the company, it is recommended to exclude the spend on Legal fees and Advertising expenses from the scope of Procurement. It is assumed that these spend is currently well controlled within the company and managed by other functions or departments.
This leaves Procurement with a scope of US$ 8million spend. If this proportion of spend is fully managed by Procurement, the company can consider that its Spend Under Management is at 39%, which is below the market average. However, this is a modest start and will help the new Procurement function to gain experience and confidence in managing more spend in future.
The key question is what is considered as “Spend under management by Procurement”? The other benchmarks from CPO Rising give indications on what can constitute this term. They are:
- Addressable spend that is sourced: Take the example that a specific supplier or contract is in use by the company for a number of years. The question to ask is: “Is this contract or supplier still competitive in the market?” If the answer to the question is uncertain, conducting a simple tender or RFQ (Request for Quotation) exercise will suffice to give management an indication of the spend being under control. Otherwise, there is potential to re-tender the contract under current market conditions and gain potential savings over the outdated contract.
- Spend that is contract compliant: Purchases made outside of contracted terms should be regarded as not managed. It is clear that suppliers are not obliged to provide favourable terms and rates for any services or products which are purchased outside of established contracts. Likewise, any consumer should not expect a flat rated discount of 20% off every merchandise when the store advertisement simply stated “20% off children’s clothing”. The same basis applies here, ie. purchases made from approved suppliers outside of contracted terms should be regarded as not managed.
- Contracts stored in a central, searchable repository: Documented contracts concluded with suppliers are legally binding documents. Such documents should be retained, kept and stored under controlled conditions so that they can be relied on when contract disputes arise. Properly documented contracts should be reviewed and approved by the company’s authorised representatives, before the contracts and their associated spend is considered as managed and put in control.
Other organisations have adopted different criteria sets to define spend managed by Procurement. Regardless of the definition used, it is imperative that an organisation state the expectation of Procurement by using clear measurements, and have the expectations communicated within the organisation before the Procurement function will be effective.
The rest of the benchmarks relate to the ePurchasing and eSourcing enablers and will be addressed in future articles on the topics. At this juncture, it should be clear that spend values is paramount to the operation and success of Procurement. A fitting concluding remark is from CPO Rising 2016, which states that CPO’s who manage their operations without spend analysis is tantamount to “committing procurement malpractice”. The use of spend data to drive Procurement activities cannot be over-emphasized.
Talk to our experts to find out how ThunderQuote can help your organisation in managing indirect spend and increasing cost savings.
In our next article, we will shed light onto the activity of spend analysis. A balanced bottom-up approach to spend analysis is needed to avoid any acts of “procurement malpractice”.