Savings & Finance

6 steps to measure real savings for indirect spend

Indirect spend management requires much more communication with internal stakeholders than direct spend to get commitment and results.  This article gives you 6 steps to measuring savings in the very trick indirect spend category.

Tell Me More

Updated: Dec 19, 2022

I was having discussions a few weeks back with one of our clients regarding actual savings calculation, where you calculate how much of the savings you have claimed hit the bottom line.

These conversations left some interesting questions: If last year my spend in category X was 100 and now it is 90, what are the main drivers for the change? Did procurement contribute to this change?

For direct spend, they have state-of-the-art reporting used widely in the company, not only by procurement. There is only one truth, one set of numbers. Market-, volume- and currency impact, and even substitution impacts are all isolated from the actual procurement savings reporting. Great stuff!

Now they are interested in expanding the same measurement for indirect spend. It is a much more arduous journey than direct spend but still entirely doable.

Keep in mind that there are no shortcuts to reaching the goal. It’s like crossing a frozen lake in the springtime; it’s tempting to cut corners and do it, even if there is a risk of falling in the cold water.

But it’s better to be patient and find another way to go around the lake, even if it is more time consuming and requires more effort.

 

6 steps to measure indirect spend

I have tried to summarize some simple steps, by far nothing revolutionary, to keep in mind on the journey.

 

1. Dedicate resources to indirect spend management

Basic stuff, but you will fail miserably if you don’t have dedicated resources or an organization around indirect spend. It is wishful thinking that the same resources that manage direct spend could also manage indirect spend.

Indirect spend management requires much more communication with internal stakeholders than direct spend to get commitment and results. 

 

2. Classify your spend properly

When the whole organization is aligned, create a hierarchy structure that reflects the organization and is supported by the data quality.

I have seen structures where companies try to get into very detailed levels, but no data points are available to support the classification. The discussion is dominated by classification errors and unreliable data in these cases. As long as the category managers can do their work effectively, that should be enough.

Another bad example regarding category structure is where every node in the category tree does not have an owner/category manager. Why have those nodes if nobody is looking after them? I have had multiple discussions with clients regarding the optimal/best practice hierarchy structure.

In my opinion, the key is to find a structure that gives you enough detailed visibility to spend for the category managers to do their work that is still supported by the source data. Four hierarchy levels should do the trick.

 

3. Understand where you're spending

When the organization and hierarchy structure are in place, the next question you should focus on is where to spend your money. This is basic spend analysis to understand where the money is going and to find opportunities to focus on.

 

4. Track your savings initiatives

Next, you need to track all the initiatives that the opportunity identification process has generated. The result of the process is what we call ‘approved savings.’

This is the best guess of the savings based on some expected volumes. It is good to involve other internal stakeholders rather than just procurement (e.g., finance) to get credibility behind the numbers. Otherwise, there is a risk of getting into the ‘Mickey Mouse-money’ talks.

 

5. Monitor compliance

To ensure that the contracts you have negotiated can hit the bottom line, you need to ensure that contract compliance is monitored. The maverick buying is eliminated to a large extent.

 

6. Measure results

Finally, you are in a position where you can start to see if the savings hit the bottom line.

Indirect spend is tricky to measure because, in many cases, you miss the same kind of data granularity as you might have for direct spend, material codes, quantities, etc. But don’t lose faith.

 


Final tips for measuring savings

One way is to implement purchase-to-pay tools to enable easier purchasing activities. The problem with these solutions is that they are time-consuming to roll out, and there is still a significant amount of spend (small purchases, consumption-based purchases, etc.) that never end up in the tool.

A much easier method is integrating supplier data into your reporting in what we call data enrichment. For example, in many companies, logistics is a large, even strategic category. Still, the visibility of what has been purchased is low (in worst cases, one consolidated invoice row for all the transports during one month).

But these suppliers have good visibility of what they have sold to your company in their systems: routes, volumes, etc.

Now, when you have consolidated the transports to one or a few suppliers, you have the opportunity to get full visibility of your spend by asking those suppliers to deliver the data to enrich your invoice data. That way, you can split the spend change into different components.

If supplier data is not available, you can implement what we call proxies. The idea of proxy is to create a volume component to spend to track that change. One example could be facility management, where a proxy could be floor space, e.g., how much we paid per square for cleaning this year compared to last year.

Before moving into proxies or supplier-enriched data, it’s worthwhile to think about the more strategic categories and where it makes sense to maintain this approach. But for the selected categories, this approach gives you a new insight into actual savings and credibility in those savings discussions with other stakeholders.

 

Photo by Mike Kononov on Unsplash

Mikael Hellström

Mikael is a former Vice President Customer Development of Sievo.

    Ultimate Guide to Procurement Cost Savings

    Everything you need to know about procurement savings, with 23 different methods explained.

    Ultimate Cost Savings Guide Cover

    Everything you need to know about procurement savings here!

    This guide explains the 5 major approaches to cost savings in procurement. 23 different savings methods are explained, from Hard Savings to Cost Avoidance. In addition, you'll learn how best to identify, measure, and communicate those savings to your organization.