Spend management – progress in last decade
Sievo has been in business for bit more than decade. Over that period, we’ve grown from 2-man startup to 70 person growth company with respectable client list. But not only has Sievo changed, so has the best practice in spend management field. The purpose of this blog post is – no more, no less – to summarize the progress of spend management during last decade.
1. The starting point: spend analysis and contracted savings measurement.
Spend analysis is the basic building block of spend management, and no procurement organization can be run professionally without good understanding of spend. Even though spend analysis has been around long, and will continue to do so, what can be achieved with spend analysis has changed drastically. We’ve seen a move from static, quarterly updated reports into drillable on-line analytical tools that are based on data that is updated weekly, if not daily.
Another old-time friend of spend management is contracted savings measurement. Even though procurement functions have, rightfully so, expanded their impact way beyond traditional savings chasing, savings measurement is here to stay. For me it’s just a license to operate – in the very same way that all sales functions need to deliver closed deals, (almost) all procurement functions need to deliver savings. It’s definitely not the only thing procurement needs to do, but it is one of the key aspects procurement needs to deliver.
In short, spend and contracted savings have been around for long, and continue to do so. At the same time, these concepts have two fundamental limitations:
- They are backward-looking concepts
- They are procurement oriented concepts
To understand how or clients, and spend management domain in general, has progressed beyond spend and contracted savings during last decade, it’s useful to look at the chart below.
2. Adopting a forward looking view – savings portfolio management.
Natural next step beyond spend and savings measurement is to adopt a proactive approach on managing procurement performance. At this stage, spend analysis is still used, but not only as a high-level, static tool for creating sourcing strategies and designing category organizations. At this stage, spend analysis is leveraged as a daily tool to identify savings and value creation opportunities. Instead of getting reports on “average payment days by categories”, analytics platform proposes improvement actions such as “by harmonizing payment terms for supplier XYZ, you can free up 72 kEUR working capital”.
In addition to identifying opportunities, at this stage procurement organization constantly and proactively manages savings opportunity portfolio. CPO is less concerned about “how much savings was created last month”, and more concerned around “how much savings pipeline I have for next 6 months”. Obviously, savings actions should cover the full spectrum of value creation activities, such as price savings, policy changes, demand management, working capital and supplier innovation. The good news are that transparency on savings pipeline almost automatically also increases the pipeline. Transparency will drive idea sharing, positive competition and learning across categories and regions.
3. Communicating in a way that business partners have a chance of understanding you.
Measuring contracted savings based on specific savings actions makes sense from procurement point of view. However, this absolutely does not make sense from the perspective of CFO and business. There are many reasons why measuring contracted savings based on savings actions just is not enough: contracted savings
- Are defined through categories – not through PnL accounts and cost centers. This means that the numbers do not have relevance for business stakeholders
- Are focused on procurement contribution, and clear of commodity and currency impacts – which makes sense from procurement contribution measurement point of view, but again, leads to limited business relevance
- Covers only part of overall spend that is actively managed – any changes on other parts of spend go unnoticed, and smart suppliers take advantage of this
In short, procurement needs to get away from communicating “savings by category” to communicate “cost changes by cost centers / PnL accounts”. Key approach for doing this is to report spend and savings in an integrated way (and not in isolation). Picture below describes how this can be done (to learn more, you can order a book describing this approach from Sievo’s web site). Key is that we isolate (i) procurement contribution from (ii) total cost changes. Too often procurement and finance try to compromise on “what is saving”. The point is that there’s no compromise that would satisfy both parties, as “savings” is and will be fundamentally different from “cost change”. Instead of creating a compromise, one should create two interrelated metrics – and both of these must be based on realized invoice data, not a bottom-up activity based savings measurement exercise.
4. Creating forward looking view on cost changes.
Depending on your industry, procurement costs cover 30-70 % of total costs. As procurement costs tend to be much more volatile than other cost elements, procurement costs cover 60-95 % of total cost volatility. With this fact, I find it absolutely amazing that very few companies have mastered to create a robust view on the impact that spend changes have on the profitability. It’s not that businesses wouldn’t have recognized need for it – they have, and most businesses try to navigate around this issue with lot of Excel files and countless hours of controller work. But, let’s face it, if Excel is not good enough for serious spend analysis, it’s definitely not good enough for any professional forecasting, which is much more complex and data intensive process requiring many inputs from different stakeholders.
For us, the current best practice of spend management is the ability to create a forward looking view on what’s going to happen to your profitability. Creating this forward looking view requires that your forecasting process
- Provides procurement perspective (category, contributing savings action)
- Provides business perspective (cost center, business line, PnL account, end product)
- Is collaborative – collecting input from various stakeholders
- Is dynamic, allowing quick iterations when key assumptions (say, oil price) change
When procurement can switch the key message from “category savings” to “expected cost changes”, the interest and collaboration from business partners is guaranteed.
This blog post was designed to cover the past decade of spend management development. The next blog post will be the interesting one – what will happen to spend management in next decade.