Spend Analysis

The Window into Strategic Sourcing

Kirit Pandit, Haralambos Marmanis

• Publisher: J. Ross Publishing
• Year: 2008
• ISBN:
  9781604277029
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Operaciones

A growing number of senior executives are coming to realize that strategic supply management can be a significant driver of improved corporate performance and better risk management. Spend analysis is the most critical component, and the starting point, of strategic supply management and is essential to achieving world-class performance. If you can't analyze your spend data, many opportunities for improvement beyond the low hanging fruit are without doubt being missed. One of the foundation blocks for transforming an organization's practices to world-class supply management is the business process called strategic sourcing. And one of the requirements for enabling world-class strategic sourcing results is rigorous spend analysis. There is a lot of confusion on what constitutes spend analysis and what benefits can it provide. Spend analysis can help improve several areas: the identification of cost reduction opportunities, the prioritization of sourcing projects, the negotiated results, and the tracking and monitoring to ensure that negotiated results reach the bottom-line. It can also play an important role in improving compliance with Sarbanes-Oxley. However, implementations are complex and involve many departments within an organization. If the implementations are done correctly, they can yield high ROI. If not, they can consume money and deliver no returns due to lack of adoption. Spend Analysis: The Window into Strategic Sourcing is the definitive text on this important subject, written by leaders in the field. It is currently the only reference that provides in-depth guidance on what spend analysis really is, what it involves specifically and how to use it in your journey to world-class performance. It provides both an executive overview and technical details for practitioners. Readers do not need specialized knowledge in database systems, information technology or any other field to gain insights from reading this book. It is a must read for procurement, supply chain management, operations, and finance executives, and for practitioners and consultants.

PART I

FUNDAMENTALS OF
SPEND ANALYSIS

Every CFO’s dream is to be able to cut millions of dollars in costs, not on a onetime basis, but annually—and to keep raising the bar for the procurement and operations teams to squeeze out additional savings year after year. Over the last few decades, most CEOs have focused on driving frontline revenue growth as a means of increasing EPS (earnings per share) and have often ignored or neglected the other side of the equation, namely, the cost. Now, the focus is slowly shifting. In today’s global economy, in which more than half of your products and services might be sourced from suppliers in different countries, the ability to systematically manage a large and diverse supply base could well prove to be the single most important differentiator between leaders and laggards over the next 10 years.

Companies who understand this have already implemented strategic sourcing initiatives and are reaping handsome rewards. Take the example of Dave Picarillo, VP of Sourcing at BrainTree Sourcing, a division of Royal Ahold.¹ Ahold, as you might know, is responsible for sourcing goods and services for 6 grocery brands and more than 1200 supermarkets in the United States. Dave also oversees sourcing for Ahold’s divisions that operate 85 warehouses which provide goods and equipment to restaurants throughout the United States. In the United States alone, Ahold spends more than $3 billion annually on indirect goods and services.

Ahold launched its strategic sourcing program in 2003. In 2 years, the program had yielded a mouth-watering savings of $350 million just on indirect procurement! What’s more, the savings have kept growing each year. Ahold now expects to expand the program to private label goods, expecting to save 5 to 10%. So how did Dave accomplish this? What did he do that others should be paying attention to?

Ahold’s biggest problem prior to this new strategic sourcing program was getting good visibility into their category spend. Ahold’s traditional methods relied on distributed category teams submitting spreadsheets to the procurement team. Because of different standards and the differing quality of data, the spreadsheets and the data were not tightly organized at the corporate level. Therefore, Ahold was never able to get a clear, corporate-wide view of what it spent. Without this visibility, Ahold could not identify overall efficiencies and weaknesses of its sourcing process. With this in mind, the first step that Dave took was implementing a Web-based spend analysis application. With the new system, procurement and category managers at Ahold could get corporate-wide spend visibility through a Web browser from anywhere in the world. Managers could “slice and dice” the spend data in real time, identify opportunities for vendor consolidation and other savings, and generate actionable reports on a continuous basis, which gave Dave the foundation to implement an integrated Web-based supply management system which could be used to create and manage savings programs that could be monitored on a continuous basis.

In short, Dave replaced the ad hoc, disconnected sourcing processes with an integrated strategic program, which not only produced lower spending on goods and services, but also shortened the production conception to reception time in stores. The spend analysis application empowered category managers to review more spending projects in less time. The RFx (request for information/quote) portal allowed buyers and suppliers to collaboratively finalize requests for quotes, thus replacing the emails- and spreadsheets-based point-to-point system. Furthermore, the new system also made it possible to score supplier performance. Managers in different divisions can now rate the same supplier across different categories. Finally, Ahold can now leverage the optimized bidding and allocation capabilities of the tool to ensure that contracts for certain categories such as washing windows are given to local providers.

The payoff from such systems has been staggering to those on the cutting edge. According to a 2005 ROI leadership report in Baseline Magazine,² GlaxoSmithKline (GSK), a drug maker and distributor in the healthcare industry, boasts of an annual return of 5451% from its sourcing programs—and this is just the beginning. As companies gain more visibility and control in sourcing, they can hold suppliers more accountable, negotiate for better terms and conditions, and channel the learning process across the entire supply base. Managers at Ahold went through about 3 days of training, followed by biweekly meetings on best practices. Ahold incurred about $1 million in costs to implement the complete system. Thus the benefits of $350 million in savings far exceeded the cost.

WHAT IS SPEND ANALYSIS?

Spend analysis is the starting point of strategic sourcing and creates the foundation for spend visibility, compliance, and control. Spend analysis organizes procurement information via supplier hierarchies, commodity alignment, and spend amount, in order to:

• Ascertain true category spend
• Identify strategic sourcing opportunities through demand aggregation and supplier rationalization
• Identify expense reduction through increased compliance—in the form of vendor rebates, maverick spend, contract compliance, and budget variance

The savings can range from 2 to 25% of total spend.

Basics

Let us simplify the above definition even more. Put simply, spend analysis is a process of systematically analyzing the historical spend (purchasing) data of an organization in order to answer the following types of questions:

• What was the corporate-wide spend associated with each cost center last year? Does the aggregate amount enable me to increase leverage with suppliers?
• What are the top commodities? What has the spend trend been over the last few years? Which of these commodities represent opportunities for spend reduction?
• Which suppliers are the most valuable and strategic?
• How much am I spending with preferred suppliers? How much am I spending with poorly performing suppliers?
• What percentage of spend is associated with contracts?

The idea is to be able to examine these reports and identify opportunities for savings. For example, if the spend associated with nonpreferred suppliers is high, this category is clearly where spend “leakage” is occurring because the prices and terms negotiated with preferred suppliers are usually better than the prices and terms that are in effect with nonpreferred suppliers. Similarly, if a particular commodity is fragmented (i.e., is being sourced from many suppliers), this commodity could be consolidated into fewer suppliers and better prices could be negotiated by channeling a higher volume of spend through them.

If your purchasing or finance department can readily provide accurate answers to the above questions, then your company has perhaps already implemented a good spend analysis solution. If the latter is not the case, then you should challenge the accuracy of the answers. Chances are, though, that your purchasing department will not be able to provide the answers. In fact, there is a high likelihood that you will not receive even one answer. If that is the case, you are not alone. A vast majority of enterprises have not yet implemented spend analysis.

At this point, you might wonder what is so difficult about analyzing purchasing data. The above questions seem simple enough to answer. To understand this situation, take a look at Figure 1.1, which shows a few transactions pulled from the AP (accounts payable) systems of two divisions of a corporation. Examine these transactions and try to quickly answer the following questions:

1. How much did the company spend on personal computers?
2. How much did the company spend with IBM on software?
3. What was the spend associated with IT and professional services in Q3 and Q4 of 2006?

You will quickly figure out the challenges in analyzing this data. The two divisions have separate cost centers and separate GL (general ledger) codes, which have not been integrated. You may also have noticed that all of the transactions belong to IBM, but this might not be easily apparent if you did not know that Lotus Corporation, Ascential, and MRO Software are subsidiaries of IBM. You might also have noticed the many different variations of the name IBM. Also, the various fields in the two extracts are not identical. Division 2 transactions do not show commodity codes or SIC (standard industrial classification) codes. They do contain descriptions, but they are not very good.

In short, the data residing in business systems are many times not cleansed, enriched, consolidated, and organized at the corporate level. This makes it very difficult to make like comparisons. Moreover, the information is finance-centric. The various GL, cost center, and other codes were created to facilitate accounting, not purchasing. Figure 1.2 shows a...