Companies large and small underestimate the importance of effective procurement management. Over the years, we have seen that most of our middle market clients underestimate the importance of effectively managing their supplier base and the flow of materials. Rather than viewing proactive procurement management as a strategic advantage to improve finished goods quality and cost, most middle market firms view procurement as a transactional necessity. In many cases, it takes a serious supply disruption to prompt senior executives from Sales, Operations, and Finance to appreciate the importance of their suppliers. The COVID-19 crisis of 2020 is a recent example of a supplier-related crisis that many companies were ill prepared to manage.
In 2020, the COVID-19 pandemic has wreaked havoc on the global supply chain as the world economy shut down for three months. The flow of goods and materials literally stopped for some companies, and it will take months to years to repair the global supply chains. While most companies saw their customers and orders disappear during the pandemic, other companies experienced 40-60% increases in demand. In most cases, neither category was prepared for the change in demand and in turn the change in supply. The loss in demand may eventually resume to pre-COVID-19 levels, and as companies begin their post-COVID-19 transition to more normalized operations, many firms will have a heightened focus on their supplier base and on spend management.
Spend management is a proactive, rather than a market reactive, approach that begins with an analytical assessment of what a company spends on the goods and services they procure to support their business. Spend management is an improved way of managing the procurement activities of a company.
Spend management is broken down into two types of spending. Direct Spend includes good and services that a company buys to support their manufacturing and customer services. Dependent upon the company, these materials may be commodity based (e.g., steel, aluminum, plastic resin) but also include packaging and other materials needed to produce a finished product for a customer. Indirect Spend includes goods and services needed to run their business that are not directly incorporated into a product or service. These materials include items such as office supplies, laptops, network routers, legal services, consulting services, and marketing agencies. Direct spend is usually the largest spend category in terms of dollars, and it is also considered more important to the business. In some cases, it is better managed than indirect spend as companies put more resources into the management of these materials. However, indirect spend can also deliver material savings for many companies and should also be actively managed.
The following diagram illustrates the 10 steps of the FortéOne Spend Analysis process.
As with all business analyses, it all begins with data. Most middle market companies today have either a G/L system with a detailed chart of accounts or an ERP system that supports their business, and at least some data is usually available for analysis. The data required are purchase orders, goods receipts, supplier invoices, and supplier payment data. These analyses many times center on identifying critical and expensive materials that companies buy on a repetitive basis to support their manufacturing process. Most companies do not attempt to analyze all direct spend categories, but rather look to the materials that are the most critical to producing finished goods and have the potential for cost reduction. The same approach applies to an indirect spend analysis.
The initial step is to aggregate a company’s spend by item (SKU) and to understand current purchasing patterns and pricing. Are contracts in place for favorable pricing, and are all purchases made under these contracts? Are primary and secondary suppliers in place? In many cases, we see that companies buy all their material from a single supplier to get a better price, while others buy from multiple suppliers in a haphazard, buyer-preferred supplier approach. In the first scenario, the company risks supply disruption if their only supplier can not provide them the material they need and in the second scenario, there is no preferred supplier and therefore the spend has not been leveraged to reduce cost. Both of these have played out in 2020 during the COVID-19 pandemic. Adding new critical supplier or improving an existing supplier relationship is nearly impossible during a supply chain crisis period.
Once savings opportunities are identified, a source to contract approach needs to be identified and executed with suppliers. This involves finding a prospective supplier, vetting the perspective supplier, and negotiating the price and terms with the supplier. Multiple methods (both digital and traditional relationship methods) may be used to facilitate this process. Some middle market companies today use digital platforms to conduct reverse auctions to evaluate multiple potential suppliers simultaneously, while others use industry sources and internet research to identify and vet potential suppliers. Processes like these should become a procurement routine within the company, and coupled with improved performance metrics, one-time or periodic spend analysis will evolve into spend management, which in most cases lead to a material reduction in costs. FortéOne consultants can help your company on this journey.
So why don’t middle market companies conduct a spend analysis program that ultimately leads them a continuous spend management improvement program? The simple answer is procurement expertise. Most middle market companies have transactional purchasing employees—often called buyers—that generate purchase orders, check for the receipt of inbound materials, and expedite shipments with suppliers when the need for purchased material is greater than expected. In many cases, these buyers lack formal supply chain management education and do not processes analytical and negotiation skills. Similarly, many purchasing supervisors or managers also lack this expertise, and they do not conduct routine spend analysis projects as part of their overall responsibilities.
If your company lacks skills and experience in spend analysis and management, you may consider outside consultants for guidance. At FortéOne, our procurement consultants have worked with hundreds of businesses to conduct spend analysis, create a spend management strategy, and assist in negotiating the best price with new and existing suppliers while teaching your procurement staff how to do spend analysis and management. Prior to beginning a spend analysis project, FortéOne works with business owners and leadership to evaluate the skills and capabilities of current procurement/purchasing staff. We will also evaluate the sourcing and negotiation skills of procurement/purchasing management. In many cases the remedy is simply giving qualified staff the tools and techniques needed to participate effectively in a spend management program. Other times, our evaluation indicates that there is need to upgrade company personnel, and we will work with ownership to hire employees with the skill and experience to manage an effective spend management program. Once critical resources are hired, we can begin the spend analysis and spend management project, working with company personnel on how to continue the program and its necessary analysis forward.
To greater leverage investment in a spend management program, we suggest a bi-annual review of the program. Post-implementation reviews allow all levels of management to understand the overall progress and what needs to be improved to get maximum value from a company’s spend management program. In a recently completed spend management project, working with company personnel we were able to deliver $1.5MM in annual spend reduction. Equally important, we trained their staff to continually maintain and improve these savings.
The evolution of the traditional middle market “buyer” organization to a strategic spend management organization takes time. The skills and experience needed to react in difficult economic times are developed and honed during less economically stressful times and can be deployed when needed to ensure supply. To evolve your procurement organization, you must make it a priority to begin the process. At FortéOne, our consultants have started this journey with many middle market companies, and we will work alongside you to provide the catalyst for change. Although it can be challenging in stressful times to begin a strategic improvement initiative, today’s supply base challenges highlight the need to be better prepared for the next supply change disruption.
Contributor: Philip Franz