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Do You Know How Much Your Company is Spending?

Rob Handfield, Co-Director of Supply Chain Resource Cooperative, North Carolina State University
Rob Handfield, Co-Director of Supply Chain Resource Cooperative, North Carolina State University

Rob Handfield, Co-Director of Supply Chain Resource Cooperative, North Carolina State University

As CIO’s think about their role in the organization, many are recognizing the need to work more closely with their supply management leaders to build the capabilities for establishing a data-driven analytics culture. In this respect, CIO’s play a critical role in supporting the journey towards supply chain transformation and stakeholder integration into supply chain decision-making. To enable effective supply chain improvements, data readiness and fact-based decision-making made by cross-functional teams of empowered users yields outcomes such as effective contracting archetypes for different products and services, supply chains designed based on lower total cost of ownership, and the right mix of local, diverse, and global suppliers to meet multiple stakeholder objectives.

"Primary efforts should be focused on the most fundamental yet most critical form of supply chain systems output"

Rather than striving for “perfect data” in all supply chain systems, my research suggests that primary efforts should be focused on the most fundamental yet most critical form of supply chain systems output: the spend analysis.

A spend analysis answers the simple question of how much money has the organization spent on all third party products, services, and expenses in the last year, what is the budgeted rolling horizon for the next year, and what is projected change in the mix of suppliers we are contracting and spending with? This seems like a simple question, yet most Fortune 500 companies struggle to provide any type of granularity beyond top line spending numbers. A spend analysis was often viewed as a one-time annual event to derive budgeting estimates, and develop insights into annual contract negotiations. Today, spend analysis is evolving into spend management, which is a much more dynamic and on-going assessment and tracking of spending patterns, matched to other cost drivers and activities. Spend analysis does not need to occur only on an annual basis, but can be applied also to reviews of a category or subcategory of spend that occurs when a contract is being negotiated, or when a strategic sourcing project is initiated for a particular category group. Spend analysis is also a critical component of effective budget planning, and setting key performance indicators for sourcing teams to consider in their assigned duties. An on-going real-time spend management capability provides answers to the following questions:

• What did the enterprise spend its money on over the past year? This value is an important component in calculating the cost of goods sold in the financial statement. Purchased goods and materials are often more than 40% of the total cost of goods sold in healthcare and manufacturing sectors. Many systems fail to include indirect spending in their analysis, which is missing an important piece of the spend analysis piechart.

• Did the enterprise receive the contracted level of products and services based on payments made to third parties? Although many companies route purchases through an ERP or purchasing system, there is nevertheless a need to audit and verify that services and products delivered met not only contracted pricing, but also service level agreements, statements of work, and appropriate levels of support services. A thorough spend analysis will often reveal areas where products and services are being paid for, but the goods or services are not even being received or being used by the system. This is particularly true, for example, in the case of software licenses, where many licenses are auto-renewed or contracted for, but never used. In other cases, multiples licenses may exist across the enterprise with varying terms and requirements that overlap.

• What suppliers received the majority of the business, and did they charge an accurate price across all the units in comparison to the requirements in the POs, contracts, and statements of work? (This is an important component to ensure contract compliance.) Understanding WHO we are spending our money with is an important input into making decisions on strategic leverage, and ensuring that the same prices, same levels of service, and potential economies of scale are being fully applied.

• Which divisions of the business spent their money on products and services that were correctly budgeted for? (This is an important component for planning annual budgets for spending in the coming year.) Understanding the “power users” of a particular category of spending can help drive the right sets of discussions for the supply chain team when they being to rationalize the supply base, and eliminate poorly performing suppliers.

• Are there opportunities to combine volumes of spending from different parts of the enterprise network, and standardize product and service requirements, reduce the number of suppliers providing these products, or exploit market conditions to receive better pricing? (This is an important input into strategic sourcing).

• Are we dedicating the right resources to categories of spending that represent not only an important source of cost savings, but which are deemed critical to the organization, in terms of enterprise risk, impact on revenue, or customer impacts? T his issue has been of particular importance to the financial services sector, which is concerned with the right level of risk mitigation for suppliers that handle customer data.

Moreover, spend management provides insights and clarity into these questions and yields an important planning document for senior executives in operations, supply management, and financial management. Despite the importance of this capability, many enterprise systems struggle to develop a comprehensive and accurate spend analysis report. Too often, information on spend analysis occurs through an ad hoc, manual process entailing combining multiple spreadsheets from users systems, not through a realtime system providing visibility to spending against budgets and progress towards cost savings targets. This is because purchasing was for many years a paper-based system, and data was entered manually into accounting systems (or not at all!). Even with the evolution of sophisticated enterprise systems such as SAP and Oracle, purchasing transactions are often entered incorrectly, which elicits the old phrase “garbage in, garbage out.”

Another problem is that many enterprises have grown through mergers and acquisitions. When a new division is acquired, they may be using a different system from the acquiring system, and so the data is not easily translatable. For this reason, many enterprise systems are undergoing major initiatives to streamline procurement through electronic procurement systems that will revamp the purchase to pay process and automate different portions to capture transactions more effectively. Indeed, research suggests that “best in class” firms are more likely to have a higher proportion of their spend under management, which has led to important improvements such as cost reductions, reduction of non-compliant purchases, supply base reduction, and electronically enabled suppliers.

The move towards building an integrated spend management (or procure to pay “P2P”) system should be recognized as a cultural change, and the need to bring multiple parties into the effort in a collaborative endeavor to relentlessly pursue joint cost reduction and improved value as an integrated team effort. Some of the parties affected include not just supply management, but planning, finance, legal, accounting, capital planning, and others.

As part of this change it should be recognized that supply chain transformation is a journey.

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