The leading IT magazine, CIO Review, today published a special issue on supply chain transformation, and included an article I wrote on spend management as a core capability.
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.
Some of the most basic questions that determine whether an adequate spend management system is in place include the following:
- 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? This 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.