Using Spend Analysis to Understand Supply Chain Risks

A comprehensive understanding of spending patterns in the business is a function of the enterprise’s ability to capture data in a meaningful way.  The importance of conducting a thorough analysis of spend was emphasized in an interview with a Big Three automotive executive, who recalls how this first came to light in the 1970s during the dramatic run up in petrochemical prices.

In the 1970’s our company was facing over $400M of economic exposure impacting transportation costs, resins, chemical feedstocks , and other parts. I interviewed buyers and tried to get an idea of which parts were made of what material, and the relative level of exposure they had to oil prices. As this wasn’t very accurate, I sought to understand where the raw material was coming from in the third or fourth tier of suppliers based on the types of plastics. But how could I get all the parts and consolidate them in a way that made sense to measure exposure?  The only way I knew how to do this was to dive down into the Bill of Materials and review the commodity description that the part code was associated with.  Although   there were thousands of part codes, I was able to work it down to 200 specific groupings of parts and compared this to the buyers assigned to each part.  And then I compared this grouping to a list that should be the buyers for each part.   This allowed me to look at the “deck” of the current buy for a commodity group. I started by looking at no more than 10 commodity groups, and look at the production buy across these commodity groups.  With the data organized this way, I was able to see that I could consolidate the number of suppliers by commodity, the value of the buy for the group, using data that no one had ever seen before. I could then start to see how many commodities I was dealing with, and was able to reload the commodities to a smaller group of buyers with broader responsibilities that might cover more than one commodity.  I also had to consider the complexity and workload required for a buyer to cover a single commodity group, and sometimes had to split it.

This example illustrates how the need to understanding spending patterns can lead to other insights on how to better organize internal governance over spending categories of parts and services, including supply chain risk, vulnerability, and exposure.  The discovery made by this automotive executive in the 1970’s applies today, although the spend analysis systems have evolved from the environment of computer punch cards this individual had to struggle with.  The important lesson here is that analysis of spend data needs to be combined with business conversations to derive a full picture of who is responsible for the sourcing decision, which suppliers are part of each point of origin for sourcing, the vulnerabilities exposed by this analysis in terms of single sources and capacity requirements, and the commonalities and differences that exist.

This discovery does not necessarily lead to immediate recognition for procurement’s authority over sourcing decisions.  In many cases, the mechanics of moving towards Source to Pay represents a major change for organizations in the early stages of procurement transformation.  One executive recalls that “when I showed up at meetings on budget and technology planning, people at the meeting looked at me and asked ‘Where did you come from?  And what are you doing here?’, which then led to a conversation on ‘How are we supposed to work together, and what will the outcome be?’”  Engaging with stakeholders on budgeting and product design issues requires sourcing executives who are sophisticated in their approach and who are knowledgeable enough on the commodity to be able to have the right conversation demonstrating expertise and professionalism.

Using the right platform for a dialogue with line of business stakeholders should align on terms that are not necessarily immediately associated with driving cost savings.  Procurement does more than just manage cost – they are being asked to manage risk.  In many of the financial services companies we met with, the primary driver was around risk exposure due to stricter OCC guidelines around measurement of supplier risk.  This is in large measure due to the 2008 banking crisis.  Using a platform focused on risk can be used as a means for investing in software that creates a spend database, which then leads to the process of stratifying suppliers based on operational and business risk, as well as exposure of customer data in the supply chain.  This was described by a Chief Procurement Officer at a large global bank:

At the highest level we have a risk segmentation around concentration of data privacy risk, and an elaborate segmentation around the inherent service a supplier provides as well as the overall stability of the vendors inherent risk.  But we also consider the balance of trade they have with our core partners.  We collect four levels of risk which in turn dictates its own level of governance and management.  Tier 1 is the low spend low risk, which involves no assessments.  Tier 2 is higher risk and we rely on self-assessments.  But Tiers 3 and 4 involve much more due diligence by our risk officers and take much more time.

In this manner, spend analytics can serve as the foundation for an effective set of category strategies, which leads to increased insights on supply base risk.