February 25, 2016
Most organizations have a commodity code structure in place to support their purchasing. However, very few have an effective strategy that fully leverages the benefits of commodity codes within their sourcing and procurement platforms. A deeper understanding of the use of commodity codes can help an organization craft a strategic policy to realize the benefits.
What are commodity codes and why are they important?
Commodity codes are a key tool to categorize products and services and gain visibility into where a company is spending their money. They are used to consolidate similar types of purchases across suppliers to give a holistic view into what is being bought and from whom. Knowing this information allows an organization to identify and target specific commodities which could benefit from supplier consolidation and contract negotiations to realize savings.
There are many classification systems out there, but the most widely used commodity code system is the United Nations Standard Products and Services Code (UNSPSC). It is made up of four pairs of numbers, each with an hierarchical relationship to the one before it:
E.g. “Wooden Pencils” – 44121706 – AABBCCDD
• AA Segment – 44000000 – Office Equipment and Accessories and Supplies
• BB Family – 44120000 – Office Supplies
• CC Class – 44121700 – Writing instruments
• DD Commodity – 44121706 – Wooden pencils
How to think about Commodity Codes
There are two functions within an organization that care about commodity codes: Sourcing and Procurement. And each of these departments have very different reasons why they care.
Procurement uses commodity codes to drive and control purchasing:
1. Approvals: Commodity codes can be used to tag and route purchases to the appropriate owners of that commodity for review and approval. This use case can be applied to any department which requires review for compliance purposes to ensure predefined specifications are being met before a purchase is made.
E.g. Most IT hardware has defined specifications and a review/approval by the IT commodity owner ensures all incoming hardware meets those specifications.
2. Defaulting: A well-structured commodity code system can facilitate defaulting of purchasing data. The primary benefit of defaulting is that it removes the responsibility of inputting the data from the user (where user error can occur) to a consistent systematic process.
E.g. Commodity codes can be mapped to General Ledger (GL) accounts to automatically default account coding to a purchase and remove the confusion that a user may face if they were asked to select that account coding.
3. Other procurement platform related functions: Commodity codes can be used to drive other control/purchase features such as defaulting tax codes, drive 2-way or 3-way matching tolerances and product discovery by browsing commodity codes.
Sourcing primarily uses commodity codes to drive spend analytics:
1. Reporting/Spend Analytics: Spend analytics can use commodity codes to parse purchasing and supplier data to identify categories which may not be realizing optimal savings. Sourcing can use this data to identify new opportunities.
2. Go-to-Market (GTM) Baskets: Commodity codes can be used to understand the components of GTM baskets and better help drive reporting GTM strategy. One important note is that GTM baskets may not align with UNSPC/procurement hierarchy structure.
E.g. All items in the GTM for “wireless communication bundle” (mobile phone, wireless carrier service, mobile phone accessories) are from different UNSPSC commodity categories.
Procurement and Sourcing both care about the consistency and accuracy by which a product or service is assigned a commodity code:
1. Garbage In, Garbage Out: A product or service which does not consistently get assigned the same commodity (E.g. A pen is designated as a pencil one time, and a highlighter another time) will be useless for both Procurement and Sourcing needs. Similarly, if the commodity code is not assigned with accuracy (E.g. A pen is assigned as a keyboard), then again both Procurement and Sourcing will not be able to leverage commodity codes to drive their processes.
So how do Procurement and Sourcing fully leverage Commodity Codes for their benefit?
Effective use of commodity codes can vastly improve the procurement processes and help identify hard savings. An organization can take the following steps to fully leverage the potential of commodity codes:
1. Develop a unified standardized commodity code structure that meets both the control needs of procurement and the reporting/spend analytics needs of sourcing. Most commodity classifications get defined “upfront” by Procurement during the purchasing process. Unfortunately, as a result, this structure aligns more with procurement needs and does not necessarily go into the level of detail needed to support spend analytics or GTM baskets as defined by Sourcing.
2. Create a robust data governance policy and a governance enforcement support structure to monitor and support all commodity code assignments and ongoing maintenance. Without this, data will become inaccurate over time and in turn become useless for driving control and reporting processes.
3. Ensure the commodity code structure aligns and maps to GL accounts to ensure accurate defaulting. The UNSPSC code goes 4 levels deep into detail and finding the right level is key to this mapping.
By following these three steps, along with allocating resources to devise an effective strategy, an organization can fully realize the benefits of commodity codes.
If you would like to know more about how Shelby has helped organizations achieve maximized business value with strategic procurement and sourcing initiatives, please contact firstname.lastname@example.org.
The Shelby Group