April 9, 2018
Spend Analysis – A First Step in the Procurement Journey:
A frequent message we hear from our clients is that they need to do more with less. One area that is tasked with delivering increased value with no significant additional investment is strategic sourcing. As always, the challenge here is to deliver savings while still providing the internal stakeholders the same quality of goods and services.
In pursuit of these ends, how do you gain better leverage in negotiations with suppliers? The first step is to ensure you have the most accurate and comprehensive spend data.
The Shelby Group’s spend analysis methodology provides critical insight into spend data and can identify opportunities that you didn’t know existed.
Identify Opportunities, Capture Savings:
A recent client asked The Shelby Group to help with increasing PO-backed spend. Of their one billion of indirect spend in 2016, only 2% was PO-backed. Shelby initiated an effort to better understand the current state of spend and identify methods of looking at the data to tell a compelling story.
One of the first findings was that the 2% of PO-backed spend was limited to IT supplies. The data showed a commodity structure that allowed detailed views into item level, supplier, price and frequency but it was only for IT spend. For the remaining 98% of spend, no detailed commodity structure was available. By using the GL codes, Shelby could identify a broad categorization of the spend.
From here, a journey began. We knew where the client wanted to go (increased PO-backed spend) but to get there, we needed to first better understand the supplier spend landscape. The client was excited to learn that through spend analysis techniques, they could increase categorization of spend and then provide to the sourcing team a proactive set of data that could be used for a wider set of tools – supplier consolidation, supplier scoring/ranking, managed supplier relationships, supplier risk identification and more. They could then be better equipped to negotiate new contracts and then be able to cut POs from the contract.
Spend Analysis Methodologies:
The spend analysis required manual investigation and manipulation to address inconsistencies in the data, such as missing invoice line descriptions, mismatching GL accounts to invoice line descriptions and missing supplier type information.
This type of detailed analysis is best performed with the experience and knowledge of the Shelby Group as a partner rather than relying solely on rule-based packaged software. A great example of the limited capabilities of simple rule-based packaged software for spend analysis came when a previous client asked about opportunities for savings in their internal training category. The client assured us that their spend data was accurate, as it had been cleansed by a leading commercial spend analysis software package.
Our first step was to run the report through our methodology and we found a major discrepancy. Invoice data showed that the client paid a licensing fee to a company with the word “workshop” in their title. This spend had nothing to do with internal training but the string rules that the software followed saw “workshop” as a key word and assigned it to the training category. This was a multi-million-dollar miscategorization of spend by the rules based software . Only through the use of experienced Shelby professionals was a true spend profile revealed.
Inconsistencies and inaccuracies impact how clients react to suppliers, market forces and internal demand fluctuations. To help mitigate these issues, Shelby led a data cleansing and categorization effort.
Following are the steps that were taken to cleanse the rules engine based data:
- Step 1: Identify and Define
- Commodity categories and subcategories
- Supplier and invoice line categories
- Mapping of invoice lines
- Step 2: Supplier Rationalization
- Supplier analysis results highlight subcategories with either too few or too many suppliers
- Subcategories with too few suppliers are opportunities to introduce competition
- Subcategories with too many suppliers are opportunities for consolidation, potential volume discounts
- Step 3: Commodity Structure
- Commodities structure, preferably based on UNSPSC, allow tracking of where spend is going
- Allows for consistency in purchasing and GL allocation
- Facilitates accuracy in spend reporting and analysis
Spend Analysis Techniques:
The client was then able to see that the current spend data was not allowing strategic and proactive measures to be taken. After we outlined the methodologies, specific actions were taken to cleanse, organize and extract detail. Actions included:
- Rule creation based on patterns found in the data using GL account descriptions, invoice line descriptions and the supplier name
- Triangulation of data using line item descriptions, supplier and general ledger to create transactions mapped to the internal organizational hierarchy
- Subcategorization and subcategory identification to assign each invoice line within each grouping
- Patterns were identified and rules were created to subcategorize the spend based on the level 1 category description, GL account descriptions and invoice line descriptions
- Validation checks to ensure each supplier or line was categorized and subcategorized correctly which highlighted subcategories, GL accounts or rules that were over or underutilized
A New World – AI and Machine Learning
AI and machine learning based technologies are a different story. These solutions show a level of context and intelligence that go beyond the standard rules engine based solutions of yesteryear. Utilizing AI and machine learning solutions to categorize large volumes while leveraging the knowledge and experience of the Shelby Group as a partner to operate and provide context and knowledge would get you the best of both worlds – accuracy and capacity to deal with large scale spend data sets.
Many of Shelby’s clients have yet to move to AI. As such, many are executing projects with legacy tools. In those environments, here is how you can make them work for you.
Make the Analysis Work for You:
The Shelby Group understands how important it is to gain insight into operational spend in order to improve spend management. Spend analysis allows you to do just that. Here, we’ve outlined the techniques implemented in a recent spend analysis.
Cleanse and Organize Data:
Cleanse your data. As the above example illustrated, there is nothing better than procurement professionals using best practices and experiential knowledge to properly cleanse spend data. This includes finding and correcting errors in descriptions and transactions, as well as standardizing the spend data for easy viewing.
Consolidate Spend: When spend in one category is spread out across many different suppliers, this is an indication that the category could have too many. If they are offering the same items or services, there is an opportunity to consolidate spend. Spend consolidation establishes preferred supplier(s) for a subcategory across the company to direct users to purchase standardized items or services.
Negotiate Contracts and Pricing: Subcategories where the majority of spend is between only a few suppliers or is dominated by a single supplier signifies an opportunity to negotiate contracts and pricing. Suppliers that dominate a subcategory typically have strong relationships with the client but can be negotiated with to decrease item or service prices or bundle purchase orders to optimize delivery times and reduce shipping costs.
Consolidate and Negotiate: Subcategories that have spend across many suppliers but are dominated by one or two represent an opportunity to both consolidate spend and negotiate contracts/pricing. If 80% of the spend is split between a couple of dominate suppliers, there is an opportunity to negotiate between suppliers and leverage their spend, items and services against each other to optimize deals and consolidate the supplier pool.
Source Additional Suppliers: Subcategories contain too few suppliers if the spend is concentrated on one supplier or split between a couple of suppliers. If the subcategory hasn’t been sourced recently, there is an opportunity to run a sourcing event to analyze the current market pricing and potentially source additional suppliers.
Spend Analysis Benefit – Leverage in Negotiations:
Ultimately, spend analysis is about increasing accuracy in data. Accuracy that comes from experienced procurement professionals who can see patterns in the data that can lead to increased opportunities.
Without proper spend analysis and visibility, your suppliers may know more about your spend than you do. With proper spend analysis that imbalance can be mitigated and in some ways tipped to your favor. When it comes time to negotiate a new contract with a supplier, you now have accurate spend data on that specific supplier but more importantly, you now have insight into how much you are spending with that supplier’s competitors, which is valuable information that your supplier doesn’t have. This shift in knowledge increases your leverage.
Finally, benefits of spend analysis do not end at the signing of a new contract. Consolidating suppliers and creating preferred supplier lists increase legal policy compliance and reduce maverick spend throughout the procurement life cycle. To take full advantage of these techniques and to achieve sustained success, it will be important to fully digitize procurement. See Shelby’s blog post on this subject here.
by Charlie Barlow, Senior Manager