Spend Analysis: Identifying Cost Reduction Opportunities

Spend Analysis: Identifying Cost Reduction Opportunities

In recent years, supply management developed into a significant driver of improved organizational performance as well as improved risk management. Spend analysis plays a critical role in achieving world-class performance because it can provide an in-depth guide to cost reduction opportunities, prioritization of sourcing projects, negotiation and results, and the tracking needed to ensure the opportunities are reaching your bottom line.

The chart below is an example of possible savings in common commodities.

Possible savings in some common commodities

Possible savings in some common commodities. (© 2006 by Rudzki, Smock, Katzorke, and Stewart.)

Spend Analysis: Identifying Cost Reduction Opportunities

What is a Spend Analysis?

A spend analysis is the process of systematically analyzing your organization’s historical spend, or “purchasing”, data in order to make cost reduction opportunities easier to identify. Conducting a spend analysis empowers your team answer questions like:

  • Is there a company-wide spend associated with each cost center and will it increase our leverage with suppliers?
  • What are the top commodities and which ones represent spend reduction opportunities?
  • Which of our suppliers are the most valuable to our organization?
  • How much are we spending with our preferred suppliers compared to how much we spend with under-performing ones?
  • What percentage of spend is associated with contracts?

As an example, if your spend with non-preferred vendors is high, then this category is clearly where spend leakage occurs because the terms and conditions negotiated (or lack thereof) with this set of suppliers aren’t ideal. Once this problem is identified and you determine the root cause, it’s easy to make the proper correction, i.e. only make purchases through preferred vendors or negotiate better with a non-preferred vendor to change its status.

Contracts

Another example of spend leakage may be associated with contracts. We often negotiate the terms and conditions as a “check-the-box” activity and neither side (supplier/buyer) enforces them. However, contract violations constitute the largest and the most difficult to achieve portion of spend leakage.

To put a finer point on it, even when contracts are well executed, there’s the potential risk that suppliers don’t stay compliant with their responsibilities and then do something like invoice incorrectly and/or provide goods and services not described in your agreement. Within contract compliance, the categories with the highest incidence of unrealized losses are discounts/rebates, quantity violations, and delivery date violations. For example, if you’re cash flow positive, a 2% early payment discount on $3,000,000 spend is $60,000! A poor performing, habitually late, supplier can mean back orders or surplus inventory, both of which increase operating costs.

Knowing your organization’s spend values allows management and team members across the company to take action ensuring maximum resource efficiency and high-quality production at the lowest possible cost.

-Andy