The enemy within: How indirect spend management impacts profit margins
Friday, May 01, 2015
As the global economy continues to sputter, careers stall and many companies continue to tread water, we obviously cannot just watch helplessly as economic conditions continue to compress and batter our profit margins with continually depressed revenue streams.
But what can management do? As opportunities to bolster our top lines diminish, we need to focus intently and intelligently on the issues that impact the bottom line that can help us to mitigate the cash flow challenges, help expand profit margins and take advantage of emerging opportunities as others fail.
Hiding in plain sight
One of the biggest and most persistent negative contributors to the bottom line and a major opportunity for dramatic and positive impact lies in the area of "indirect spend." Loosely defined, indirect spend refers to purchases of goods and services that are not directly incorporated into a product being manufactured or service provided by the enterprise.
This means that all enterprise expenses not directly associated with the product or service being delivered is considered an indirect expense and covers many areas such as MRO, professional services, travel, supplies, leased vehicles and many more such categories. The impact on the enterprise by not addressing this situation not only adversely affects spend activity but also results in lost productivity!
Indirect spend can account for 50 percent of the total spend for manufacturing companies and up to 90 percent for some non-manufacturing sectors. Yet 50 percent of all indirect items remain unused or inactive over any 12-month period. Over 80 percent of procurement resources are typically consumed acquiring indirect material. Once this phenomenon is discovered, it is usually too late and the bottom line has already taken a big hit. But why the surprise, and why is this activity undetected? How has it been able to fly under the radar for so long?
In the current economy it is surprising to learn that companies are ignoring or missing opportunities like this that could contribute millions of dollars to their profit margins.
As enterprises are being pressured more and more to combat rising prices and reduce costs in this slow growth period, it is curious that more companies have not aggressively addressed indirect spend. Most companies have taken good control of their direct material spend and supply chain activities and are reaping the benefits. So why it is that indirect procurement is so frequently neglected when it can have such an important impact upon the bottom line of a business?
Indirect spend has danced through time escaping the rigors, oversight and vigilance of traditional direct spend. There is generally no central focus or accountability. Indirect spend does not exist on bills of material, or part of a centralized planning system such as MRP or ERP. There are usually no part numbers and an incongruent vendor naming convention. Indirect spend is dispersed throughout the organization and is subject to the influence and whims of many and varied individuals and organizations. Most control activity aimed at addressing this financial issue is ex post facto. From a central focus point of view the problem of excessive indirect spend is essentially hidden and once the problem has been discovered it is already too late!
Beyond the embedded issues already presented, there are other factors which contribute greatly to this problem of indirect spend management:
- Rogue spending has perhaps continued for a long time, escaping scrutiny and has become institutionalized
- Individuals feel empowered and will resist efforts to conform
- "Special relationships" with vendors may have formed
- A general lack of commodity expertise
- A lack of analytical capability
- Unqualified vendors
- Inaccurate or incomplete data
- Unquestioned payment
- Lack of coherent audit trails
Light at the end of the tunnel
The scope of the problem is great and the intricacies of the situation make an attack on the problem appear to be quite daunting, which may cause one to question is the effort really worth it?
According to a study conducted by Michigan State University, centralized focus on indirect spend will result minimally in:
- 25 percent cost reduction
- 50 percent improvement in lead times
- 93 percent reduction in non-approved suppliers
- 18 percent reduction in inventory
The rewards are great and the effort is definitely worth it!
The question is how to go about harvesting this potentially great cost savings? The reality is that nothing can occur without a clear corporate mandate, strong leadership, a coherent strategy and active participation. In practice, there is no easy way to do this as the effort is intensely manual.
Since, as previously indicated, there is no central focus or repository of data, the hunt for data is essentially boundless and requires dogged patience and perseverance. A singular body of data does exist but lies in many disparate places such as: cost center reports, accounts payable or disbursement files, actual "hard copy" purchase orders, purchasing/payable audit trails, capital projects, chart of accounts, system error reports and transaction files.
Beyond the obvious mechanical and analytical problems, there is an emotional component that is pervasive throughout the enterprise. Individuals view indirect spend activity as almost a private rite and will resist any attempt at what they perceive as an intrusion into the running of their domain. Perhaps in no other area are emotions so easily aroused. For these reasons it is almost always necessary to have a fresh set of eyes from outside the organization to conduct an initiative of this nature and magnitude.
Stop feeding the beast
Companies that do not act on indirect spend issues are ignoring or missing opportunities that could contribute millions to profits. The challenge, of course, is to stop the offending behaviors and institutionalize the necessary administrative and organizational adjustments to control indirect spend and prevent the accumulation of unnecessary cost and margin compression.
How to accomplish this depends upon each company’s unique situation, but world-class procurement organizations take an integrated, end-to-end approach and make the commitment needed to develop internal stakeholder relationships aimed at attaining maximum indirect spend control under management and this requires the right mix of technology, people and processes. It is time to effectively respond to economic conditions, act against the status quo and address indirect spend directly.
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