The Importance of a Spend Analysis: A Step-by-Step Guide to Strategic Procurement Success
Spend analysis is a crucial tool that gives organisations better visibility over their expenditure, supports the development of strategic procurement decisions and, most importantly, identifies opportunities to generate savings. This analysis provides organisations with clear insights into how and where they are spending their money. It also enables them to group spend into categories and develop robust procurement strategies that focus on cost savings, strategic supply, and the development of key partnerships with suppliers.
I’ve developed the following seven steps to guide organisations on how to carry out a spend analysis, categorise expenditures, and use the findings to help develop solid procurement strategies that deliver cost savings, smarter supply methods, and stronger supplier agreements.
Step 0: Understand the Importance of Spend Analysis
Before diving into the key steps, it’s essential to understand why it is necessary to undertake a spend analysis and what we aim to achieve from it. By reviewing and analysing the spend data, organisations can unlock key information to:
Identify Cost-Saving Opportunities: Understanding spend categories and patterns helps teams spot areas where opportunities for savings exist (i.e. by consolidation, tendering, or redefining scopes and specifications).
Enhance Supplier Relationships: Spend analysis allows organisations to identify which suppliers hold the majority of the spend. This can enable the redevelopment of contracts with stronger terms and conditions and initiate the formation of strategic partnerships with key suppliers.
Reduce Supply Risks: Spend analysis can reveal dependencies on specific suppliers, allowing for the development of risk mitigation strategies.
Support Strategic Planning: With clear insight into their spend, organisations can align their procurement decisions with broader organisational goals through the development of solid procurement strategies.
Once the objectives of a spend analysis are clear, we can proceed with the following steps:
Step 1: Collect Data
Gather Data: Collect all relevant spend data, including date, description, amount invoiced, supplier, and category (where available). It is recommended that the data covers at least 12-36 months to be able to identify trends.
Consolidate Data from All Areas within the Organisation: Consider that other departments within the organisation may also procure directly. If so, ensure their data is included. You may also need to consider any purchases made through credit cards, as these are sometimes hidden opportunities for consolidation.
Clean Data: Eliminate any duplications and set aside incomplete records. Ensure consistency across supplier names and clarity on what has been procured. If high spend is found in generic categories such as “services” or “miscellaneous,” consider reviewing these, as they may hold hidden opportunities.
Step 2: Categorise Expenditure
Categorising spend forms the foundation for understanding what is being procured and how much is being spent, providing solid support for developing subsequent strategies. Begin by classifying spend into two major categories: Direct and Indirect Expenditure and then into sub-categories.
Keep these concepts in mind: Direct Expenditure refers to the spend directly related to the production or supply of the core product or service, while Indirect Expenditure refers to the spend that does not directly contribute to the final product or service.
Break Down into Subcategories: For each category (Direct and Indirect), break it down into specific types. For example:
For a manufacturing organisation, direct spend (related to the final product) might include raw materials, packaging, and production equipment. For a vessel salvage organisation, it could include towing services, cranes, divers, and for a retail organisation, it could include merchandise, product packaging, and warehousing.
Examples of typical examples of Indirect Spend include utilities, facilities management, IT hardware and software, office supplies, and marketing services
Step 3: Group into Categories:
When creating categories, consider using existing categories under recognised industry standards such as UNSPSC (United Nations Standard Products and Services Code) to ensure universal consistency. The UNSPSC has thousands of categories, which can be overwhelming, so remember to keep it simple and avoid overcomplicating things.
Step 4: Create and Refine Categories
When setting up categories, keep the following in mind:
Ensure the categories chosen reflect and resonate with the organisation’s specific needs and goals. For instance, a retail company could use categories like merchandise, store fixtures, packaging, warehousing, and product. For a construction organisation, some common categories are labour, raw materials, equipment, and waste disposal, to name a few.
Build Flexibility: Ensure categories are adaptable and reviewed at least once a year to allow the organisation to adapt to market or strategic changes.
Consult Other Teams: Engage with internal clients to validate the chosen categories and ensure they are suited to their needs and aligned with their operational and strategic goals.
Step 5: Analyse and Interpret Spend Data
Once the spend has been categorised, start looking for:
Top Spending Categories: Identify areas with the highest spend. These often hold the biggest opportunities for cost savings and strategic initiatives.
Supplier Concentration: Identify the spend across multiple suppliers to understand which suppliers hold the largest share of spend. Pay attention to cases where one supplier supplies multiple categories, as this presents an opportunity to revise terms and conditions or initiate negotiations. Also, look for cases where a strategic category is assigned to only one supplier, which increases supply risk.
Spend by Business Unit: Identify expenditure across all business units and look for overlaps or redundancies in contracts.
Step 6: Turn Spend Analysis into Strategic Actions
The strategic path to be followed will be unique to each organisation. The next actions must be tailored to what the organisation needs to achieve. Some common strategic paths to follow are:
Establish Strategic Contracts: For high-spend categories, consider setting up strategic contracts with suppliers to ensure better terms and conditions (including pricing). This is important, especially for consistently high-demand categories.
Buy on Demand: For low-value or infrequent purchases, consider a “buy on demand” approach that could be done via credit-card purchases. This will help avoid excess stock.
Create Supplier Agreements and Catalogues: Use spend data to help establish agreements and purchase catalogues with preferred suppliers. Agreements and Catalogues help buy directly from suppliers, avoiding the need to go through a formal procurement process every time.
Consider Outsourcing: If the analysis shows high costs in non-core areas, outsourcing could be considered. Common areas to outsource include IT or HR services. By outsourcing support activities, organisation can focus on core activities.
Consolidate Spend: Streamline the supplier portfolio by consolidating spend with fewer, high-performing suppliers. This can lead to cost savings, stronger supplier relationships, and efficient supplier and contract management.
Step 7: Measure and Track Results
Ensure that the implemented strategies are monitored, measured, and adjusted where needed. These are common tracking indicators you can use:
Cost Savings: Track savings achieved through new contracts and negotiations.
Supplier Performance: Establish a supplier performance framework to measure how suppliers are tracking and complying with supply conditions under the contract (e.g. time, price, and specifications).
Spend Creep: Ensure contracts are actively managed and spend is frequently tracked. It’s not uncommon for some contracts to experience spend creep, where uncontrolled scope increases or budget overruns occur.
Hiden Spend: Implement processes to ensure that spend goes through the established contracts (and not outside them). Spending outside established contracts can affect:
Volume discounts for total expenditure
The real spend figure under that contract
The purchase price, as prices outside contracts can be higher
Quality and service inconsistencies, as suppliers outside contracts may not be bound by the required terms and conditions of supply, specifications and warranty.
It’s not only important to set up these metrics but also to regularly track them to ensure that the benefits of the spend analysis are maintained in the long term.
In conclusion, spend analysis is an essential tool that organisations can use to gain better visibility into their expenditure, identify opportunities for cost savings, and make informed procurement decisions. The seven steps in this guide will help organisations effectively categorise their spend, analyse data, and implement strategic actions, leading to more efficient procurement processes, stronger supplier relationships, and savings that can last in the long-term.