Is Your Indirect Sourcing Quietly Draining Your Budget?

Money Down The Drain.A debt-laden consumer gets a money makeover from a celebrity financial expert. The first step?  Taking a long, hard look at spending habits to see where all the money is going.  Inevitably, the financial guru zeros in on the little, seemingly innocuous things—the daily trip to the gourmet coffee shop; the five-dollar fast food lunch, the weekly lotto ticket. Ultimately, the consumer learns that, by cutting out these little excesses, he or she could save a boatload of money, clear debt and have the down payment for a house in just a few years. Who knew you could waste so much money on such tiny expenditures?

The fact is the corporate equivalent of that small-but-mighty money drain is also quietly siphoning funds from company budgets worldwide. The culprit? Unmanaged indirect sourcing—that comparatively miniscule annual expenditure that is zapping profitability, one ream of paper at a time.

“Historically, companies focus their energy on managing direct sourcing (items that directly enter the production process; such as ingredients for a food company) because direct sourcing has a higher dollar value attached to it and represents a much larger percentage of sourcing spend,” explained Mitzi Campbell, a director in PwC’s Advisory practice. “However, if that company has 40 different offices buying 15 different types of paper, 10 different brands of printers and getting temporary labor through multiple vendors—with no controls, no policies and no negotiated rate—this could have a major impact on cost.”

Not only are companies paying more than they have to for these products and services, they’re spending more just to process the bills.

“With more vendors, more purchase orders and more individual invoices to process, the Procure-to-Pay costs exponentially increase, as well,” Campbell said. “That’s on top of the higher cost of goods and services that come from offices and plants handling the indirect purchases—unchecked—on their own.”

The Five-Step Solution to Improved Indirect Sourcing

So, how can companies regain control of their indirect sourcing spend?  Campbell suggests they start with these five critical steps.

1.    Get a Complete View of What You’re Actually Buying.

“For most companies, an ERP won’t give you all the information you need. You probably have expenditures through expense reports, corporate cards—a variety of sources. But, it’s critical that you go through the process of understanding where and how you’re spending your indirect dollars,” Campbell said.

No one is suggesting that this is an easy task.

“I think the only way you can get a true picture is to talk to people. As a consultant, I travel to different sites, finding out what they buy and why they need what they buy; as well as working with the accounts payable department to see what’s coming through that area,” Campbell said. “It also makes sense to reach out directly to your suppliers to either validate the information you’re collecting internally or to fill in the blanks.”

Look for patterns. Where is there potential for economy of scale? And, just as important, where is there waste—a purchase that’s nice to have, as opposed to a business necessity.

2.    Negotiate with Suppliers.

When you fully understand your indirect spend, you can see patterns. Some things you can standardize, like printer paper, pens and other rudimentary office supplies. You may want to negotiate with a national supplier to get the best price and service offering.

Although Campbell recommends replacing the rogue, “every office for itself” purchasing process with a standardized process, just going with large national vendors is not always the answer.

“There’s not one indirect sourcing strategy that works for every company. Just having a national contract in place doesn’t solve the problem. For office supplies, yes, you may want that one, big retailer. But for maintenance, repair and operations (MRO) equipment, like valves and safety glasses, you may not be able to do that effectively on a national basis. Particularly if your plants are in small towns in Wyoming or Idaho, for example, where it’s tougher to source than in a major metropolitan area,” Campbell said. “You may well get the best combination of price and service if you go regional. But, do your homework, go to both types of suppliers via a strategic sourcing agreement and compare on not only price but delivery, service and proximity.”

3.    Create Policies, Procedures and Controls.

Of course, negotiating supplier contracts isn’t enough. Companies have to put policies and controls in place to regulate what purchasers can and cannot buy.

“One of the best ways to control indirect costs and make it easy for offices to get what they need is to create an ordering catalog or P-Card (purchasing cards) with approved providers and products,” Campbell said. “This ‘here’s what you can buy’ catalog concept makes it easy for employees to get what they need and do it within company guidelines. It also prevents the rogue spender from purchasing a 50-dollar pen when the three-dollar model is the corporate standard.”

Campbell recommends reviewing most suppliers and contracts every two-to-three years. The exception to this rule is labor, the costs of which could fluctuate on an annual basis.

“When you source a labor contract, you pay for cost of living increases and other expenses over the length of the contract,” she said. “You’ll pay more if the market is tight on labor, like it is with the oil and gas industry right now. If something shifts, you have to look at new suppliers sooner rather than later to get the greatest value.”

To protect your company, Campbell suggests that if you have a three-year labor contract, you also include language in that contract that states that the contract price is valid “as long as you remain competitive in the market,” based on a correlating index, like the U.S. Government’s  Cost of Living Adjustment information.

That language gives companies the freedom to negotiate as industry supply and demand changes.

4.    Make Sure You Track Compliance Through the Purchasing Cycle.

Just having a policy in place doesn’t mean that policy will be followed. Continual monitoring and reporting are critical to orchestrating change—and realizing the resulting financial benefits.

“You have to have a system in place to monitor compliance and report violations through the executive team,” Campbell said. “Typically, you’ll identify the repeat offenders. It’s important not only to understand who they are but what are they buying that counters policy—and why. That’s the only way to deal with the issue and change that mindset.”

A number of different tools are available to track this data and feed everything into the ERP solution. Without them, it’s an arduous, manual, spreadsheet-based process driven by keyword and vendor searches. Either way, the spend has to be monitored accurately every month to ensure real results.

5.    Create a Long-term Strategy.

Most companies have long-term strategies in place for their direct sourcing. Campbell suggests that they do the same for indirect procurement.

“Organizations have to look at how their long-term strategies impact indirect sourcing. For example, a goal of reducing working capital directly affects how you source and manage your MRO needs,” Campbell said. “Companies need a master plan to keep everything in check.”

Reaping the Benefits

If your company doesn’t have the resources to handle these steps in house, consider a consultant.

“For less mature organizations, without the arms and legs to focus on indirect procurement or identify opportunities to reduce cost, a consultant with the analytics and processes in place can be a real asset,” Campbell said. “The big benefit of working with a consultant is time to savings. We can also help you set up an internal organization and processes for ongoing monitoring.”

How significant are the potential savings?

“I have been doing procurement and sourcing for 20-plus years and research shows that in order for sales to achieve the same gross profit impact of sourcing savings of one dollar, they would have to sell five dollars worth of product/services. That 5:1 ratio is typical across most businesses,” Campbell said.

The actual savings depends on the maturity of the organization. But, according to Campbell, the cost benefits typically have significant impact on the bottom line.

What You Don’t Know Can Hurt You

Most company executives get a little wake-up call after truly understanding where their indirect spend dollars are going.

“We’ve had clients who were shocked to see the number of gourmet coffee makers at each office and the amount spent on individual brew packs every month,” Campbell said. “A hundred-plus dollars for the maker and fifty dollars a month for the one-cup brew packs doesn’t seem like a lot of money, but when you multiply that by every internal organization in a large corporation, it really adds up.”

The moral of this story?

When it comes to indirect procurement, the little things mean a lot. Know where you’re spending your money. Put policies and controls in place. Refresh your suppliers as market demand changes.

And one final note: consider cutting down on the caffeine. That cup of coffee seems to be breaking our budgets—at home and at the office.

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