Businesses and not-for-profit organisations that fail to analyse how they spend their finances regularly may pay 16 – 21% per annum more than organisations that closely monitor their spending patterns. To be cost-effective, an organisation must periodically review what it spends, as increased spending patterns may be incurred through:
- Spending ineffectively by purchasing products and services that aren’t required.
- Paying prices that are 7 – 9% ahead of the open market.
- Incurring increased commercial, legal and Health and Safety risks.
Analysing what is purchased is essential to understand how an organisation utilises its financial resources before taking the necessary steps to ensure they are used effectively. Buying more of what adds value by spending less and eradicating ineffective spending is crucial to maximising spending efficiency and the effectiveness of an organisation’s financial expenditure.
Organisational risk threatens an organisation's ability to achieve its financial or operational goals. Commercial risk is centred on an organisation's trading plans that may differ from those planned. It refers to the possibility of an organisation inefficiently using its financial resources due to the uncertainties brought about by its failure to manage risk.
Risk management is a procedural approach used to identify, evaluate, reduce, or eliminate the chance of an unfavourable deviation from an expected outcome. The more common risks to consider are:
- Financial: These can range from an unexpected or unfavourable exchange rate change to a supplier’s bankruptcy. Some financial risks include budget overruns, limitation findings, constructive changes, and missed milestones requiring additional funding.
- Legal and Contractual: These are often related to disputes, interpretations of contractual obligations, or not meeting the Supplier's terms and conditions. Intellectual property use or misuse can also be considered a legal risk, especially when patent infringement is possible.
- Health and Safety: This is one of the most critical areas of risk management. An organisation must protect its staff, customers, and members of the public from harm and ill health when conducting business activities. Hazard identification and management are essential when selling products but never more critical than when purchasing Supplier services on behalf of customers.
It is important to note that the severity of risk may not be proportional to the damage it may cause and that some risks are unavoidable. No matter how much time and effort is spent on risk avoidance measures, focusing on the actions required to mitigate and contain them to reduce the damage is crucial.
It is imperative that organisations mitigate their commercial, legal and health and safety risks and that they are transferred back through the supply chain to their suppliers by having the appropriate co-ordinated customer/supplier contracts and applicable quality, assurance or legislative standards in place to meet CE, ISO or relevant compliance commitments.
Within high-performing organisations, a procurement function will take the initiative by regularly providing spending reports for budget managers to provide accurate and up-to-date information to increase the understanding of where and how the organisation's financial resources are spent. By presenting budget managers with regular spending reports, a proactive procurement function can
- Meet with budget managers to regularly review areas of spend.
- Increase the budget managers’ understanding of how financial resources are used.
- Ensure a risk assessment is conducted across all organisational spending areas.
- Provide opportunities to engage periodically with budget managers.
- Suggest potential areas that should be renegotiated or tendered.
An organisational-wide commercial plan, usually of two to four years duration, must be formulated to ensure that all areas of an organisation’s spending are regularly reviewed and formally tendered or negotiated as appropriate. The aim of the commercial plan must be to reduce the bottlenecks in people’s time to undertake tenders or negotiations whilst timing these to coincide with the start/end of current supply contracts.
A spending report is more detailed than a traditional financial budget report in which organisations manage their budgets. A budget report may contain information on up to sixty areas of spend. A spending report drawn up by procurement aims to provide a more detailed analysis of an organisation’s spending.
The number of defined areas of spend, or “spend categories” as they are better known, will increase and can total more than five hundred. A spending report aims to provide more meaningful data upon which budget managers can base their tender or negotiation decisions.
Analysing how financial resources are used is crucial as a starting point for understanding an organisation’s spending patterns. The ideal place to start is a list of Supplier invoices for the last 24 months to capture all regular and irregular spending patterns. Organisations will need to assign spending categories to each area of supplier spending.
The assignment must accurately depict what the Supplier's spend is used for. However, where a Supplier spend is used for purchasing assorted products and services, the spend category must be assigned to the highest financial value of the various products or services.
Ensuring that financial resource use efficiency is maximised can be broken down into multiple crucial steps. It is essential to take a logical approach to develop a commercial plan to reduce costs. A commercial program's success will depend on engaging with stakeholders to undertake the appropriate negotiations.
The spending report aims to provide budget managers with relevant, accurate and understandable information to conduct a financial review for their area of responsibility. The information provided will be crucial to obtaining the support of budget managers in undertaking the actions required to increase the effectiveness of organisational spending to reduce costs.
The analysis of an organisation’s spend will
need to split the spending into different groups and descending levels of
priorities, for example:
- Strategic Items (High Value + High Market Complexity/Supply Risk).
- Leverage Items (High Value + Low Market Complexity/Supply Risk).
- Bottleneck Items (Low Value + High Market Complexity/Supply Risk).
- Non-Critical Items (Low Value + Low Market Complexity/Supply Risk).
It is essential to prioritise tendering or negotiation opportunities based on the size of the potential benefit of the outcome of the tender or negotiation. However, it is equally crucial to ensure that the risks of legal and health and safety compliance are considered in prioritising the tendering or negotiation of spend categories and that the risk is transferred back to suppliers by having the appropriate customer/supplier contracts in place.
It is crucial to preserve any cost savings, as these can easily be lost. So often, the top line of cost savings is gleefully celebrated without much thought about how the organisation will realise the savings. Here, solid commercial management skills can assist the organisation in maintaining and increasing those hard-won cost savings. Several ways of doing this could be:
- Consolidate the Supply Base: Supplier management is critical to maximising cost savings. Taking the time to identify strategic Suppliers and consolidating the total number of suppliers an organisation uses increases the leveraging of the purchasing function. It can save time and money as Supplier selection is reduced during the purchasing cycle.
- Reduce Maverick Spending: Maverick spending or allowing people to select or utilise Suppliers without any thought can account for up to 25% of purchases made within an organisation and could potentially reduce the chances of maintaining cost savings.
- Improve Risk Management: Every organisation has business risks. One of the largest is over-reliance on a particular group of Suppliers. While the aim should always be to consolidate the supply base, when possible, one of the iple principal ways to manage risk is to ensure that an organisation reduces its reliance on major suppliers.
- Reduce Internal Costs: An organisation can reduce operational costs by streamlining processes. Procurement should work with organisational Teams to define transparent processes with improved visibility and detailing of overall spending and data accuracy.
- Use Category Management: Category management is a procurement approach that identifies spending patterns by categorising spending streams and allocating a category to each type of spend. It assists an organisation in finding opportunities to save money and cut internal costs by reducing multiple similar transactions and consolidating the number of purchase orders and invoices processed.
- Contract Management: Spend leakage occurs with purchasing outside the terms of the Supplier contract or framework agreement. Organisations should monitor all purchases to comply with the contract and payment terms. If non-compliant purchases cause spending leakage, the organisation should work to put controls in place to prevent it from re-occurring.
- Tender Management: Tender management is part of any good sourcing strategy. When an organisation offers numerous suppliers the opportunity to bid for products or services, their bid should include how they will solve the organisation’s demand issue and provide the most competitive pricing. However, designing and writing these proposals, also known as specifications, can take time and effort.
- Demand Management: Research shows that every £1.00 an organisation spends on supply management returns £6.77. By decreasing demand, an organisation can achieve the highest cost savings by reducing overall product or service consumption, which can reduce or eliminate hidden costs. This is especially important when considering products like laptops, smartphones, or the leasing of company vehicles.
- Staff Skills: Spending on training Staff to become more empowered and make better decisions for an organisation can improve the bottom line over the long run. For instance, investing in enhancing negotiation skills can make for better supplier relationships and easier contract management. Employees are an organisation’s biggest asset, so investing in them and their professional development is in the organisation’s best interest.
- Technology: Using e-procurement software and other technology to communicate more speedily and efficiently with the supply chain will give improved access to supplier catalogues, ensuring a better range of product choices, ultimately leading to increased savings.
- Inventory Levels: High stock levels in a warehouse will not make any profit and will cost money to store. The longer the stock sits, the more deteriorated it becomes, with a higher chance of obsolescence. Keeping a close check on stock levels ensures that it rotates with the first in, first out principle to reduce waste.
As organisations face ever-increasing cost management issues, they must review their current and future spending requirements. Not carrying out a financial review will invariably increase costs by 16 – 21% per annum, higher than the open market.
Assisting budget managers in understanding where and how they spend an organisation’s financial resources will facilitate their ability to set tendering or negotiation priorities to maximise cost reductions for their current and future anticipated spending.
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