The segmentation of spend patterns into discrete
groups will depend on an organisation's primary functions. Some of the major
categories into which an organisation might rationalise their spending could
include:
- Overheads.
- Finance.
- Operations.
- Direct / Indirect.
Category management is a systematic cost analysis
approach describing how financial resources are used. The descriptive process
allows the understanding of past and present spending patterns and is used to decide
the options that provides the best approach to leveraging and achieving the
greatest benefits. Preserving the savings involves the apportioning of
direct and indirect products or services spend patterns by:
- Value.
- Supplier.
- Type.
- Volume.
Associated theories used to help dissect products
or services spending patterns include Pareto (80/20 rule) and ABC analysis.
From the assimilation of category spend groups, important levels of spend are
discerned from where buying attention should focus on leveraging the highest
cost and efficiency savings. Category management is the most evolved purchasing
strategy of the three common purchasing management approaches, which include:
- Tactical purchasing.
- Strategic sourcing.
- Category management.
The simplest form of purchasing is tactical purchasing, a standard process of executing orders through the typical three bids and buy routine. In contrast, higher levels of strategy are employed at the strategic sourcing stage to capture increased levels of supplier value and merge the number of suppliers utilised.
Category management uses an in-depth insight into a market to drive value to entire groups of products and services to evolve them in real-time as the supply market changes or develops. However, category management is not a one-time implementation process, it is based on a continuous evolution and improvement of total lifecycle product or service costing.
Category management is a dynamic approach to price analysis that requires initiative-taking management and a shift towards peak effectiveness and efficiency in buying practices. It is not classified as the strategic sourcing of products or services but as a long-term approach to monitoring supply marketplace dynamics, trends, and the supplier landscape within a particular spend area, often adjusted to reflect changing organisational and supply conditions.
One of a purchasing function's primary roles in category
management is guiding stakeholders using targeted questions. However, one of
the biggest misunderstandings by an organisation's stakeholders is that a purchasing
function is trying to take over the stakeholders' role in the purchasing
process. An initiative-taking buying function should be working with
stakeholders by helping them to answer the critical questions about:
- Demand and forecast patterns.
- Financial and commercial bottle necks.
- Operational requirements.
- Quality issues.
To realign category management strategies with business needs and aims, typical outputs of this process might include:
- Understanding the critical financial strategies.
- The examination of historical purchasing patterns.
- Alignment of stakeholders to the distinct features and requirements of the products or services necessary.
- A shared understanding of what quality looks like and how it should be delivered.
While there is no standard categorisation or grouping of requirements within category management, a general rule is to group products and services that have similar characteristics. Organisations could use the following to group categories:
- United Nations Standard Products and Services coding
- UK Governments Common Procurement Vocabulary (CPV) coding
Defining demand patterns and allocating spending categories is a laborious task. It can entail the assimilation of data streams and assimilating a form of analysis to transform the data into meaningful information. This is enacted by considering the following:
Internal Needs: this should set a baseline for the strategic category management process and provide a basic understanding of sub-categories, significant suppliers, essential requirements, stakeholders, and internal controls/policies currently in place. This part of the process is instrumental when reviewing the category management strategy with someone unfamiliar with the category and its scope.
Spend Analysis: the foundation of any category management strategy depends upon having a solid understanding of the historical and forecasted spending. With accurate detail, an organisation will find it easier to formulate a practical strategy. Conducting a thorough spending analysis will enable recommendations to be made to stakeholders, the bare minimum of which should break the spending down by sub-category, supplier, location, and business cost centre.
Supply Market Analysis: understanding the supply market is critical to developing a robust category management strategy. An organisation will gather market intelligence and benchmarking information from various sources. Commonly used market analysis tools are Porter's 5 Forces model and the Structure, Conduct, Performance (SCP) model.
Category Segmentation: segmentation modelling allows an organisation to effectively apply the proper strategic category management for the products or services that are being sourced and will prioritise where the most strategic categories lie. For example, the Kraljic Matrix, developed by Peter Kraljic, is a segmentation model that evaluates the two critical factors of Value and Complexity. These factors are considered on a low to high scale across a 2 x 2 matrix, creating four quadrants or categories such as:
- 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)
Category Plan: The category plan
will define a list of initiatives, projects or tactics to deliver results. The category
plan should:
- Initiate - define the categories that the purchasing function will manage.
- Prepare - once the categories are defined, plans need to be evolved to enable a purchasing function to manage the category in alignment with the organisation's needs and requirements.
- Prioritise - aims need to be set to achieve the organisation's needs and requirements, which could be to source 50% of direct cost products from suppliers in the local area or to source only from environmentally conscious suppliers.
- Define - the strategies that should be set need to reflect the organisation's needs and requirements. For example, it could be to contact all suppliers within a 50-mile radius and invite them to tender for all indirect cost-related spending areas.
- Implement - once strategies have been agreed and approved, the purchasing function needs to work with stakeholders to gain their "buy-in" to the category management strategies. These need to be supported by everyone to ensure their effectiveness in achieving the organisation's needs and requirements.
- Maintain - the purchasing function will set Key Performance Indicators (KPIs) or Service Level Agreements (SLAs) to monitor and evaluate supplier performance. A typical KPI could be On Time In Full delivery, or "OTIF".
- Improve - purchasing is a constantly evolving function, so a relevant category may become obsolete, non-critical or move from direct to indirect spend. The review process is critical to ensure that categories remain relevant.
As organisations face ever-increasing cost management issues, it is essential that they review their current and future spend requirements. Not carrying out a financial review will invariably increase costs by 7 – 9% per annum, higher than the open market.
Helping budget managers to understand where and how they spend an organisation’s financial resources will facilitate their ability to set tendering or negotiation priorities to maximise the reductions in costs for their current and future predicted spending.
However, this requires organisations to become increasingly
initiative-taking in reviewing and coordinating their tendering and negotiating
activities, which are reliant on having exact spend data. Purchasing in
low-performing organisations wait for budget managers to ask for help. In high-performing
organisations, purchasing provides the spend data for budget managers to become
initiative-taking in their tendering and negotiating activities.
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