Increasing Purchasing Clarity
Cost management principles encompass the strategic allocation and utilisation of an organisation's financial resources for management accounting. This involves a comprehensive approach to overseeing and optimising the costs associated with operations, production, and other business activities.
Category management, on the other hand, involves a systematic and strategic procurement method. In this approach, an organisation categorises and segments its expenditures on products or services with high precision and clarity. This approach allows a more nuanced understanding of where resources are allocated and how they align with the organisation's objectives.
The segmentation of these expenditures into discrete groups is tailored to the organisation's primary functions, ensuring that resources are allocated to best support the organisation's strategic goals and operational needs. Some of the major categories into which an organisation might rationalise its spending patterns could include:
- Overheads.
- Warehousing & Distribution.
- Finance.
- Operations.
- Direct / Indirect spend areas.
- IT.
Defining Spend Categories
Category management is a systematic cost analysis approach describing financial resource use. The descriptive process allows the understanding of past and present spending patterns and is used to determine the best method for achieving cost benefits. Preserving and improving on commercial cost savings involves the apportioning of direct and indirect spending patterns by:
- Value.
- Supplier.
- Type.
- Volume.
Associated theories that help dissect product or service spending patterns include Pareto (80/20 rule) and ABC Analysis. From the assimilation of category spend groups, high levels of spend are discerned from where attention should focus on leveraging the most increased cost and efficiency savings. Category management is the most evolved strategy of the three common management approaches, which include:
- Tactical purchasing.
- Strategic sourcing.
- Category management.
Category Management Strategies
The simplest form of cost management 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 strategic sourcing stages to capture increased levels of supplier value and consolidate the supply base. The use of category management captures the following advantages:
- Uses in-depth market insight to drive value to entire categories to evolve in real-time as the supply market changes, based on continuous evolution and improvement of total lifecycle costing.
- Is a dynamic approach that requires proactive management and a shift toward peak effectiveness and efficiency in purchasing practices, which is a moving target that changes with market dynamics.
- Is classified as the strategic sourcing of products or services based on a long-term approach to monitoring supply trends, marketplace dynamics and the supplier landscape within a particular spend area, often adjusted to reflect changing organisational and supply conditions.
One of the primary roles of category management is guiding stakeholders using a series of targeted questions. However, one of the biggest misunderstandings of organisational stakeholders is that the category management process tries to take over the stakeholder's role in purchasing. A proactive purchasing function should be working with stakeholders by highlighting and helping them to answer the critical questions about:
- Demand and forecast patterns.
- Financial and commercial bottlenecks.
- Operational requirements.
- Quality issues.
Realigning Spending According to Business Needs
To realign category management strategies with business needs and objectives, typical outputs of the category management process might include:
- The examination of historical purchasing patterns.
- Understanding critical financial systems.
- Alignment of features and requirements of the products or services necessary.
- A collaborative understanding of what quality looks like.
- Deciding how quality should be delivered.
While there is no standard categorisation or grouping of requirements within category management, the process should start with grouping spend areas with similar characteristics. Organisations could use the following to define spending categorisation standards:
- United Nations Standard Products and Services coding.
- UK Government Common Procurement Vocabulary (CPV) coding
Defining demand patterns and allocating spending categories is an uphill task. It can entail the assimilation of data streams and analysis to transform the data into meaningful information, which is enacted by considering the following:
Defining Internal Needs
Defining and exploring spending patterns establishes a foundational framework for strategically managing spending categories. It aims to provide a comprehensive understanding of the various sub-categories within an organisation, identify and evaluate significant suppliers, outline essential requirements for effective category management, recognise critical stakeholders involved in the process, and assess the internal controls and policies currently in place to support these activities.
Spend Analysis
To establish an effective category management strategy, it is essential to have a comprehensive understanding of both historical and anticipated spending patterns. Organisations can develop more precise and actionable category plans by gaining accurate insights into past spending and making informed projections for the future.
A thorough spending analysis should encompass a detailed breakdown of expenditures by sub-category, supplier, location, and business cost centre. This detailed approach will facilitate formulating well-informed recommendations for stakeholders, enabling strategic decision-making and resource allocation.
Supply Market Analysis
To develop a resilient category management strategy, it is essential to have a comprehensive understanding of the supply market. Organisations gather market intelligence and benchmarking information from various sources, including industry reports, competitor analysis, supplier assessments, and market trends. This information is vital for making informed decisions and ensuring the success of the category management strategy.
Category Segmentation
Segmentation modelling is a critical tool that enables organisations to analyse and categorise their sourced products or services based on various parameters such as customer demographics, purchasing behaviour, or product characteristics.
By doing so, organisations can effectively prioritise and manage strategic categories, allowing them to allocate resources and focus their efforts where they will have the most significant impact. This approach helps identify the most valuable segments, optimise procurement strategies, and drive better business outcomes.
Category Planning
The plan will define a list of initiatives, projects, or tactics to deliver results. The Category Plan should:
- Initiate: Define the categories that the organisation will manage.
- Prepare: Once the categories are defined, plans must evolve to enable an organisation to manage purchasing patterns in alignment with its needs and requirements.
- Prioritise: Objectives must be set to achieve the organisation's needs and requirements. For example, the organisation could source 50% of direct-cost products from suppliers in the local area or 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 the strategies have been agreed upon and approved, the Procurement function needs to work with stakeholders to gain their "buy-in" to the Category Management strategies. Everyone must support these to achieve the organisation's needs and requirements effectively.
- Maintain: The Procurement 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: Procurement is a constantly evolving function so that a relevant category may become obsolete, non-critical, or move from direct to indirect at the start of a period. The review process is critical to ensuring that categories remain relevant.
A Category Management plan is an organisational tool that allows budget managers to understand how financial resources are used to enable priorities to define the highest risks regarding commercial and legal issues, allowing the organisation to mitigate them efficiently and effectively.
The Benefits of Spend Categorisation
Organisations that fail to analyse how they spend their finances regularly may spend 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 7 – 9% ahead of the open market.
- Incurring increased commercial, legal and Health and Safety risks.
Analysing the items and services an organisation acquires is essential in gaining insights into how it uses its financial resources. This understanding is necessary before taking steps to ensure the resources are utilised effectively.
By identifying the areas where spending adds value and eliminating unnecessary or ineffective expenses, organisations can significantly enhance their spending efficiency and the overall effectiveness of their financial expenditure. This process involves in-depth examination and evaluation of every aspect of the organisation's procurement and purchasing practices to optimise financial management.
More articles can be found at Procurement and Supply Chain Management Made Simple. A look at procurement and supply chain management issues to assist organisations and people in increasing the quality, efficiency, and effectiveness in the supply of their products and services to customers' delight. ©️ Procurement and Supply Chain Management Made Simple. All rights reserved.
