Companies can be very good at managing the costs that go directly into their manufactured goods, but may be unaware of or unsure how to tackle the other costs of doing business – their indirect spend. This area can seem like the Wild West with every group working with different vendors and purchasing supplies that range from paper clips to airplane travel.
This was the case for a regional packaged food manufacturer I spoke with recently. Their factories are highly efficient operations with the latest in technology to produce high quality and tasty foods. However, they didn’t realize they could bring the same level of focus and control to their expenditures across the rest of their company.
What is “Indirect Spend”?
Indirect spend consists of all the materials and services that businesses need in order to operate. This can include areas like marketing and other professional services, travel, IT and HR, facilities, utilities, and maintenance, as well as basic consumables such as paper, paper clips and other office supplies.
While it may seem like this area of spend wouldn’t be significant, especially compared to expenditures directly related to producing finished goods, recent studies have found that indirect spend can account for up to 50 percent of a company’s purchases and manufacturers specifically can spend 20 percent or more of their total revenue on indirect expenditures.
Why Indirect Spend Management is Such a Challenge
Unlike direct expenditures, indirect spend may:
- Require significantly more and varied suppliers – Building strong relationships and managing a larger number of suppliers is inherently challenging. It’s more difficult to measure supplier performance for 100 suppliers versus 10.
- Have a smaller average spend – Because purchases range over a wide variety of product categories and suppliers, the purchase volume is often not large. This lower average spend per supplier means procurement lacks leverage in contract negotiations to drive lower pricing and better terms.
- Require larger numbers of smaller purchases, more frequently – While the amounts of each purchase may be lower, the number of transactions can be higher and more frequent. If handled manually, this can require a significant amount of resources.
- Consist of more “maverick” spend – “Maverick” spend are those purchases not covered by a procurement-negotiated contract. This could be one time purchases of office supplies or travel expenditures. Often these may be purchased via credit card for reimbursement and aren’t visible to procurement.
- Be driven by more internal stakeholders – While direct spend may be primarily managed by procurement with the input of a few stakeholders in the Product or Manufacturing groups, indirect spend affects the entire company. Procurement must work with all those purchasing stakeholders, often without the mandate and power to control the spend that comes with direct expenditures.
- Require diverse experience – Purchases can include items from paper clips to catering to electricity. Such a broad spread of purchases requires the procurement team to become experts in a wider range of products and services in order to procure effectively. Because they are working with groups whose spend they may not control, adding value to the purchase process via a demonstration of deep expertise becomes critical to building confidence and gaining trust.
- Be difficult to evaluate – Indirect goods and services are not subject to an incoming inspection, making quality measurement difficult, if not impossible. In some cases, delivery of indirect goods and services is not captured within a company’s ERP system. Criteria and metrics typically applied to direct suppliers simply aren’t always available for indirect suppliers.
- Be considered less strategic – Every company understands the value of strict and strong management of direct spend, but may not realize the value of managing their indirect spend. This is somewhat of a chicken or egg scenario – they don’t realize the value of managing the spend because they don’t have visibility into the volume, but at the same time, having visibility into the volume requires making indirect spend management a priority.
4 Key Strategies for Wrangling Indirect Spend
While managing indirect spend is more challenging, the potential impact on the business makes it worth the effort. There are some initial steps you can take to start to bring those expenditures under control:
- Focus on and influence key executives – Using the data that you do have on indirect spend, prioritize areas of the largest spends, grow expertise in those areas, and build relationships with the key executives in order to gain greater insight and be more deeply involved in their purchase processes.
- Choose Preferred Suppliers – Minimize “maverick spend” by negotiating contracts with key suppliers in each of the top expenditure areas. By pooling the smaller spends into a fund with fewer suppliers, you will gain increased leverage on pricing.
- Manage with Automation and Measurement – The volume of transactions and diversity of suppliers make indirect spend an ideal area to manage through collaboration tools. Look for a solution that provides a variety of ways to connect (web, EDI, SFTP), integrates with a variety of back office systems, allows closed loop procure-to-pay in order to minimize manual processes, and provides metrics on spend.
- Set KPIs – While measuring and scoring indirect suppliers may be more challenging due to the variety of supplies and types of vendors, Karen M. Fedele and Tim Dolan, of Gillette, suggest that there are some general KPIs that can work across a variety of vendors: contract compliance, customer satisfaction, and cost competitiveness and continuous improvement.
Indirect spend is the next frontier of spend optimization
While your company may have optimized every cent spent with direct suppliers, Lean Six Sigma’d the heck out of your manufacturing operations, and tightened your supply and delivery timelines down to the hour, indirect spend presents the next frontier in opportunity for increased efficiency and cost control.
The packaged food manufacturer I spoke to is considering using our OneSCM® management solution, with an easy-to-access supplier console, configurable workflow automation and close loop procure-to-pay processes, to improve spend visibility, reduce manual workload and improve the efficiency of their indirect spend.
If you have questions about how to bring your indirect spend under control, please email me at email@example.com or follow me @TSC_Godfrey. And if you have a topic you’d like me to cover in this series on “supply chain pain,” please send me a suggestion!