Don’t sweat the small stuff? Why industry experts point to Indirect Material Spend as an important reservoir of untapped savings!

Posted on September 12, 2011

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With regard to costs, the conventional wisdom is that procurement should focus principally on the “big ticket” areas of spend, such as raw materials and energy.  And, you certainly should devote attention to raw materials and energy – not just to reduce costs, but also to reduce volatility through better risk management.

But, if you focus only on the big ticket spend categories, you’ll be missing out on the enormous opportunities presented by all other, indirect areas of spend.  It is often possible to achieve double-digit reductions in costs for those indirect spend categories.

from Take It Straight to the Bottom Line: Drive Outstanding ROIC and EPS through World Class Management an Executive White Paper by Robert A. Rudzki, Greybeard Advisors, LLC

It is often times interesting how the same conclusion can be reached through multiple or varied paths.

For example and not surprisingly, I can readily remember 2003 when I could for the first time, consistently identify the emergence of a trend in the area of Indirect Material spend that held out the promise for significant but largely ignored savings for enterprises of all sizes.

Back then, the vast majority of companies were myopically focused on reducing the costs associated with the acquisition of Direct Materials as this represented the largest dollar expenditure and thus garnered the greatest attention from the finance department.

While there were important savings to be achieved in the DM area of spend, this was by no means the only area from which savings could be extracted.  In fact, and as demonstrated by subsequent studies including a CAPS 2003 paper on Reverse Auctions, once DM savings were realized, subsequent reductions in spend leveled off to the extent that organizations could no longer justify the significant and on-going licensing fees for the ERP applications they had used to buy more effectively in the first place.  In essence, and in an ironic twist in which the cure (i.e. ERP-based solutions) became worse than the ailment (re non-strategic DM buying) it was designed to remedy, companies ultimately bled more money through the pursuit of automated savings than they did through the prior purchasing inefficiencies.  The why and the eventual impact on the industry as a whole of this revelation is best suited for a separate discussion, however and suffice to say, it provides an important window into why some analysts have predicted the possible demise of an SAP.

For the purpose of today’s post, I will examine more closely the inherent flaw with using dollar volume as the sole means by which to prioritize a company’s focus relative to savings.

In this regard, the words of Robert Rudzki referenced in the opening paragraph should provide a resonating ring.

Of course Rudzki, about whose efforts to bridge the disconnect between finance and purchasing I had written in a January 8th, 2008 post titled Bridging the Communications Gap Between Finance and Purchasing, approached the concept of widening the savings net to include Indirect Material spend from a pure finance perspective.  That said he provides a compelling argument as to why this long neglected area of a company’s purchasing practice represents tremendous potential to improve the bottom line, especially from an ROIC perspective.

My arrival at the same conclusions came by way of a research grant from the Government of Canada in which I had identified what I would eventually refer to as commodity characteristics.  Specifically the existence of both Dynamic Flux and Historic Flat Line tendencies that aligned with Indirect and Direct Material pricing performance.  For those who read the recently re-released Dangerous Supply Chain Myths Series here in the Procurement Insights Blog, you will undoubtedly recall Part 7 (Enabling Technology), in that I discussed the existence of commodity characteristics at length.  You can also check out the link (see below) to my white paper Acres of Diamonds: The Value of Effectively Managing Low-Dollar, High Transactional Volume Spend for actual commodity characteristic examples.

What is most noteworthy is that even though there was back in 2003 ample evidence to support the earnest pursuit of IM savings, the confining limitations of ERP-based solutions made it a somewhat cumbersome and in the opinion of many, unprofitable exercise.  Today, it is a generally recognized fact that low-dollar and high transactional spend actually represents a tremendous and sustaining opportunity to impact a healthy bottom line paralleling that of the expected savings through an efficient big ticket acquisition process.

As a result the disconnect that I had referenced in my January 2008 post between finance and purchasing has for the most part dissolved into a more holistic understanding of the interconnecting complexities of individual functions within a global enterprise, and how they collectively impact an organization’s financial health.

The advent of SaaS technology and, the corresponding shedding of the unflattering “bolt-on” application moniker, has in no small way helped to facilitate this change in executive thinking and savings pursuit, however . . . to what extent has the finance department’s jargon become a discernible reality for those in purchasing and vice-versa?

After all, it was not that long ago that an Aberdeen Study reported that more than 80% of all savings claimed by purchasing are routinely discounted by CFOs as being irrelevant to the company’s bottom line.

In this week’s Procurement Insights series I will once again recall and review what Robert Rudzki, president of Greybeard Advisors and author of the book Straight to the Bottom Line indicated were the “five critical finance terms” every purchasing professional should know.

Robert Rudzki

Acres of Diamonds White Paper:

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Posted in: Commentary, Finances