By Keith Hausmann, Chief Revenue Officer at Globality,
When inflation is in the system, or a supply chain system is under pressure from Chinese COVID disruption, war in Ukraine and deglobalisation, the traditional way of reducing costs, crunching the supply chain for savings, may not work. The only practical way of reducing overhead is to look at other parts of the business which are less sensitive to inflationary pressures. The obvious area to look at is people costs, but for most organisations, that’s a last resort. Unless you redesign business processes and automate to the hilt, you’ll end up outsourcing the work, so it’s not a move that will help you make progress in cutting costs.
There is, however, a better option—optimising your indirect spend. That approach may give you pause for thought, as this spend category has been historically overlooked as a source for cost rationalisation, but it should be made a priority. Most companies spend significant money on items that aren’t supply chain-related—on their technology, marketing, people and facilities costs, real estate, and so on.
For example, a pharma company might record the cost of making a medicine as quite low, unit-wise, but the R&D, marketing and sales activities associated with getting the medicine on to the market is a far bigger ongoing cost. The technology function within a company will spend more on third parties than it will on paying their own internal staff. Legal advice is often a hefty line item that tends to be just let go.
The hidden nine tenths of the overall spend iceberg
Meanwhile, P&L statements place indirect spend as between, at the low end, 20% of revenue to as much as 40% or more at the high end. That’s a broad spread because the finance team can struggle to get genuine numbers due to the complexity and bespoke nature of many indirect expenses, such as legal services or consulting, which require bespoke contracts and agreements. In order to maximise your company’s value from these suppliers requires market knowledge that may be at a premium or completely absent from your firm. Meanwhile, in the average Global 2000 company, indirect spend amounts to billions of dollars of cost that impacts net income dramatically.
Procurement teams may also struggle to accurately track and attribute savings from managing indirect spend. You may have saved money through optimising your indirect spend, but the savings (the 90 out of the 100 dollars you were spending before) are not properly accounted for and drop out of budgets. There’s one last factor at play that’s held indirect spend optimisation back—when it comes to getting visibility into on-the-ground indirect spend, many business leaders dismiss these costs as low-level rather than as a significant source of expense. That’s a mistaken view, as indirect spend is huge money—it’s how you function as much as the widgets or the professional services you provide.
So, it’s time to get serious about indirect spend. And I’m far from the only one saying this is the route of travel. Accenture talks about closed loop spend management, and McKinsey says we need a revolution in indirect procurement. There’s interest in zero-based budgeting (ZBB), a method of budgeting in which all expenses must be justified for each new period which has gained popularity as a way to optimise indirect spend.
The good news is that indirect spend is an area that, provided you have the right tools available is a perfect area for cost optimisation. The introduction of smart sourcing technology that introduces machine learning into decision-making has made the leap forward possible.
BT: savings across indirect spend
In April 2021, BT Group set up a dedicated procurement arm, BT Sourced, which has indirect spend improvement across the group as a priority (“challenge the traditional ways of buying goods and services by simplifying processes and introducing new technology and partnership-based approaches to the way BT works with suppliers”). BT Group now uses innovative procurement tech to quickly and easily source the best suppliers for consulting, marketing, IT, HR, legal and other service categories. The aim is to use all this deeper spending intelligence to achieve double-digit cost savings off its annual indirect services procurement bill.
For cost optimisation in tough economic times we are in, effective management of indirect spend is crucial. It’s a great tool for improving visibility into an area that has traditionally been a bit too opaque for your organisation’s good. By introducing technology to assist in exposing this as a cost centre, CFOs and FDs can better understand and control expenses and achieve significant savings in ways that don’t mean slashing headcount or squeezing a groaning supply chain yet one more time.
Spend management expert Keith Hausmann is Chief Revenue Officer at Globality, the sourcing platform that maximises outcomes from companies’ indirect spend