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Sourcing best practice: understand your spend history

Before rushing into any sourcing activity, be sure you understand what it is you are asking for and who can provide it for you. We use spend analysis techniques to help you make better sourcing and supplier decisions.

Your requirements will most likely be based on your expenditure history, but you also will have your future requirements in mind. Professional procurement organizations have developed some best practices and it makes sense to follow these steps to achieve the best results.

1. Analyze your spend

Doing an in-depth analysis of your spend over the last one or two years will reveal patterns of expenditure that may be a surprise to you. Study your accounts payable information and use this information to group your expenditure into categories.Don’t forget to add other types of spend outside the mainstream, e.g. company procurement cards or personal credit cards.

Firstly, it is best to divide the historical spend into two groups, one for direct spend (this is expenditure that is directly linked to your core business) and one for indirect spend (goods and services necessary to support the business).

  • Direct spend

Direct spend refers to purchases of goods and services that are directly incorporated into a product being manufactured, or are goods for immediate resale. Examples include raw materials, subcontracted manufacturing services and component parts. Sourcing of these strategic and expensive items often requires the input and support of subject matter experts and technical professionals.

  • Indirect spend

Indirect spend is that which is needed to run your business.It is likely to include some or all of these depending on your operations: I.T., utilities, communications, physical facilities management, travel, marketing services, transport and logistics. The spend value may be lower but it may be more controllable. Cost savings can be made in this group and additional benefits can be obtained from suppliers.

In both groups, you may need to “cleanse” the data, i.e. check for errors in allocation and convert all the spend values into your currency. Now you are ready to work with categories. The objective is to develop a sourcing strategy (and possible cost savings) for one or more of the important categories.

2. Create your categories

When you have grouped your historical expenditure into those two main categories you can then break each one down into sub-categories, also sometimes called commodities. You can choose your own category structure or use an existing method such as UNSPSC. Let’s look at an example of a category and its sub-categories:

These sub-categories can be analyzed further, e.g. types of cards. We do this detailed breakdown because different specialist suppliers may be needed to deliver the best combination of price, quality and service.

3. Forecast your spend per category

Although history is not always an exact predictor of the future, it is an important guideline.When requesting a proposal or a quote from suppliers, the more information you can give about your future needs, the better. Suppliers are able to fulfill your requirements more accurately and affordably if they know what is expected of them.

Ideally, you should aim to reduce the number of suppliers in each category.Value is obtained by leveraging your spend rather than splitting it and this also reduces your administration costs.

In the next article we will cover how to research the supply market and select the best potential suppliers for your business.

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