Sunday, August 31, 2008

A Cautionary Tale of Zero Investment (Originally Released in England Under the Title: "I Didn't Do a Spend Analysis But I Sourced Anyway")

(Note: the names, client details and even spend categories in this post have been changed to protect the “not so innocent”!)

Following on the heels of my posting “Can a Spend Analysis Have an ROI?” I feel obligated to provide a living breathing example of a situation where someone – in this case a consulting firm - decided NOT to do a spend analysis but plow ahead with sourcing. Okay, it wasn’t just any consulting firm – it was the firm that yours truly was working for at the time (but I’ve worked for so many you’ll never guess which one). And okay, it wasn’t just any project at this consulting firm but it was the project that I was working on at the time. Shame on you, Mark. But hey - I was young and I definitely needed the money!

Anyway here’s the back-story. Our firm had just won a major strategic sourcing project for a $5B consumer products company. Big – about $1.5M in total fees for sourcing of seven spend categories including office supplies, MRO, temps, janitorial services, PCs, corrugated packaging, and travel. How do you think we picked the Magnificent Seven? They sound the typical band of villains, right? Well, it was a very scientific process that unfolded late one Thursday afternoon in the middle of a mid-west summer. I know it was a Thursday afternoon because we would fly in to the client on Monday mornings and fly home Thursday night, and I remember the meeting where the Seven were picked took place just before we all grabbed our taxis for the airport. My Partner and I were sitting with the client’s VP Procurement and a snippet of the conversation went something like this:

CONSULTING FIRM PARTNER: Well Chris, looking at the GL numbers from Charlie (Charlie was a Financial Analyst in Accounting) I’d say we have seven candidates that look perfect for strategic sourcing.

CLIENT VP OF PROCUREMENT: What’s the rationale, Brian?

CONSULTING FIRM PARTNER: Well we usually find that the best categories to pursue are the ones with reasonable spend that haven’t been sourced – that means higher savings – and ones that also don’t present too much of a challenge from a complexity or stakeholder resistance point of view. That way you stand the best chance of capturing some decent benefits while also building the skills and confidence in your organization for taking on more challenging categories later.

CLIENT VP OF PROCUREMENT: Makes sense. So these are the categories? (Looks at the list of the Magnificent Seven). Total spend about $100 million…….that would net us about $10-15 million savings from your estimates, right? I like it. What’s next? Your team will create the detailed work plan?


What happened next? Well it turned out that three of the categories proved to be massive disappointments after we found that the spend available for sourcing in each of these categories was much less than what had originally been thought. Embarrassingly less, in fact. The reason for this was very simple – the accounting data used to make the sourcing decisions (spend by general ledger code with a few cuts of spend by supplier) had failed to provide the necessary detail and accuracy to make an informed decision. What should have happened? We should have conducted a spend analysis to cleanse the accounting data and classify it into commodity groups based on all the clues available such as vendor name, GL code and cost center. Where we didn’t have enough clues in the data to break out a commodity we should have asked the using departments to help clarify what had been spent with whom. Oh, and we should also have asked whether there were any planned reductions in usage in any of the categories. If we’d done that we would never have picked three of the Magnificent Seven, would never have wasted months of our time and the client’s time chasing minuscule benefits (one category was canned early on, but the other two were continued largely to save face) and – most important – would not have disappointed our client.

What really happened in this case? We believed Charlie from Accounting! Now Charlie is a good guy and does good work. His accounting data works fine for financial reporting and budget planning. But in its raw form it just doesn’t cut it for making effective major resource deployment decisions during the planning of a strategic sourcing program. To accomplish this you need to invest in a spend analysis to transform Charlie’s numbers into meaningful purchasing intelligence. Ignore this advice while recruiting your next “Magnificent Seven” and you may find yourself riding into Sourcingville firing blanks with Charlie watching safely from the saloon.

Monday, August 25, 2008

Can a Spend Analysis Have an ROI?

Would a private equity firm ever think about investing in a company without conducting a comprehensive analysis of its ability to generate an attractive future return? Of course not! A friend of mine in private equity once told me that for every one hundred million dollars a PE firm invests it has spent a million dollars in internal salaries and due diligence consulting fees analyzing the deal prior to pulling the trigger.

In a somewhat similar vein, would you ever think about buying a new or used car without carrying out at least a rudimentary analysis of the comparative reliability and performance of the various models? I didn’t think so. If you’re like me, in addition to burying yourself in Consumer Reports you also spend all the weekends between February and July test driving every vehicle under the sun until your significant other finally explodes “enough already – make up your mind!”

What about hiring someone for your company? You wouldn’t make an offer to a person without a rigorous evaluation of their capability to perform the job would you? You pick apart resumes, fly candidates in for interviews, give them case studies, call their references, and conduct drug screens and background checks before extending an offer.

What’s the common theme in each of the above examples? It’s that in each case someone is making an investment of money (the due diligence consulting fees, the job candidate travel expenses) or time (lost family time at weekends doing test drives, lost work time interviewing candidates) to gather information critical to a particular decision making process. The return on the investment is an increased probability of a favorable outcome from the decision – a higher profit when the PE firm sells the company three years later, a pleasurable ownership experience for the car buyer, and a high performing employee for the hiring company.

So Mark, I hear you all saying exasperatingly, what the Sam Hill does all this have to do with spend analysis? Quite simply, numerous companies of all sizes across many industries are making high dollar resource deployment decisions in procurement while having little or no access to a piece of information that is critical to the procurement decision making process. That piece of information would be about SPEND. Information providing answers to massively important questions such as: What is total spend? What is spend by commodity, supplier, and department? How much spend is currently under contract, in total and within each commodity? How many suppliers account for the top 80% of spend in each commodity? With how many different departments are your highest spend suppliers doing business? How much spend in each commodity is with non-approved suppliers? Which departments are responsible for the non-approved spend? Only by having answers to these type of questions will an organization be able to identify those commodities, suppliers and departments where the application of scarce procurement resources will yield the highest return.

How does an organization get these answers? By conducting a SPEND ANALYSIS, a process for producing a consolidated and accurate view of an organization’s purchasing expenditures by commodity, supplier and department. I won’t go into the intricate details of the spend analysis process here or the various tools available in the market to conduct one but, yes, to perform a spend analysis you will need to….make an investment! Depending on the approach you take the investment will take the form of people cost to conduct an internal analysis, software license fees for a tool, consultant fees, or a combination of all of these. The key is to perform an effective spend analysis that allows your procurement organization to focus its people, processes and technologies in the areas that will yield the greatest benefits. Examples of such areas are commodities with the highest total spend across the enterprise, commodities with too many suppliers, suppliers doing high volumes of business with different departments, and departments spending large amounts with non-approved vendors.

One of my clients with $500M of total spend recently conducted a spend analysis that identified just over $100M of spend with opportunities for sourcing, incumbent renegotiation and maverick spend reduction. Following the spend analysis this company focused its best and brightest commodity managers exclusively on this $100M and realized $28M of annualized cost savings. Without the spend analysis the same talent would have been wandering blind amongst the $500M and would have been very lucky to have found half of the $28M. Let’s say they were very lucky and found over half, say $18M. That would still mean that conducting the spend analysis had led to an additional $10M of savings. And what did the spend analysis cost? Less than $100K in software and services. Guess what, there’s a spend analysis ROI. And an attractive one at that.

You would be surprised (unless you get to see as many procurement departments as I do) just how many companies today are not able to identify the opportunity areas described above, and by inference are not able to prioritize the deployment of their procurement resources. Many of these companies will tell you they know where the cost savings are. They’ll tell you they know their business and that they know where to look. But they don’t really. They guess where to focus their people. They roll the dice on where to conduct a reverse auction. And they come up with dry holes again and again. Why? Because they haven’t invested. They haven’t done the due diligence. They haven’t test driven the commodities. They haven’t fully evaluated the candidates. They haven’t done a spend analysis.