In downturns companies focus on ways to control outlays. CFOs (Finance Directors for those of you who speak the zedless and u-full version of the language) and controllers tend to rely on two levers to help them limit outlays. The big lever in a majority of companies is capital spending; the smaller one is travel and entertainment. Interestingly, CFOs and controllers with the longest tenure rely less on these items than those that are relatively new to the position. Why? Because the experienced ones know where to find the pockets of wasteful spending. During good times, it may not be worth the trouble (or internal political capital) to root out these spending issues. However, when belts have to be tightened these finance executives have plenty of suggestions as to where (and how much) to cut. That, in essence, is the objective of spend analytics which should be a priority of yours (See: “Effective Financial Performance Management – Priority for 2009"). To throw a light on where money is going – in good times or in bad – to ensure that unnecessary costs and wasteful practices are eliminated. Spend analytics is the foundation for spend management – you can’t control what you don’t understand and you can not optimize what you do not analyze. The analytics also must facilitate action by monitoring outlays, creating alerts when necessary and offering reports that provide visibility and decision support.
People, particularly if they’ve worked in a large company, know there are many ways in which companies routinely waste money. For example, companies – even midsize ones - fail to centralize purchases to be able to negotiate volume discounts. Spend analytics can identify opportunities to earn volume discounts and, once in place, create alerts if employees are deviating from policies or if the vendor misprices an item. Frequently, companies discover there is duplicate spending for all sorts of overhead items. In some areas like travel and entertainment, companies that have not fully automated requisition-to-pay as an end-to-end process may be spending too much or they wind up cutting back across the board, rather than focusing spending reductions in specific areas that are not as critical. When used properly, spend analytics also enables organizations to forecast cash flow more accurately because it updates future cash outflows at the moment spending is authorized (either on the creation of a purchase order or some other defined documents).
Spend analytics is like having a purchasing department robot at work 24 by 7 by 365. Purchasing spends most of its time focusing on big ticket items but it either does not control or cannot be effective enough in handling smaller, day-to-day purchases. Spend analytics enables companies to monitor the full breadth of purchases and provide alerts and guidance to achieve savings. Individually, these savings may be small but can easily add up to several percentage points of profit margin over the course of a year.
Spend analytics and spend management are used more in certain categories of outlays than others. Companies have both an internal spend – money most paid to employees and for facilities and equipment – and an external spend – monies paid out for everything else. Typically, spend analytics is not used to control internal spend. Organizations use all sorts of HR and compensation analytics and management tools to ensure that it is paying the right amount to employees in salaries and benefits. There also are plenty of benchmarks to guide companies in controlling their capital spending or leasing costs, as well as metrics that should give them a good idea if they are over- or under-spending on the property, plant and equipment categories.
As for controlling their external spend, these are classified in two categories. One is “direct spend” (also referred to as “strategic spend”), which are the major components of the costs of sales (that is, mainly raw materials and purchased parts). The second is “indirect spend” which is everything else including office supplies, telecommunications services and so on. Typically, purchasing departments are responsible for handling all of the direct/strategic spend – ensuring that the company has negotiated the best deals and that suppliers are meeting contracted provisions and usually have involvement in the centralized elements of the indirect spend.
It’s relatively easy to analyze and manage the big ticket items. In manufacturing or assembly businesses 20% of the purchased items account for about 50-80% of the strategic spend (that is, it tends toward a Pareto distribution) and therefore these items receive the lion’s share of attention from the purchasing department. That leaves everything else as an opportunity to use spend analytics (and spend management) to identify opportunities and achieve savings. This is particularly important for services businesses, because decentralized indirect spend may be a significant chunk of the outlays excluding personnel and occupancy costs. Many of these services companies centralize only a relatively small portion of their non-strategic spend, such as travel for example.
A spend analytics application must be able to track prospective expenses in real time to give those responsible alerts when outlays that do not conform to policies are requested. It must provide controllers with the ability to incorporate spending commitments in their future cash flow forecasts. This should take place at the time authorization takes place (that it, at the earliest point of the process), not when the invoice is booked, to ensure that there is sufficient cash available. Analytics should be able to identify opportunities to consolidate and centralize purchases and detect unnecessary duplicate spending.
“Watch the pennies and nickels and the dollars will take care of themselves” is a good piece of business advice (which recently received some unfortunate attention in politics – but that’s another story). In many companies, however, it is too difficult or too expensive to do this manually. Spend analytics software and the management techniques that these analytics make possible should be adopted by companies of all sizes and in all industries and with new advancements from vendors like Ariba and their acquisition of Procuri, Concur, Emptoris, Endeca, ExpenseWatch, IBM Cognos, Infor, Ketera, Oracle, Rosslyn, SAP BusinessObjects and Zycus. A decade ago these applications were expensive to implement and use, so they were useful mainly to larger corporations. Today, however, there are options available to any size company either as on-premises software licensed perpetually or in a software-as-a-service format paid for monthly with no installation required. Finance executives looking for savings (and who isn’t?) should be looking into spend analytics and management.
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Robert D. Kugel - SVP Research