In our previous articles, we defined the concept and key activities of spend analysis using a basic business process. We revealed that the core function of spend analysis is to assign material categories which represent the supply market view to payment data incurred at the organisation level. This concluding article will help to define the material categories, and some metrics that could be adopted to manage the spend analysis program.
If spend categorisation is the core of spend analysis, it follows that the taxonomy of material and commodity categories is the heart of the Procurement organisation and standards. Almost all performance metrics, reports and strategies of Procurement can and should be established with material categories as a management unit. Hence, the definition of material categories is as important as the definition of spend for the spend analysis program.
To draw up the taxonomy of material categories, several methods can be used. These are:
- For organisations with an established Procurement function, mirror the organisation resources that are assigned to the categories. This approach will not be relevant for organisations that are in the midst of implementing a new Procurement function. And even if an organisation’s Procurement function has been established for some time, resources should be assigned to tasks and standards rather than bending standards to suit an organisation. So this should be the least favoured method in drawing up the taxonomy of material categories.
- Use a variation of the chart of accounts from the Accounting function. This will ensure a high level of data commonality between the functions, resulting in less effort and complexity required to categorise spend data. As shown in the example of the previous article, the chart of account has gaps in terms of addressing the Procurement view of the supply markets, and is one of the reasons why the spend categorisation step is required for the program.
- An industry standard that define and classify traded goods and commodities, such as UNSPSC, eClass and even HS codes. Each of these standards has their own basis for the grouping and hierarchy of commodities, with some inherent weaknesses as well. The UNSPSC hierarchy can be confusing, especially with its more than fifty thousand (50,000) codes to choose from. eClass standard is more commonly used among European Union economies, while HS codes are extensively used for the classification of internationally traded goods only.
Probably the best option for any organisation is to use a materials structure that relates closely to its core business. And that means a tailored structure and definition of materials which the organisation is likely to use, for both direct and indirect spend. But instead of starting from a clean sheet to draw up the taxonomy, organisations can tap on to the known industry standard such as UNSPSC as the starting point. The UNSPSC is after all, an international standard that is accessible, understood and used by many supply organisations worldwide.
Once a standard was adopted as the basis for the customised material structure, establish and limit the material hierarchy to not more than four levels. Select the material codes that are relevant to the organisation, and ignore those materials which are not relevant. Keep in mind the statement that “less is more”, for too many codes will confuse the organisation who will then find little meaning and relevance in the subsequent spend reports.
Once the material categories have been identified and allocated in a hierarchical structure, maintain a mapping of the spend categories to the adopted standard for referencing and future adaptation of the taxonomy. Bear in mind that the tailored structure of categories may need to evolve with the organisation over time. So a structured and disciplined approach to review and update the material structure (not more than once a year) is strongly recommended to ensure the continuing relevance of the spend analysis program.
A sample hierarchy of material structures is shown here, and is referred to as a “Category Tree”:
Spend Analysis Metrics
As with all management programs, metrics are useful to monitor and track the progress and improvement made. The spend analysis program is no different, and a number of simple metrics have been identified and used by the Procurement community at large. Here are two metrics which are worth to consider:
- Coverage/Completeness of spend analysis program: This metric measures the level of transparency achieved from the spend analysis program. Organisations who have achieved high level of transparency will have all spend data categorised and aggregated from the program. No market benchmarks are known to exist for this metric, and the maximum achievement is 100% only. After which it is no longer meaningful to track this metric unless the business has undergone a major change such as acquisition or divestment of business interests.
- Proportion of spend categorised automatically: In past surveys of procurement organisations (by Aberdeen Group, 2007), best-in-class organisations were able to leverage on technology to automatically categorise their spend data up to 69-76% of the time. With the development and evolvement of technology, this rate of automatic categorisation should be higher than the reported benchmark now.
Whichever metrics are identified and used for the program, it is important to monitor and track the progress within the organisation, and not be too fixated with market benchmarks. A steady progress will bring much confidence and trust in the reported spend data, and enable the Procurement function to act more strategically in sourcing for supplies and bring long term benefits to the organisation.
This concludes the series of articles on spend analysis, which is often regarded as one of the core competencies of Procurement. It bears to repeat that although spend analysis is a requisite for professional Procurement, it is the larger organisation that benefits from the result spend analysis. A dated research has shown spend analysis program brings impressive incremental benefits to the tune of:
- 93% increase in savings achieved from sourcing efforts;
- 39% improvement in spend under management;
- 30% increase in contract compliance; and
- 16% reduction in maverick or uncontrolled spending.
With this understanding in mind, organisations who have yet to implement a structured spend analysis program will be well advised to consider the investment. And organisations who operate a spend analysis program for a number of years may wish to review and rejuvenate the program for the next level of growth in their Procurement function.
Chee Kin has extensive experience in developing and implementing business strategies to transform business practices. In his career, he held responsibilities in the structuring and operation of strategic procurement in a logistics company both on the global and regional levels.
ThunderQuote is the “Gebiz for businesses” and most comprehensive business services portal in Singapore, Australia and ASEAN , where hundreds of thousands of dollars of procurement contracts are sourced every month by major companies like Singapore Press Holdings, National Trade Union Congress and more.