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5STEPS

to navigate from opportunities to savings

5STEPS

to navigate from opportunities to savings


Most procurement departments have a good understanding of the most critical categories of goods and services that their organizations buy. These are the direct materials, subcontracted services, and other things that are close to the core of what the organization is in business to do. This understanding of these categories means that these procurement departments know what they buy, how much they buy, who they buy from, and what fair market pricing is. This understanding enables these procurement departments to manage these critical categories well, achieving respectable cost savings and getting good supplier performance. But these critical categories only represent a small portion of the organization's overall spend. They only represent a fraction of the line items purchased in a given year. And they only represent a minor percentage of the cost savings opportunities that the organization has the potential to achieve. The majority of the cost savings opportunities are hidden in the rest of the categories of goods and services that the organization buys. Because these categories have less visibility within the organization, they have been historically undermanaged, characterized by the use of too many suppliers and are bought at higher than benchmark prices. Because of this lack of visibility, procurement departments can find it challenging to figure out a way to address the opportunities. And it's not uncommon to see them perceive this challenge as so insurmountable that they end up ignoring those categories that are so ripe for cost savings. Identifying these hidden opportunities does not have to be so difficult. We shall look at a 5 step process that helps organizations identify as well act upon the opportunities in these categories.

The 5 steps are

1 2 3 4 5

Mine procurement information

Transform the procurement information

Identify sourcing opportunities

Execute sourcing opportunities identified

Calculate your savings

5STEPS

to navigate from opportunities to savings

Step 1 Mine Procurement Information


Most organizations have some sort of electronic system in place for managing their purchase orders and supplier invoices. The data can be retrieved and used for identifying opportunities. Of course this process is not as simple as it sounds. The ground reality of the data mined from procurement and purchasing systems is very different. Let's look at a typical data dump as shown below. This kind of a data dump is found irrespective of industry, geography and organization size. Item Description 647445 HP NC6000 LAPTOP WIRELESS Latitut HP NC6000 Latutude NX6120 notebook / 256MB RAM KINGSTON 256MB PC2700 HP PAVIL Ordinateur portable donn pour la haute de Napoleon DELL-L131 0206ZX XSDF12 43211503 Material code Material Group Office supp Notizbuchcomputer Computer "Mach & Equip, Misc" Mainframe Purchases quipement d'Office

US German Australia England Australia France

The data we see is quite poor in terms of item nomenclature, material coding and at times even item description. Why does this happen? Simple fact there is no uniform process or code or means of classification to represent the data. As we can see in the illustration something as simple as a notebook computer can be misrepresented in the electronic system across different business units and geographic locations. Thus, in spite of having your data available unless it is classified uniformly it will not help you achieve any meaningful savings.

Step 2 Transform the procurement information


Now that you have the data mined from your systems it's time to actually convert this raw almost unusable data into actionable information that can be utilized to streamline your processes. Basically it is now time to derive value from your data. There are several pieces of information you need from each record in the database: a clear description of what you've bought, a correct category, and the supplier. If you have an organization with multiple people entering data into your electronic system there are bound to be disparities in your data.

5STEPS

to navigate from opportunities to savings


As we saw in the illustrated data dump the same latitude notebook computer is represented with several different names.-HP Laptop Wireless, Notebook, Latitut and so on. Again if you look at the material group under which the same product is categorized it shows an alarming level of random categorization. A laptop is categorized under Office Supplies at one location and under mainframe purchases under another. This is simply because the importance of accurate categorization is not clearly understood. The same issue may reflect in the way vendor details are entered into the system. This may result in you thinking that you have more suppliers than you actually do. All of these very common errors can provide the procurement professional with data that is either less than adequate for a good sourcing initiative or, in the worst case, not usable at all. While the adage garbage in, garbage out held true and crippled many sourcing plans, there is a way to transform that garbage into more accurate information. That's called data cleansing. For data cleansing a pre-requisite is an automated classification tool that makes your data comprehensible. This classification tool needs to be able to handle data that is multi-lingual, contains misspelled words, cryptic data and even abbreviations. Adopting a uniform code like UNSPSC can be a very good start to making your data actionable. Plant
US German

Item Description
647445 HP Nc6000 LAPTOP WIRELESS Latitut

Material code

Material Group
Office supp Notizbuchcomputer Computer

Classification Code
43211503 43211503 43211503 43211503 43211503 43211503

Category
Notebook Computers Notebook Computers Notebook Computers Notebook Computers Notebook Computers Notebook Computers

43211503

Australia England

HP NC6000 Latutude NX6120 notebook / 256MB RAM KINGSTON 256MB Pc2700 HP PAVIL Ordinateur portable donn pour la haute de Napoleon DELL-L131 0206ZX XSDF12

"Mach & Equip, Misc"

Australia France

Mainframe Purchases quipement d'Office

The data classification should be granular and then combined with an analytics tool that not only reads the data and gives you a full picture of your spend but also provides what if analysis and suggest areas where savings opportunities can be mined.

5STEPS

to navigate from opportunities to savings

Step 3 Identify Opportunities


Once you have clean data, you are able to conduct a meaningful spend analysis. Simplified, spend analysis is the systematic review of historical purchase data. The output of a spend analysis is a summary of purchases by various variables, such as category, supplier, and/or business unit. The primary reason for conducting spend analysis is to identify opportunities for cost savings. The output for spend analysis is the identification of opportunities for cost savings. These can be classified in the following ways.

Maverick or Off Contract Spend: A large amount of spend in categories for which enterprise-wide contracts do not exist.
Several times purchases are requisitioned by people who are not part of the procurement department. Purchases might also be requisitioned in cases of urgent requirements whereby the available discounts which have been negotiated based on volume with supplier are not met. A major benefit from spend data can be obtained by using it to analyze contract compliance within the organization. Comparing and benchmarking compliance from spend data for various business units within your organization can help you eliminate maverick spend and thus create savings without even changing any processes. Let's look at a hypothetical example of how eliminating maverick spend can be a potential source of savings opportunities. According to a research conducted by the Center for Advanced Purchasing studies in a traditional manufacturing organization the amount of maverick spend made off contract is about 2 - 5% of the total spend on goods. Based on this assumption let us look at a small example of how much you can save by eliminating maverick spend from your process. Considering total revenues of US $ 500 million for company ABC we assume that total spend is about 50% of total sales. For a company in the manufacturing domain assuming a 60-40 percentage ratio between direct and indirect spend, we get that about 100 million is the indirect spend. Assuming maverick spending to be about 5% of this total indirect spend, nearly 5 million is lot in maverick. An above average spend analysis implementation would help you achieve about 70% elimination of maverick spend which in turn translates to elimination of about 3.5 million of maverick spend and potential for more.

Purchase Price Variance for a high-spend item or category


Total Revenue Spend at 50% of total sales (500,000,000) Indirect spend @ 40% of total Spend (250,000,000) Maverick spend @ 5% of total Indirect Spend (100,000,000) Percentage of maverick spend eliminated by Spend Analysis Total Savings potential bu using SA to eliminate Maverick Spend 500,000,000 250,000,000 100,000,000 5,000,000 70% 3500000

5STEPS

to navigate from opportunities to savings


Purchase Price Variance is the difference between the average price paid and a standard cost. When there is a large Purchase Price Variance, this indicates one of two things: either your standard cost is not valid or you are paying too much. In the latter case, you should consider taking some type of action, such as negotiating or sourcing, to ensure that you are paying a fair price. PPV analysis of your spend data can help you identify those categories which will need to be put up for auctions and RFPs and help to curb down on current leakages.

Disproportionate number of suppliers for a category:


The basics of any procurement guide will state that the more you buy from a single supplier the more likely you are to avail discounts and cost savings. If you're buying from too many suppliers, you're not leveraging your volume and likely not taking advantage of supplier discounts that your organization might have already negotiated. For e.g. John Deere reports that it studied its $70 million annual MRO spend across 40 North American units, and reduced the number of suppliers from 1675 to 20 and cut costs by 13 percent. Seeing a large number of suppliers in a category can tip you off that supplier rationalization can deliver savings to your organization through price reduction and also through the more advanced benefits of an optimized supply base. If by supplier is one of the variables by which your spend data is categorized then you can easily identify the number of suppliers in each category and hence determine whether supply base rationalization is one of the steps that can be implemented to create savings. A classification tool needs to be supported with a robust reporting and analytics too to help you identify saving opportunities. The analytics tool should be able to translate reports into an opportunity pipeline similar to a typical sales funnel as shown below.. The opportunity should move across the funnel based on its priority to be acted upon just like a sales prospect

Need Recognition 100%

Information Search 83%

Evaluation of alternatives 58%

Evaluation of alternatives 46%

Purchase evaluation 34%

moves across the various stages in the sales cycle. This will be an aid to Sourcing heads or CPOs to see clearly what savings opportunities are available and need to be acted upon immediately.

5STEPS
The Easy Savings Categories

to navigate from opportunities to savings

Step 4 Execute on the identified opportunities


Once you've analyzed your spend and identified the categories to target for cost savings, the next step is prioritize those opportunities and conduct sourcing initiatives for each. For now, we'll concentrate on the prioritization of the opportunities you've identified.

When launching a new process, starting with little risk and gradually accepting more is wise. So begin your strategic sourcing initiative with a category where success is easier to achieve. Simple categories like office suppliers where several competent suppliers compete against each other with fervor may be the first place to look for easy savings.

Non-Traditional Categories
So after a procurement department gets through the easy savings categories and hopefully and saves the company tons of money they need seek other opportunities to use sourcing to save money. Now categories that have been traditionally managed outside of Procurement need to be addressed. These areas include health benefits, advertising, travel, and fleet services. Identifying these areas and learning to work with your new internal customers is a challenge all to itself. Some of the categories you've identified will require careful consideration and a very cautious, deliberate approach to supplier selection. But some of the categories will be a bit more straightforward. These more straightforward categories will enable you to use e-Sourcing, which has been a proven way of achieving higher degrees of cost savings compared to traditional competitive bidding.

Considering your entire sourcing process as demarcated into 3 main stages


1. 2. 3. Sourcing planning Event creation Supplier Evaluation and Awarding

Each of these stages is plagued by particular issues when your sourcing process is purely manual or even spread sheet based. In terms of the planning stage, lack of collaboration between sourcing teams or even sourcing departments at multiple locations is a common problem. Process for event planning becomes ad hoc and tedious when done by manual means. Modeling the RFx in an eSourcing tool - Creating an electronic RFx in the desired format (identical to the one created in your excel sheet) with all the necessary requirements such as a detailed cost break-down with respective item attachments and inclusion of decision parameters and cost benchmarks is unarguably the most cumbersome and time consuming task in the eSourcing process. It accounts for as much as 25% of the entire sourcing cycle time and still leaves the users far from satisfied, simply because it is either not easy to use or it doesn't have the capability to model the complex cost breakdown structures. This often leads to user frustration and beginning

5STEPS

to navigate from opportunities to savings


signs of users dropping out of the much celebrated eSourcing program that you had envisioned for your organization. The most basic issue that arises out of this manual process is that event planners invite only a limited number of suppliers which they can manage. On top of that several times to reduce the tedious nature of the process the event planners revert back to the suppliers that they usually deal with, leading to lesser chances of competitive bidding and savings. Moving on to the supplier evaluation stage consolidating supplier responses through emails and spreadsheets is of course not the most time or cost effective way to go. Analyzing suppliers in Excel sheets is still the most preferred way of analysis. Sourcing managers find it most convenient to do their pivot analysis in Excel sheets. However, Excel sheets have limitations as the scale of analysis spans across a wider threshold. Consider a scenario where a buyer has to analyze 4-6 suppliers across 50+ items parameters like price, lead time, warranty, service factors, delivery capacity, etc. Manual means simple fail to scale leading to inaccurate decision making and excessive delays. In addition, buyers have to be Excel experts in addition to being strategic buyers. Sourcing Challenge
High material costs Avg sourcing cycles 3.3 -4.2 mo High transaction & admin costs Long time to market cycles

Average Improvement Through E-sourcing


14.3% cost savings Cut sourcing cycles in half Reduce sourcing admin costs by over 60% Shrink time-to-market cycles by 10-15%
Source: Aberdeen Group

An e-Sourcing tool can provide benefits at each stage of the sourcing process Sourcing planning ! Enhanced collaboration between multiple business units can be encouraged to enable streamlined
planning within the sourcing process.

! Profiling can be done for multiple categories. Event creation ! Existing events can be replicated to create events faster and more effectively ! More suppliers can be invited for sourcing events and hence cost savings can be induced Supplier Evaluation and Award scenarios ! Supplier responses can be viewed, scored and analyzed easily to make objective evaluation much simpler. ! Multiple what-if scenarios can be built and analyzed before awarding the contracts to suppliers.
Let's look at a case study to further understand the benefits derived from an eSourcing solution.

5STEPS
nearly 35 countries

to navigate from opportunities to savings The Company: A global manufacturer of complex medical devices based in London and having centers across

The Problem: The sourcing process was completely manual. The two parameters which defined the sourcing process were how efficiently the sourcing could fit within the tight timelines and the quality of the products sourced. Being a player in the healthcare segment both being able to deliver the required surgical equipment on time as well as the quality of the equipment delivered were of paramount importance. The manual process spread across the various business locations was simply not able to match up to either of these parameters The need: The need was to implement a solution that helped to conduct sourcing events quickly and
efficiently within the desired timelines as well as create a process of thorough supplier evaluation to ensure the high level of product quality that was needed.

The Solution: A comprehensive e-sourcing solution was implemented that helped the organization to model
RFPs/RFQs for several complex categories and evaluate suppliers across almost 40 different parameters. The total amount of spend sourced across the eSourcing solution was nearly $18 million. At the end of the event the resultant saving was close to $ 6 million-nearly 35% of the total spend sourced. More importantly the organization was enabled with a solution that enhanced the sourcing process while reducing time and complexity An e-sourcing solution thus helps to reduce the time to source, reduces complexity in your sourcing process and increases the potential to generate savings from your current process. An e-sourcing application seamlessly integrated into a Spend Analysis solution can be a great enabler to realize

5STEPS

to navigate from opportunities to savings


maximum value from your Spend Data. Categories in which savings opportunities are identified by the Spend Analysis tool can be used to run sourcing events in the e-sourcing tool to create a streamlined procurement process.

Step 5 Savings Calculations


Traditionally, cost savings is calculated by subtracting the new price from the baseline price and multiplying that difference by the current year's estimated quantity. Generally, that's a good starting point for estimating your cost savings. However, there are some potential adjustments you may want to make to your cost savings numbers. Here are just a few:

! Provide savings calculations which are accurate and actual rather than providing estimates and
predictions. Estimates if not met raise questions on whether there has been a slip up at the procurement department end. This approach also helps to ensure that you keep your eye on end-user compliance with the new contracts often the difference between a sourcing initiative that delivers what was expected and one that does not.

! Second, be careful in how you claim cost savings when quantities change from year-to-year. If your
quantities are increasing by 50% from last year to this year while price goes down by 5% that means you are still buying more than last year. Change in quantity should be compromised with the change in prices negotiated to report actual savings.

! Calculate savings on a year-on-year basis comparing average prices from the previous year with that of the
current year and state the quantum of savings.

Conclusion
Well, as you can see, it is possible for a procurement department to identify and act on cost savings opportunities, even when the starting point involves very bad data. While many people in the procurement field would consider overcoming the lack of data to be a gargantuan task, with five structured steps, you can deliver some real results. And the best part is, none of this involves tediously long processes or resource investments. The primary enabler for all the steps here is the data that your organization will already possess. All that needs to be done is the establishment of the correct processes to ensure realization of these savings potential.

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