In the first of a series of article for NSW based spend aggregator, SUPPLY CLUSTERS, Jonathan Dutton FCIPS addresses the business benefit of managing indirect expenditure:
The difference between direct and indirect expenditure can sometimes blur. Ultimately all corporate spend is dollars-out-of-the-door, so why should it matter so much that we categorise the spend and its relative important – DIRECT is important, INDIRECT not so?
DIRECT spend clearly matters. It is the strategic spend, the operationally dependent spend, and covers the cost of goods sold and the COST OF DOING BUSINESS.
INDIRECT spend is the non-strategic spend. That is, if the goods don’t turn up tomorrow, it doesn’t matter much. It is the cost of your operational expenses on your profit & loss account and is the COST OF BEING IN BUSINESS.
Everybody running a business understands cost of sale. The essential business expenditure on goods that are for resale to your customers. On raw materials, components or packaging. All volume dependent, all critical to customer service.
Nobody running a business wants to spend good money on those dozen spend categories of INDIRECT cost - things like stationery supplies, office equipment, computers, travel, fuel or facilities management. The boring stuff. But the things the business has to buy because it is in business, and because we are serving a need. Ultimately the need for staff productivity on the indirect side.
Yet indirect spend is almost always considered less important than direct spend. Even when, on odd occasions, it totals even more cash than direct spend on your Profit &Loss account.
However, direct spend is the lifeblood of the business. It drives inventory. It fuels the service of the customer – the real customer, the one that buys our products and services in the marketplace. Without good management of direct spend, your customer service is compromised, margin is eroded, and risk levels can become intolerable.
So, if the case for managing direct spend closely is so tight, why bother managing indirect spend at all? It is often far less a sum of money than direct anyway, so does it really matter?
There are FIVE important reasons to proactively manage INDIRECT expenditure:
1. It is usually still significant expenditure and is real cash out of the business. Reducing your operating expenses should reduce your cost base and increase margin – assuming you don’t let USERS fritter away savings buying stuff they don’t really need; as they are wont to do.
2. Managing the tail of indirect spend also improves demand management – that is, it shapes your corporate culture to understand that saving money is good business practice. It embeds this message into your business. It is anti-waste. It improves your S2C and P2P processes and reduces your supplier base. And it recognises that eventually everything you buy is a direct expense if it can ultimately harm productivity or efficiency & effectiveness. Reducing the risk of non-supply holding up production or service.
3. Critically, proactive management of indirect spend reduces CORPORATE NOISE. This can be a painful distraction for busy procurement teams. The two most distracting indirect categories can be very high maintenance - travel and fleet. Managing down the corporate noise from indirect categories also allows the time and space to better manage operationally direct spend. Proactive spend management also reduces the overheads you need to manage spend reactively. It is a cost saving in itself.
4. Managing indirect costs well is also good training for managing the more critical direct supply lines downstream. It builds corporate capability to manage spend and confidence in the team doing it …. Ready for more critical challenge of direct spend.
5. Managing indirect spend well, can also bring competitive advantage. In the end, it matters not so much that you have got a great deal on indirect supplies, but that you have a better deal on them than your closest competitors. For if you do, it offers you a low cost base, more robust margins and a competitive advantage in your marketplace.
Managing your indirect spend portfolio also fits neatly as one strategy in the four box model of spend management – mapping spend against risk; the renowned Kraljic Matrix:
Generally speaking, indirect goods and services are supply lines that fit on the left hand side of this matrix. Direct lines on the right.
Having a clear acquisition strategy for each box on the matrix that meets your business need will elevate your purchasing plan to a strategic procurement programme. An example strategy for each box might be:
Category management and market sourcing
Operations management & automation
Supplier management and SRM
Contract management and risk management
Far from being the ‘poor relation’ of your spend portfolio, your INDIRECT spend programme can be a good enabler towards better business. And, as direct spend lines naturally garner the most attention over time, indirect spend categories can also be where the “opportunity” lies for significant margin improvement. What are you waiting for …?
Jonathan Dutton FCIPS is the former founding CEO of CIPSA - the procurement peak body in this region. He now works as an independent management consultant specialising in procurement and has a non-executive role at Supply Clusters www.jdconsultancy.com.au