Develop spend profiles for key categories

Based on all previous findings, a high-level spend summary can be provided per each
addressable category.

The purpose of the Spend Profile is to:

Provide a clear, summary-level snapshot of spend for each addressable category
Reveal obvious trends and patterns in the data that can guide more detailed analysis

Each spend profile can include contract implications, top spend, top suppliers, savings opportunities and etc. These unique spend profiles can act as a basis for comparing spend impact across different categories. Common indicators of relative spend impacts include spend volume, significant off-contract spend, category criticality and areas showing significant supplier fragmentation. In other words relative spend impacts are the data points which allow you to understand whether you have savings opportunities or not.

spend profiles 1 spend profiles 2

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Quick wins

Quick wins are opportunities which are easy to implement but usually deliver small potential savings. Consultants love quick wins. Quick wins allow to show how one brings value to the company almost immediately. We should not be shy using the same tactic.

Examples of Quick wins:

Opportunity: Different prices were charged for the same part
Solution: Determine the lowest price paid and negotiate to get
every supplier to match the lowest price. In case there is only one supplier request to credit back the difference between the lowest and the highest price paid and negotiate to stick to the lowest price from now on.

Opportunity: Service levels/requirements on existing contracts beyond what clients actually need
Solution: Re-adjust service levels on contracts according to what is required and re-negotiate a price reduction

Opportunity: Currency Exchange
Some foreign suppliers who ship to Canada tend not to adjust the exchange rate in a timely manner (i.e. does not track to the market rate)
Solution: If the offset is to your advantage, it is an easy process to monitor the rate monthly and the suppliers can be convinced to give you the rebate on the difference.

Quick wins can usually be found nearest the lowest right corner

Prioritization Matrix

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Prioritize potential savings

Now that we finished with the category segmentation we need to prioritize potential savings, i.e. we will answer the question – which opportunities do we pursue first?

Prioritization may depend on the political environment in the company, business requirements, the role that procurement group plays in the company and many other factors. We will look into that in a few moments.

Prioritization depends on two factors:
1. ease of implementation
2. potential savings

How do we estimate potential savings?

Usually a savings estimate can be based on benchmarks which are based on either or both:
1. historical savings in your company – not a very good indicator but definitely should be taken into consideration combined with
2. market research data

Market research is a very broad topic which I will discuss in more detail in my future posts. For now let’s assume that we are using benchmarking data from market research companies, e.g. Gartner.

When we collect data for a savings estimate we should consider reliability of sources and if necessary cross check data by using several data sources. Another point for consideration should be the size of the category – the larger the size of the spend category the better the leverage opportunity we will have. The last statement is true In most cases but not always e.g. if within the last few years we already received significant discounts from contractors on labor there could be nothing else left to squeeze from them. At the same time we can keep working with contractors on innovation initiatives to bring more value and efficiency to the company.

As a result we will build a savings estimate table which may look like this one

savings range estimate

To determine the ease of implementation we will look at several aspects:

1. Contract commitment against the commodity groups that we selected for analysis
Is there a contract currently in place?
Is there a commitment in the existing contract clauses? Is there an exit clause in current contacts ?

2. Resourcing requirements needed to carry out sourcing activity
Is there appropriate category expertise present within the organization?
Is there appropriate sourcing expertise?

3. Sourcing savings can be realized through supporting activities
Do select categories require set policies and procedures to support on-going activities?

4. Additional analytical review needed to support sourcing activities
Is there a detailed commodity profile required beyond the initial analysis?

5. Risk of realizing savings
Is there a high number of vendors to source against?
Is there a long change lead time required to change vendors?

6. Internal alignment to current operational strategies
Is the sourcing category aligned to current strategies and initiatives?
Will the sourcing activity support existing operational initiatives?

7. Internal readiness for change
What is the main impact of change?
Will there be an internal or external impact?

Depending on your experience in the company and in the category you may need to conduct interviews to find answers to the questions above. Once documented you may want to build a table which will weigh the importance of each factor. This will help you to quantify and back up your decision.

ease of implementation table

You can add complexity to this table by adding weight column which will represent the importance of each of the factors for the overall exercise.

Now we are ready to build the prioritization matrix. For this we will use the spend data, Kraljic model and ease of implementation scores.

Prioritization Matrix

Each category is mapped on this matrix based on the estimates for the two parameters. The size of each circle represents its size of spend.
Categories with low implementation complexity and high savings potential get a higher priority (upper right corner).
Wave lines help to “schedule” the work.

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Ethical procurement practices/policies

Ethical procurement practices let’s call those EPP to save some time are implemented by many companies. But still from time to time we see petitions taking traction on the internet asking this or that corporation to stop destroying rainforests, employing children or polluting the environment. All this is amazing and sad.
Amazing because we live in the times when the crowd aka consumers can influence big companies and change their sourcing processes. Sad because such violations need to be unveiled by activists and wrapped in a socially acceptable and repulsive enough imagery for the crowd to pick up and click “sign the petition”. This e.g happened to some extent with the Starbucks’ palm oil/deforestation policy.
It is also sad because I am pretty sure those companies had EPP in place. It looks like those companies knew what their suppliers did. I assume those companies selectively picked data to present to stakeholders and did nothing to change the status quo when injustice was happening. They were encouraging wrong with their big mighty bucks…
Why does this happen? If we don’t want to dive into a philosophical discussion about the divine nature of events the answer lies on the surface. This happens because companies really do not care about EPP. This is not the KPI which they need and most important want to track. The reputational risk in the absence of an alternative or when the consumer is hooked up on a brand is insignificant.
Here is what I mean. Remember when Apple’s factories in China were denounced in child labor use and factory employees working in dangerous conditions? Did any telecom operator or big smartphone reseller refused to sell Apple products? Of course not. People are crazy about this brand. At the end of the day it is all about profit and it is all about the customer desires. Take another example – Nestle sucking water and reselling it to consumers. Of course Nestle has EPP in place but this is the nature of their business – take water and resell it. EPP is there to merely show that they are a good corporate citizen.
My point is EPP from corporate perspective is nothing unless there is a consumer pressure or legal requirements. So why bother?..

This my opinion and nothing more. Legal disclaimer if matters :) – opinions expressed here are solely my own and do not express the views or opinions of my employer.

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Category Segmentation Example

By creating a category segmentation as was described earlier we have created a risk profile of each addressable category which helped to enhance opportunity assessment. Category segmentation also provided us with a high-level plan or strategy for each addressable category to support category analysis.
As a result we should have created something like this:

Category segmentation example

or/and this:

Category segmentation example table

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I am back

Greetings my dear readers! I have been away from this blog for a long time.
I decided to revive the blog and continue writing about sourcing and “stuff”. I will try to post once a week.
Also I am thinking about launching a newsletter where I will cover the latest sourcing trends and news.
If you would like to receive updates on this blog and potentially in the future want to receive a newsletter – please subscribe by leaving your email either on the right side or at the bottom of the screen. I promise – no spam.

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Category Segmentation

In addition to spend data and contracts addressable spend categories should be classified according to strategic importance. This will help us in the future to prioritize strategic sourcing activities based on suppliers/category criticality to the company.

The Kraljic Portfolio Model is a commonly used method for this purpose though there are many other models and almost all of them mimic the Kraljic model this or that way. Those other models just change the x and y axis criteria mainly based on the priorities of the categorization exercise.

The Kraljic portfolio model helps map out category segmentation in two dimensions:

Profit Impact: volume or value purchased, impact on supply chain “value-add”, business growth potential or dependency

Supply Risk/Criticality: product availability, number of suppliers, ease of switching a supplier, availability of substitutes

Determine profit impact by answering the questions below:
Is the category total value important in the company’s total spending?
Do the client’s end customers perceive that this category adds significant value?
Does the category differentiate the end product significantly?
Would a category failure affect the client’s end customer satisfaction?

Determine supply risk by answering the questions below:
What is the market internal competition?
Can you easily switch to another category?
What is your buying power for this category?
What is the bargaining power of sellers?
Can new entrants be easily found and invited to tender?

In the end category segmentation is all about the approach we will take in supplier relationship management and understanding the type of value category/supplier provides. Hence we can also determine which and how many resources to allocate for supplier segments.

After the segmentation is done we have a strategic direction for each category:
1. Leverage products
Leverage products allow the company to exploit its full purchasing power through tendering, target pricing and product substitution

2. Strategic products
The company should be maintaining good relationships with strategic partners

3. Bottleneck products
Bottleneck products should be handled by volume insurance, vendor control, security of inventories and backup plans.

4. Routine products
Routine and non-critical products require efficient processing, product standardization, order volume and inventory optimization

Another approach to take after the segmentation is complete is to shift categories to neighbour segments. It is called Moving in the Matrix:

– Leverage products -> Strategic products
Develop a strategic partnership
Exploit buying power

– Strategic products -> Leverage products
Accept the locked-in partnership
Maintain strategic partnership
Terminate undesirable partnership, find new supplier

– Bottleneck products -> Routine products
Reduce dependence and risk, find other solution
Accept the dependence, reduce the negative consequences

– Routine products -> Leverage products
Pooling of requirements
Individual ordering, pursue efficient processing


See category segmentation example here:
Category Segmentation Example


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Total Cost of Ownership

Total Cost of Ownership (TCO) is a concept used to determine direct and indirect costs and on that basis compare suppliers’ proposals/bids or segment suppliers for strategic sourcing analysis.

In our case TCO will be used in two phases – it will help to determine cost drivers for each category and estimate savings ranges.

TCO generally could be characterized by eight components:
1. Acquisition (Purchase Price, Freight, Engineering, Installation, Customization)
2. Operating (Labor, Utilities, Fuels)
3. Training (Software Upgrade, Personnel Training)
4. Quality (Cost of Returns, Durability of Goods)
5. Maintenance (Spare Parts, Maintenance Labor)
6. Warehouse (Storage)
7. Environment (Electricity Consumption, Electricity Savings)
8. Salvage (Salvage Value (Positive or Negative) of the assets at the end of its life)

So TCO is not just about the unit price reductions. TCO can be reduced by demand management, improved process efficiencies and better supplier management. While focusing on achieving TCO savings we can look closely at e.g. delivery lead time, days in inventory, parts shortage or defect level per part.

Acquisition cost may not be a representation of the total cost of a commodity, though very often acquisition and operating costs are the only ones taken into consideration when choosing the supplier. The following example shows why:

Total Cost of Ownership

At first glance the acquisition cost of the first item from Supplier 1 seems to be the highest but when we analyze TCO for this item across all three suppliers we see that actually
Supplier 1 provides us with the best offer as TCO for his offer is the lowest. Therefore Supplier 1 delivers better value.

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Contracts review

In order to better understand where the main savings opportunities lie the existing contracts are to be reviewed. This exercise will help to determine which categories represent potential savings, track expiring contracts to identify new negotiating opportunities, and identify cost savings opportunities.

Within each contract, the following information can be found:
Current contract status
Contract expiry date
Spend covered by contract
Product specification
Internal customers
Agreements to lock the prices
History of price increase
Contract change notices
Other terms and conditions

At the high level phase of the spend analysis, there are three main items that must be checked before starting opportunities assessment:
1. Contract expiry date
2. Penalty for early termination
3. Terms and conditions
These items help us to identify addressable spend and prioritize categories for which contracts are expiring in near future.

General steps of contract review:
Identify existing contracts
Identify contract termination penalties
Identify contract renewal cycle
Identify recently sourced contracts
Analyze total annual spend and relevant contracts to determine the proportion addressable through strategic sourcing initiatives
Evaluate total cost of ownership to determine cost drivers
Evaluate project duration
Evaluate resources required
Evaluate supplier switch costs
Evaluate potential disruption to operations (risks)
While evaluating contracts we usually build the following table in order to capture the key data.

which later when completed transforms into timeline for savings summary.

This summary helps us to identify when new negotiation opportunities become available and whether the benefits of early termination outweigh its costs.

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What is addressable spend?

Today’s post is short but it is a really important one.

Addressable Spend is defined as spend that can be impacted through sourcing activities.
In order to determine if spend is addressable one may require to conduct interviews with internal clients referencing to the preliminary spend data analysis.
We should also determine “sourceability” of each category e.g. taxes, depreciation, transfer pricing, royalties, wages cannot be regulated.

The following questions may help to determine spend addressability:
1. Is the relationship with this supplier crucial regardless of the opportunity cost?
2. Is there a preference for suppliers for special reasons?
3. What are the political factors to be considered when assessing opportunities?
4. Is there a management preference for suppliers? (Esp. in private sector)
5. Are there upcoming projects that would hinder the sourcing activities? E.g. a CPU manufacturer was selected earlier for the launch of a new mobile product. This cannot be re-sourced because the whole product technical design is based on certain CPU parameters.
6. Are there any requirements for quality, service level? I.e. only a certain suppliers can meet the requirements.

You may also want to read about:
Five sample spend data views and the insights each offers
Data Categorization and how to mapping data into categories


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