Sounds like magic, doesn’t it. Increase profit margins without raising your prices or making more sales?
You’re probably thinking the only option left is slashing your costs, or curtailing investment you had planned.
It’s all about understanding what you buy, and then being able to leverage that spend to your advantage.
Through having robust, well-analysed data, you can then drive a whole manner of improvements to how you manage your vendors, and drive cost savings without compromising on quality or specification.
Spend Analysis: The Easy, Hidden Route to Increase Profit Margins
Ultimately, there are 3 ways to improve the numbers in your business:
- Increase sales (difficult, takes time)
- Raise prices (easy, but highly risky with major potential downside)
- Reducing your input costs: i.e. what you purchase plus the cost of your staff.
Let’s assume you’re not planning to cut headcount. This certainly has a downside, both in terms of staff morale and the human resources you have on hand to run your business.
The only way you can drive your bottom line quickly is through understanding and ultimately leveraging your spend.
I put together a separate how-to guide on running a spend analysis which delves into the detail of how to source and analyse the spend data.
Why proper vendor management can drive fast results with no risk
I firmly agree that you can’t cost-cut your way to success.
The actions from understanding what you’re spending with your supply base don’t revolve around cost cutting.
Rather, it’s about leveraging what you’re currently buying in the best possible way, so as not to leave cash on the table.
To do this, you need data.
Without effective data, you’re taking pot shots with no idea whether they’re targeted in the most efficient way.
Likewise, through a robust spend analysis, you can also take data-driven decisions around how your procurement resources are best allocated, based on opportunities arising from the data.
Do you have talented, ambitious buyers performing a mainly reactive, firefighting role resolving day-to-day issues with non-critical vendors? If so, then understanding what you buy, and where from, will show you where they should be concentrating their efforts instead.
Or, conversely, it may convince you that you need to hire capable talent to look into these potential opportunities which would otherwise remain unexploited.
Important metrics you should look for when analysing your spend data
There are a few key performance indicators you can pull from your spend data without the need to be a statistics nerd. (I’m definitely not a “maths & stats” anorak, however, basic data analysis can be a gold mine!)
Tracking these KPIs will set you well on the way to increase profit margins, through better and more informed external vendor spend analysis.
1. Total vendor count
The total number of vendors you’ve transacted with over the past 12 months
Why you should track it:
With every vendor comes potential problems. It’s one more vendor you have to manage.
One more vendor who might deliver something late, put you on stop due to invoicing disputes, go into administration, increase their prices, change their terms and so on.
All of this takes up your staff’s time and resources and also costs your business in terms of production downtime if a vendor is at fault for a stock-out.
Most of your vendors are not million dollar suppliers. How much time is your staff spending on transactional issues which add no value?
2. Average PO value
The mean average value of a purchase order. Calculated by taking total spend and dividing it by total number of purchase orders.
Why you should track it:
If your average PO value is low, this indicates a lot of time spent by your procurement staff on transactional, day-to-day admin versus strategic buying.
Each invoice has a real cost attached to it.
The more invoices you receive, the more accounts payable clerks you need to employ. The lion’s share of your invoices will be for low value, low impact purchases.
3. 80/20 analysis (a.k.a. the Pareto Principle)
Known as the Pareto Principle, named after the Italian economist Vilfredo Pareto, who noticed that 20% of the pea pods in his garden accounted for 80% of the total yield. He further went on to show that 80% of land in Italy at the time was owned by just 20% of the population.
Does 80% of your spend come from just 20% of your vendors? Or conversely, do 80% of your vendors account for just 20% of your spend.
Why you should track it:
In the procurement and spend analysis sense, this is important because it helps to divert resources to the vendors which should have more of your attention.
If 80% of your procurement department’s resources are going into servicing operational issues caused by vendors with low, non-strategic levels of spend, this indicates a mainly transactional purchasing organisation with lots of untapped, low hanging fruit.
This should be the catalyst to management to ensure that the best and brightest resources flow towards managing the 20% of vendors which account for 80% of the spend.
That’s where your potential savings and negotiation opportunities lie which can help you increase profit margins through strategically managing what you spend with your supply base.
It should also highlight where you may have opportunities for procure-to-pay process (P2P) automation or supplier consolidation.
4. Number of POs
The total count of purchase orders issued in any given time (for this purpose, I usually look at one calendar year).
One can also count total number of PO lines but this is a little misrepresentative. Typically orders are delivered in one batch and one invoice is sent per PO. Therefore, I prefer to look at total PO count.
Why you should track it:
Tracking the number of POs will give you an insight into how much time is being spent on administrative work around PO creation and maintenance.
The average operational buyer will be able to raise about 15-20 POs a day, including follow-up.
The administrative time taken to process these POs is predominantly a non-value added task, save for perhaps 2-3% cost avoidance gained through horse-trading over the final price during the quotation review.
When you start drilling down and looking at the number of POs raised under €5,000, and especially under €1,000, you’ll soon realise that even if a buyer is negotiating 3-5% out of each offer, the total saving is likely to be less than your cost of employing them.
Not only that, you also need to consider the opportunity cost of them not being able to perform a more impactful task during the time they are spending on administrative work.
With an average operational buyer in Western Europe costing somewhere in the region of €30,000 per year, plus any employer’s social security contributions on top, your buyer suddenly looks like an extremely expensive admin assistant if this is all they are doing for most of the day.
The data is almost certainly screaming at you to outsource or automate your low value purchase orders.
Free up your procurement team so as they can concentrate on finding the golden geese lurking in your vendor spend analysis.
Of course, you can drill down into the details and slice and dice spend analysis to your heart’s content.
Nonetheless, with these fundamentals your business will:
- Gain a very good overview of what bottom line potential is hiding inside your company’s spend.
- Evaluate how effectively your current procurement staff are being utilised.
The logical next step would be to look at:
- Who are your top vendors by spend?
- How long are they under contract for
- Are any of the contract terms unfavourable?
- If so, are you able to issue renegotiate these by dangling the threat of a competitive tender?
- What could you gain in terms of savings and improvement to service levels through conducting competitive tenders.
To conduct a robust spend analysis and contracts deep-dive, you need a knowledgeable procurement professional to extract the data and analyse it accordingly, including filtering out some of the false flags that may be lurking in there as a result of imperfect data.
So, you now understand the potential of extracting value from what you purchase.
Then I’d love to hear from you.
Let’s discuss how we can evaluate and unleash this. Drop me an email or send me a Skype message and we can arrange a brief introductory call to explore how you could benefit.