Talking about the return on investment of a spend analysis can be a tricky subject.
On one hand, procurement professionals typically see the value of a spend analysis right away. “We don’t know what we don’t know” is a quick and dirty assessment of why a spend analysis is important – it provides the foundation to identify paths forward in strategic sourcing initiatives and, therefore, helps produce savings. While procurement may have a beat on which specific market initiatives to pursue based on apparent pain points, many more will be hidden in their spend data. A spend analysis draws this out.
On the other hand, it can be difficult to convince upper management of this value without assigning a specific ROI to the analysis. Upper management doesn’t have the visibility into the sourcing process and shouldn’t be expected to – that’s what they trust you for. Because of this, tagging an ROI figure to the process seems like a good idea. It is a quick, easy number to track against for decision makers. But does this really make sense?
Where ROI Doesn’t Make Sense
The goal of assigning ROI to a spend analysis seems like a good idea until you look under the hood. As luck would have it, I typically use a car example to explain what I mean by this.
Consider the idea that you’re in the market for a new vehicle. You consider switching to an electric vehicle because gas prices are getting pretty high. Is this a good idea? One way to find out at a glance is to calculate an ROI on this purchase. Namely, you can find out at what point your new green car starts to save you money:
- First, find some price points of electric vehicles in the market.
- Determine how much you can sell your current car for.
- Subtract the old car’s sales value from the new car’s price to develop a baseline target.
- Figure out your monthly fuel expense for the old vehicle to arrive at a break-even cost.
Simple enough. However, this ROI calculation considers the vehicle as a whole – what it can’t do is tell you the ROI on the steering wheel, leather seats, sun roof or any other individual component. Spend analysis is similar in that it is a component of an overarching strategic sourcing initiative. You can’t easily determine a true dollar ROI because those dollars are made within the sourcing projects that result from the analysis; finding a differential in savings due to spend analysis is murky at best.
I don’t want to suggest that spend analyses should be conducted without a care for costs. It can be all too easy to get lost in the weeds, especially if you’re looking at a large set of data points. When this happens, the amount of time (and therefore money) that goes into an analysis can explode if left unchecked. Procurement needs to ensure that a spend analysis has as much bang for the buck as possible. To do that, you must consider what your goals are and how you can best achieve them.
Targeting Analysis Efforts
Take, for example, travel and entertainment (T&E) spend. T&E may represent a scant few percentage points of your overall spend. However, it may make up the bulk of individual line items in your analysis. As an example, one of my current clients has over 7,000 line items annually for Starbucks purchases alone, not to mention the thousands of other restaurants, pubs and burger joints on the list. You could spend hours collecting, consolidating and scrubbing these line items to come up with a clear view of per diem expenses like these. Before you do, however, ask yourself:
- How much time will I need to invest to manage this spend?
- How sizeable (or negligible) is the spend within this category?
- What strategies do I intend to enact to save money in this space – does it require a detailed, line-by-line analysis?
Often, the overarching sourcing strategies that would impact this spend may not require the same amount of spend analysis time investment as other categories. As such, procurement can save a lot of time by holding off on a detailed T&E analysis until it is critical to do so.
Considering Tail Spend
As mentioned above, T&E spend has a pretty long tail. This isn’t unique to just T&E—any category of spend can build up a big tail. But at what point should you consider attacking this tail a wasted effort?
I recommend establishing a line in the sand and sticking with it. Seek to analyze only suppliers in the top 90 percent of your total spend. This will weed out plenty of transactions while still delivering actionable results. Why? Because that huge tail will take considerable energy to address but it doesn’t net much in terms of strategy.
For example, take a supplier consolidation strategy. Say you have three suppliers providing the same product: to simplify this example, assume they all have an even slice of the volume pie. The carrot-and-stick market strategy is clear: “Give us the best deal and you triple your volume with us. Give us a bad deal and lose it all.” Will this be effective?
It depends on the overall spend volume. If a given vendor’s average deal is for $100,000 and your spend is well above that point, you have a pretty tasty carrot and pretty big stick. But what if you are only spending $10,000 annually? Plenty of suppliers will shrug and offer similar terms and pricing that you are already getting – the carrot just isn’t good enough to bait them. So, why spend the time when you don’t have the leverage? More importantly for the spend analysis, why spend the time working to analyze this spend when it won’t help you create leverage?
The worst thing you can do is spend too much time on an analysis – doing so will lead to otherwise avoidable missed opportunity costs.
If I were to define what makes a spend analysis valuable, I’d say it is an analysis that is both timely and impactful. Consider your entire population of data but target only the spend that is truly relevant to procurement’s strategic sourcing goals.