Businesses in today’s world rely on external third parties to provide them with goods and services. Based on the industry type and size of your organisation, your spend with external third parties can range between 40% to 80% of your company’s total cost.
Category management is a strategic and structured approach within the procurement function where organisations segment their spend into areas that contain similar or related products enabling focus on opportunities for consolidation and efficiency.
There are 2 main categories of spend based on industry best practices – direct and indirect spend. Direct spend is defined as the spend on raw materials and goods used to create a product and indirect spend is defined as those expenses like technology spend, HR spend, office supplies or rent that keep the business running behind the scenes. Usually, most of the companies will have very good control on their direct spend but spend in indirect categories is usually the one that needs attention to ensure this is managed well.
To get better visibility and control on their spend, organisations will code or categorise their spend data into various categories and sub-categories. In this article, we will understand the relevance of categories and best practices in category management.
The value of spend analytics in category management
Category management plays a pivotal role in strategic procurement. Category Management enables procurement professionals or business unit heads (where there is no formal procurement department) to focus their time and conduct market analysis to fully leverage their negotiations and correctly manage their suppliers in alignment with the corporate objectives. Category Management helps to organise the procurement team resources and contributes towards economies of scale and enhanced supplier relationships whilst gaining an in-depth understanding of how each category contributes to risk management.
However, only a minority of global enterprises either follow or consistently leverage a category management framework in their day-to-day operations. This means that a lot of potential value is lost - organisations lack visibility into external spend, making it difficult to identify opportunities to reduce spending across supply markets (even across multiple categories and subcategories), suppliers,and locations, as well as volumes and prices. The emergence of smart and intelligent spend analytics, which is underpinned by AI/ML, can help such organisations to get visibility on spend based on categories. Spend analytics creates transparency that goes beyond spend and cost. It can bring to the surface several elements in your supply chain such as supply-market exposure and associated risks, reliance on a single source or region rather than a more optimal supplier mix, or different price points from different supplies for the same products/services.
Sample KPIs for effective category management
It is practically impossible to list all the KPIs for effective category management but below are some recommended KPIs:
- Number of Suppliers – Tracking the number of suppliers by each sub-category, especially at level 4 or level 5 of taxonomy can be very effective. For example, if you can track the number of suppliers being used to buy computer hardware such as laptops or desktops, it can help drive category strategy for end-user devices.
- Percentage of PO vs non-PO spend/contracted versus non-contracted spend – This KPI will help understand the process compliance and by identifying business area/stakeholders with low compliance, procurement can work on better collaboration by way of either training or process re-design
- Spend under management (SUM) – This is one of the key KPIs and acts as a litmus test. Spend under management is the percentage of spend that is regulated or controlled by the procurement organisation. As an organisation’s spend under management rises, its ability to optimise cost and forecast expense increases with it. SUM = Total approved spend (i.e., direct, indirect, and service-related cost ) – Maverick spend
- Negotiation power with supplier – This is a very simple but very effective KPI. By understanding the supplier’s total annual revenue versus % of your spend with that supplier can help you drive your negotiations strategy. For example, if your organisation contributes 10% of the supplier’s revenue, you have significant leverage. On the other side, if you contribute only 0.25% of their revenue but can increase this to 0.5% by aggregation or supplier rationalisation, you will be able to use this increase as a negotiations leverage.
- Spend by transaction counts – Any good spend analytics tool can help you get an overview of suppliers with either a single transaction or suppliers with several small value transactions. Usually, most finance departments will have a view of the cost of processing an invoice.Identifying such transactions where organisation is incurring high processing costs can also help drive category strategies to stop such leakage.
Spend analytics tops supply chain leaders' priority list
63% of respondents in the 2021 Supply Chain Insights Global Survey from IHS Markit said their companies "lacked the necessary data, platforms, and technology needed to make critical cost-saving decisions."
The number of supply chain leaders, out of 340, identified the following categories as a priority.
How to implement category management?
Category Management can be approached differently based on several factors, including:
- your industry - for example: is your business service or product-focused or both,
- your company’s future strategy / operating model (e.g. insourced vs outsourced)
- your procurement model (centralised or decentralized),
- what drives the most spend in the organization,
Hence,there isn’t a perfect guide or manual on implementing best practices in category management for your business. But there are certain guidelines to guide you can follow:
- Start with data – We have all heard that data is the new oil. However, raw oil is only useable once it has been through the refinery. Spend Analytics is the refinery engine for your spend data. A good spend analytics tool will enrich poor quality spend data. This enriched data from your spend analytics system will enable you to build your category management approach. For your spend analytics to be effective, it will need to ingest raw data from ERP or P2P tools. Line item-level detail from POs or invoices is helpful to gauge exactly what you are buying from your suppliers. Any good spend analytics tool will use all this information to map your third-party spend into the right spend taxonomy.
- Develop a plan – An effective plan can help solve complex challenges. Applying the same principles of project management and planning can help develop a category management structure to enable defining a clear, easy to use and follow category plan. The points to consider and include in your category plan are: spend profile (by categories, suppliers, distribution, region, etc), supply base overview, contract summary, sourcing event pipeline, and short- and long-term strategy roadmaps.
- Ensure you have a competent team – Most plans will fail due to a lack of a competent team to execute it. Many organisations believe that by just hiring the right people to do the right job from day one, they have solved the problem. However, the fact is that even if you have a staff that truly, deeply understands how to apply Category Management, they will still need to be aligned on how your organisation approaches it. All Procurement staff who are leveraging a Category Management process should follow the same basic methodology. Like your plan, this methodology will vary from category to category based on the level of complexity and spend, but there still needs to be a base foundation that everyone within the organisation can understand and apply.
- Measure and track - Management guru Peter Drucker famously said, “If you can't measure it, you can't manage it.” Implementing category management is not a one-time activity but an ongoing process. Organisations need to continuously measure the value it is delivering by establishing metrics from the beginning. Don’t hesitate to recalibrate your metrics or introduce new metrics based on your learnings. This will ensure that you regularly measure and demonstrate the effectiveness of the program.
- Stakeholder Management – Another key aspect of successful category management is the inclusion of your business stakeholders in the process. Procurement should take lead in driving category management, but this cannot be a siloed program. Ensure that you are onboarding your key stakeholders from across the business in the journey. Procurement’s role is to advise the stakeholders while collaborating on delivering the best value to the organisation and individuals in their respective roles. Category management should be seen as an excellent opportunity for building stronger partnerships within the business. Unless business stakeholders consider procurement colleagues as their trusted partners, they will not embrace your category management processes.
Category management may not seem to be simple, but it isn’t complicated either. The impact of well-implemented category management includes better stakeholder collaboration, deeper market knowledge, long-term vision, and strategic planning through data tracking (periodic trends), increased visibility, benchmarking, and better stakeholder collaboration.