Moving the Needle — Turning the Focus to Direct Materials Sourcing

Today, Spend Matters would like to welcome guest contributor, John R. Sharman, Jr. John has a highly distinguished career in the procurement world both as a practitioner, and as an advisor to senior executives. John recently launched a new consultancy, Sharman Consulting Group, LLC. We look forward to publishing additional contributions from John in the future. If you'd like to get in touch with him directly, please send an email to: jsharman (at) sharmangroup (dot) com

It's been over 10 years since the promise of e-procurement was introduced to business. With this passage of time, most of the hype promised across many business areas has failed to materialize. Senior executives in most businesses have grown weary of hearing about how they would or will save millions of dollars on office supplies and other minutia merely by buying from preferred suppliers over the Internet, using one of many e-procurement applications.

Is this because senior executive don't want to save millions or is it because the savings have failed to materialize despite numerous attempts to realize (and continue to save) those millions? Well, clearly, any senior executive worth his or her salt is always interested in saving money, so disinterest is an unlikely reason.

Maybe it's because the applications don't work? As an ex-CEO of an application provider in this space, I can assure you the applications do work, so this is not the reason. In fact, the applications have continued to evolve significantly over the past few years.

My wife Kim has an expression: "We all find time for those things that are truly important to us." I saw the wisdom in this saying years ago, and I think this is the fundamental reason "spend management" programs largely do not succeed. This is not to say that saving a million dollars on office supplies is unimportant, but the reality is that, to a President or CEO of a large corporation, those savings are not significant enough to hit most of their radar screens. If a significant transformation program is not important to the CEO, chances are the success of that program is in jeopardy. The success of this is not enough to "move the needle."

This phenomenon worked for and against spend management programs. It worked for the programs by focusing on selling into an area that was not particularly important to senior executives. It worked against the programs for the same reason. If I am a big business CEO and my annual spend is $1B per year, focusing on the savings I might get on my 10% or 15% spent on indirect materials does not bring enough savings to really merit a personal time commitment from me. However, if a program targets the $850MM to $900MM I spend on direct materials and has the potential to save $50MM to $100MM or more, now you have my attention.

So if it's so easy, why isn't everyone focused on direct rather than indirect materials? Many players in the spend management space believe that, because direct materials are the primary focus of most procurement organizations, these teams must already be doing a good job. This, as a rule, is not the case. It is not the case for three major reasons.

1st – Since most CEOs operate at an arm's length or better from their procurement operations, the connection between requisite resources and results is often not made. This lack of connection often results in most procurement organizations being under-staffed.

2nd –This under-staffing drives organizations to take shortcuts, and there are NO effective shortcuts in strategic sourcing. The end result is a tactical sourcing effort that focuses on price in lieu of total cost of ownership. The shortcuts taken frequently involve inviting the same group of suppliers to bid on a single category, with the incumbent supplier usually winning.

3rd – Suppliers who are frequently asked to bid in on a category with little-to-no chance of winning are not going to price a bid aggressively, nor will they put much effort into their response.

This is not to say that addressing direct spend is easy; in fact, it is usually more difficult in the early stages. The good news is that once a direct materials supplier is changed, maverick or bypass spend is not an issue, so the identified savings almost always become achieved savings.

The sourcing of direct materials must begin at the highest levels in a company, and the program must be a broad-based business initiative and not just another procurement exercise. The trick to this is understanding how to effectively engage the CEO. That however, is the subject of another article to be written in the near future.

Spend Matters would like to thank John Sharman for his contribution. We look forward to his forthcoming musings on how to engage CEOs and other executives around the subject of direct material cost reduction.

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