Beyond Price Benchmarking: Spend Benchmarking (Part 1)

Spend Matters welcomes a guest post series from The Hackett Group's Pierre Mitchell. We strongly encourage Spend Matters practitioner readers to take advantage of the offer Pierre will share in Part 2 of the series next week.

Most procurement organizations have done some type of spend analysis followed by strategic sourcing activities that may have included price benchmarking as a way to determine whether they are getting a good price. They tend to do this selectively on high spend direct materials (via total cost modeling) or on easily comparable SKU-type items, mostly done selectively because of the effort involved. Unfortunately, it leaves large swaths of spend untouched and it ignores demand management and dives into price/cost alone. Additionally, it also tends to devolve into gory details on cost baselines, incremental cost savings, and the narrow management question: "is procurement getting us a good price?"

Another approach is to bring benchmarking into the discussion as a much broader context for expense management in a way that can be easily related to by the broader enterprise: how much are we spending on a comparable basis for different "consumption units" (spend per employee, laptop, audit, square foot, dollars-of-revenue, etc.)? How does this compare to what we spent last year? How does it compare to what others are spending?

These last two questions go hand-in-hand to provide a better picture of performance externally as well as year-on-year performance. For example, consider the highest level of spend benchmark: spend as a percentage of revenue. This is not a great metric for external comparisons unless you have nearly identical firms in size, structure, and strategy. It is, however, a useful metric to compare year on year to show overall spend/expense management effectiveness, and can be easily tailored to show stakeholder-specific spending views. For external benchmarking, it can help identify when your spend is an "outlier" relative to other firms. There may be good reasons for the discrepancy, but there may also be an opportunity.

Of course, the "apples to apples" comparison problem is even bigger for spend benchmarking because it brings into question not just the equivalency of specifications, but also a firm's strategy for outsourcing, cash variabilization/capitalization (buy vs. lease vs. rent), for consumption timing, for budgeting (zero-based vs. incremental), and for other factors. But, these are higher-level business questions to discuss before the spend actually occurs, and should be aggressively pursued rather than ignored if true expense/cost management is to occur. It naturally leads to earlier stakeholder alignment, procurement influence, demand shaping, and potentially a higher procurement value-add.

I say "potentially" for a reason. Just as the breadth of the category value objectives for different spend categories will vary (and will be understood by looking at the above), so will the depth by which those spend categories are managed in terms of category management capabilities (and associated levers/practices). Hopefully, the spend categories are being managed holistically enough to align to their potential in driving strategic business value. If so, the question then turns to how well are spend/supply management practices being brought to bear? Spend category performance based on spend magnitude (even when 'normalized') is somewhat hollow without looking at the spend value objectives and spend management capabilities.

In Part 2 of this post, I'll discuss some approaches to capturing this spend information to provide a complete view of spend category value objectives, performance, and capabilities.

Pierre Mitchell leads Procurement research and IP development at The Hackett Group.

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