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Addressing CSR and Sustainability Goals Through Improved Indirect Spend Management (Part 1): Background and Challenges

12/19/2018 By

The list of corporate social responsibility (CSR) and sustainability risks in the physical supply chain is long.

When securing direct materials, procurement organizations must assess factors from restricted or hazardous substances to the kind of labor that went into raw material extraction and even political restrictions like sanctions on whether companies from certain countries are even allowed to do business with you.

Because of these and numerous other potential issues, many companies have begun to focus on identifying and eliminating such risks from their supply chains with the help of third-party CSR data sources and risk-monitoring platforms. But while the value of assessing CSR risks for direct materials spend has gained prominence in recent years, the other side of the procurement coin, indirect spend, has not received nearly as much interest.

That’s a shame — and a risk in itself. Especially when you consider the mostly unmapped territory of tail spend, indirect procurement can actually contain CSR risks just as harmful as those found in direct materials spend.

Part of the issue is that indirect spend, despite its impressive size and the number of resources dedicated to supporting it, also has several unique and persistent challenges that procurement professionals need to address.

To get to the roots of the problem, let’s take a look at the scope and nature of indirect spend, including trends driving its growth, and how several factors specific to indirect categories make these purchases more difficult to manage.

Indirect Spend: Background and Context

While direct materials spend is an easy concept to grasp, indirect spend can feel a bit slippery. That’s because its definition often frames the concept by declaring what it isn’t.

Indirect spend refers to purchased goods or services that are not directly incorporated into a product or service delivered to a customer. Said another way, indirect spend encompasses goods and services not for resale. These include office products, IT equipment and safety goggles, as well as supporting services such as utilities, travel, corporate promotional items, consultants, janitors, legal counsel, marketing (advertising) and outsourced services like call centers.

Given the broad scope of goods and services that a company may choose to use in support of production, the size of a company’s indirect spend can be considerable. According to the Dryden Group, a provider of procurement outsourcing services, indirect spend represents 15%–27% of revenue at a typical company.

When considered as a component of total spend, the size of indirect spend varies between industries. At a manufacturer, which will focus more of its procurement efforts on strategic commodity purchasing, indirect spend can represent as little as 20% of total spend. Within industries where direct spend is not tied to a physical product (e.g., financial services), the share of total spend can rise to as much as 50%.

To understand how procurement organizations tackle indirect spend across industries, consider these findings from ProcureAbility’s October 2016 Indirect Spend Management Benchmarking Study, which examined 31 companies in nine verticals with revenues of $120 million to $75 billion.

  • The average “company spend” is $2.6 billion per year on indirect purchases, representing spend with 4,225 distinct suppliers.
  • Of those purchases, 85% of indirect spend is considered “under management.”
  • The category in question determines how well controlled the spend is. IT, facilities, and general supply and services are typically more accessible to procurement, with more than 70% of organizations surveyed claiming procurement control. “Sacred cow” categories like marketing (55%), HR and related services (53%), and capital goods (49%) were more out of reach.
  • Within the average company, procurement assigned 32 full-time employees to indirect categories, creating a ratio of 1 FTE per $70 million of spend.

The approach and success a company experiences when tackling indirect spend, of course, varies depending on organizational maturity. According to The Hackett Group, world-class procurement organizations can claim to have as much as 95% of indirect spend under management. At lagging companies, however, that figure falls to 66.5% under management.

Challenges of Managing Indirect Spend

Whether a procurement organization is a master of managing indirect spend or just beginning to get a handle on it, maintaining high performance or improving it will only get harder.

As the ProcureAbility study found, 84% of companies expected their total indirect spend to increase by at least 10% (with some up to as much as 25%) in one to two years. Yet only 26% of companies expected an increase of 10%–25% in FTEs to support indirect procurement. For the majority of companies, then, indirect spend will continue to grow, but employees will have to “do more with less” to manage it.

This only makes the opportunity to miss hidden risks higher.

While the specifics challenges and risks within indirect spend will, of course, vary between companies, the issues can generally be segmented into three categories: the tail spend problem, the services problem, and the process and ownership problem.

First, a sizable amount of indirect spend consists of tail spend, the portion of purchases not actively managed and spread out through numerous uncategorized suppliers. Tail spend typically reflects the 80/20 rule: although it accounts for only about 20% of total spend, it often encompasses 80% of suppliers. That high number of suppliers spread over a small volume of purchases, many of them one-time events, creates numerous obstacles to achieving proper spend visibility and maintaining accurate supplier master data.

Because of this poor visibility and lack of control, efforts to bring this spend under management are often hobbled by the sheer number of suppliers and amount of related data — like purchase orders, invoices, disparate price benchmarks — unless a serious attempt at automating purchasing has been made. According to one 2014 study by Accenture, the average billion-dollar company wastes tens of millions of dollars annually as a result of poorly managed tail spend. This is only compounded by potential financial risks created from procurement not knowing what suppliers have been selected or how service providers are meeting their obligations.

This leads to the problem of managing services in general. The issue here is that services are much more difficult to buy and for procurement to control than goods.

Services dominate indirect spend. In one survey conducted by the Shared Services and Outsourcing Network, when respondents were asked to pick their top three spend categories by spend (value), they were all in the services area: IT hardware and software (56%), professional services (48%), and facilities and office management services (37%). All of these categories are complex in nature and require a more intricate approach to requisitioning in order to accurately define the need for the stakeholder. They also can be difficult to benchmark in terms of price and quality because many are initiated on a “relationship” basis.

Complicating this situation is that categories once procured as goods are now becoming services too.

Print, for example, is now delivered as service, as is, thanks to the ubiquity of cloud computing, software. Also, the hiring of freelance workers — a more complicated practice as the gig economy grows and businesses blend their workforces — falls under services.

The availability of indirect materials and services through internet-enabled businesses only compounds the tail spend problem, as employees can now initiate rogue purchases for far more complex goods or services than they could before. And while tools and (additional) services exist to help procurement get a handle on these categories, making further investments to support this can be a hard sell.

Finally, an extension of the services problem is that many indirect categories are difficult for procurement to touch or manage properly.

Indirect purchases, unlike direct materials, are often not made with any regularity or in bulk. This creates significant challenges for managing such categories strategically, since volume discounts and service agreements are much harder to attain. For global enterprises, this becomes even more difficult, since regional offices frequently make decisions about services and supplies to maintain their operations.

Absent a concerted effort to centralize and rationalize indirect procurement into a single function, these categories will lack strategic management. On top of this, when it comes to marketing and legal services in particular, procurement frequently lacks the knowledge and relationships needed to lead supplier selection, and stakeholders in these categories also resist procurement efforts to control spend, which they often view as meddlesome.

Next Up: The Risks Hidden in Indirect Spend

The size, scope and inherent challenges of managing indirect spend make procurement’s task of finding savings and assuring supply only more difficult, especially as spend in these categories increases while the number of resources assigned to manage it stay the same. Yet managing indirect spend is only one factor: Identifying and mitigating hidden risks within indirect is another issue altogether.

To learn more, stay tuned for Part 2 of this series, in which we will explore three areas with examples of where organizations miss — but, with proper tools, can address — CSR and sustainability risks for indirect procurement.