Would you like to significantly improve your company’s bottom line? A thorough evaluation of your organization’s indirect spend may yield surprising, significant and relatively quick results.
The first step in analyzing your organization’s indirect spend practices is to understand the difference between direct and indirect costs. According to the APICS Dictionary, direct costs “can be directly attributed to a particular job or operation.” Within a typical manufacturing environment, this includes the purchase of goods and services that are incorporated into a product to be sold, such as raw materials, subcontracted manufacturing services and components. In contrast, a cost that is allocated across various cost objects is indirect. Examples include utilities, security, cleaning, maintenance, recruitment and travel agencies, office supplies and furniture, and related overhead expenses.
Thorough evaluation and effective management of indirect spend can be challenging and highly complex, but with these costs accounting for as much as 25 percent of a company’s expenses, it is well worth the effort. A 10 percent overall indirect savings reduction often is possible within one year, resulting in a 2-3 percentage point improvement to the bottom line.
There are three key indirect spend opportunities on which to focus:
- Decrease purchase quantity and frequency by identifying and avoiding any noncrucial spending.
- Reduce per-unit costs. This can be done via specification review and adjustment to ensure what’s being purchased isn’t unnecessarily sophisticated. Additionally, stock keeping unit (SKU) and supplier rationalization will limit the number of SKUs and vendors for better leverage and volume discounts. By centralizing purchasing and seeking out competitive bidding by multiple vendors and face-to-face negotiations, you can ensure fair prices are reached and strengthen relationships.
- Simplify and improve processes. Sophisticated tools, such as enterprise resources planning (ERP) systems, frequently are under-utilized; improperly applied; or hampered by tacked-on, lingering manual process. This results in complicated, inefficient and ineffective indirect spend practices.
Decrease purchase quantity and frequency
The first task is to get an accurate snapshot of what is being purchased, who is doing the purchasing, the timing of each spend and whether the purchasing trend is going up or down. Answer these questions by conducting a Pareto analysis of each spend by category, department or function, and the individuals involved. This will help identify the biggest indirect spend categories and the top spenders.
Next, perform a sanity check for the spending timing of an assortment of items at various levels of the business. One thing to look out for is if your company’s spend in the last two months of its fiscal year is significantly higher than the average of the other 10 months. If this is the case, employees may be spending simply to use up their budgets. Conduct similar checks with at least a handful of specific items.
Another great opportunity for getting indirect costs under control is travel-related savings. Study a sampling of travel that occurred in the past year, and ask the following questions:
- Was the travel crucial? If the trip had not been made, what adverse impact would there have been on the organization?
- Could the same results have been achieved if the employees had used audio or video conferencing technologies?
- If multiple people made a trip, what crucial roles did each person play? If even just one less person had traveled, would there have been adverse impacts?
Money spent on subscriptions, memberships and licenses should be reviewed carefully. Consider switching to e-memberships to save money by accessing benefits digitally; cancel what’s unnecessary. Many information technology (IT) firms charge for their systems based on the number of licenses. Review these regularly to make sure money is not being spent on fees for people who have left the company or taken a position that no longer requires a license.
Check your supply cabinets. Actually walk in there and look for yourself. First, if there is a separate cabinet for departments with fewer than 50 people, eliminate those immediately. Then, consider if there is more inventory or variety than required. Centralize and standardize the options. There is no need to offer your employees a rainbow of paper clip options. Resist the temptation to mimic an office supply store.
Something as simple as a printer setting can make a small, yet immediate savings. Color printing is three-to-five times more expensive than black-and-white copies. Check your default settings. In the same spirit, make sure employees are turning off room lights and projectors after a meeting. Set the right tone by doing so whenever you leave your own office. These actions may not yield big financial savings, but, if everyone pitches in, they will foster a more frugal mindset for all, which eventually touches people and areas throughout the entire organization.
Train managers to not automatically rubber-stamp requests. Many managers feel uncomfortable rejecting a request or base their approval decision on what’s left in the budget. Remind them to think strategically about training, conference attendance, customer visits, team outings, supply purchases, subscriptions and the like.
Reduce per-unit cost
For the second step in the indirect-spend assessment process, begin by reviewing the scope of work done by service providers. Assess the specifications and duration to ensure alignment with business requirements. Conduct a similar review of physical goods suppliers. Make sure your organization is making purchasing decisions based on business need, not supplier suggestions or employee personal preference.
Finally, analyze the number of suppliers you work with. Rationalize the choice based on price, quality and delivery performance. A great bonus to consolidating is that, by becoming a bigger customer, you will gain leverage during negotiations.
Simplify and improve processes
This step involves developing a concise set of weekly and monthly reports to make your indirect spend more transparent. The reports should clarify how money is spent, by whom and for what reasons. If possible, have this report generated automatically by your ERP system.
Have one person or a small group responsible for indirect spend. Create a new position, such as operational excellence or cost optimization director. This person will be responsible for analyzing current procedures and identifying and leading cost-savings initiatives.
Schedule regular meetings to review indirect costs as well as the status of spend-reduction initiatives. If your company is in urgent need of significant bottom-line improvement, hold a separate monthly discussion solely on savings initiatives. To be effective, the meeting must be attended by the highest levels of the organization, along with all functional heads.
Make sure spend-request processes aren’t too complicated or frustrating, as this can cause employees to bypass the established procedures. Clarify the approval chain, eliminating needless layers of sign-offs. Another Pareto analysis here can establish approval levels such that less than 5 percent of the request volume requires CEO or CFO approval, less than 10 percent of the request volume requires department head approval, and less than 20 percent of the request volume requires director approval. Likewise, maximize system capabilities so these tools are not considered cumbersome red tape, but methods for simplifying and improving spend control.
Instill discipline and accountability throughout your organization. Check the authority levels of each user to ensure no conflicts exist. There should be proper limitations and constraints associated with each identification. Then, hold the owners accountable. Some managers will delegate responsibilities over what many consider to be the mundane task of indirect spend, but this can have a detrimental impact to your organization.
Do not allow invoice-splitting. Some employees will try to split spend requests in order to shrink the totals and avoid review by higher management. Clearly communicate to your workforce that this practice is not allowed — period.
Lastly, pursue additional IT solutions only when discipline and accountability are solidified. There are several software packages that can be very helpful with indirect spend, but hold off on such investments until the fundamentals are in place.
Joong “Joon” Hyun is a director at ABeam, a global consultancy with more than 4,300 consultants. He has 25 years of strategy- and operations-related work experience in the United States, Europe and Asia. Currently, Hyun leads ABeam Thailand’s strategy and operations practice. He may be contacted at email@example.com.