Spend Management To Improve Profitability

IBM Global Business Services White Paper

Spend management: transforming your mid-market business to improve profitability. Getting spend under control — companywide

Supply Chain Management

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IBM Global Business Services Page 

Executive summary Economic conditions and fierce competition are forcing many midsize businesses to find new ways to reduce costs, fund business growth and enhance profitability and cash flow. The CEOs, COOs and CFOs of these companies feel enormous pressure to improve procurement and sourcing effectiveness, but resource constraints — specifically, lack of strategic procurement expertise and the technologies to support it — make this a difficult goal to achieve. In fact, many midsize companies are not organized to effectively control spending through indirect materials and services procurement. Few of them, in fact, truly understand how much they actually spend on products and suppliers. The reduced cost savings arising from this lack of visibility can bring down a company’s bottom line and lower earnings per share. It should be no surprise, then, that a growing number of midsize companies are seeking new solutions and resources that can help deliver more responsive and effective procurement. Spend management in perspective In recent years, spend management — a major new business strategy — has emerged to help businesses achieve two key strategic goals. First, spend management helps to increase earnings per share to protect operating profit. Second, the savings it generates frees up money to reinvest in the company, its technologies and future growth. These benefits are achieved by deploying procurement and business transformation initiatives that bring the cost of spend management down within the reach of most midsize businesses.

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Growth in third-party spend Procurement savings is more important due to: - “The increased price of raw materials,” C&P - “Industry deregulation,” Energy and Utilities - “More budget reductions,” Government - “Market pressures,” Pharmaceuticals

Importance of procurement savings over next three years

5%

Much More

17%

Slightly More 14%

64%

Equally Slightly Less

Source: IBM 2005 CPO Survey

Competitive pressures have placed procurement squarely back on the strategic boardroom agenda. Several factors contribute to this shift, due to a combination of cyclical cost pressure changes and a permanent structural shift; contributing factors including a desire for profitable growth, a “zero inflation and more” mindset, and global competition and sourcing. Spend management basics

Put simply, spend management is the way companies control and optimize the money they spend. It involves cutting operating and other costs associated with doing business. Spend management represents a holistic view of the enterprisewide activities in the “source-to-pay” process, which means strategically sourcing all spend. While many midsize organizations employ professional spend management techniques in handling direct expenditures, they approach indirect spend through tactical procurement, separately conducted by each business division. This approach has several disadvantages. The people making the purchases are typically not procurement specialists and usually do not use strategic sourcing — which requires competitive bidding — to take advantage of available savings when sourcing indirect spend items like maintenance, repair and operating supplies. Company divisions, therefore, have no way to track indirect spend and report it to the CFO. As a result, companies typically control only 35 percent of their indirect spend.1

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“The on demand service model allows us to avoid implementation headaches — and realize these savings and benefits almost immediately.” —Phil Wehrli, director, Strategic Sourcing, Avnet

Spend management, on the other hand, takes advantage of the realities of cost reduction versus revenue generation. Here’s how it works. Companies divide money into two buckets: revenue and cost. New sales generate increased top line revenue, while cost cutting increases bottom line profits. Traditionally, cost cutting comes through across-the-board budget reductions. By contrast, spend management is a strategic approach that specifically targets the purchase of goods and services to reduce expenses in these areas. Achieving these savings can only come from making use of procurement professionals to manage all of the “spend” — or strategic sourcing — in the organization. This is a three-step process. In step one, outside procurement consultants analyze the company’s needs. In step two, after the solution is defined and ready to implement, the company purchases and deploys on demand e-procurement technologies. In step three, the company continues to deploy outside consulting services and e-technologies on an as needed basis — although internal employees are also trained to use e-procurement solutions themselves. This engages the whole organization — not just the procurement division — in becoming a spend-management-centric business. A corporate cultural shift

For spend management to succeed, senior management must initiate a major shift in corporate culture. Such a shift becomes attractive when senior executives realize how it can help them achieve key strategic goals. CEOs can please stockholders — or themselves if the company is privately held — by delivering increased earnings per share (or earnings, in the case of a privately-held company), thereby freeing up more money to reinvest in the business to facilitate growth. COOs can protect corporate operating profit by gaining control over where money is spent across the business. Through spend visibility, COOs can control costs and increase or decrease spend appropriately throughout the company. CFOs can become high performers in savings by getting spend under management in each of the company’s profit and cost centers. The savings that result from increased spend visibility can positively impact the company’s overall financial performance. All these benefits are achieved not only through the on demand business technologies but also through the shift in business processes, policies and procedures.

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Raising the bar — CPOs recognize that organizational and behavioral challenges are key to success New Model

Traditional Model

Relationship Management Strategic Sourcing

Operational Buying

Transactional

Category Management

Tactical Operational Buying

Transactional Source: IBM Global Business Services

Chief procurement officers (CPOs) increasingly recognize that procurement strategy must align with business strategy. In essence, the CPO’s role is changing dramatically — from being a buyer to becoming a business partner. As the figure above shows, when procurement leaders transform their business models, they turn the organization on its head, producing a new business model. How spend management can improve the bottom line Spend management affects a company’s bottom line directly: a dollar saved drops directly to the bottom line; whereas a dollar earned drops only 11 cents to the bottom line due to the costs incurred in generating this income. Typically, companies within the industry norm apply strategic sourcing to only 35 percent of total spending and negotiate only 7.5 percent cost reductions, on average. By comparison, best-in-class companies apply strategic sourcing to 82 percent of total spending and negotiate 14.4 percent cost reductions, on average.2 Improvements in strategic sourcing alone return more than four times the procurement cost savings and a six percent improvement in earnings per share. With the right strategic procurement strategy, expertise and technologies in place, a company can get 80-90 percent of its spend under management, positively impacting the “spend portfolios” of every profit and cost center in the organization. Getting such a high percentage of a business’s spend under management can yield as much as 15 percent in savings, versus the two to three percent savings typically achieved through tactical budget cuts. The following callout from Karen Beavor, CEO, Georgia Center for Nonprofits, substantiates these percentages.

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“The nonprofit sector continues to deal with an escalating need to find both operational efficiencies and hard dollars as community needs rise faster than the pace of revenue recognition. For some nonprofits, their spend on goods and services can be up to 70 percent of their annual funding. IBM Express Spend Management Solution and IBM Global Business Services have enabled Georgia Center for Nonprofits to develop a strategic procurement strategy, expertise and technologies that will enable nonprofits to realize 15 percent net savings on all goods and services and up to 24 percent net savings on office supplies almost immediately.” —Karen Beavor, CEO, Georgia Center for Nonprofits

Spend management improves bottom line profits by providing spend analytics — which means identifying total spend and achieving total vendor leverage (getting the best pricing from all vendors through competitive bidding). It helps improve regulatory compliance by assisting companies in creating the internal procurement controls required by the Sarbanes-Oxley act. And it helps businesses increase savings, by tracking projected versus actual savings according to each business unit. Spend management achieves these goals in four ways: 1. 2. 3. 4.

Decreased maverick spend. Maverick spend means purchasing from non preferred suppliers. Spend management eliminates this savings-depleting practice. Increased economies of scale. Through consolidating spending and leveraging purchases, a company can negotiate favorable pricing based on the amount of money spent with each vendor. Increased process efficiencies. Spend management automates sourcing, procurement and payment processes. Increased procurement efficiency. Using strategic procurement approaches and e-sourcing tools for the bidding and contract award process helps companies shift the focus to results and effectively track savings.

Conclusion Spend management has emerged as a major new business strategy to help midmarket organizations increase earnings per share, protect operating profit and free up more money to reinvest in the company, its technologies and growth. Once open only to large organizations, new technologies and services now put spend management solutions well within reach of midsize businesses. Under spend management, all the spend — or strategic sourcing — in the organization is managed through procurement professionals. This means the entire organization — not just the procurement division — must become a spend-management-centric business. Senior executive sponsorship is therefore crucial. Spend management helps CEOs deliver increased earnings per share by freeing up more money to reinvest in the business to facilitate growth. COOs are able to protect corporate operating profit by gaining control over where money is spent across the company. CFOs can achieve substantial savings by getting spend under management in each of the company’s profit and cost centers.

© Copyright IBM Corporation 2006 IBM Global Services Route 100 Somers, NY 10589 U.S.A. Produced in the United States of America 06-06 All Rights Reserved

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For more information To learn more about how IBM Global Business Services and IBM Express Spend Management Solution can help your business achieve better savings, visit: ibm.com/bcs/supplychain About the authors Jeff Brooks, Associate Partner, Global Business Services Mid Market Practice Jack Hess, Associate Partner, Global Business Services Procurement Practice William Pettinicchi, Associate Partner, Global Business Services Mid Market Practice Charles Vianey, Partner and Supply Chain Leader, Global Business Services Mid Market Practice

----------------------------------------------1

Source: IBM Analysis

2

Source: Strategic Sourcing in the Mid Market Benchmark, Aberdeen Group, 2005

3

Source: Strategic Sourcing in the Mid Market Benchmark, Aberdeen Group, 2005

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