An Indirect Path to Manufacturing Savings and Cost Reduction?
Posted by Ellis Booker and Chris Masterson, JAGGAER Marketing in Indirect Solutions / Manufacturing on January 14, 2020
Whether your organization is purchasing raw steel, injection molded plastics, or fully finished office supplies and IT equipment, a streamlined P2P system can be a game changer. By optimizing the areas where you spend the most, your company and organization can drive significant savings in your supply chain. However, by focusing only on your largest spend categories, you may be overlooking easy opportunities for big savings.
Indirect Spend in a Direct Environment
In many manufacturing and direct materials companies, procurement teams place heavy emphasis on optimizing their raw materials purchasing, while neglecting the indirect business spend that’s necessary to keep their office running. When direct spend is already managed efficiently and teams work harder for every penny saved, indirect spend often sits ignored, with quick wins sitting untouched.
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Nila LaVanaway Charles, CEO at Pierpont Holdings, recognizes this pattern as well. “A lot of companies that don’t have a huge amount of indirect spend haven’t focused beyond improving the efficiencies that are built into the ERPs.” But those companies are leaving money on the table by putting so much emphasis on direct materials over indirect P2P. “Curiously enough, big companies that are providing raw materials to other P2P companies tend to have their procure-to-pay be less of a focus,” Charles says.
When you’re just starting out, a little optimization goes a long way, while trying to refine spend that is already hyper-optimized will see smaller results. As Supply Chain Dive points out, “The law of diminishing returns implies a process can only be improved so much before it becomes cost-ineffective. Striving to be best-in-class in every category will ensure your supply chain is flawless, but at a marginal benefit to the buyer.” You’ll have to look for other places to advance savings.
…it’s crucial to look at areas that might initially be considered “out of scope.”
Experts at McKinsey agree, saying that processes like “negotiating for lower prices yields diminishing returns over time.” Instead, they suggest it’s crucial to look at areas that might initially be considered “out of scope.” For manufacturing companies, this is often the indirect spend that keeps the business functioning. The initial phase of getting spend under control often provides the biggest boost to the bottom line.
Many manufacturing companies will feel that they’re not, in fact, just starting out, because they have a very mature spend management system for their direct materials. But taking just the first few steps to apply those same principles to indirect spend can offer a huge business boon.
For best practice examples, Charles suggests looking toward services industries, where a strong focus is put on indirect spend. “You see that with universities, you see that with hospitals, where they have a diverse staff that needs to be able to purchase a lot of office equipment and indirect supplies, that are essential to doing that versus those that are in really focused on direct material space and still using the ERP.”
Just How Big is Indirect Spend?
While it may seem like only a tiny fraction of a manufacturing company’s budget, The Dryden Group reports that, in reality, “Manufacturers specifically can spend 20 percent or more on indirect expenses.” That 20 percent is a massive opportunity to improve profits. Moreover, business leaders have long recognized the potential benefits in front of them. A 2012 Survey found that half of Fortune 1000 leaders saw reducing non-product costs as an option to provide savings without disrupting business.
As leadership comes to recognize the potential savings of indirect procurement, buy-in will be easier to win and procurement teams will find themselves in a potential gold mine.
How to Reduce Indirect Spend
The steps to reducing indirect spend are not altogether different from managing direct material costs, and many of the same principles can be applied. At the end of the day, it comes down to tracking spend, leveraging data, and automating manual processes.
“What gets measured gets managed.”
As the famous phrase goes, “what gets measured gets managed.” Without clear visibility into where your money is going, it’s impossible to get a handle on it. The first step is to begin tracking your spend, particularly through a digital procurement tool that allows you to track by category, project, and more. From there, you can begin targeting the indirect areas where you’re overspending to find deep savings.
Second, take advantage of your data. Tracking spend is a good first step, but big data and the tools that leverage it can bring your workflows to a new level. For example, contract analysis that uses previous data to identify opportunities and weaknesses in your supplier agreements offer savings beyond what humans might negotiate manually. Similarly, predictive analytics can take advantage of a data-rich system to predict item costs and business spend months in advance, allowing you to adjust your budget allocation or look for other areas to save.
Finally, automating manual processes like invoicing can save both money and time, giving you the chance to focus on more strategic indirect approaches. Electronic invoicing can reduce the cost per invoice from $30 to $4 while cutting cycle times in half. Digital assistants can help get you the specific information you need without having to click through menus and interfaces, saving valuable time. Advancements in automation are changing the indirect procurement industry, and companies that are already leveraging technology for direct materials are perfectly positioned to take advantage.