Direct Spend – A Battle Procurement Cannot Lose
In war it is common practice for second or first lieutenants to sit their platoons down and hear from each squad the current state of engagement. As squads are dispersed over specific zones the feedback given is always critical in shaping tactics for the next engagement. Although the lieutenant in charge would be positioned in battle in which they have an overarching view of the entire area, it is only by hearing and learning from the squads where they truly get a holistic view of the battlefield.
In many ways we can draw similarities to how Procurement departments currently manage their spend. Over the past 5 years across, all industries, we have seen a large push in the need to digitize procurement through process and system transformations, but at the heart of this lies one fundamental problem – these transformations only address one side of spend, the indirect categories.
Direct spend affects the product and service the customer will receive/consume and is therefore mission-critical. Not only is it the job of procurement departments to keep costs low but they are also the central cog to the entire development/manufacturing process with key responsibilities:
- Driving supplier collaboration to build long lasting relationships which benefit both sides
- Liaising with internal engineering departments to understand technical requirements
- Working with sales departments to understand estimated volumes
- Sourcing competitive prices whilst keeping Quality at the heart of the requirements
Direct spend is 9x larger in volume than indirect spend. Through this we can begin to understand the gravity of the situation with the aforementioned problem. A digital procurement transformation which only address 10% of the overall spend within an organization is similar to a lieutenant only listening to 1 squad – without the holistic view, the lieutenant/CPO is not making the correct informed decision on the next strategic move.
Direct spend processes are industry specific and should never be generalized alongside indirect spend, specifically within source to contract and supplier management processes. This is largely due to the fact that direct categories in their very nature are complex, as they involve the creation/delivery of a finished good/service. The risk involved is greatly increased as organizations, jointly with their key delivery partners (suppliers), need to ensure the finished good/service is free from defects, having undergone a rigorous development lifecycle. In case of indirect spend, the overall source to pay process is industry agnostic, but this is not the case for direct spend. For direct spend we tend to find three main flavors of processes, which are for discrete, process and retail.
A key observation is that operationally, direct spend processes are very mature, already running highly automated processes in the backend ERP. However, there is a disconnect with the direct strategic source to contract process, which currently is mainly done offline. In order to gain that holistic view and ensure process compliance, the direct source to contract processes need to cover the strategic procurement process from the beginning of the source to contract flow and the result needs to be integrated into operational procurement to ensure that the sources of supply are based on the negotiated prices and conditions to ensure operational compliance.
Many organizations have been reluctant to tackle the need to digitize their strategic procurement processes for direct spend, primarily due to challenges faced during new product development:
In many organizations the engineering teams work within their Product Lifecycle Management systems without engaging sourcing and procurement teams at an early stage. This can lead to inaccurate sourcing strategies being developed, delays in finding a credible source of supply, etc. Breaking down these internal silos by allowing engineering teams to collaborate early and easily with sourcing and procurement teams will not only speed up internal collaboration but also help obtain more accurate pricing.
Difficulties in involving suppliers early in the design phase
Engineering teams are not able to get instant feedback from their suppliers and contract manufacturers regarding cost impacts related to certain capabilities or design choices. Considering that 80% of costs have been determined by the time design is completed, cost avoidance during the design phase is essential. Nowadays, it is not enough just focusing on cost reduction after the product is in the market. It becomes increasingly more expensive to make changes later in the life cycle process. 75% more costs are incurred for engineering changes made after release to production.
The winning recipe for driving down costs is the combination of early cost avoidance and the resourcing of selected components after market introduction.
Additionally, the early collaboration with suppliers allows engineering to multiply their innovation power by tapping into the innovation capabilities of their supplier base. We are now seeing a new RFx type being run by procurement departments with their direct spend supply base, which is Request for Innovation.
Finally, experienced category managers can involve additional suitable suppliers into the new product design (NPD) / new product introduction (NPI) process to ensure that the suppliers provide a competitive price for their components and services.
Lack of supplier due diligence and supplier risk monitoring
Adding supplier management and supplier risk capabilities to the NPD and NPI process will ensure that the suppliers are evaluated based on their intended contribution and categorized accordingly. It will ensure that all the required certificates are available and that a supplier and its supply chain risk is understood and monitored during the whole lifecycle of the product. This is critical now more than ever as organizations look to become more agile within their supply chain. It is important to have central visibility on supplier capabilities should there be any disruptions seen within the market, whether they are global or local; adaptability and agility will be a competitive differentiator.
Sharing sales and production forecast information
Including sales and production forecast information into the NPD / NPI process provides the supplier and contract manufacturer with important information to plan and reserve enough capacity. During a competitive sourcing cycle, it can be easier to convince a supplier to reserve the requested capacity to win the business and negotiate longer term volume discounts.
Sustainability is gaining importance.
Sustainability is increasingly important for regulators, customers, future employees, and financial investors alike. A critical aspect of sustainability is visibility into direct suppliers and into their supply chain and manufacturing processes. Companies tend to focus on their top-tier suppliers, but the real risks come lower down in the supply chain. Based on latest reports, the majority of companies have a high or very high visibility into their tier 1 suppliers, but only 10% have visibility beyond. Being sustainable no longer starts and ends within the organization’s own processes – it extends out to its external business partners and assesses their capabilities in sustainability. Customers are also now changing their buying patterns; opting for product/service choices where sustainability has been factored in. It is due to this that sourcing and procurement teams are now introducing sustainability metrics and evaluation criteria as the deciding factors when it comes to award decisions.
Procurement departments need to look beyond indirect spend and transformations which only focus on 10% of the battle. In our next blog we will explore how SAP Procurement technologies can be leveraged to solve the key challenges currently facing direct spend.