Whether your company is in growth mode, protecting what they have on hand, or adapting to a new normal, responsible expense management is never far from an executive’s mind. This is particularly true during an economic downturn when the cash generated from expense reductions can be invested in growing your competitive advantage or as an alternative to layoffs.
Despite the need to be frugal in the short term, pursuing expense reductions without an eye on medium and long term objectives or specific stakeholder needs can actually lead to higher costs. Internal and external relationships can be easily damaged, and employees may circumvent procurement policies to buy the products and services they need rather than using the contracts in place.
Sustainable expense management programs should be managed to align outcomes with company objectives. Doing so amplifies their impact, strengthens stakeholder and supplier relationships, and provides real savings that can be reinvested as necessary.
In this guide, we will share with you the steps and tactics that you can take, and the major pitfalls to avoid, as you look to develop an expense management program that maximizes its return while aligning the actions that you take with the short, medium and long term needs of your organization.
Part One: Five Mistakes to Avoid in Achieving Cost Savings that Stick
There can be a fine line between securing costs savings that stick and failing to meet your expense reduction goals. The four most common mistakes we see are:
Mistake #1: Setting Unrealistic Cost Savings Targets.
Here is how the conversation often goes between procurement and the CFO/CEO: “We spend $1B per year on products and services. We need to save $100M. At 10% savings, that should be doable”.
The harsh reality is that to achieve $100M in savings on a $1B spend, you may have to save 50% on every product or service you renegotiate. Suddenly, the $100M doesn’t look as doable at that point.
Why is this the case?
→ You have identified $1B in external spend
→ 80% of the spend is addressable. The remaining 20% consists of “unaddressable spend.” These are expenditures that cannot be negotiated, such as taxes and pass-through expenses such as intra-company transactions, investment costs, and charitable donations. This takes your $1B in external spend down to $800M
→ Of the addressable spend, it is highly unlikely that you will have real-time line of sight into all of it. Procurement teams use a metric called “Spend Under Management” to measure the percentage of spend that is influenced by procurement, or that runs through a formal best-practice spend process. Think of this as spend that you are able to see proactively (and therefore influence before it is spent) vs. reactive (the first time you see it is in a spend analysis report).
Spend under management varies by industry. Best in class organizations typically have >90% spend under management. For most companies, this is closer to 50% – 70%. If we take 70%, the $800M in addressable spend now becomes $560M in influenceable spend.
→ Of our $560M in influenceable spend, not every contract is available for renegotiation or resourcing every year. Many contracts are multi-year, and they often have minimum volume commitments. There are tactics you can use to renegotiate contracts before their expiration that are based on your contract termination for convenience language (if it exists), market conditions in a particular category, and the strength of individual supplier relationships. In our benchmarking, we assume an average contract length of 2 ¼ years. This reduces the $560M of influenceable spend to $250M in any given year.
→ The final consideration when setting a realistic savings goal is ‘leakage’. One of the primary areas of friction between procurement and finance is that the CFO does not see the reported (forecasted) savings hit the bottom line. Reporting accuracy is one cause, but the primary reason is that the renegotiated contracts are not fully utilized by the business. This may be because actual purchase volumes end up being lower than expected (a good thing, you save 100% of the money you do not spend), because the new deals do not align with the needs of the business, or have not been communicated effectively, and so buyers end up going rogue and sourcing products and services directly. If I had a penny for every time someone told me they could buy something cheaper from a local retailer, without them seeing the backend rebates and benefits that actually make the total cost a lot lower, I would be able to buy my local professional football club.
In this podcast, the Insight Sourcing Group CEO told me that he sees savings leakage of over 40%. Let’s be conservative, and say 20% (which requires 80% savings compliance). That means you have to target a savings goal that is 20% larger than the savings you actually need.
→ Let’s put that all together. To save $100M on your $1B spend in any given year, you may actually need to save 50% on all of your savings projects, and not the 10% that you had originally expected. Saving 10% returns $20M in savings rather than $100M.
Outcomes do vary based on industry and level or procurement maturity – the good news is that almost every one of these is influenceable based on the tactics used.
Mistake #2: Determining arbitrary savings targets at the category level rather than taking into account market conditions.
Your company may have an enterprise wide savings target. That doesn’t mean you should apply the target arbitrarily across all categories of external spend (for example “20% logistics savings, 10% marketing savings, 15% legal expense savings etc…). This may be the quickest and easiest way to set savings targets, but the result is that you enable a “cost savings at all costs” mindset. These may not be in the best interests of your company, and they create significant friction between your procurement team, business stakeholders, and suppliers.
Mistake #3: Sending a letter to all savings with a demand for a certain percentage reduction or cash rebate.
“Dear Supplier. In these challenging times, let’s come together to ensure positive outcomes so we can continue to buy from you in the future. With that in mind, we require a 10% cost reduction from all suppliers effective next Friday. Please respond that you agree to this reduction. If you are not able, please anticipate a meeting with me to discuss your reasoning. Thank You. Signed, your friendly Chief Procurement Officer. #StrongerTogether.”
This is sometimes seen as the easiest, quickest way to generate cash. I have personally worked in companies who have sent this letter to their suppliers, and I have been on the front line of supplier responses. Needless to say, unless your company is in an existential crisis (i.e. you are a couple of weeks from bankruptcy) it doesn’t work. It causes far more damage than good, and the reality is that in times when letters like this seem like a good idea, your supply base will have the same challenges. Don’t put them in that position unless it is your last resort.
Mistake #4: Taking actions that do not have alignment and buy-in from key stakeholders.
It is easy to operate in a silo, especially in times when expense reductions are an urgent necessity. However, in doing so, key stakeholders may feel that you are reducing their ability to do their job (at best), and find ways to circumvent company policy and spend with non-approved suppliers (at worst – a primary cause of savings leakage). Communication and change management are a critical part of an expense reduction program. Vision care health insurance company VSP Global created a “fiscal fitness” program that aligned with their organization’s culture to encourage employees to spend company money like their own.
Mistake #5: Losing sight of your medium to long term goals.
As part of our Procurement, Inc. framework, we help organizations break the “hamster wheel” of changing priorities resulting from short-term decision making. Organizations have a burning platform to save costs. They pursue an aggressive focus on price reduction and policy compliance. Savings are achieved, but a trail of destroyed supplier and stakeholder relationships are left in its wake. As business conditions improve, the focus changes to supplier relationship management and business partnering. It takes a long time to regain the trust lost during the cost reduction phase, and as soon as you start making progress, the focus shifts back to cost reduction.
Every time you go through this cycle it becomes more difficult to utilize your supply base as a strategic growth driver. This is why it is extremely important to be communicative and transparent with all stakeholders, internal and external, about your expense management program, it’s goals, and what success looks like. Once again, change management is key.
Part Two: Building an Expense Management Program
The most successful expense management programs are managed on a programmatic basis following this general process:
Collect third party spend data so you can get a complete view of your supplier expenses. Many companies already have spend analysis reporting capabilities – for those, nothing more than data maintenance and cleansing may be required.
If you are starting from scratch:
→ Identify data sources (such as from your general ledger, supplier invoices, P-card data), and gather the raw data in one place.
→ Cleanse the data. Remove line items that are obviously not third party spend (such as taxes), or that you know to be unaddressable (intracompany, pass through expenses, etc). Normalize line items where you have multiple supplier names that represent a single supplier (e.g. IBM, I.B.M, IBM (UK), International Business Machines, etc).
→ Categorize the spend using your chosen taxonomy. You can use a standard taxonomy such as UNSPSC or build your own. I recommend that companies build their own – but do not spend too much time on it. If you are doing this as part of an expense management program, it is more important to be directionally accurate than perfect. You can refine the taxonomy later.
Step 2: Needs Assessment
A primary pitfall of expense management programs is undertaking strategies and tactics that are not aligned with the needs of the business.
A needs assessment comes in two forms.
#1: What are the overarching goals of the company? This may be an expense reduction target that has been communicated to investors (hopefully you had some input into the procurement contribution to this number, in line with the principles discussed previously).
#2: What are the needs of the individual business or functional leaders and budget holders? An effective place to start is a bottoms up review of external spend, categorizing each supplier and product/service as mission critical, nice to have, or luxury. Think about this as Zero Based Budgeting (ZBB) for each category of spend.
Step 3: Build a Structure
The most effective expense management programs are guided by a strong framework. Here are some elements you will want to include:
→ Program Management & Governance
Assign an Expense Management PMO (Program Management Office). This may be a partial resource in smaller organizations; in larger ones, it may be a dedicated program manager with additional specialists in finance, communications, and change management. This person is responsible for overseeing progress against goals, liaising between departments, and leading program governance.
→ Create a Project Intake & Triage Process
The biggest challenge a procurement team faces during an enterprise-wide expense reduction program is bandwidth. There are many ways to address this (the topic of a future post!). The foundational block, however, is a project intake process. It is key that all projects, and potential projects, are managed through this process. It will help leadership quickly understand resource constraints, and allows procurement teams to assign each project to the most appropriate resource so your most impactful team members are not leading low impact projects because it was hard for them to say no. Take the decision out of their hands!
→ Use a simple project stage / gate process.
Few things turn off more potential stakeholders than a complex project stage-gate process. “I can get things done much faster if I do it myself”. This is a common argument, but it does not have to be. When used strategically, this can be a critical driver of stakeholder alignment.
Only two stages are needed.
Stage 1: Strategy Approval
Agree on baseline spend, savings/benefit calculation methodology, scope of opportunity, suppliers to be involved, and tactics and strategies to be used. Gain sign off from procurement, finance, and stakeholders. This should be secured before executing any of the agreed upon strategies or tactics.
Your savings methodologies should be agreed upon in advance with your finance leadership team. Examples include:
- Baseline methodology: comparing the price paid in a previous period for the same (or materially similar) products and services vs. the new price paid.
- Substitution methodology: comparing the price paid in a previous period with the new price for a different product or service that provides the same outcome.
- Market basket methodology: comparing the previous price paid vs. the new price paid for a representative selection of products and services, where it does not make sense to track every item individually due to the volume of different items purchased.
Within procurement, there is an age old debate on whether or not to count “cost avoidance” towards a savings target. This usually results from the purchase of a product or service for the first time, or reducing / mitigating a cost increase. The rationale is that, without negotiation, a company would spend more money on these products and services – which is the truth. Our recommendation is to track and report cost avoidance separately as part of a balanced scorecard rather than including it in your expense reduction reporting.
Stage 2: Outcome Approval
Agree on the chosen supplier and pricing, implementation time frame, roles and responsibilities, and the final savings/benefit calculations. This should be signed off on by the same team (procurement, finance representative, and stakeholder), and should be formalized once a final decision is made and contracts are signed.
Step 4: Build a Wave Plan
A wave plan is a prioritization of risk mitigation initiatives that you have identified through an analysis of your spend. Factors to take into account when building a wave plan include:
- Specific needs of the company (and relative urgency)
- Needs of individual stakeholders
- Complexity and time to value of each initiative
- Strategic importance of the product / service
- Micro-market conditions for the product / service
- Time since you last sourced or reviewed the spend
- Contract expiration dates
- Bandwidth of your stakeholder team and procurement resources
- Executive support for expense management for each area of spend
Critically, this wave plan is not a “procurement” wave plan. It must be signed off by other executive leaders. The exact leaders will be dependent upon the governance framework in place. At a minimum, it should be agreed upon by the functional leaders and budget owners impacted. Even better is when it is approved by executive management such as the CFO, COO/CEO, and in the case of broad expense management programs, the executive program leader.
Step 5: Deliver
Now it is finally time to determine and execute your expense management tactics at the category level. To help you select the most appropriate tactic to use, we have created a printable cheat sheet and worksheet called “24 Expense Reduction Tactics that Generate Cash for Your Business”. You can download it here for free.
Part Three: Delivering the Goods – 24 Expense Reduction Tactics
You now have your wave plan of project opportunities, but how do you know which expense reduction tactic you can use to maximize savings while minimizing time to value for each initiative? The toolbox of tactics available to you can be captured in the following areas:
- Incumbent supplier tactics (reducing the cost of products / services with your existing supplier)
- Demand management tactics (reducing the volume of products / services purchased)
- Category management tactics (taking a holistic approach cross-category to change what, how, and from whom you buy while still achieving the same delivery outcomes)
- Sourcing tactics (reducing the price paid by leveraging market conditions)
- General tactics (a catch all for everything else!)
Here are examples of the tactics that you can use.
Incumbent Supplier Tactics
- Renegotiate / restructure existing contracts
- Changes in market conditions may enable you to renegotiate existing contracts. Consider giving contract extensions as well. Termination for convenience clauses also enable renegotiation but these should be used judiciously – only for providers who are true “commodity” providers.
- Reduce the cost to serve (e.g. less aggressive metrics)
- Our actions often increase the cost for a provider to serve us, with these expenses priced in. Consider reducing overspecified KPI’s (does it really matter if a phone call is picked up 99% of the time within 3 rings or 95% of the time?). Reduce payment terms (hint: most providers will increase their price by more than the cost of capital (and your working capital benefit) for payment days over 30). Speak to your suppliers and ask them if you can help them reduce their cost to serve you without impacting the desired outcomes.
- Value Analysis / Value Engineering (VA/VE)
- Born out of the manufacturing industry, VA/VE initiatives are collaborations between you and your supplier to re-engineer a product or a service delivery model. They require multi-disciplinary support across both companies, and an agreement up front as to how any benefits will be shared. This has to be equitable for both sides. The benefit for you: your supplier can share ways in which you can achieve the same (or improved) outcomes in a more cost effective way (remember, they are currently most likely providing a product / service based on the specification or scope of work that you designed). The benefit for them: any new ideas can be applied to their other clients, most likely in a way where they retain most of the derived benefit.
- Reduce scope of work
- Do you need everything that is in your existing scope of work? If not, renegotiate based on a new reduced scope. Consider building in triggers that incrementally increase the scope back up to the original agreement over time (for example, based on employee numbers, revenue – whatever is most appropriate for the product or service in question)
- Negotiation with tier 2 suppliers
- In some industries, such as manufacturing, you may be directing your supplier to use a certain tier 2 supplier. I’ve never personally been a fan of this model, as it absolves your supplier of responsibility for any quality or price issues (“hey, you told us to use them”). That doesn’t mean that you shouldn’t get involved with tier 2 suppliers. They may use materials or have input costs where you are able to leverage your scale and contacts to negotiate a more competitive price that they can get alone. If doing so, they pass through all the savings to you, and they get to pocket the difference of any reduction in input costs on business with their other clients.
- Inventory reduction / reassignment
- For stock products (e.g. MRO), carrying high levels of inventory can have a huge effect on your cash flow. Consider reducing the minimum on-hand quantities or the point in time at which you take ownership of the inventory. Just remember that whoever bears the risk of being stuck with unused inventory usually prices it into their commercial model. Also, if you lessen your inventory levels, you will need to increase your awareness of supply chain disruptions and shortages.
Demand Management Tactics
- Tighten approval authority levels
- Consider increasing your delegation of approval authority levels so that any expenditure requires greater scrutiny. This can be applied to all products and services purchased, or just applied to certain categories (e.g. corporate travel). Similarly, reduce purchase limits on corporate credit cards. Neither of these tactics will win you any friends, so roll out with care.
- Standardize product / service specifications
- Do you give employees the chance to choose between 10 laptops? 5 office chairs? 5 types of uniform shirts? If so, consider standardizing your product and service specifications so that employees have only one or two choices. You aren’t likely to see any difference in performance, but it will allow you to consolidate volumes, and there are many other benefits throughout the value chain (think of it as a small scale version of Southwest Airlines only using a single type of plane and all the additional benefits that it has).
- Reuse products / services
- Are you going to reuse a pair of boots? No! But there are many categories of spend where products and services bought elsewhere in the company can be reused. A great example is market research and data. I’ve seen many organizations purchase data that can be used by many other areas of the business, but it remains locked up on the hard drive of the individual who purchased the report. There also may be ‘cash in your trash’. Are you able to resell or recycle products and materials that are no longer necessary (waste management is a great category to look at here), or rent an empty office roof to the local electric utility for solar panel installation? Get creative!
- Controls to stop duplicate purchases
- Stakeholders buying products and services in a silo increases the chances that you will be buying things that you already have. Your procurement software may be able to flag potential duplicate purchases before a PO is placed. If it does not, the most effective way to identify these opportunities is to instill some level of governance (really a sanity check) on potential purchases over a certain financial threshold before final approval. This could be at the Category Manager level, or for those companies who are more tightly managing external expenses, a cross-functional, executive, procurement approval board.
- Spend / supplier consolidation
- This is the go-to, foundational strategy that category management was built on, and for good reason, as it generally works. That said, it is not usually a quick-win strategy as you need to align contracts, and implementation can be complex. As Signet CPO (and former VP of North America Procurement for The Coca-Cola Company) Brian Bancroft reminded us in this podcast, you may have a global strategy, but you have to adapt it to fit each location or region. “In requiring global suppliers we have set a lot of people up for failure.” Wise words, indeed.
- Adjust volume mix across multiple suppliers
- This often is a quick-hit opportunity in a commoditized market where you have a small number of dominant players. Examples where we have had success using this strategy range from automotive lighting to credit reports. Oftentimes, in these types of markets, your volume mix hasn’t changed in years. The providers become complacent, knowing that they can happily push their 3% year over year cost increases without any effect to their business. Now is the time to shake things up. Bonus points if you know which SKU’s are more important to which company (perhaps they have a manufacturing line that they need to keep running, or a new product innovation that they are motivated to bring to market). You can use this as leverage for lower pricing on the less desirable, lower volume SKU’s. The only caveats are that switching costs must be low, and you have to have the authority to make the volume changes that you commit to. Nothing undermines this strategy quicker than committing to make changes and then demonstrating that you do not have the organizational support to do so.
- Substitute products / services
- Can you replace what you buy today with an alternative approach and still drive the same (or better) results? This could be a substitute of lower quality (fly Spirit on your Chicago-New York city pair vs. JetBlue), a change in delivery method (communicate with customers using email and PDF statements vs. snail mail and printed documents), or a completely different approach (replacing paralegals with computers to do the initial discovery work in legal matters).
- Bottom-up review of critical and non-critical spend.
- I mentioned this previously when discussing ways in which you can undertake a needs assessment, but it is important to capture it here as a category strategy tactic, too. By performing a bottoms up review of external spend you can categorize each supplier and product/service as mission critical, nice to have, or a luxury. Are there spend items that we can just stop using? What are the areas that are fundamental to our competitive advantage that the risk/reward payoff isn’t worth opening a hornets nest. Recognize, however, that a lot of stakeholders will initially label most of their spend as mission critical. This requires an empathetic approach, and is often most effective in a group situation – where you can debate without prejudice – rather than 1:1 with the budget owner.
- Local sourcing to reduce total cost of ownership
- This may not be obvious, because it may actually increase the purchase price vs. the incumbent supplier, but few things give procurement a bad reputation like not considering the total cost of ownership. A 5% cost reduction initiative can actually increase the total cost of ownership by 10%. Use local sourcing to reduce the total cost of ownership, reduce supply chain risk, and demonstrate a commitment to investing in your community. Just ensure that your math is correct, and that you appropriately communicate the business case for increased product or service cost (where the cost is higher than before) to those that matter.
- Market test (e.g. eAuction) for commodity items
- eAuctions have gotten a bad reputation over the years, often because they have been used and abused (true story: I once inherited a category where the use of an eAuction had driven up prices rather than reduced them. But that’s a story for another day…). eAuctions are a quick way to do market price discovery, and secure some savings where you have commodity type products and services with low switching costs. Just make sure that a truly competitive market exists, and you have the ability (and commitment) to switch suppliers if that is the ultimate outcome of the eAuction.
- Go to market (e.g. RFP) for contracts within 12 months of expiration.
- The route to market for more complex products and services is the trusty RFP. Don’t wait until the last minute to go to market. Now is your chance to issue an RFP for any product or service whose current contract is within 12 months of expiration. If your incumbent wins the RFP, make your award contingent upon the new deal being effective from the time of award vs. the original contract expiration date. And if you select a new supplier partner, you will have time to fully implement the new contract so that you can take advantage of the new agreement on day 1.
- Leverage a GPO model
- GPO’s were often considered to be for companies who did not have the volume to negotiate directly with the types of providers that a GPO typically covers. Not true! More and more, GPO’s are used by larger organizations as part of a broader category strategy. As a procurement team, you can also leverage a GPO to provide an opportunity to your suppliers, and your customers, to help them lower their SG&A costs (this is a model that I built for my company in the 2008 recession). Ask any prospective GPO what they do to ensure the prices remain in line with market pricing – many only negotiate periodically, which means you may start with a big savings opportunity, but over time end up paying higher than market pricing. (If you are interested in a GPO model, let’s chat).
- Buying desk for low-dollar spend items
- You may recall at the beginning of this guide, I discussed the notion of Spend Under Management. That a certain percentage of your third party spend is tough to influence proactively – it mostly just shows up when you do the reporting. A big part of that number can be attributed to your tail spend (the thousands of low-dollar purchases that are made from a large number of suppliers). Typically, this bottom 20% of your spend accounts for 80%+ of your total number of suppliers. You probably already have a spend threshold for when you buy a product or service more strategically (e.g. $100,000), and you may have a corporate credit card program or delegation of authority policies where employees can buy what they want under a certain threshold (e.g. $5,000). But what about the spend in between? This is where a buying desk comes in. We would typically build a buying desk in a low cost country to ensure it delivers an appropriate ROI. The buyers will negotiate directly with these suppliers (who otherwise would just have their quotes accepted), and where it is appropriate, go to market in an attempt to get three quotes. This may sound like “old school” procurement, but it is an effective way to bring oversight to your tail spend.
- Provide greater access to negotiated deals
- Returning again to the spend to savings funnel that we discussed earlier, the difference between gross savings and net savings can be attributed to savings leakage. One of the reasons this occurs is because employees do not actually know about contracts that are in place, and so continue to purchase in the way that they always did. At a minimum, consider using your internal website to provide directions on all the negotiated deals you have in place, and how employees can leverage them. Better still, enable self-service through online catalogs or utilizing a guided buying solution,
- Institute spend governance to reduce savings leakage
- Speaking of savings leakage, another tactic you can use to reduce this is to have tighter oversight of who is buying what. This can be achieved by providing regular reports on the “spend offenders” who are buying outside of approved channels. I hesitate to recommend this tactic as it places procurement squarely in the position of compliance police – which I’ve been advocating we move away from for a long time. But, in tough times, this is an option… just try and use it as part of a broader change management initiative instead of a big stick to beat your employees with.
- Audit supplier invoices for accuracy
- Another primary driver of savings leakage is inaccurate billing. Put simply, you may be paying for things that you did not receive, paying prices above those that were negotiated, because of billing mistakes made by your suppliers. This is especially prevalent in categories with a lot of SKU’s, line items, or a high volume of transactions. Think freight / logistics, telecom as just a couple of examples.
- Increase P-card usage
- Hold on a minute. Earlier in this guide, I suggested the potential to tighten controls on your corporate P-card usage. The good news is that you can tighten controls while still increasing your net spend. Most corporate P-card programs are severely underutilized. Increasing total spend reduces internal transaction costs associated with the procure to pay process, while increasing the cash rebates that you receive from the card issuers.
- Creative bartering
- Last, but by no means least, is creative bartering. When I say bartering, I don’t mean in the traditional sense (“I’ll give you a barrel of oil in return for an hour of your time”). But there may be opportunities to reduce the cost of something that you want to buy by offering something in return. An example: when I was a practitioner, one of my categories of responsibility was childcare (long before we had kids!). We needed an onsite child care center, and had an empty building to use for it, but no budget to pay for its ongoing operation. We found a leading provider of childcare services who were motivated to use our childcare center as a pillar of their strategy to expand into our country of operation. We leased them the building for free, and they operated the childcare center with zero cost to us. A true win-win all around.
It is possible to build an expense management program that delivers outsized returns that are in line with the exact needs of your business. That said, to do so requires care and consideration – and a very targeted approach.
According to The Hackett Group research, world-class procurement organizations achieve two times the ROI of those in their peer group. Taking the steps that we have discussed will ensure you maximize your impact while positioning your procurement team as a driver of business success rather than a “cost savings at all cost” tool to be deployed on in times of crisis.
If you need help at any point of your expense management journey – please let me know. We develop customized programs that pull from a broad network of pre-vetted subject matter expertise, and who are specialists in leveraging some or all of the tactics detailed above, often at zero up-front cost.