Around 60% of a company’s revenue is spent on goods and services from external suppliers in most mature businesses. But how much of this is sourceable spend? And how much of what your organisation purchases is actually spend that’s addressable, or currently being actively managed?
If these terms are confusing to you, then read on. I’m going to explain everything and help you to get to grips with the different types of spend in your organisation.
Almost every company understands and has manages what’s being sold to their customers. Usually, salespeople or Key Account Managers are responsible for managing this.
But very few truly understand, and more importantly manage, what they spend with their suppliers. In an inflationary environment where suppliers are taking every opportunity to increase prices, it’s an urgent requirement for you to know and understand this.
For example, did you know that a 2.5% purchasing saving across the board can deliver the same result to the P&L as a 10% increase in revenue?
Understanding sourceable spend vs. what is non-sourceable (and other key metrics)
One of the first things that any Head of Procurement who is new in role must understand is what their organisation is buying, and from whom. Conducting a spend analysis as a first step is key. Ideally, using spend analytics software to be able to slice and dice this data. This can provide answers much faster and unlock more opportunities.
One of the key benefits of spend analysis is that it gives incredibly powerful insights into how an organisation can deliver some easy cost reduction opportunities.
We’re going to look at 5 common procurement terms and explain what they mean:
- Sourceable spend
- Addressable spend
- Spend under management
- Tail spend
- Maverick spend
What is Sourceable Spend?
The basic definition of sourceable spend is anything where you have a fundamental choice whether or not to purchase it. As opposed, for example, to you being legally obliged to pay for something.
Your organisation must pay taxes, excise duty payments, subscriptions to mandatory professional organisations, payments to municipalities for the provision of basic services, and so on. These are legal obligations. You have little choice whether you pay them.
All of your other spend, theoretically at least, could therefore be considered to be sourceable.
What is Addressable Spend?
Addressable spend is anything where you fundamentally can choose whether or not you decide to purchase it from a specific vendor.
For example, the raw materials to produce a finished product would normally be considered addressable spend. So would Marketing and most IT spend.
You could split this between any spend that is immediately addressable, and that which, in theory, could be addressable but can’t be actioned at this specific time.
Let’s take a look at this a bit more closely.
Addressable and non-addressable spend: What’s the difference?
Non-addressable spend is typically considered to be any spend which has already been committed to. It can also be where there are limitations on whom you can purchase a good or service from. These limitations are usually due to spend being either under contract, or committed to on purchase orders already issued.
The most obvious example of this is a supplier which has a monopoly for a good or service and there is no obvious substitute. Utilities suppliers in regulated energy markets are a great example.
Non-addressable spend includes any spend under contract, where there is no available option to terminate for convenience or renegotiate terms. This is also known as a “take or pay” contract.
An example of this would be a lease contract. If the terms of the lease stipulate that there is no exit opportunity without paying the full value until the end of the initial lease period.
Another example of non-addressable spend could be parts and servicing for machinery and equipment during the warranty period. In many cases, original equipment manufacturers (OEMs) stipulate that any spare parts and servicing must be purchased from official dealers. By not complying with this, you would invalidate the warranty. Changing the supplier cannot really be addressed until the equipment you purchased is out of warranty.
These two examples are theoretically sourceable. The reality though is that in both of these situations, you can’t immediately be address these purchases. Running a sourcing event or renegotiating the contract can only be tackled at a later stage.
What is Spend Under Management?
The common spend under management definition is the amount of your company’s spend with external vendors that is being actively managed by your procurement department.
Note that spend under contract is not the same as spend under management. Your company may have a bunch of contracts that nobody in procurement knows about. They could be saved on people’s hard drives or filed in their desk drawers.
Having a contract doesn’t mean that a supplier’s spend is being actively managed.
There may be an argument to say that departmental managers or subject matter experts (SMEs) who manage the suppliers could be considered “spend managers” too. I would, however, argue against this.
Why? Because they are usually not experts in negotiation, commercial terms, contract management, strategic sourcing and data analysis, even though they may be good at managing day-to-day supplier relations.
What is a good benchmark for spend under management?
World class, mature procurement teams will be above 90%. Decentralised, fragmented organisations which don’t have a well-established procurement function will often be below 25%.
For me, it’s less about comparing your organisation to the outside and more about setting a benchmark of where you want to be in 1 or 2 years’ time versus where you are now. A fragmented organisation with dirty data, a limited mandate and a high percentage of unmanaged spend is unlikely to be transformed into a world class procurement team in a short period of time.
What is Maverick Spend?
This is rogue spend and it usually hampers spend visibility. A maverick spend definition would be any spend which has either not been authorised, or which is not compliant to your organisation’s procurement process.
Many people confuse anything that is not managed spend to be maverick spend. This is incorrect.
You may have purchases which are not managed by Procurement, but which still follow a compliant process from requisitioning through to payment. A requisitioner has the budget authority, a purchase order (PO) is created, and the goods are supplied from an existing supplier.
On the other hand, maverick spend is committed without any PO or visibility of the spend. Usually, the first time anyone is aware of what’s happened is when the invoice lands in the Accounts Payable team’s inbox and they reject or query the invoice.
This causes all sorts of nightmares for the CFO, Accounts Payable and Procurement.
Firstly, CFOs can’t accurately predict cash flow due to maverick spend invoices hitting the accounts team at any given time. Secondly, if the supplier is not an existing vendor in your system, it can cause delays to payment. Not only that, but it also results in missed opportunities missed for your Procurement Managers to bundle the spend with vendors who can offer better commercial terms.
What is Tail Spend?
Tail spend is the lower value spend that your business has. It’s usually not strategic or critical in nature. An invisible cost having bad data in your organisation often means that this spend is completely unmanaged. Free text descriptions make it impossible to classify what is being spent. Your procurement team therefore has problems tackling it.
We call it tail spend because it represents your long tail of suppliers and orders. These are low in value but constitute a high number of transactions.
Common definitions for tail spend can include:
- Any PO with a value below a certain threshold
- Any supplier with an annual spend below a certain amount
- The large number of suppliers who make up the bottom 20% of an organisation’s total spend
Over recent years, there has been an increased focus of software solutions providers to provide ways to tackle this spend. Automation or semi-automation of this spend can free up scarce resources in procurement teams to tackle more strategic, value-added opportunities.
Understanding your sourceable spend is just the first step
Looking at sourceable vs. non-sourceable spend is just the start of your journey towards understanding what your organisation is purchasing. Once you have gone past this first, easy step, the next steps will help you to truly uncover value opportunities for your business.
Why is spend analysis so important? Because diving into what you purchase from whom will enable you to find easy cost savings and any potential risks lurking in your supply base.
