By focusing on high-dollar indirect spending areas and making a few adjustments, your company could see significant savings and pre-empt some costly contractual issues.

I’ve worked with companies of every size during my 30-year career in procurement and supply chain management, from multibillion-dollar companies to small firms. And while small but fast-growing organizations are the least likely to put much focus on indirect spending, they also have the most to gain by paying attention to it as part of their standard operations—and the most to lose by ignoring it.

What is indirect spending?

First, let’s define this often-overlooked concept. Indirect spending includes any expenditure on goods and services that are not directly incorporated into a product being manufactured. This makes it a diverse category that includes telecommunications, IT software, travel, cleaning supplies, janitorial services, office supplies, 401K contracts, healthcare agreements, consultants and more.

Why should growth companies care?

Indirect spending accounts for a large portion of a company’s budget, and those that make a point of managing their spending in this area can see equally large savings. According to a 2014 report from EY, optimizing indirect spend can reduce costs by as much as 25%.

But it’s about more than cost reduction. Paying more attention to the quality and value of products and services that fall under indirect spending can strengthen company operations, improve the quality and reliability of the products and services you deliver to customers, and reduce your risk exposure.

For high-growth companies, the issue can be particularly critical, because they tend to be staffed by people who wear multiple hats and seldom have the benefit of well-developed policies and procedures. As the company expands, the vendor contracts they sign grow bigger, the list of purchases grows longer, and the costs and risks can quickly spiral out of control.

Paying more attention to indirect spending can strengthen your operations, improve the quality and reliability of what you deliver to customers, and reduce your risk exposure.

Curbing indirect spending doesn’t have to be complicated. By focusing on high-spend areas and making a few adjustments, your company could see significant savings and pre-empt some costly contractual issues.

Set the priorities

Start by identifying the spending areas where change is most likely to bring the greatest benefit. Prioritize areas that represent a high proportion of your indirect spending budget and those that have the biggest impact on your company’s ability to deliver products and services to your customers. For a manufacturing or industrial business, I often see this being maintenance, repair and operations (MRO). For a technology business, it could be staffing services or consulting agreements. In healthcare, the highest areas of indirect spend are often IT, staffing services, insurance (risk coverage) and training. Generally, all businesses face ever-increasing costs in IT software, staffing and recruitment, and healthcare.

Many organizations now use data analytics to assess risks and quantify the total obligations of these expenses, including termination obligations. Once the analysis has been conducted, the vendor relationships that don’t seem to deliver value for the money or are otherwise problematic need to go to the top of the pile. These are the areas you’ll want to review first.

Read the fine print

Resolving high-cost or problematic areas doesn’t necessarily involve going to market and finding a new supplier. Often, quality and cost issues can be addressed by re-engaging with your existing vendor.

First, examine the contracts that govern the service or product delivery. Too often, these contracts are not reviewed thoroughly at the outset and contain unexpected restrictions that drive up costs or limit service. Remember, these contracts are written by the supplier, which means the terms and conditions are favorable to them, not to you.

Here are a few common issues to watch for in vendor contracts:

  • Does the contract include automatic price increases? It’s not uncommon for a contract to specify a percentage increase year over year, and that percentage can be unexpectedly high.
  • Are specific levels of service guaranteed? If you’re unhappy with the levels of service, check to see whether the vendor is meeting the terms of the contract. If they are, you may need to renegotiate the terms or find another vendor. If they’re not, this is something you can address with them to either improve quality or get a price break.
  • Are there termination charges? Before you start researching new vendors, make sure you factor in any costs involved in terminating the existing contract and the cost of implementation for a new provider.
  • Does the contract specify automatic renewals? Many vendor contracts auto-renew unless the buyer opts out within a specific time period.

Renegotiate the terms

Once you have identified the contractual elements that drive up costs or limit service, see whether the vendor is willing to adjust the terms. Many companies don’t realize how much room there is for negotiation in a vendor contract, but as a procurement specialist, I negotiate on a daily basis.

Payment terms are often the first place to look. While everyone wants to be paid in 30 days, it may be possible to stretch the terms to anything from six weeks to 120 days. Ask for price stabilization in a contract with a year-over-year price increase or ask for an incremental increase pegged to an accepted index rather than a fixed percentage. These changes may seem minor, but the cost difference can be significant, especially across the lifetime of a multi-year contract.

Many companies don’t realize how much room there is for negotiation in a vendor contract, but as a procurement specialist, I negotiate on a daily basis.

Factor in the risks

Controlling your indirect spend can improve the bottom line, but it’s also about reducing risk. The selection process should factor in the vendor’s stability and reliability as well as the security and protection that their products and services offer—and that applies to name-brand suppliers, too. Maureen Minard’s article, CIO Playbook: 4 Rule for Technology Vendor Selection, offers great insights into evaluating and selecting vendors. While it’s focused on technology vendors, many of her points apply to other vendor types. And risk mitigation extends to the product as well as the vendor. For example, an employee travel program shouldn’t be selected based on price alone, it should also support the company’s duty of care to its employees and protect the company from the risk of litigation.

Leverage the data

MRO, for example, is complex and spans multiple departments, which makes it challenging to compare costs and other factors, such as quality and reliability, across multiple vendors.

For companies that are serious about maximizing the value of their indirect spending, a new generation of data analytics tools are applying big data to determine market prices and optimize savings and value. For example, at SDI, we developed the ZEUS platform to help companies consolidate and analyze data from purchasing records, supplier catalogs, and other sources to identify the best prices as well as areas where they may wasting money or jeopardizing operations by over- or under-ordering.

For companies that are serious about maximizing the value of their indirect spending, a new generation of data analytics tools are applying big data to determine market prices and optimize savings and value.

 

Here’s the bottom line.

Indirect spend is often ignored by growth companies, but it can play a significant role in the company’s success. Taking the time to re-examine those high-cost products and services and find ways to reduce costs, maximize value, and minimize risk and exposure can deliver substantial returns—returns that can be redirected to market expansion initiatives or other growth drivers.

If you’re like to learn more about this topic, I’ll be speaking about the importance of data analytics in the MRO supply chain at ProcureCon MRO on October 29th. See you there?

 

LLR Partners believes in sharing the wealth of experience and expertise within our portfolio companies, network and teams in order to inspire and help accelerate growth for a wider community of business leaders. We hope you find these GrowthBits helpful and share them with your network. Read more growth insights here.

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