Procurement KPIs (Part 4) – Deep Diving Into ‘Spend Under Management’

One of the goals of a business is to have as much spend (with a capital “S” for all expenditures: CapEx, OpEx and COGS) under management as possible. And that goal should extend to supplier spend, where procurement wants to have as much supplier spend influence as possible. That way you know what you are spending on suppliers (and the pricing component of that, of course), what you are getting from those suppliers (i.e., supplier performance) and how well you are spending in terms of applying best practices and tools/intelligence to the process (e.g., proactively guiding stakeholders and minimizing maverick spend).

This spend under management (SUM) metric is actually determined by a set of indicators that we shall explore in this latest installment of our series on KPIs that all procurement leaders should know. In the first two parts of this KPI series, we highlighted some of the foundational measurements for procurement pros and the problems of traditional procurement key performance indicators in terms of how they can be incomplete, misleading and even damaging to a value chain transformation. We also delved into the “keys” that unlock the value of spend and supply management.

For SUM, we will explore the true spirit of how this metric is used, what role technology plays and how to get a balanced scorecard for different segments of supply base management.

KPI: Spend under management

Spend under management is an important and vexing KPI – or set of KPIs. It is both underestimated and misunderstood. One of its challenges is that the addressable spend and SUM concepts are interpreted differently across organizations. But, based on our experience and that of practitioners who use the metric, here is the basic definition. SUM is the percentage of annual truly addressable supplier spending correctly disbursed against preferred suppliers’ contracts.

The definition contains 14 simple words, but their meaning and implications are what matter. First off, let’s examine the term “addressable.” True addressable spending means all cash disbursed to suppliers, not just the spend deemed touchable/influenceable by procurement. Next, we are talking about spend that is pegged to contracts that can be measured with proper spend analytics. This is how you get visibility of maverick spending happening for whatever reason and the data you can use for continuous improvement.

Most importantly, the contracts are associated with preferred suppliers that themselves are established via a procurement-led strategic sourcing process, i.e., a “center-led,” procurement-designed process that can have distributed resources in execution. This is different from approving suppliers that might have been set up properly with AP controls, but not with procurement controls. This is why most firms make their CPOs the global process owners for procure-to-pay (P2P) and why procurement must sign off on every new supplier added to the supplier master.

Finally, we say “correctly disbursed” because spend is only under management if the execution systems in P2P are purchasing and paying the preferred vendors with the correct transactional “pathways,” such as three-way match, ERS and recurring invoices.

SUM is not a perfect metric because it measures the quantity of spend influenced/managed by procurement, not the quality of spend influenced/managed (i.e., earlier, more deeply and on an ongoing basis). For example, you can have 100% SUM through rigorous policy enforcement that requires procurement’s involvement in contract negotiations, but if procurement is brought in too late to exert meaningful influence, that spend is not getting managed properly. There are different ways to measure the quality of influence, and it goes beyond the scope of this piece. We do recommend, however, that you base it more on adoption of best practices, e.g., involvement during planning and budgeting, than the percent of effort reporting up to procurement or the exact RACI model you’re using.

Finally, SUM tends to be very sourcing-centric, though it has also been implicitly extended to supplier management. And while there is no real “SUSM” metric (spend under supplier management), the benefits of supplier management programs and processes are no less real, and they become even more important to drive value within ongoing relationships, especially strategic ones. Supplier management is also an area that lights up many metrics because it is multi-faceted, such as including risk management, regulatory compliance, performance management, etc., and it also highlights the complexity of “supply base management” that involves measuring supply base segments like these shown in the spend/supply management framework:

• Supply base demographics show the attributes of your supply base overall (e.g., measuring strategic supply base concentration via the metric of percentage of suppliers representing 80% of spend) or certain criteria, such as diversity criteria.
• Spend categories from low-level sub-categories/commodities up to “super categories,” such as contingent labor and services spend, direct vs. indirect and others. The power of good supplier information (which itself is part of supplier management) and a common category taxonomy helps to enable scorecarding at any of these levels.
• SRM segmentation, such as strategic, critical, A/B/C, preferred, under-performing, etc., and risk segmentation, which is based on risk values of various risk types or scoring by NGOs, e.g., CSR ratings. Of course, this all assumes that you have the data here to report, and if you do not, that is also a key driver to getting such insights.

Tier-2 supplier metrics can also be added to the list for firms with critical tier-2 suppliers to measure and manage (directly or via the tier-1 supplier). Another example is that some companies measure supplier diversity at tier-2 level.

Another finding from more advanced practitioners is to standardize the “palette” of KPIs (including their definitions and calculation methods) so that these types of metrics can scale up from a supplier level (and even down to a contract level where the KPIs become performance SLAs) up to the end-to-end supply chain level.