Spend Analysis 101
As a procurement professional, I am frequently tasked with conducting a spend analysis on behalf of current and potential clients, but for those outside of the industry, this may be an unfamiliar exercise. In this post, I will attempt to provide a crash course on spend analysis, answering some of the most commonly asked questions about the topic: What is a spend analysis? Why should I do one? And finally, how do I do it?
A spend analysis is a very broad term that refers to… you guessed it! Analyzing the spend of an organization with the objective of understanding where money is being spent and where there may be opportunity for cost savings or process efficiencies. Spend analyses are conducted by procurement professionals in an attempt to get a comprehensive view of all of an organization’s expenditures and they are frequently the starting point for beginning the strategic sourcing process. There are a number of benefits to conducting a spend analysis, but the most important is transparency. A spend analysis provides a holistic view of all spend (indirect and/or direct) in a given time period, typically during a fiscal or calendar year. By doing this, you are able to gain visibility into where spend is being allocated, who the top suppliers are, how many suppliers you use for certain services, and areas of opportunity. For decentralized organizations, a spend analysis may reveal potential service redundancies across departments/brands and provide insights into areas of consolidation across supply bases. Along the same lines, a spend analysis provides organizations with the information needed to increase spend control by showing where and how spend/budgets are being allocated. Although there are many reasons why an organization would conduct a spend analysis, the benefits are consistent.
Now that we have discussed the importance of undergoing this exercise, we will cover how to conduct a spend analysis. A spend analysis can be broken down into five key steps: Gather, Cleanse, Categorize, Analyze, and Report.
First, gather the data. Oftentimes a spend analysis begins with a large data dump from your organization’s general ledger or accounting system. The level of detail and layout of the data set(s) will vary depending on your internal systems and reporting requirements. The level of detail in your GL report may range from only supplier names and spend to transaction level detail, but will be useful nonetheless. If you are unable to collect one report for all spend in question, you will have to work with each department or functional area individually to collect their spend data and consolidate it. In addition to the GL report, you should collect as much backup detail (i.e., invoices, purchase orders, etc.) as possible to fill in the gaps where details may be lacking.
After you have collected all of the necessary data, the next step is to cleanse it. As mentioned, you may be required to combine various sources of information if a single report is not available or insufficient. As such, you will need to consolidate the data into one location before conducting your analysis. Regardless of the source of your data, it is necessary to take time to cleanse the information to improve the results of your analysis. If you are combining multiple data sources, you will need to spend time checking that the formatting is consistent. Not only should you cleanse the formatting, but you will also need to remove any duplicate entries and check for consistency in supplier names and descriptions. There may be multiple versions of the same supplier name in the report and unless you create one uniform name, you will not be able to consolidate all of the relevant spend. An example of this is GE, which could appear as GE, General Electric, General Electric Company, GE Co., etc. Along the same lines, if your report includes categories or descriptions, you should follow a similar name cleansing process to guarantee consistency. To ensure the accuracy of your results and avoid potential errors down the line, you must take all steps to cleanse the data upfront.
Once you are confident that your data is cleansed, it is time to start categorizing. Prior to beginning any categorization, you should discuss what your categories will be, especially if multiple people will be doing the categorizing. A best practice in this area is to use high level categories, such as Marketing, IT, etc., and then apply subcategories that fall within these buckets. Once you have decided what your categories will be, you should begin categorizing each of the suppliers within the report. A general approach is to apply the 80/20 rule when categorizing data and review at least the top 80 percent of spend. The level of detail in your data set will help to complete this process, meaning detailed descriptions of the purchases tied to spend or suppliers will be a key indicator of how to categorize. For those whose reporting already includes descriptions or categories, this step is essentially complete, however, you should take this time to review the categorization for accuracy. Otherwise, you will need to conduct research or internal interviews to get an understanding of the services each supplier provides and categorize them accordingly. This is the most time consuming step in the process, but also the most important.
Now that the data has been cleansed and categorized, you can (finally!) begin analyzing the information. You should review the information through multiple lenses to gain insights into spending habits and areas of opportunity. For example, spend by category and spend by supplier are common ways to analyze the data. Spend by category will reveal which locations or business units are responsible for the majority of the budget and how many suppliers fall within those buckets. Also, reviewing spend by supplier will show you who your top suppliers are and help to identify which supplier relationships should be a focus area. (This is not be the only criteria in determining your critical suppliers, but that’s a topic for another day…) Finally, you should report your findings and begin acting on the opportunities identified.
Procurement professionals are commonly tasked with conducting spend analyses, but this exercise is not limited to the procurement department. Conducting this type of activity can be a daunting task as it requires a great deal of data collection and a large time commitment. That said, the end result is beneficial for you and the rest of your organization. Whether you are interested in conducting a spend analysis of an entire organization’s spend, or just a segment, it is important to understand the basics behind the exercise.