Procurement teams are continually challenged to align spending with business goals. One of the most important places for Procurement to start is with indirect spend.
This may look like right-sizing a service contract to curb costs or seeking more competitive materials costs to bolster profitability. While the sums for these transactions may fly under the radar, in aggregate, they often comprise the most significant portion of overall spending.
What can organizations do to get a handle on indirect spending? How can costly indirect spend come into better alignment with company goals?
Today, we’ll look at ways to better manage and evaluate indirect spending. You’ll learn:
- What indirect spend is
- The difference between direct and indirect spend
- Challenges in tracking indirect spend
- How technology can curtail excess indirect spend
What is indirect spend?
Improving bottom-line KPIs is important for aligning with business needs, but first you need to understand how and where spending occurs.
Indirect spend, also called tail spend, is the incidental and small dollar purchases that cannot be tied to a project or a product.
Tracking expenditures can be difficult in indirect spend categories. Here are some examples of expenses that qualify as indirect spend:
- Administrative fees
- Salary and compensation packages
- Travel and hospitality fees
- Office supplies
- Facilities management
- Consulting costs
- Corporate card expenditures
- Inventory management costs
All of these expenses are necessary to support business functions. Tracking and managing these fees and expenses can improve your company's financial health.
The difference between indirect spend and direct spend
Direct spend refers to purchases directly related to the production of products or the administration of services billed to the client. Direct spend may include:
- Products and services
- Raw materials
- Project-related consultants
Because direct procurement can be tracked and monitored according to its associated initiatives or clients, it’s far easier to control than indirect procurement.
Indirect spend deals with small sums, but it can cumulatively represent a significant percentage of overall expenses. It’s not easy to manage because it often happens outside the documented purchasing process.
Despite this difficulty, it’s essential — indirect spend management is one of the best ways to reduce overall spending.
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Common challenges in indirect spend management
Indirect spend management is a complex process since small cash leaks can be hard to find. Continuous monitoring is the best defense against uncontrolled spend.
Companies often encounter the following challenges when first attempting to manage their tail spend:
Lack of visibility
To track spending across the organization, you need to see it as it happens. Often, businesses do not have the tools to see spending patterns until it’s too late.
Increasing visibility into your company's direct and indirect spending ensures only necessary purchases are made and budget estimates remain accurate.
Spending outside the purchasing policy significantly increases procurement costs and risk.
This type of spending is called maverick spend, and it’s hard to spot and even harder to control. Software that centralizes purchasing reduces this hidden spending.
Poor negotiation can show up in many ways. You may negotiate at the last minute, take the first price offered, or agree to an extended commitment without vetting alternative products or vendors. Missing these key negotiating points results in lost leverage and buying overpriced or unnecessary supplies.
Establishing a strong negotiation practice lowers costs by leveraging preferred vendor relationships and taking advantage of volume pricing. Using procurement software increases opportunities to buy competitively and streamlines vendors across locations.
Lack of research
Failing to benchmark your most common purchasing categories reduces visibility into competitive market rates. It leads to spending leaks and loss of cash optimization.
For instance, the commercial paper market experiences fluctuations similar to the oil and gas industry. As a result, it’s important to follow pricing trends and negotiate on volume to get the best deal. Without up-to-date pricing, it’s hard to know if you’re getting a fair price.
Regular benchmarking for supply pricing ensures you negotiate from a well-informed position and sign the most competitive contracts for each spending category.
Poorly managed corporate cards
Corporate cards offer internal stakeholders the freedom to purchase items or services when needed. Without oversight, these purchasing tools can lead to uncontrolled spend, poor visibility, and increased risk.
Managing corporate cards by limiting cardholders, implementing strong guidelines, and auditing for fraudulent or out-of-policy spending ensures you have full visibility into any indirect spend occurring on cards.
Steps to managing indirect spend
Establishing and maintaining an effective indirect spend management process is vital to realizing cost savings opportunities and creating value.
Follow these steps to get the most out of your supplier relationship management and maintain satisfactory cash flow.
Create and document spending policies
Stakeholders need clear and concise guidelines to steer the procurement process. Start by outlining and documenting the purchasing guidelines governing your office.
Creating a strong, well-detailed corporate spending policy gives buyers the tools they need to make informed decisions, choose options based on cost and overall value, and steer their purchasing activity in the right direction.
Establish an approval workflow for purchases
Approvals ensure your corporate spending policies are followed as prescribed. Beyond this, they ensure that every purchase flowing through the finance department is necessary, compliant, and properly documented.
Conduct legal and security reviews on every contract
Cross-departmental approvals ensure that every angle is covered when committing to a new purchase. Here are the steps of a typical legal or security review:
- The department lead ensures the necessity of the purchase
- Finance reviews it to ensure compliant use of funds
- Legal examines associated contracts to ensure correct and advantageous terms
- IT reviews the purchase to evaluate the integration and risk profile of the app in question
These reviews reduce risk and increase the strength of your purchasing process. They ensure every purchase meets the same standard and benefits the company in the long run.
Establish preferred vendor relationships
Strategic sourcing provides incredible cost and resiliency benefits for the supply chain. Relying on a list of approved vendors establishes stronger relationships, reduces risk, and improves cost outcomes.
Be sure key suppliers are prominently featured in your purchasing process. In cases where a new vendor is needed or desired, be sure to establish a strong business case for the new vendor relationship.
Conduct supplier performance reviews
Once preferred vendor relationships are established, vendor relationship management and performance reviews maintain the effectiveness of those relationships.
These reviews evaluate the level of contract compliance from an individual vendor, the number of delivery or compliance exceptions over time, the competitiveness of pricing, and the cost efficiency of remaining with one vendor for multiple contract years. Supplier performance ensures the savings and service you experience at the beginning of the vendor relationship carry on as time passes.
Use software to manage spend
Even small-to-medium businesses can generate thousands of monthly invoices. Many of these are low-dollar, one-off, and incidental purchases that make up a large portion of overall expenses.
Implementing spend management software helps you manage and administer your procurement policies. It automates many manual processes that slow down your accounts payable department.
It can also help finance identify risk and fraud, speed up the approval and invoice processing cadence, and deliver valuable insights regarding spending patterns and issues within your organization.
How Order helps companies manage indirect spend
Order gives you the visibility and tools to gain real-time data about corporate spending. It provides robust procurement tools to guide the purchasing process from point-of-sale to payment, enabling procurement professionals to increase profitability and cost reduction.
Order offers robust features to help company’s track, manage, and control indirect spending throughout their organization:
- Dynamic permissions and guidelines for purchases
- Automated routing for purchase approvals
- Strategic sourcing and curated lists of preferred suppliers for buyers
- Procure-to-pay automation for invoices, including automatic general ledger (GL) coding, three-way matching, and invoice reconciliation
- Spend analysis tools and reporting to examine category management and purchasing trends
To take control of your procurement processes, you need a tool to simplify and automate your purchasing and reporting functions. Schedule a demo of Order to learn more.