Daily Archives: January 13, 2008

How much do you know about your (corporate) spending?

Today I’d like to welcome Bernard Gunther of Lexington Analytics, a specialist consultancy in spend analytics based in Lexington, Massachusetts.

How well do you understand the pricing you actually get from your vendors? Many companies don’t know as much as they should. Think about a typical situation:

Last year you finished a sourcing project and signed a contract with a vendor. The entire team, including purchasing, the business line and finance all believe the new rates will save the company significantly. Since then you have been buying from that vendor. Now, a year later, you want to know, are you getting the pricing you expected to receive?

How much do you really know about the spending? There are seven simple questions that you should consider. If you are managing your vendors properly, these should be easy for you and you should have the analytics to support them. If these are hard to answer, you have to ask yourself, “Do I really know what I’m paying for?”

  1. Contract Pricing
    Does your contract contain a pricing schedule?
    This sounds simple, but surprisingly many contracts don’t have pricing. Sometime the pricing is buried in different statements of work. This can be fine if the pricing is consistent across all statements of work. But you have to ask, why can’t the pricing be transparently put into a single location where it can be referred to by other documents? This should be true if the pricing is contained in a schedule; a formula; a discount from list retail price; or even if it represents a discount from a benchmark.
  2. Invoice detail
    Does your invoice contain enough detail for you to determine which price you are supposed to be getting?
    For each item on the invoice, can you tell the relevant contract terms to calculate the price? If you have fixed hourly rates for different types of electricians, but the invoice just states “Replace 10 power outlets – $1,546.05″, you have no way to confirm the pricing is correct. If your contract states you obtain a discount from a list price, do you have the list price on the invoice or even a separate table of list prices? If you don’t regularly capture these prices, you will find it very hard to reconstruct this data a year later.
  3. Electronic invoice
    Do you get the invoice data electronically?
    If you are ordering electronically, this should be easy. If you only have paper invoices, doing any analysis is going to be difficult. You’ll have to have data entry done on the data before you can do any comparisons. Every vendor should be able to provide you with a spreadsheet with their invoice details along with each invoice.
  4. Contract Coverage
    For what percentage of the spending is there a price which can be calculated from the contract?
    Using your electronic invoice data, you determine the portion of spending for which you can calculate the contract pricing. If this number is 98%, you have good coverage. If it is much less, you have to ask if you are comfortable or if you need to expand the coverage of your contract. For example, shipping rates might not be included in the contract pricing, but if they represent 1% of spending, it may not be an issue to worry about. If shipping costs end up being 25% of your spending, perhaps you should establish pricing (using your contract, their contract or a new contract). You may have a great price for PC hardware, but if 40% of your PC spending is not covered by the contractual rates, you need to understand the pricing on these other items.
  5. Pricing correctness
    For what percentage of spending is the pricing the same as in the contract?
    For items you buy that can be priced from the contract, are you getting the contractual price? This may sound obvious, but errors happen. If you don’t check, you don’t know. Error rates can be significant, sometimes approaching 20% or more of the items purchased. If 20% of the items you purchased are at prices 15% higher than the contractual rates, you have just had a 3% price increase across the board.
  6. Pricing trends
    If the contract pricing allows for pricing variation (for example, if the price is a discount from list price), how does the unit pricing vary?
    Are prices regularly rising where they shouldn’t be? Are prices flat when they should be declining? For example, you might expect general office supply pricing would stay flat; paper products might vary with the price of paper; technology pricing to decline; labor prices to vary based on market pricing; etc. Do prices drop when a new, lower price contract is put in place? Your analysis should be able to make these pricing changes transparent to all interested parties.
  7. Demand mix trends
    Has the demand for different items changed?
    Is the change in the contract coverage a function of users buying new items? If you are measuring, in detail, how a vendor is used, you will understand, in detail, how the user demand is shifting over time.

Some people assert that this is all useful, but it’s too hard to do. If you don’t manage your spend data and do not have detailed contracts, it will take some work to do this the first time. But we’re talking a few days or weeks of effort, not months or years. Once you’ve designed your invoice data and contracts for easy analysis, using the right tools, these reviews can be done in hours. The value delivered can be significant. If you don’t look, you will never know.

Thanks, Bernie.