Cost management principles define an
organisation's use of its financial resources for management accounting reasons
in rather broad terms. Category management is defined as a strategic approach
to buying, where the organisation segments its spending on purchased products
or services with greater accuracy and clarity, based on spend patterns over a
period of time.
The segmentation of spend patterns into
discrete groups will depend on an organisation's primary functions. Some of the
major categories into which an organisation might rationalise their spending
could include:
- Overheads.
- Finance.
- Operations.
- Direct / Indirect.
Category management is a systematic cost
analysis approach that describes financial resources. The descriptive process
allows the understanding of past and present spending patterns. It is used to
decide the options that provide the best approach to leveraging and achieving
the greatest benefits. Preserving the savings involves the apportioning of
direct and indirect products or services spend patterns by:
- Value.
- Supplier.
- Type.
- Volume.
Associated theories that help dissect product
or service spending patterns include the Pareto (80/20 rule) and ABC analysis.
From the assimilation of category spend groups, essential levels of spend are
discerned, where buying attention should focus on leveraging the highest cost
and efficiency savings. Category management is the most evolved purchasing
strategy of the three common purchasing management approaches, which include:
- Tactical purchasing.
- Strategic sourcing.
- Category management.
The simplest form of purchasing is
tactical purchasing, a standard process of executing orders through the typical
three-bid and buy routine. In contrast, higher levels of strategy are employed
at the strategic sourcing stage to capture increased levels of supplier value
and reduce the number of suppliers utilised.
Category management uses in-depth
insight into a market to drive value to entire groups of products and services
and evolve them in real time as the supply market changes or develops. However,
category management is not a one-time implementation process. It is based on continuous
evolution and improvement of the total lifecycle product or service costing.
Category management is a dynamic
approach to price analysis that requires initiative-taking management and a
shift towards peak effectiveness and efficiency in buying practices. It is not
classified as the strategic sourcing of products or services but as a long-term
approach to monitoring supply marketplace dynamics, trends, and the supplier
landscape within a particular spend area, often adjusted to reflect changing
organisational and supply conditions.
One of a purchasing function's primary
roles in category management is guiding stakeholders using targeted questions.
However, one of the biggest misunderstandings by an organisation's stakeholders
is that a purchasing function is trying to take over the stakeholders' role in
the purchasing process. An initiative-taking buying function should be working
with stakeholders by helping them to answer the critical questions about:
- Demand and forecast patterns.
- Financial and commercial bottlenecks.
- Operational requirements.
- Quality issues.
To realign category management
strategies with business needs and aims, typical outputs of this process might
include:
- Understanding the critical financial strategies.
- The examination of historical purchasing patterns.
- Alignment of stakeholders to the
distinct features and requirements of the products or services necessary.
- A shared understanding of what
quality looks like and how it should be delivered.
While there is no standard
categorisation or grouping of requirements within category management, a
general rule is to group products and services with similar characteristics.
Organisations could use the following to group categories:
- United Nations Standard Products and Services coding
- UK Government's Common Procurement Vocabulary (CPV)
coding
Defining demand patterns and allocating
spending categories is a laborious task. It can entail the assimilation of data
streams and a form of analysis to transform the data into meaningful
information. This is enacted by considering the following:
Internal Needs: This should set a baseline for the
strategic category management process and provide a basic understanding of
sub-categories, significant suppliers, essential requirements, stakeholders,
and internal controls/policies currently in place. This part of the process is
instrumental when reviewing the category management strategy with someone
unfamiliar with the category and its scope.
Spend Analysis: The foundation of any category
management strategy depends upon a solid understanding of historical and
forecasted spending. With accurate detail, an organisation will find it easier
to formulate a practical strategy. Conducting a thorough spending analysis will
enable recommendations to be made to stakeholders, the bare minimum of which
should break the spending down by sub-category, supplier, location, and
business cost centre.
Supply Market Analysis: Understanding the supply market is
critical to developing a robust category management strategy. An organisation
will gather market intelligence and benchmarking information from various
sources. Commonly used market analysis tools are Porter's 5 Forces model and
the Structure, Conduct, Performance (SCP) model.
Category Segmentation: Segmentation modelling allows an
organisation to effectively apply the proper strategic category management for
the products or services that are being sourced and will prioritise where the
most strategic categories lie. For example, the Kraljic Matrix, developed by
Peter Kraljic, is a segmentation model that evaluates the two critical factors
of Value and Complexity. These factors are considered on a low to high scale
across a 2 x 2 matrix, creating four quadrants or categories such as:
- Strategic Items (High Value + High Market
Complexity/Supply Risk)
- Leverage Items (High Value + Low Market
Complexity/Supply Risk)
- Bottleneck Items (Low Value + High Market
Complexity/Supply Risk)
- Non-Critical Items (Low Value + Low Market
Complexity/Supply Risk)
Category Plan: The category plan will define a list of
initiatives, projects or tactics to deliver results. The category plan should:
- Initiate: Define the categories that the
purchasing function will manage.
- Prepare: Once the categories are defined,
plans need to be developed to enable a purchasing function to manage the
category in alignment with the organisation's needs and requirements.
- Prioritise: Aims need to be set to achieve
the organisation's needs and requirements, such as sourcing 50% of
direct-cost products from suppliers in the local area or only from
environmentally conscious suppliers.
- Define: The strategies that should be set
need to reflect the organisation's needs and requirements. For example, it
could be to contact all suppliers within a 50-mile radius and invite them
to tender for all indirect cost-related spending areas.
- Implement: Once strategies have been agreed
and approved, the purchasing function needs to work with stakeholders to
gain their "buy-in" to the category management strategies.
Everyone needs to support these to ensure their effectiveness in achieving
the organisation's needs and requirements.
- Maintain: The purchasing function will set
Key Performance Indicators (KPIs) or Service Level Agreements (SLAs) to
monitor and evaluate supplier performance. A typical KPI could be On-Time
in Full delivery, or "OTIF."
- Improve: Purchasing is a constantly
evolving function, so a relevant category may become obsolete,
non-critical, or move from direct to indirect spending. The review process
is critical to ensuring that categories remain relevant.
As organisations face ever-increasing
cost management issues, it is essential that they review their current and
future spend requirements. Not carrying out a financial review will invariably
increase costs by 7 – 9% per annum, higher than the open market.
Helping budget managers understand where
and how they spend an organisation’s financial resources will facilitate their
ability to set tendering or negotiation priorities and maximise cost
reductions for their current and future predicted spending.
However, this requires organisations to take
the initiative to review and coordinate their tendering and negotiating
activities, which rely on exact spending data. Purchasing in low-performing
organisations waits for budget managers to ask for help. In high-performing
organisations, purchasing provides the spending data for budget managers to
become initiative-taking in their tendering and negotiating activities.
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