Increasing Purchasing Clarity
Cost management principles encompass the
strategic allocation and utilisation of an organisation's financial resources
for management accounting. This involves a comprehensive approach to overseeing
and optimising the costs associated with operations, production, and other
business activities.
Category management, on the other hand,
involves a systematic and strategic procurement method. In this approach, an
organisation categorises and segments its expenditures on products or services
with high precision and clarity. This approach allows a more nuanced
understanding of where resources are allocated and how they align with the
organisation's objectives.
The segmentation of these expenditures
into discrete groups is tailored to the organisation's primary functions,
ensuring that resources are allocated to best support the organisation's
strategic goals and operational needs. Some of the major categories into which
an organisation might rationalise its spending patterns could include:
- Overheads.
- Warehousing & Distribution.
- Finance.
- Operations.
- Direct / Indirect spend areas.
- IT.
Defining Spend Categories
Category management is a systematic cost
analysis approach describing financial resource use. The descriptive process
allows the understanding of past and present spending patterns and is used to
determine the best method for achieving cost benefits. Preserving and improving
on commercial cost savings involves the apportioning of direct and indirect
spending 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, high levels of spend
are discerned, where attention should focus on leveraging the most significant
cost and efficiency savings. Category management is the most evolved strategy
of the three common management approaches, which include:
- Tactical purchasing.
- Strategic sourcing.
- Category management.
Category Management Strategies
The simplest form of cost management 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 strategic sourcing stages to capture increased levels of supplier value and
consolidate the supply base. The use of category management captures the
following advantages:
- Uses in-depth market insight to drive value to entire
categories to evolve in real-time as the supply market changes, based on
continuous evolution and improvement of total lifecycle costing.
- Is a dynamic approach that requires proactive
management and a shift toward peak effectiveness and efficiency in
purchasing practices, which is a moving target that changes with market
dynamics.
- Is classified as the strategic sourcing of products or
services based on a long-term approach to monitoring supply trends,
marketplace dynamics and the supplier landscape within a particular spend
area, often adjusted to reflect changing organisational and supply
conditions.
One of the primary roles of category
management is guiding stakeholders using a series of targeted questions.
However, one of the biggest misunderstandings of organisational stakeholders is
that the category management process tries to take over the stakeholders' role
in purchasing. A proactive purchasing function should be working with
stakeholders by highlighting and helping them to answer the critical questions
about:
- Demand and forecast patterns.
- Financial and commercial bottlenecks.
- Operational requirements.
- Quality issues.
Realigning Spending According to
Business Needs
To realign category management
strategies with business needs and objectives, typical outputs of the category
management process might include:
- The examination of historical purchasing patterns.
- Understanding critical financial systems.
- Alignment of features and requirements of the products
or services is necessary.
- A collaborative understanding of what quality looks
like.
- Deciding how quality should be delivered.
While there is no standard
categorisation or grouping of requirements within category management, the
process should start with grouping spend areas with similar characteristics.
Organisations could use the following to define spending categorisation standards:
- United Nations Standard Products and Services coding.
- UK Government Common Procurement Vocabulary (CPV)
coding
Defining demand patterns and allocating
spending categories is an uphill task. It can entail the assimilation of data
streams and analysis to transform the data into meaningful information, which
is enacted by considering the following:
Defining Internal Needs
Defining and exploring spending patterns
establishes a foundational framework for strategically managing spending
categories. It aims to provide a comprehensive understanding of the various
sub-categories within an organisation, identify and evaluate significant
suppliers, outline essential requirements for effective category management,
recognise critical stakeholders involved in the process, and assess the
internal controls and policies currently in place to support these activities.
Spend Analysis
To establish an effective category
management strategy, it is essential to have a comprehensive understanding of
both historical and anticipated spending patterns. Organisations can develop
more precise and actionable category plans by gaining accurate insights into
past spending and making informed projections for the future.
A thorough spending analysis should
encompass a detailed breakdown of expenditures by sub-category, supplier,
location, and business cost centre. This detailed approach will facilitate
formulating well-informed recommendations for stakeholders, enabling strategic
decision-making and resource allocation.
Supply Market Analysis
To develop a resilient category
management strategy, it is essential to have a comprehensive understanding of
the supply market. Organisations gather market intelligence and benchmarking
information from various sources, including industry reports, competitor
analysis, supplier assessments, and market trends. This information is vital
for making informed decisions and ensuring the success of the category
management strategy.
Category Segmentation
Segmentation modelling is a critical
tool that enables organisations to analyse and categorise their sourced
products or services based on various parameters such as customer demographics,
purchasing behaviour, or product characteristics.
By doing so, organisations can
effectively prioritise and manage strategic categories, allowing them to
allocate resources and focus their efforts where they will have the most
significant impact. This approach helps identify the most valuable segments, optimise
procurement strategies, and drive better business outcomes.
Category Planning
A Category plan will define a list of
initiatives, projects, or tactics to deliver results. The Category Plan should:
- Initiate: Define the categories that the
organisation will manage.
- Prepare: Once the categories are defined,
plans must evolve to enable an organisation to manage purchasing patterns
in alignment with its needs and requirements.
- Prioritise: Objectives must be set to achieve
the organisation's needs and requirements. For example, the organisation
could source 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 the strategies have been
agreed upon and approved, the Procurement function needs to work with
stakeholders to gain their "buy-in" to the Category Management
strategies. Everyone must support these to achieve the organisation's
needs and requirements effectively.
- Maintain: The Procurement 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: Procurement is a constantly
evolving function, so a relevant category may become obsolete,
non-critical, or move from direct to indirect at the start of a period.
The review process is critical to ensuring that categories remain
relevant.
A Category Management plan is an
organisational tool that allows budget managers to understand how financial
resources are used to enable priorities to define the highest risks regarding
commercial and legal issues, allowing the organisation to mitigate them
efficiently and effectively.
The Benefits of Spend Categorisation
Organisations that fail to analyse how
they spend their finances regularly may spend 16 – 21% per annum more than
organisations that closely monitor their spending patterns. To be
cost-effective, an organisation must periodically review what it spends, as
increased spending patterns may be incurred through:
- Spending ineffectively by purchasing products and
services that aren’t required.
- Paying prices 7 – 9% ahead of the open market.
- Incurring increased commercial, legal and Health and
Safety risks.
Analysing the items and services an
organisation acquires is essential in gaining insights into how it uses its
financial resources. This understanding is necessary before taking steps to
ensure the resources are utilised effectively.
By identifying the areas where spending
adds value and eliminating unnecessary or ineffective expenses, organisations
can significantly enhance their spending efficiency and the overall
effectiveness of their financial expenditure. This process involves an in-depth
examination and evaluation of every aspect of the organisation's procurement
and purchasing practices to optimise financial management.
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