In the face of a likely post-pandemic recession, finance leaders are focused on maintaining day-to-day operations, identifying potential risks, growing the business where they can, and avoiding layoffs.
During the Great Recession from 2008 to 2012, we helped hundreds of organizations accelerate bottom-line savings during a time in which it was challenging to grow top-line revenue. That experience has informed our perspective that this time companies must embrace new ways of managing spend. Those that do will outperform their peers.
What Can You Afford to Spend?
Recessions require a mindset shift in managing spend. CFOs need to go from, “How can I pay less for what I already buy?” to, “How much should I spend, period?” To do this, it is critical to understand the spending landscape by leveraging data to build a spend cube and appropriately classify spending into relevant categories.
With spend visibility, it becomes possible to partner with key business stakeholders, closely scrutinize spend, and make decisions from the bottom up. Once you go back to ground zero and determine what the organization can afford, you can challenge what to buy, including the need, specification, and service level. Then, and only then, should the CFO and his or her staff focus on how much to pay for what it buys through sourcing and negotiations.
Challenge Spend and Manage Demand
One way to challenge spend is to use top-down benchmarking to detect overspending. Common methods include reviewing spend categories as a percentage of revenue, per employee, per location, or even per square foot. Once finance has the estimates, it can compare these ratios both internally and externally to understand what costs should be. Then, it can engineer specifications and service levels to meet cost targets.
Demand management includes strategies such as reducing consumption, standardizing or substituting the products or services you buy, or changing what you buy altogether (re-specification). It can drive up to 60% of the cost savings of a spend optimization initiative. (See chart, Proportion of Value by Lever and Category.)
In normal times, it can be challenging to get organizational alignment for these kinds of changes; however, in recessionary times, when every dollar matters, if the changes are analyzed and presented in the right way there is significantly more openness to change.
Paying the "Right Price"
Uncertain conditions and a softening economy create opportunities to drive aggressive price-related savings. This can be done through, among other tactics, volume optimization, unbundling, disintermediation, and global sourcing. Given the unprecedented supply and demand forces in today’s economy, it is critical to closely monitor market conditions and dynamics for a given category.
One approach to determining whether the company is paying the “right price” is "should-cost" modeling. Understanding the underlying cost structure within a category and leveraging a “bottom-up” approach to determine the "should-be price" illuminates savings levers. As such, it allows the company to determine the best-fit sourcing strategy to pull those levers. Whether market conditions are changing favorably or unfavorably, the approach allows management to understand:
Is pricing fair? Are adjustments from suppliers appropriate?
Are there unidentified cost savings in other areas that may not be accounted for?
Is there a way to better leverage indices, whether actual or synthetic, that will tie to market fluctuation so that if there's another dip the company gets a pass-back?
Leave No Stone Unturned
On average, procurement organizations influence only 30% to 40% of spend strategically. They proactively challenge needs and specifications and lead supplier negotiations and selection processes. Our analysis shows that procurement typically has the least influence in five areas: real estate and facilities, marketing, human resources, information technology, and professional services.
In an economic downturn, CFOs and other executives need to partner with procurement leaders to deliver savings in every area possible — including the untapped ones. Based on reports from hundreds of our clients, CFOs who work alongside their procurement officers can dramatically improve their EBITDA through procurement-related optimization and mitigate risk through supplier resiliency.
Successfully penetrating the areas where procurement has historically been on the sideline requires more than a simple request-for-porposal process. Instead, it requires a deep understanding of the supply market and best practice cost structures. It also requires analytical expertise.
Quick Wins Through Compliance
Even where procurement is involved in the pricing and supplier selection process, the level of compliance, defined as the proportion of spend with preferred vendors, averages 46%. (See the chart, Proportion of Spend With Preferred Suppliers). This significant savings leakage cannot be allowed to occur during a recession. There could be legitimate reasons for leakage. But assuming qualified suppliers were selected and requirements were well understood, the company can capture immediate opportunities by driving greater compliance against preferred programs.
Enforcing compliance requires organizational alignment that starts with the C-suite. It requires clarity regarding decision rights; defined roles and responsibilities between procurement and business or functional stakeholders; and a system to track compliance and execute corrective action plans. Such a governance structure establishes and manages accountability, minimizes savings leakage, and ultimately drives meaningful savings results.
For companies bracing for an economic downturn, the degree and rigor with which spend is managed will be a key factor in how severely impacted they will be by a recession and what state they will be in once the economy returns to growth. Remember to always
- Start from ground zero before spending;
- Think about costs well beyond the price;
- Leverage data to stay in front of market changes; and
- Maintain disciplined spending to achieve maximum savings.
Brian Prantil and Jake Wojcik are executives at Insight Sourcing Group. They provide consulting services on strategic sourcing, cost optimization, and procurement operational transformation.