Delivering sustainable savings from third party spend

Graeme Morris a Senior Manager in our operational transformation team looks at how to deliver sustainable savings from third party spend.

In today’s market conditions, increasing numbers of businesses are looking closely at their costs. Top line growth is hard to achieve when the increased cost of living is putting a squeeze on consumers, interest rates are high and input costs are escalating, while Supply markets are volatile given geopolitical tensions and disruptions. It is unsurprising therefore that UK profit warnings have risen to their highest levels since the financial crisis and that in response costs are under such increased focus.

To tackle costs, it doesn’t take long before the focus falls on the supply base. After all, this is where anything from 50-80% of most organisations’ costs sit. However, it’s often an area where there is a lack of transparency and it’s hard to gauge value for money, with much focus being placed on the price of goods and services as an indicator of cost performance. Most businesses will probably have reasonable visibility over key commodity costs, but the picture is usually much less clear in other areas such as the services a business procures from third parties. How much are these services actually costing, how much value are they delivering, and how does the cost and value delivered compare to other options such as managing services internally instead, or revising the specification of goods?

In many cases, there is also still an overhang from times when supply chains were highly challenged and constrained in the wake of the pandemic. Many businesses responded to these constraints by over-ordering, paying a premium to secure supply or putting excess capacity into their supply base, to cover themselves against a shortage. There are still flare points today such as in the Red Sea and volatility will continue – but businesses need to look carefully at their supplier risk approach and inventory position to ensure its fit for this point in the economic cycle. Action is needed.

Traditional responses to these problems tend to be a blunt instrument that don’t yield sustainable results, focusing on price rather than the total cost of acquisition which can often result in unexpected additional costs. Introducing a diktat, for example, to reduce spend in all areas by 10% is a crude measure that could result in cutting some activities which help achieve growth. In other words, blanket budget freezes and reductions risk cutting into the bone as well as the fat. They also miss the opportunity to reconfigure the supply base around what the future business needs (taking account of areas like the ESG agenda, net zero, and supply chain innovation) and often restrict supplier ability to be innovative in delivering value.

Another measure sometimes used is to make a cash call on suppliers – asking for a rebate on past business or a discount going forward. This is another blunt instrument that risks irreparably damaging relationships, leading to quality and performance reductions in key areas of spend. There may be a time and a place for cash calls, particularly if the situation is sudden and severe, but it’s a mechanism that should be used carefully and sparingly.

At KPMG, we advocate a different approach. Taking cost out of the supply base needs to move beyond blanket measures in the here and now to take a whole life view of the total cost of acquisition. By examining the 4 Cs – compliance, cash, consumption, and cost – we bring an end-to-end solution that is correctly targeted, gives a 360-degree view, and tracks savings right to the bottom line.

Firstly, compliance. This includes looking at past spending. Through reviewing contract compliance, it is possible to look back at spending and assess whether you are eligible for cash rebates due to duplicate invoices, billing at incorrect rates, recovery of warranty or service credits that were due. This process routinely yields unexpectedly high financial returns without damaging supplier relationships.

Then it’s about looking at how the organisation presently spends cash. The focus here is on optimising working capital and payables to free up liquidity. This involves looking at payment terms, payment processes and payment policy – and re-aligning with leading practices by spend category and geography. This could free millions of extra working capital to fund operations.

Consumption comes under the microscope too. Are you ‘gold plating’ certain services or products from suppliers – paying a premium for a level of quality you don’t need, a service level that is unnecessary, or packaging that is overengineered and expensive to dispose of? Are you utilising all of the goods and services you are buying? Realigning what your business buys with what your business really needs will be a large driver of savings.

Another area we help clients work through is the cost of maintaining suppliers. This is about getting the right suppliers on the right commercial terms. It may involve retendering or renegotiating key contracts, changing suppliers where necessary, consolidation of suppliers, looking at the insourcing vs outsourcing mix, product standardisation, redesign, or reconfiguration in the light of changes to input costs or moving to output specifications to open up competition. A further longer-term aspect may be considering a migration to a sophisticated procurement system if one is not already in place that gives greater visibility, granularity, and control over the supply base.

Key to our working are advanced data & analytics, along with AI-driven tools that unearth and accelerate savings. Through data & analytics, we bring penetrating insight into spend patterns and where cost is leaking. We can apply a range of AI tools that unlock real value. For example, using AI solutions to read supplier contracts, orders, and invoice data to identify areas where suppliers have not invoiced in line with the agreement, rebates have been missed or service credits are due. We can also help deploy automated sourcing solutions to negotiate with and rationalise tail spend suppliers. It is even possible for the AI to carry out automated negotiations itself! With tail spend, this is often a more cost-effective method than to tie up a procurement professional’s time on small individual contracts – collectively, however, these renegotiations add up.

In our experience, when third party spend is placed under the microscope, significant savings and sustainable improvements can be made. The time is ripe to make them.

Ask yourself the following:

• Are we looking beyond raw budget cuts and exploring all the cost reduction levers
• How well do we manage our supplier lifecycle and relationships to prevent spend leakage, unmanaged commitment of cash and ensure suppliers are meeting their commitments?
• Are we involved at key decision points in our buying process to ensure we get maximum value?
• Do we have proper visibility of our third-party costs base and a thorough understanding of our total cost of acquisition?
• How are we driving sustainable cost reductions and tracking that these lead to long term margin improvements?
• Are we exploiting digital solutions to drive process efficiency, accelerate and amplify our savings?
• Do we have the right people doing the right things at the right time – are we properly utilising skilled buyers to drive value by reducing their time spent on low-value adding, transactional tasks?