The current economic turmoil is causing multiple issues for big corporates, and it is the cumulative effect of these challenges which means businesses are entering unchartered waters. When faced with economic turmoil in the past, big corporates have usually been able to overcome the challenges they face as the issues have occurred individually or in small clusters. However, the snowball effect experienced since 2009 has resulted in many businesses facing an overwhelming number of challenges simultaneously. And the old rules no longer apply.
The typical response to a drastic shrinkage in the top-line is a series of cost-cutting initiatives. But the initial wave of cost cutting initiatives that took place (reducing head count, closing retail stores, cutting budgets, etc) were often not sustained into 2011; they were done to release cash in the short-term and once the breaks came off, costs crept back up. Even where they have been sustained, what’s next on the agenda to improve the situation? Very few businesses have looked to fundamentally changing their expenditure patterns.
Organisations generally have good controls in place over their core costs. However, the same can not be said for non-core spend. Why is this? When you consider that on average organisations spend 10-15% of annual revenues on non-core products and services, meaning hundreds of millions of pounds for large corporates, it should be a top priority to focus on this area. Transforming how non-core costs are managed can drive the following benefits:
- Increased availability of cash: tens of millions of pounds of savings are achievable in large corporates, which, if captured, go straight to the bottom line and thereby increase enterprise value. Cash is often unnecessarily tied up in stock, which through better management can become liquid and reinvested back into the business or banked. And improved working capital management, by taking advantage of agreed payment terms, or even taking advantage of early payment discounts in times of high cash levels.
- Changed cultural approach to cost management and ultimately changed buying behaviours.
- Greater visibility over spending activity – we typically find that business not only don’t have visibility of their spending activity, but don’t even know how much their non-core spend is.
- Greater spend control, and control over what is going on in the business.
- A forward-looking approach, which anticipates needs and solves problems even before they arise.
- Demand management.
- Supplier-led innovation.
- Improved compliance.
- Efficiency improvements through reduced number of suppliers, and reduced accounts paybable (AP) headcount.
Considering the list above, it is hard to understand why in the vast majority of businesses the management of non-core spend is: low on the priority list; is hugely under invested in, under appreciated by the business, and generally misunderstood. The money that is left on the table is vast, and real improvements in operational performance are missed.
To put this into perspective, in the first six months of 2011 we delivered over £30m of in-year cash savings to a UK FTSE 100 business.
Case Study: £90m in Bankable Savings Over Two Years
A UK and FTSE 100 retailer, looking to drive maximum benefit out of its non-core spend (which is called goods not for resale (GNFR) expenditure in the retail world) and in response to diminishing top-line growth, approached buyingTeam to discuss a sustainable, tailored solution to its unique and complex business model.
It was recognised that price wars, inflation and the stagnating economy were putting pressure on the retail market and that competition for market share would only intensify. In response the FTSE 100 retailer recognised that GNFR procurement could be the driving force behind a business-wide initiative to change the way it operates and thus engaged with buyingTeam to support this initiative.
The GNFR purchasing team was responsible for less than 5% of total GNFR spend, the majority being managed by individual business divisions. It was evident that an inconsistent approach to procurement could lead to business risk, particularly when the decision was made that the code of conduct relating to goods for resale suppliers would also be applied to GNFR suppliers.
buyingTeam was charged with the role of repositioning and redefining procurement within the business to improve operational performance and bottom line profitability. A first year target of £30m in-year savings was set, although considerable emphasis was also placed on the need to mitigate supplier risk and embed best-practice procurement throughout the business.
Within the space of six weeks, the GNFR team went from being a necessary evil to a service provider massively in demand.
Over the course of the 24 month engagement with the retailer, total project savings of £90m have been delivered back to the business. In addition to this significant saving number, risk mitigation and process improvements were also delivered above expectations.
What is significant about these achievements is not only that the GNFR team was able to overcome what had previously been an inwardly-focused silo culture, but it is the speed and scale at which this was achieved.
The level at which the GNFR team managed to obtain the engagement of the functional stakeholders is also incredible considering that the ultimate aim was to cut its budgets.
Key to successful management of non-core spend is understanding the nature of the activity that is going on – it is very different to core spend and it demands a dramatically different response. See Figure 1 which demonstrates this point.
The key point to understand why non-core spend requires a different response to core spend lies in two fundamental points:
- Non-core is made up of hundreds of areas of spend, each requiring deep expertise to effectively manage the costs. Yet to have this expertise in-house would be prohibitively expensive. So the typically response from organisations is to have generalists to manage the spend and thereby accept mediocrity.
- Because businesses fail to understand the area of non-core spend, they target the procurement function managing the spend in the wrong way – focusing them mostly on like-for-like in-year savings. Give this some thought and you will see that it is a short-term, flawed approach – the real value from managing non-core costs comes not from focusing on the supplier base and achieving a great deal (although of course this is important), but from turning the attention inwardly to: the organisation itself; the behaviours of the people within the business; the business rules that underpin the activity; what is fuelling the demand; policies and procedures; and the approach to risk.
What the procurement function needs to become is a partner to the business – to the functional managers, business units, the operational heads and ultimately to the finance community. The procurement function can, and should, be viewed as a strategic support function at the heart of the business driving change and challenging behaviours – and be managed as such.
There is a parallel journey that has already happened that maps out the path in which procurement needs to follow: the finance function. Go back 25 years and the role of the finance function was largely a backward-looking, accounting-based number-crunching function. Today, this is changed beyond recognition to also become a strategically important function looking at business performance and future strategy. Procurement needs to go on a similar journey from being a supplier negotiator armed with a big stick, to a driver of change within the organisation, armed by strong influencing, communication and leadership skills.
What can be done?
Managing non-core costs effectively requires a huge variety of skill sets – skills which are a far cry from the classical view of a strong negotiator, working from a position of power, where communications skills are deemed surplus to requirements. Skill sets such as:
- A very broad range of deep category expertise – which needs to be constantly up-to-date. This is a real challenge due to the constantly changing nature of best practice in each of the hundreds of categories, the volatile commodities markets, evolving technologies, etc.
- Instinctive commerciality.
- An understanding of all areas of the business and the ability to have a business conversation – not just a procurement conversation.
- Excellent change management and facilitation capabilities.
- Influencing skills.
- Rapport building – and the ability to interact and engage with people across the business at all levels from the board down.
- Negotiation and supplier management.
- Data analysis (turning raw data into business insights and intelligence).
- Technological know-how.
The reality is that having all of this capability in-house is too expensive for all but the very largest of businesses, particularly when you consider the importance of having up-to-date expertise in all spend categories.
Options for Effective Management of Non-core Costs
The challenges of managing non-core spend more effectively, mentioned above, hinge on the ability of the procurement professional to constantly engage with internal stakeholders which often results in the assembly of large teams that can beunderutilised if each team member specialises in a particular category, underperforming if they generalise, or underappreciated if they do not perform effectively and commercially alongside their stakeholders.
There are three options available in pursuit of better management of non-core costs:
- Build in-house capability.
- Bring in interims/consultants.
- Outsource to an external provider.
The table available here explores each of these options. All options have their pros and cons. The arguments for and against outsourcing, in particular, are heavily influenced by your organisation’s own unique internal factors, such as the company structure, corporate values, beliefs and culture, the current in-house capabilities, past experience of outsourcing, etc.
However, the arguments for outsourcing are many and largely outweigh the pros of keeping the function in-house. Yet, many chief financial officers (CFOs) and senior executives still remain unconvinced, or perhaps more likely unaware, of the benefits that procurement can deliver, let alone what is achievable on top of this through procurement outsourcing.
There is a contradiction between what senior executives say they want and their on-going behaviour. buyingTeam recently ran a study in conjunction with NelsonHall that included the views of 120 CFOs and chief procurement officers from Europe and North America to uncover how non-core procurement is viewed by the wider business, including senior executives and board members.
The study found that 53% of today’s senior executives are looking to drive more value from their procurement operations. It also found that over 70% of CFOs are seeking a strategic business partner from their non-core procurement function rather than a tactical support function (yet only 46% express satisfaction with the extent to which this happens in their organisations). So there is a desire to improve the current situation, and yet it’s not being acted on at present. Perhaps the reason why the change is not being seized is a lack of awareness of the procurement outsourcing model and the wide array of benefits it can bring and sustain.
Outsourcing has become mainstream in HR, finance and IT – and while procurement has been predicted to follow for several years now, it is not being adopted at the same rate. This is because it is a different type of outsourcing, and this has not yet been realised by the market. Procurement outsourcing is about doing something much better and getting a large return on investment (ROI) in return (we typically see ROIs of 5-10 times). This is very unlike the human resources (HR), finance and IT models which are about running the same processes more efficiently and for less money.
Procurement outsourcing is slowly building its own head of steam. The early adopters that are being open minded and inquisitive enough to understand the model are fast reaping the benefits ahead of their competition. And they are fairing the current economic turmoil far better than their competition and shall emerge as leaner, fitter, stronger businesses.
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