When working in procurement, mastering the terminology is crucial for analyzing and optimizing your company’s spending. Two often misunderstood terms are “Spend Under Management” and “Addressable Spend.” As a Procurement professional, I’ve seen firsthand the confusion these terms can create during presentations of spend analyses. This blog post aims to clarify these concepts and provide an illustrative example of a spend analysis to enhance your understanding.

Spend Under Management refers to the portion of your organization’s total spend that is actively managed and influenced by the procurement department. This includes all expenses that are subject to procurement policies and procedures, from supplier selection and negotiation to contract management. The key aspect here is the degree of control procurement has over the spend; the higher the percentage of spend under management, the greater the opportunity for cost savings and efficiency improvements.

What is Addressable Spend?

Addressable Spend is the portion of an organization’s overall spend that can potentially be influenced by procurement practices. It excludes categories like taxes, inter-company transfers, and other non-negotiable expenditures. Essentially, it represents the total spending that could be put under management if procurement strategies and processes are fully implemented.

The Relationship Between the Two

While all Spend Under Management is part of Addressable Spend, not all Addressable Spend is currently under management. The goal for any procurement function is to increase the proportion of Addressable Spend that comes under management, thereby maximizing cost savings and optimizing spending patterns.

How do you calculate spend managed?

Imagine a company, XYZ Corp, with an annual total spend of $100 million. Here’s how Spend Under Management and Addressable Spend might be presented in a spend analysis:

• Total Spend: $100 million
• Addressable Spend: $80 million (excludes $20 million in non-negotiable expenses like taxes and dues)
• Spend Under Management: $50 million (currently actively managed by procurement)

Calculating spend under management kpi. This means 50% of XYZ Corp’s total spend is managed by procurement, and there is a potential to increase spend under management with an additional $30 million (the difference between Addressable Spend and Spend managed).

Spend under contract

“Spend under contract” typically refers to the portion of an organization’s spending that is governed by formal agreements with suppliers. This spending is usually considered both addressable and under management because it falls within the purview of procurement policies and is actively overseen through contractual relationships.

However, during the contract term, the nature of how this spend is considered “addressable” can vary depending on specific circumstances and the flexibility of the contract:

1. Locked-in Contracts: If the contracts are fixed and provide no room for renegotiation or modification during their term, this spend might be considered temporarily non-addressable in terms of making changes to suppliers, prices, or terms until the contract is up for renewal. In this scenario, although the spend is under contract (and thus under management), it is not immediately addressable for further optimizations.
2. Flexible Contracts: Some contracts may allow for adjustments during their term, such as periodic reviews of service levels, pricing based on market conditions, or volume adjustments. For these types of agreements, the spend remains addressable because procurement can influence the contract conditions and optimize spending even within the contract term.

Potential saving

When conducting a spend analysis, identifying potential savings is a key objective. Potential savings refer to the opportunities to reduce costs without compromising on quality or service levels. These savings are crucial for improving the financial efficiency of an organization. Here’s how potential savings are identified and what they might include:

Types of Potential Savings

1. Price Reductions: This involves negotiating lower prices for the same goods or services. It can be achieved by leveraging volume discounts, consolidating purchases to fewer suppliers, or renegotiating contracts based on market price benchmarks.
2. Process Improvements: Savings can come from streamlining processes, such as automating procurement tasks, reducing order processing times, or minimizing errors and rework. This reduces labor costs and improves cycle times.
3. Product Standardization: By standardizing products or services across the organization, a company can reduce complexity and increase purchasing power, leading to lower costs.
4. Demand Management: Reviewing and controlling the quantity and frequency of purchases can lead to significant savings. This might involve eliminating unnecessary purchases or substituting less expensive alternatives.
5. Supplier Optimization: Shifting to suppliers who can offer better rates or more favorable terms can generate savings. This may also involve improving supplier relationships to secure exclusive deals or incentives.

Category Management

Category management on the other hand, is a strategic approach that organizes procurement resources to focus on specific categories of spend. This involves segmenting spend into distinct groups of products or services that are managed collectively to optimize sourcing and supplier relationships. By developing deep market insights and leveraging data analytics, category managers can identify opportunities for cost savings, risk reduction, and innovation.

The Connection:

1. Enhanced Spend Visibility: Effective category management relies on comprehensive spend analysis to identify spend patterns and trends within specific categories. This enhanced visibility allows procurement teams to bring more spend under management by strategically targeting categories that were previously unmanaged or under-managed.
2. Strategic Sourcing: With category management, procurement teams can implement tailored sourcing strategies for each category, leading to more effective negotiations and supplier management. This strategic approach helps increase the proportion of spend that is managed actively, driving better value for the organization.
3. Cost Efficiency: By categorizing spend and applying specialized knowledge and strategies to each category, procurement teams can identify and exploit cost-saving opportunities. This, in turn, increases the efficiency of managing spend and ensures that more of the organization’s expenditures are optimized for cost and performance.
4. Supplier Relationship Management: Category management emphasizes building strategic partnerships with key suppliers. This collaborative approach improves supplier performance and innovation, contributing to better management of spend and more favorable terms and conditions.
5. Risk Management: By understanding the risks associated with different spend categories, procurement teams can develop targeted risk mitigation strategies. This proactive management ensures that spend managed is not only cost-effective but also resilient to market fluctuations and supply disruptions.

Bringing it together.

Understanding and increasing your Spend Managed, and identifying the full scope of your Addressable Spend, are crucial steps towards optimizing procurement functions. By applying category management and supporting sourcing events, you can ensure more of your company’s spending is actively controlled, leading to significant improvements in cost-efficiency and effectiveness.

By clarifying these terms and their applications in a spend analysis, procurement professionals can better communicate their strategies and outcomes, paving the way for more informed decision-making across the organization.

Spend managed and category management are interlinked concepts that, when effectively integrated, enhance the procurement function’s ability to control costs, improve supplier performance, and drive overall value for the organization. Through category management, procurement specialists can strategically manage a greater portion of the organization’s spend, leading to better financial outcomes and operational efficiencies.

Learn more in the course: Spend Analysis by EFFSO. Spend analysis is the process of collecting, cleansing, classifying, and analyzing expenditure data with the goal of reducing costs, improving efficiency, and monitoring compliance.

About Learn How to Source

Learn How to Source (LHTS) is an online platform based in Sweden, offering a range of procurement courses accessible globally. It serves as a community where procurement experts share their knowledge through online courses, designed for various experience levels from introductory to expert. Courses are concise, about 30 minutes each, and cover different aspects of procurement, tailored for different buyer roles. The courses focus on practical knowledge, presented by seasoned professionals, and includes quizzes and certificates. They can be accessed from any device, emphasizing microlearning for flexibility and efficiency. Learn more in the Introduction course.

About EFFSO

Get unbeatable procurement results! EFFSO’s extensive experience in procurement enables organizations to achieve concrete results. Regardless of the challenge!

EFFSO is a leading procurement consultancy in the Nordics, passionate about procurement excellence and change management. Since 2007, they’ve offered expert management consulting services in procurement, including spend analysis, potential assessment, category management, and more. EFFSO’s experienced consultants manage everything from category projects to coordinating major transformations for procurement functions. They focus on developing procurement operations to achieve tangible results, enhancing the value of procurement in organizations. EFFSO also values nurturing procurement talent, offering great development opportunities and a friendly workplace. Why not try the EFFSO bundle explaining the basic terms in procurement or an EFFSO introduction to procurement course.

Illustration to the blogpost was created by Chat-GPT on April 21, 2024. 

Visit Utbildning Inköp for information in Swedish about LHTS’ courses.