Beyond procurement: Transforming indirect spending in retail

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If retailers treat indirect costs as an opportunity for business transformation rather than just a procurement matter, they can boost return on sales by as much as 2 percent.

For retailers seeking to cut costs and generate cash for growth investments, indirect spending can be a big untapped opportunity. Indirect costs—the goods and services that retailers purchase but don’t resell—are equivalent to 10 to 15 percent of sales on average, and most retailers know that their indirect spending is far from optimized. But while recognizing the potential is easy, capturing it has proven stubbornly difficult.

The challenges aren’t new. They include a lack of spending visibility, fragmented ownership and spend authority, a dearth of incentives to reduce indirect spend, and a siloed approach to procurement of not-for-resale (NFR) categories. In addition, indirect procurement typically focuses on negotiations with suppliers over price, rather than on higher-impact opportunities to optimize what and how the retailer buys. Our research has also shown that capabilities and resourcing for NFR procurement in retail are significantly weaker than in many other sectors: NFR goods and services are viewed as much less important than goods for resale, so the NFR sourcing staff tends to receive less management attention and less investment in talent. Furthermore, even NFR sourcing professionals typically have little expertise in NFR categories. Rare is the procurement team that has deep knowledge of, say, elevator maintenance or marketing-agency overhead costs.

Visionary retailers, however, are taking a radical new approach to indirect spending—and achieving radical results. These retailers aren’t viewing indirect costs as a concern only for the procurement function. Instead, they’re looking to transform indirect spending across the entire business. They’re overcoming the challenges by leveraging three new ways of working: a cross-functional approach that incorporates category-specific demand levers, the use of digital and analytical tools, and stronger supplier collaboration. And they’re taking specific actions to bring about lasting change in mind-sets and behaviors.

In doing so, retailers are shaving as much as 10 to 15 percent off their annual indirect spend, capturing impact worth 1 to 2 percent in return on sales, and seeing a more than fifteen-fold return on the cost of their NFR sourcing team. We’ve found that the value at stake is remarkably consistent across retailers—even at those that have been working on reducing indirect costs for a long time, whether in-house or with external support.

A business transformation

To capture maximum value from a cost-reduction program, retailers must be deliberate about the program’s scope and ambition level. A broad scope and high targets are indispensable elements of a truly transformative effort.

Historically, retailers have cut costs primarily by reducing store labor or travel expenses. Few retailers have tapped into the full potential of optimizing NFR spending (Exhibit 1). Furthermore, even retailers explicitly seeking to reduce indirect spending sometimes ring-fence certain cost categories as “not addressable.” For instance, some retailers consider marketing expenditures out of scope; their rationale is that marketing is critical to the core business of retail. Other retailers don’t bother trying to lower rents, because they assume that they can’t renegotiate terms unless they’re in financial distress. Some indirect costs—such as supplier-managed logistics—remain unchallenged because they’re “hidden” in cost of goods sold. And some retailers look for cost-reduction opportunities only in operating expenses, leaving all capital expenditures untouched—even though the latter often has higher savings potential (as a percentage of costs).

Exhibit 1

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Source: McKinsey&Company
By Steve Hoffman and Patrik Silén
Date: August 2018