When, Why, and How to Get Started with Category Management
In a smaller business, procurement tends to be informal and transactional. There’s probably someone in operations, or an admin, whose job it is to go out and buy things. There’s no sourcing being done. They simply search online and buy what they need, and that’s fine.
However, as businesses grow to mid-size, they become aware that they could be getting more leverage from their increasing spending. But, attacking that is not really on anybody’s plate.
Eventually though, someone takes a look at the financials and they see that have multiple contracts with the same supplier, but for different business units, or even for the same group. For example, the finance group might have a contract with Ernst & Young to do auditing and a separate contract with them to do accounting. That naturally leads people to ask, “Why aren't we leveraging our spend across these different business units and functions?” and “What's the right way to structure procurement in order to do that?”
Nine Out of Ten Consultants Recommend . . .
Nine times out of ten, the answer is to get started with category management.
What is category management? I define it as having the ability to understand your internal customers' needs in a given service and/or materials category, and translate that into a model where you're meeting those needs while getting the greatest value from your suppliers.
For example, let’s say you’re a CPG company with ten brands in three different food categories. Should you have ten advertising agencies--one for each of those individual brands? Should you have one agency for each of those three food categories? Or does it make sense to have one agency for everything? That’s the beginning of category management thinking.
Depending on the industry you’re in, when you have somewhere between $200 million and $1 billion in revenue, that usually translates into enough supplier spend for your company to benefit from category management. Here’s how:
1. Improved Pricing and/or Terms and Conditions. By aggregating all of your spending, you should be able to get more favorable pricing. That can come in the form of better unit prices, but it can also be rebates, or better payment terms. Maybe you’d like to pay in 60 days instead of 30. Or, if you’ve got plenty of cash and an efficient AP department, maybe you’d rather have 2% net 10 discount terms.
2. Better Supplier Performance. When you’re negotiating supplier contracts instead of buying on the open market, you have the opportunity to introduce performance measures and bonus-malus business arrangements. For example, you could negotiate a bonus for beating the delivery deadline, or a penalty for missing it. The point is not to beat up on your suppliers, because it cuts both ways—there may be things they need from you in order to perform optimally. The point is for each side to understand which things are non-negotiable and where there’s flexibility, and to align around what the expectations are and hold everyone accountable for meeting them.
3. Shorter Purchase Order and Invoice Processing Cycles. Category management introduces standardization, and that speeds up processes. For instance, the first person who typically sees an SOW from a supplier is the category manager. Because the category manager has seen multiple SOWs coming back from multiple suppliers, they have a better understanding of what they are looking at in terms of pricing, SLAs and terms and conditions, and they can execute faster.
4. Fewer Supplier Contracts. Part of the purpose of category management is to have better relationships with fewer suppliers. That also speeds up processes because you have less to manage in terms of risks, setting up vendors, verifying invoices, etc.
5. Greater Internal Client Satisfaction. The category manager is the market expert and go-to person for all things related to a given project or managed service. They gather requirements, collect bids and negotiate contracts. That frees up time for business people to focus on their jobs, and should deliver better value to them.
6. Improved Supplier Relationships. Category management lets you establish single points of contact within your organizational structure, and maybe even roll those up into an account management structure where coordination takes place at the highest level and specific tasks are delegated out at the business unit or functional level. Clarifying and streamlining communication in that way usually improves relationships.
7. Improved Visibility Into Spending. When nobody owns a category, there’s no one who can say whether the spend that's being reported is accurate or not, because they're not seeing all the contracts coming in. They don't know the full list of suppliers, or the full extent of spending.
As you can see, the benefits are many. So, when would you NOT employ a category management model? If you have less than $200 million in revenue, you probably don't have enough spend to leverage to pay for the program.
Another case might be if you’ve got business units with completely different purchasing needs, such that there’s no overlap. For example, let’s say you’re a conglomerate with a unit that makes perfume, and another unit that makes steel. It sounds far-fetched, but I actually do know of such a company.
But, even in that situation, if the level of spend warrants it, you could put together a hybrid model with category managers at the unit level specialized in the needs of that business unit, and category managers at the organizational level handling office supplies and MRO services for both units.
With a few exceptions, getting a category management program going is an excellent choice for mid-market companies. Otherwise, you have a lot of duplication of efforts, and you’re not leveraging your growing spending power. You can achieve maybe 50-60 percent the value you could if you had a proper category management structure in place.
So, how do you get started? The first thing you have to do is dig into your data and figure out how much you’re spending in different categories, and where you’re going to have the most leverage.
If you’ve been running an ad hoc, transactional program, this is going to take some time and discipline up front. A lot of companies don't have one single source of truth. They have multiple ERPs due to mergers or acquisitions, so somebody has to come in and normalize all of that data categorize it accurately.
Once you have a clear view of what’s being spent where, then you can start to figure out what categories you want to tackle first, and how you want to do it. There are several different ways you can go about it.
You could have a full category coverage model internally, which could include unit level category managers, centralized category managers, or a mix of both, as mentioned previously.
You could outsource the whole thing to consulting company, or you could have what I call a flex model, where you cover most of the categories internally, and bring in consultants for spot buys and with infrequent large purchases where it doesn’t make sense to bring in specialized expertise on a permanent basis. These decisions are going to vary a lot from company to company.
The Right Tool
What doesn’t vary is that you’re going to need to support the program with a proper spend management platform so that you have the tools, dashboards, data and intelligence you need to optimize the program. You only want to have to go through that big, manual spend categorization exercise once.
If you don’t have a good tool, you usually end up only hitting about 60 percent of the spend in a given category, either because the other 40 percent is uncategorized or miscategorized and the category manager doesn’t even know it’s out there.
This is a program that should pay for itself in the short term. Over the long term, a strong category management program, staffed with category managers equipped with the right tools and data can become a strategic asset that can have a real impact for midmarket companies.