Introduction

In today's rapidly evolving business landscape, strategic cost management plays a pivotal role in maintaining competitiveness. Selling, General, and Administrative (SG&A) expenses and indirect spend are often key areas where significant cost optimization potential exists. However, these elements of the financial framework are frequently overlooked or treated independently, leading to missed opportunities for efficiency gains and cost savings. Understanding the interplay between these two categories and carefully managing them can result in significant benefits. Still, it is also vital to remember that overemphasis on cost reduction in one area without considering its impact on the other could lead to unwarranted cost escalation.

However, to realize the full potential of commercial optimization and to improve the company's competitive position, it is necessary to build a compelling and comprehensive indirect spend plan that addresses these focus areas in line overall business strategy of the company.

To be competitive, procurement organizations need to cover three key areas when developing their indirect spend strategy:

1. How to link indirect spend to SG&A optimization measures

2. How to prevent savings leakage

3. How to leverage technology in SG&A and indirect spend management

These building blocks should be on top of every CPO's agenda as they guide the development and execution of an indirect spend procurement strategy that will not only help procurement departments to boost their own operational performance but also contribute significantly to the company's overall strategy as a driver of transparency, budget control, collaboration and third-party integration.

A Closer Look at SG&A Optimization

SG&A costs include all non-production costs, such as those related to sales and marketing, administrative overheads, and other general expenses. These costs, if left unchecked, can negatively impact a company's bottom line. Techniques to optimize SG&A costs vary, ranging from process automation to strategic outsourcing or demand management. While these strategies can unlock substantial cost savings, the journey is often fraught with hurdles such as organizational resistance, maintaining service quality during transition, and managing the potential impact on indirect spend.

It's important to realize that while SG&A optimization is a key aspect of cost management, an excessive focus on SG&A reduction without considering its effects on indirect spend can lead to a surge in overall costs. For instance, a significant reduction in administrative personnel in the name of SG&A cost optimization might reduce oversight over procurement processes, resulting in an uncontrolled rise in indirect spending.

Understanding Indirect Spend

Indirect spend encompasses expenditures not directly tied to the production process, including office supplies, IT services, professional services, and maintenance contracts. These costs, often distributed across multiple business units, can rapidly accumulate if not properly monitored and managed.

Effective management of indirect spend often includes strategies like centralized procurement and strategic sourcing. However, drastic reductions in SG&A without considering the impacts on indirect spend can lead to counterproductive results. For example, if you reduce personnel on the SG&A side, it could lead to the procurement department sourcing more external staff, capabilities, or services, resulting in an increase in total indirect spend.

Linking SG&A Optimization with Indirect Spend

A strategic, integrated approach to SG&A optimization and indirect spend management can offer substantial cost savings. By fostering a culture of cost-consciousness across the organization and extending it to the indirect spend, organizations can drive down costs through economies of scale and operational efficiency. However, this approach requires a thorough understanding of the interplay between these two areas. Any attempt to achieve cost savings in one area should consider the potential impact on the other.

Preventing Savings Leakage

Savings leakage often results from an imbalance between SG&A and indirect spend strategies. It can occur due to non-compliance with procurement policies, unauthorized spending, or ineffective contract management. An overly narrow focus on SG&A reductions can inadvertently drive-up indirect spending, leading to savings leakage. Therefore, to prevent savings leakage and maximize cost benefits, organizations need a comprehensive approach that combines procurement optimization, stringent demand management, and strict contract compliance.

Potential Areas of Savings Leakage

In our experience at Alvarez & Marsal, we've observed that savings leakage can occur across several categories of expenditure, especially in the absence of a well-coordinated decision-making process. Here are five common areas, sorted by frequency, along with real-life examples:

  • Outsourcing of Services: Often, central SG&A costs, such as engineering personnel, are managed more carefully than decentralized outsourcing of engineering tasks in production departments. This can lead to inconsistent spending and unnecessary costs.
  • Professional Services: From consultancy to legal services, decentralized procurement can cause a company to pay different rates for the same service.
  • IT and Telecommunication Services: The rapid evolution of technology often leads to uncoordinated procurement of IT hardware, software, or services. An example could be the unmanaged procurement of SaaS applications leading to software sprawl and increased costs.
  • Maintenance, Repair, and Operations (MRO): With a wide range of products needed for MRO tasks, it's easy for cost controls to slip. For instance, ad-hoc purchases from non-contract suppliers can lead to escalated prices.
  • Office Supplies: Although small individually, office supplies can add up to a substantial cost when purchased in an uncoordinated manner across different departments.

Therefore, a cross-functional committee with a well-established decision-making process and a comprehensive view of the organization's cost structure can prevent savings leakage in these areas and beyond, ensuring a more effective and balanced approach to cost management.

Effective Governance to Prevent Savings Leakage

At Alvarez & Marsal, we've helped various organizations implement effective governance structures to prevent savings leakage. One example is an international aerospace supplier facing interdependencies between SG&A costs and indirect spend within a large transformation project. Our strategic approach involved establishing different cross-functional Committees, composed of representatives from finance, procurement, operations, IT, and quality, ensuring a comprehensive and broad view of the organization's cost structure.

The primary role of this committee was to establish a clear decision-making process with distinct decision gates. At each gate change, the involved departments were required to present and justify their business cases before the committee. This process ensured a thorough review and approval of spending plans, promoting accountability and cost-consciousness across the organization.

Furthermore, we facilitated the use of data-driven dashboards and KPIs to track and manage costs effectively. These tools provided weekly insights, helping the committee to identify potential areas of savings leakage and take corrective action.

A key aspect of this governance model was fostering a culture of transparency and cost-awareness throughout the organization. In addition, a performance incentive system was put in place to reward adherence to cost management processes and strategies.

As a result of these governance measures, the client achieved a substantial reduction in overall costs while maintaining a balanced approach between SG&A and indirect spend. This practical example reflects how Alvarez & Marsal employs effective governance to prevent savings leakage, consequently enhancing the financial health of the organizations we work with.

Leveraging Technology in SG&A and Indirect Spend Management

Emerging technologies like artificial intelligence, big data, and automation can greatly aid in SG&A optimization and indirect spend management. These tools can streamline processes, enhance spend visibility, and improve demand management, supporting both SG&A optimization and indirect spend control.

Automation technology is a powerful tool that can significantly streamline business processes, thereby reducing labor-intensive tasks and subsequently, SG&A costs. Automation can extend across various functions, from automated invoicing and payments in the finance department, to sales force automation that optimizes the sales processes. This not only reduces the need for manpower but also minimizes errors and improves efficiency.

In indirect spend management, AI and ML can analyze procurement data, identify trends, and predict future spending patterns. This allows businesses to strategically source materials and negotiate better contracts, leading to substantial cost savings. Further, AI can automate supplier risk assessments by continuously analyzing supplier data, which aids in avoiding potential procurement disruptions and cost overruns.

With strategic planning and execution, these technologies can help organizations achieve significant cost savings and improve their overall financial health. However, businesses should ensure a well-planned and effectively executed digital transformation strategy to prevent an increase in costs and avoid savings leakage.

Conclusion

The symbiotic relationship between SG&A optimization and indirect spend management requires careful navigation. By understanding this interplay and strategically leveraging technological advancements, organizations can unlock significant cost savings and prevent savings leakage. Here are five key success factors to prevent savings leakage:

  • Cross-Functional Integration: Ensure effective collaboration between different functions such as finance, procurement, operations, IT, and quality. Shared visibility and understanding can help prevent savings leakage.
  • Effective Governance: Establish a clear decision-making process with distinct decision gates to ensure all expenditure is scrutinized and justified.
  • Data-Driven Decision Making: Utilize data analytics tools, dashboards, and KPIs to monitor and manage costs, identify potential areas of savings leakage, and take corrective actions.
  • Cost Awareness: Foster a culture of cost consciousness and transparency across the organization to encourage employees to make cost-effective decisions.
  • Performance Incentives: Implement a performance incentive system to reward adherence to cost management processes and strategies.

The path to optimization may be complex and CPO's will seek opportunities to boost procurement value with the help deeper integration of the procurement strategy into overall company objectives. Hence, to enhance operational performance significantly and to deliver increased business value, it is important that procurement organizations focus on deliberate planning and execution around these key success factors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.