As a consequence of the coronavirus, revenues for most companies are or will be impacted negatively (at least in the short-term). Since costs do not flex down as quickly as revenues, profitability will decline. In fact, many companies such as retailers have withdrawn their guidance to their investors. So with the US economy likely in recession as of March, CFOs and Treasurers of most companies understand that significant actions will have to be taken to shore up the financial position to manoeuvre an uncertain and unpredictable future. Change is coming and change we must.
Finance leaders understand the architecture of their respective 10Ks very well – but often there is one exception: Third-party vendor spend. This spend gets rolled up via departmental budgets, may change frequently, may be relatively small, and may come with political complexities. But it is this spend that needs to be reviewed, leveraged appropriately, and flexed down potentially. So the question is not whether to take action but which actions to take? There are certainly real-world trade-offs to be made. This article outlines:
- How to create an actionable fact base of third-party vendor spend
- How to determine which spend to address first, next, not now
- How to assure alignment, accountability, and execution
Step 1: Actionable Fact Base
Finance leaders need to have an accurate and actionable fact base on all third-party spend. Procurement should have most (if not all) of this information as part of their category planning process. Within each spend category, Finance and Treasury teams need to review:
- Spend by vendor including a listing of the contracts (SOWs, Order Forms etc.) that governs it
- Additional information on each major vendor: Length of the relationship; Key internal stakeholder(s)
- Additional information on each major contract: Type; Lengths; Key dates such as expiration, renewal, and notification dates; Term for Convenience; Payment agreement, schedule, and terms; Renewal clause
Now that you have an overview on the spend in a given category and the key contracts that govern that spend, ask Procurement to roll-up vendor spend across different categories similarly. There will be few surprises but some vendors including their subsidiaries may be deemed not to make the cut at the category view but do make it in this vendor view.
Tip: Note that the Pareto Rule likely applies: Review or collect this information with a focus on the largest spend. The time to act is now so “tail spend” may need to be addressed later.
Step 2: Framework for Which Spend to Address Now, Next, Not Now
Note that the determination of what spend to address when will require active leadership decision making and definitely requires clear decision governance. Feelings will get hurt and decisions will get questioned, so you want to be clear as to the How, Why, and By Whom.
Now: There is no time like the present
Indicators to look for:
- Commoditized goods or services – not strategic or highly critical supply chain partners (protect innovation roadmap; leverage deeply integrated business relationships more)
- Contract expiring shortly or is expired
- Term for Convenience (in Master T&Cs)
- Transaction-based or T&M-based pricing (such as contingent labor, consulting, processing of any kind)
Actions to consider:
- Review of goods or services for volume, need, rate and/or option to consolidate
- RFx and/or ask for pricing options
- Vendor consolidation/rationalization
- Nice to get: More favorable T&Cs as part of renegotiation, renewal etc.
Next: Fast follow (i.e., within one month)
Indicators to look for:
- Less commoditized goods or services – also excludes strategic or highly critical supply chain partners
- Contract expiring in 6+ months
- Switching of services or goods with some complexities
- No or unfavorable Term for Convenience or auto-renewal triggered recently
- Prepaid retainer type of agreement like a many SaaS agreements
Actions to consider:
- Cancel auto-renewal to message intentions
- Explain this review process and ask supplier for options to renew mid-contract
- Review of goods or services for volume, need, rate and/or option to consolidate
- Ask Procurement to create playbook for key or large vendor renegotiations (which includes communication strategy, hypotheses, and action plan with options)
- Nice to get: More favorable T&Cs as part of renegotiation, renewal etc.
Not Now: Strategic Partner Review (start within 3 months)
Indicators to look for:
- Review relationships with strategic or highly critical supply chain partners
- Contract expiring in 12+ months
- Switching of services or goods supply chain integration with high complexities
- Complex contractual relationships that may need to be redefined to enable company revised strategy
Actions to consider:
- Engage partners at an appropriate senior leadership level to realign strategic relationships
Step 3: Alignment, Accountability, and Execution
Executing this effort fully will likely take 6-12 months and will likely redefine Procurement’s role and approach. During this time, leaders at various levels and from multiple functions will need to make difficult decisions. Since these decisions will be challenging and risk creating internal and external rifts, I recommend to establish a Steering Committee with clear decision governance and leadership that meets on a regular cadence. Start on a weekly cadence to initiate the process before decreasing the frequency after the initial plans of action are being executed.
Tip: With regards to decision governance, this process needs to be guardrailed with clarity regards to participants roles. I have found the RACI matrix a helpful framework to drive clarity as to who makes decisions and how to include and weight various inputs.
One last word of advice: Although reducing costs is now imperative, your strategic and critical vendor relationships matter greatly – maybe even more now than before this crisis. Behind every spend that is being reviewed is a vendor relationship that may potentially be disrupted. CFOs and Treasurers need to be mindful and clear as to why and you are leading any conversations. Procurement needs to lead and facilitate these inquiries with facts and problem statements so your vendors can help you solve the equation – in most cases this approach is much more productive than just asking for lower costs.
Sören Petsch is leading consultant at Funf Baren Process Consultancy, a company which collaborates with clients to determine root causes of problems to initiate lasting changes. It’s services focus on supply management ranging from tactical procurement to strategic sourcing.
