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Cost Reduction: Why Tech Companies Should Prioritize Third Party Spend Assessments
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With a wave of headcount reductions, the tech industry has gone through significant cost control in 2022 and 2023. But some control approaches are more effective than others, begging the question: how are you approaching your third-party spend? Have you asked for individual reactive budget cuts across departments, or have you conducted a holistic Opportunity Assessment across your organization’s supply base?
At Efficio, we see both greater long-term savings and more rigorously identified quick wins with the centralized assessment approach of the latter. So, what are the key ingredients to this launchpad?
An Opportunity Assessment builds a business case and strong implementation plan, with a clear return on investment (ROI).
This guide is designed to help tech companies get the most out of an Opportunity Assessment – whether it is self-delivered, with a third party, a one-off, or part of ongoing opportunity identification efforts. As you design any Opportunity Assessment, start with the business case: what are you aiming to do? Are there major non-cost elements to be addressed, such as sustainability, supply chain performance, or your operating model? Is your business interested in targeting a particular area, such as an acquisition or a poorly forecasted cloud spend, or might there be a short-term savings focus? Clarity on the purpose will unlock better conversations with stakeholders across the business, which will in turn help drive a clear, data-led approach to size up the opportunity and build an implementation plan.
In this fast-changing world, an external viewpoint is critical for both the “return” and “investment” side of the picture. Market-leading firms can provide a good benchmark on the potential return from an initiative, while supplier information will determine how much effort is required to achieve it.
Typically, there are a few key initiatives that both underpin the business case and demonstrate the stakes of falling behind on procurement transformation. Opportunity Assessments move this from the theoretical to a return-on-investment-based business case with a clear, trackable implementation plan, providing the perfect foundation for cost optimization and procurement transformation.
How to see the opportunities
Opportunity identification can seem like a never-ending task, with many good ideas that could be evaluated. To make this manageable, a fact-based approach, with good spend visibility and strong awareness of the key initiatives, will help you get to the business case faster.
Any transformation program is likely to have a few key initiatives that form the largest building blocks and define the program to the rest of the business. With this in mind, our approach focuses on identifying these opportunities early, and then driving the fact base for these. Mix top-down and bottom-up estimates at this early stage to evaluate potential opportunities, starting with a zero-based approach against the ideal sourcing strategy to build a picture of the gaps.
Use benchmarks and good spend visibility to build “napkin math” estimates from a spend base to quickly identify areas on which to focus more closely. If you find you have a fragmented opportunity list, consider how best to develop the storyline. Are there major, repeated themes that can draw initiatives together, focusing on operational or institutional changes that would impact multiple spend categories?
Spending time with your stakeholders helps re-set their understanding on the true magnitude of their spend. It also brings people together in your organization with similar roles – for instance, those managing third-party developers or driving cloud spend – to compare and consolidate productivity, analyze usage data across the organization, and understand commercial terms. That’s why a trusted spend analytics tool fed with robust data will help you build a robust business case, including a strong spend baseline and internal benchmark opportunities.
Fact-based approaches are common in theory but hard in practice. Many teams build extra detail in a few, possibly irrelevant, areas but miss fundamentals like how to confirm business buy-in. A look at physics cements this approach: you need to understand the formula, how uncertainty plays through, then build out your fact base for the elements that add the most to the overall uncertainty. Luckily, the formula for savings estimates is simple:
Savings Range = Spend × Addressability Factor × Savings Percentage
This formula helps us: with multiplication, reducing the dominant uncertainty will quickly reduce the overall uncertainty. This is why we start with spend visibility. Tech companies normally do not have a centralized view of spend, but this can quickly be remedied. Then, using a hypothesis-led approach, focus on addressability and savings percentage uncertainties. Addressability is most likely constrained by fragmentation of suppliers or decisions, existing contracts, or savings approaches that focus on a subset of spend. For savings percentages, there are a wide variety of options to go deeper here. We find what variable we need to understand (a unit price, discount rate, or mix ratio, for instance), then look for benchmarks: internal variation, external benchmarks, key suppliers, and their competitors’ case studies may all be good sources, depending on the category.
Final advice: don’t forget the purpose of the Opportunity Assessment. We are building a business case to understand the implementation needs and return on investment. We are not launching the savings initiative right now. Keep this phase manageable by being clear with all parties about when you will move on and accept a degree of uncertainty. – Asking for too much precision generally means people lowball the expected results. Communicating a range of outcomes can help the business understand your current certainty, giving you the ability to move beyond identifying the opportunities to building a plan.
The importance of spend visibility
Many companies really don’t know what they spend. Maybe they can see their top suppliers, but often they don’t see their spend in categories with the tail of suppliers and the full fragmentation. In particular, companies often miss opportunities that span budgets – exactly where you most want to maximize impact to bring stakeholders together and find synergies. That’s why a full spend cube across the organization, which maps all your suppliers and their annual spend against a common market-facing categorization, is the key foundation for a fact-based and target-driven approach.
Building market-facing categories highlights opportunities to consolidate spend and makes benchmarking easier. It also ensures you have a handle on what the supply base is doing. To maximize effectiveness, it’s well worth categorizing the majority of the spend before starting to review opportunities.
How to build a plan
Once you know the total size of the opportunity, it’s time to start building the plan to deliver and get business buy-in. The majority of savings are likely to be driven by three to eight key initiatives, so start building complexity and effort estimates for the key initiatives first – both in procurement and in the broader company. Effort and complexity can be hard to estimate for new approaches – so consider external benchmarks, peers, and suppliers’ stories to understand what it would take.
The strongest organization will stay unconstrained by its current capacity at the start, to really test out alternate business cases and delivery. Then layer in your procurement team’s capacity, initiative triggers like contract renewal, and any other capacity options you have. This combination helps ensure you build a realistic timeline and scope, potentially phasing this over multiple periods. As stakeholders start to see the same opportunities you do during these conversations, new opportunities may emerge for you to size up.
Given the ongoing demand for cost reduction, an “initiative pipeline” might be more helpful than a program plan. The initiative pipeline lays out the sequence, time taken, and benefit realization rates for each savings initiative, while setting the expectation that there will be both future initiatives and a limited capacity to deliver, unless you expand the pipeline.
Start building the pipeline from a spend category view in order to highlight opportunities to merge and accelerate related initiatives and to align with key contract expiry or renegotiation points, if your opportunities require this. Efficio’s “Pulse” tool allows the whole team to see and contribute to the pipeline, which is a key step to help you build robust estimates and get a diverse set of viewpoints.
Gathering momentum is key here, and so is ensuring that resource levels match the initiatives in scope. As you finalize the market approach, there is a “valley of death” in strategic sourcing prior to any quotes showing savings, so staying focused on your three to eight key initiatives rather than having an initiative for everything helps move through this rapidly.
Key operational, departmental, and financial stakeholders will play a major part in shaping the plan, both to align with their initiatives around growth or optimization and to ensure you have the leadership, buy-in, and resources needed to deliver change. As the business case and roadmap to implement crystallizes, ensure strong engagement with stakeholders to get their buy-in. This communication is critical to gather advocates for the program, and it can be challenging – particularly if you are finding opportunity in a deep-seated relationship.
A clear picture of what the opportunity is, how it was measured and identified, and a sketch of the roadmap have unlocked many of these challenging situations. We’ve found external benchmarks particularly helpful here. Be clear on what you are asking from them now – to launch an investigation with you or to agree on the size of the prize in their budget – and the governance going forward. This step also helps ensure you have the complexity of the opportunities sized correctly, and everyone agrees on what is required to deliver.
Are you ready for change?
Now, you have found your map to the savings, identified opportunities, and have a bullet-proof business case … on paper. However, two out of every three transformation programs fail. Ask: is this opportunity set up for success? We talk more about this in our guide to cost transformation – but for now, let’s address the sponsorship and team requirements to land a transformation and set the opportunity up for success.
Poor communication, insufficient leadership, and organization politics are top reasons given for the failure of transformation programs in a Forbes survey. Getting the right sponsorship early is key for a program to work. Find relevant leaders to sponsor the initiative in their area and ensure they are bought in to help you unblock challenges. For instance, will the CIO sponsor key initiatives to oversee outsourced agreements in their area? Will a CTO sponsor a cloud cost optimization program? These initiatives are aligned with their core areas of focus and will benefit them – plus, they are familiar with navigating the roadblocks in their sphere. The CFO is often a natural sponsor of the overall procurement transformation, but getting sponsorship for individual initiatives boosts buy-in.
With a world economy that is changing rapidly and increasing pressure on cost and agility from global supply chain disruptions, having a robust reset point about the value that can be delivered is a key first step to unlocking material value for the business. The scale of the opportunity should excite, and the detail of the execution plan reassure on which path to take. This is the best foundation for a more strategic purchasing function.