The Monthly Metric: On-Contract Spend
The September/October issue of Inside Supply Management® includes a feature article, “Taking Out the ‘Garbage Data,’ ” which discusses how supply management organizations can take the data governance lead at their companies.
The leverage for such an endeavor is the considerable revenue (more than a third at most companies) devoted to sourceable spend. That can provide supply managers the influence to insist on and implement higher-quality data and analytics, which enable better decision-making and result in significant cost savings.
With that in mind, the August edition of The Monthly Metric reviewed some of the spend analytics covered in this space during the last five years. This installment is designed to continue that conversation by introducing a new metric — on-contract spend — in which sound performance can help an organization not only reduce costs, but also limit risk exposure.
“Any spend that’s not on contract hypothetically leaves money on the table because it has not gone through a process — volume rebates might be missed or the spend hasn’t been optimized,” says Michael Van Keulen, CPO at Coupa, a San Mateo, California-based business spend management technology platform. “Maybe more importantly, there’s a risk profile if the supplier has not gone through a pre-vetted process.”
Coupa has compiled benchmarks for on-contract spend in its annual Business Spend Management (BSM) Benchmark Report. In recent years, procurement organizations have placed more of their spend on contract — and that progress was not derailed as the coronavirus pandemic left many companies scrambling for supplies.
Meaning of the Metric
On-contract spend is a self-defining analytic, based on a percentage; Coupa describes it as “the percentage of spend put through pre-negotiated contracts to enable better prices and terms.” A higher percentage of on-contract spend indicates that a procurement organization is driving more value, Van Keulen says.
“That’s spend that has gone through a procurement cycle, with terms and conditions and a contract awarded based on the risk metrics of the company,” he says. “Best-in-class companies achieve 80 percent of spend on-contract, and there are practitioners who are getting 90 percent. So, that shows value being driven and a high level of (organizational) maturity.”
The on-contract spend reading in Coupa’s 2022 BSM Benchmark Report is 79.2 percent, up from 60 percent in 2016 and 72.1 percent in 2018. That’s a sign, Van Keulen says, that procurement organizations are (1) sourcing more strategically, (2) doing better due diligence and (3) leveraging such technologies as contract life-cycle management (CLM) and procure-to-pay (P2P) systems, among other measures.
Perhaps most encouraging: The figure did not take a hit from COVID-19. The benchmark hit its recent high (81.7 percent) in 2019 but fell slightly to 79 percent the following year and ticked back up to 79.6 percent in 2021, while the pandemic wreaked havoc with purchasing and supply chains. As COVID-19 made companies more reliant on procurement, their risk appetites fell sharply, Van Keulen says. Also, supply managers — even as they sought products from wherever they could be found — maintained on-contract focus.
“There was no tapering off, even though you would assume buyers would be more frantic,” he says. “You’d think it would be counterintuitive as companies struggled with supplies, but procurement’s rigor in awarding contracts never came down. (The pandemic) has been a time for procurement to step up and lead, and this is one of those metrics where it’s happened.”
Ensuring Realized Savings
Technology has helped companies get more of their tail spend on such transactions as MRO, office supplies and professional services under contract, before it can turn into rogue (or maverick) spend. And while Van Keulen says he’s not a big fan of p-cards, they don’t have to become a rogue spend risk if they are “virtual” cards through a company’s spend management platform.
Along with digital tools, a sourcing strategy targeting the categories that drive the greatest value to the company can help improve on-contract spend level. A good barometer of on-contract success, Van Keulen says, is pre-approved spend, the amount of spend approved before an invoice is received. This number should be well above 90 percent; the benchmark in Coupa’s 2022 report is 95.3 percent.
“That’s what you want,” Van Keulen says. “That means you went through the proper channels and got ideal terms and conditions you wanted. But source-to-contract can be a challenge. If the pre-approved spend is unusually low, that’s a sign there’s (a breakdown) in contract execution.”
Off-contract spend, Coupa researchers say, “detracts” from cost savings — potentially creating misalignment with the finance department and minimizing procurement’s impact on a balance sheet or profit and loss (P&L) statement.
“Procurement does the sourcing and contracting upstream, but it’s got to go downstream for the financials to be impacted and savings realized,” Van Keulen says. “Unless procurement is able to demonstrate (the benefits of) source-to-contract downstream, it won’t be given credit for the value driven, whether it’s savings, better cash flow, lower risk or any number of things.”
He continues, “But if you don’t have the ability to demonstrate that, it becomes arbitrary, with no real indication of the value procurement brings to the company.”
The good news — and motivation — for procurement organizations is that savings from on-contract spend can beget savings. Higher levels of on-contract spend typically enable supply managers to negotiate better pricing and more favorable payment terms in future deals.
“(On-contract spend) is a good measurement of how effectively procurement gets what the business needs, manages risk and runs a competitive negotiation and award process that supports the strategic objectives of the company,” Van Keulen says.
To suggest a metric to be covered, email me at firstname.lastname@example.org.