For most companies, the biggest near-term opportunity to optimize costs is in their indirect spend.
Well-targeted actions regarding indirect spend can have a large – and rapid – impact on profitability and competitiveness. Yet many continue to overlook these cost categories and focus their attention elsewhere.
Companies know that cost control matters. But when they look for ways to achieve cost excellence, many default to their direct spending categories – the supplies they buy to create the products or services they sell. Indirect spend, by contrast, tends to receive far less attention. This is a mistake – important opportunities to manage costs more effectively are staring these companies in the face every day.
Indirect spend covers a range of categories broadly concerned with the business’s running costs. If companies start to treat these costs with the same care and attention that they focus on their direct spend, the effects can be remarkable.
Naturally, the mix of spending varies greatly from one industry to another. The blend of direct and indirect costs will be radically different if we compare, for example, a pharmaceuticals company and a furniture manufacturer. But as a rule of thumb, spending across indirect cost categories will typically account for 20-30% or more of a company’s outgoings. This is a meaningful share of overall spending – easily big enough to yield multiple cost savings and efficiency gains if companies are determined to achieve cost excellence.
If companies can optimize their indirect spend, every additional sale they make should come at an enhanced margin, allowing more of the incremental revenue to drop through to the profit line.
Direct and indirect costs differ by industry type but consume typically 50-70% of companies’ revenues. That implies that companies’ spending on indirect cost categories can account for 20% or even 25% of their revenues – enough to have a sizeable impact on the overall quality and cost of their products or services. So poor control of indirect spending can affect their competitiveness in a big way.
But the scale of
Another way of looking at the benefits of indirect cost excellence is to consider how many additional sales would it take to deliver the same financial gain as a 5-7% reduction in indirect spend.
What are the top three strategic priorities for executives heading into 2025?
Cost management
33% of corporate leaders are prioritizing cost reduction as their most critical priority, +8pp from 2024
Growth and expansion
Growth remains a focus, with 70% of executives reporting that they have sufficient mid-term visibility to make informed investment decisions
Revenue management
Executives are looking into pricing strategies to manage potential rising supply chain costs while addressing end-consumer pressures
Source: BCG global C-suite survey.
Another common issue that prevents companies from achieving cost excellence is inadequate data – or a complete absence of data – on their indirect spending. If procurement teams are not involved in these spending decisions, processes are likely to vary from one department to another. Companies may not produce purchase orders to document their spending and consequently will have very limited transparency.
Similarly, groups assembled from mergers and acquisitions often continue to operate siloed information systems and so find it impossible to gain a comprehensive overview of their spending. However, even in cases where data is available, it is not necessarily harnessed effectively to deliver efficiency gains. For example, data that is not clean and well structured cannot be analysed by AI tools to identify efficiencies or gain insights into spending patterns.
Deficiencies in data systems and procurement processes frequently lead to a further challenge: procurement teams find that they cannot demonstrate the value they create in optimizing indirect spend because it is not visible in the P&L. If the procurement team negotiates savings in indirect categories, these must feed through to the budgeting process so that the savings are captured and fed into the budgets for future periods. If that loop is not closed, questions inevitably arise over the value that the procurement function adds to the organization.
Failure to close this loop can lead to perverse outcomes. For example, if the procurement team negotiates a 10% saving on pens, but this saving is not fed back into departmental budgets, the budget for pens will stay the same and the department will be free to buy more in future, without busting its budget. No saving is realized, and the benefits of the procurement team’s work are lost.
By contrast, where procurement, operational, and budget processes are well aligned, not only can cost savings be properly documented but the money saved can be redeployed to support business objectives. Take the example of a successful effort by procurement and marketing teams to reduce a company’s digital marketing costs. This could be followed by an agreement to invest half the sum that has been saved back into digital marketing to generate additional sales, with agreed KPIs to monitor the effectiveness of this extra allocation. A scenario like this illustrates clearly the virtuous circle in action: by closing the loop between procurement savings and the budgeting process, the company both saves money and creates the headroom to invest more in growth.
A more rigorous focus on these indirect cost categories also offers opportunities to improve risk management, particularly around the increasing quantity of sustainability regulation coming into force. By embedding sustainability criteria in procurement processes for indirect spend, companies can identify opportunities related to sustainable purchasing and mitigate risks in areas such as supplier selection and the emissions impact of their indirect spend.
By closing the loop between procurement savings and the budgeting process, the company both saves money and creates the headroom to invest more in growth.
Companies seeking greater transparency and control over their spending in indirect categories should prioritize three main areas of action. In the following sections, we set out the most important opportunities to improve the way indirect spending is managed and conclude each section with suggested KPIs that companies can adopt to measure their progress.
1) Centralize and collaborate
Procurement is traditionally a central function, and for good reason. Centralizing the company’s procurement activities helps to ensure processes are as simple and standardized as possible and keeps lines of accountability clear. This approach brings valuable scale benefits in categories where global or regional purchasing is feasible, such as logistics and IT, as well as maximizing the benefits of procurement expertise in setting product and service specifications, vetting potential suppliers and running an effective tendering process. Another key advantage of centralizing procurement is to take advantage of procurement’s expertise in conducting negotiations with potential suppliers. Negotiations should follow a well-structured, transparent process and should incorporate input from all the teams involved to set agreed parameters and objectives. The principles of game theory can be applied to refine the company’s strategy for the negotiation process.
In some situations, however, procurement centralization is not practical. In categories such as facilities management, local service providers dominate, so procurement will need to be managed locally. In areas such as legal services, country-specific provision is essential.
When designing indirect spending processes, companies should aim to centralize wherever possible while recognizing that in some categories, spend must be managed by people on the ground. In these cases, it is important to put in place effective means of collaboration between local and central teams so that the benefits of the company’s global procurement experience and skills are not lost. The key consideration is to recognize and manage the trade-offs that are inherent in trying to centralize procurement.
In optimizing the procurement process between central and local decision-making, priorities should include a clear governance framework that embeds collaboration between procurement specialists, wherever they are based, and local operational experts. Processes designed in this way will be most effective in supporting the organization’s primary goals of efficiency and profitability. They can also help to foster a corporate culture in which cost-saving initiatives are prioritized.
2) Treat sourcing as a strategic, cross-functional process
Companies often have weak or non-existent processes around sourcing, particularly where procurement and business functions are properly coordinated. This tends to produce poor outcomes, for example where companies approach only one supplier instead of seeking a selection of quotes from the market. The most effective way to ensure robust processes is through cross-functional sourcing councils. These should include an Indirect Sourcing Council, comprising procurement and functional leaders, and an Executive Sourcing Council, made up of the Chief Procurement Officer and C-level executives, to provide a governance pillar that ensures alignment of strategic sourcing decisions with the company’s leadership team. Adopting this structure enables procurement to secure its role in the decision-making process and gives it an explicit mandate to pursue cost excellence.
Operating in this way will lead to better understanding of the company’s requirements, help to challenge assumptions and yield much better intelligence about the range of market prices and service levels that are available. It should also help to generate effective competition between groups of suppliers that will benefit the company, as well as ensuring better compliance with policies and regulations.
Operational teams may have well-founded reasons to prefer one supplier over another. Nonetheless, it is vital to preserve an appropriate distance between the internal customer and the supplier. Establishing strong cross-functional collaboration with the procurement team can help to achieve this.
In scenarios like these, it is vital to establish how the company will assess the value a supplier offers, as distinct from the cost of its product or service. The role of procurement specialists here is to work with functional teams to apply an overarching procurement and supplier strategy for each category of spend. This will identify the criteria that add value for the company beyond simple cost and put a monetary value on them to enable meaningful comparisons between different suppliers. These added-value criteria are likely to include quality, service levels, understanding of the company’s processes and markets.
Although these criteria may be qualitative to some degree, it is possible to assign a financial value to them that can help the company negotiate better terms and ensure it receives value for money.
Following this process could lead to a change of supplier. But it could also result in the company gaining a clearer understanding of what is required to bring existing suppliers up to the level of the best challengers. It is important not to miss opportunities to get better performance from your existing suppliers by exposing them to comparison with their competitors for your business.
In optimizing sourcing, companies should concentrate on large and high-cost categories and seek, where possible, to consolidate suppliers into a smaller number of higher-value relationships.
3) Prepare to harness digitalization, data and GenAI
GenAI and data analysis offer the potential to optimize procurement processes and identify cost-saving opportunities far faster than is possible using manual methods. But before companies can take advantage, they must first lay the foundations: unless their data is clean and well structured, the scope to generate insights from it using advanced data science tools will be very limited. Many companies are still struggling to complete this preparatory step, partly because they lack the necessary skills internally to develop a data science capability but also because doing so requires upfront investment that must compete against other priorities. However, GenAI tools are available to help companies clean and structure their internal data, and those that accomplish this are well placed to unlock a major opportunity: turning the data they generate every day from their business into knowledge and insights.
Once they have their procurement data – purchase orders and invoices – well organized, companies can apply GenAI tools to a variety of high-value use cases including automated spend categorization, invoice checking and reconciliation, extraction of insights from procurement documents, cost breakdowns to identify potential savings, and automated spend optimization.
Companies should also be using well-established digital tools that help to identify alternative service providers and streamline the process of obtaining tenders in areas such as transportation.
Boston Consulting Group has identified five key indirect spend categories in which GenAI tools are forecast to have a major impact over the next three years: software development, creation of marketing materials, use of chatbots to automate customer services, automation of admin and professional services including accounting and legal, recruitment and training.
Some 70% of Pioneers Consider AI as Integral to Achieving
Their Long-Term Cost-Optimization Goals
Which statement best describes the importance of AI for achieving your
short-, medium- and long-term cost-optimization goals?
PIONEERS (ALL/MOST TARGETS MET, 60% COST TARGET)
Source: FT Longitude x BCG research, August 2024
In these categories, which account for around 40-50% of indirect spending, the low end of BCG’s range of potential savings is 15% while the high end is 45%.
In marketing, for example, BCG calculates that using GenAI tools to produce marketing collateral for traditional and digital media and to track performance could lead to cost savings of up to 40%. This will be achieved through use cases including insight generation, market research, content testing, performance tracking, and automated end-to-end campaign creation, using tools such as text-to-video content generation.
However, most companies are yet to engage fully with the possibilities of AI and data science. An important step in this journey is to identify the most impactful use cases for these technologies within the business and to design limited, experimental implementations that offer the opportunity to learn from experience without making major investments.
There are strong incentives to achieve cost excellence in indirect spend. Success in these efforts will sharpen the company’s efficiency, enhance operating margins, and release funds to invest in business transformation and strengthen its competitive position. By adopting the three-step approach outlined above, companies can ensure their indirect expenses are managed as efficiently as possible and that they are regularly benchmarking their existing suppliers against the best challengers in the market.
The sourcing council structure discussed above builds in a governance framework and explicit mandate from top management to ensure cost excellence. Centralizing decision-making in this way, wherever possible, is the surest route to success. Multiple, overlapping and inconsistent processes are the enemies of cost excellence.
Managing Director
is a Managing Director in Inverto’s Munich office. With over 20 years’ experience in consulting and industry, he primarily advises companies in the automotive, mechanical engineering, chemical, consumer products and service industries on transforming and optimizing procurement and supply chains.
Principal
Marcel Weber is a Principal in Inverto’s Cologne office with 10 years of procurement consulting experience, specializing in healthcare—particularly Med Tech and Biopharma beside industrial goods clients. He partners with clients to drive cost-out projects and leads end-to-end procurement transformations across direct and indirect spend categories including optimizing procurement operating models.
Consultant
is a Consultant in Inverto’s Frankfurt office. She supports clients in the retail, consumer goods, and industrial sectors, with a focus on ESG, sustainable procurement, and achieving cost excellence through supply chain and strategy projects.