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Reducing Indirect Costs Can Have Direct Benefits in Retail

New data shows reducing inefficiency in indirect spending could have transformative effects on a business and help companies cut costs.

According to consultants at McKinsey & Company, the goods and services that retailers purchase but don’t resell, can account for as much as 10 percent to 15 percent of overall sales, on average. And most retailers aren’t optimizing their indirect spending.

“The challenges aren’t new,” McKinsey noted. “They include a lack of spending visibility, fragmented ownership and spend authority, a dearth of incentives to reduce indirect spend, and a siloed approach to procurement of not-for-resale (NFR) categories.”

NFR goods and services are consistently taking a large chunk out of the bottom line, but retailers rarely make reducing those costs a priority. In fact, the same research has shown that retailers are frequently weaker in this area than their peers in other industries.

This trend could be an indirect result of the emphasis retailers place on purchasing resale goods. They will typically place the majority of their resources in this division and think of NFR as an afterthought or “the cost of doing business.”

So, why do retailers have such a hard time with this concept?

Many retailers become locked in negotiations with their NFR suppliers and begin to view NFR procurement as a battle over price points. As a result, many inefficient practices are retained without considering the larger implications a purchase may have on the company. NFR teams tend to haggle for a lower price on an item only to find out that its effect on profitability is nearly negligible.

But “visionary” retailers, as McKinsey calls them, are looking at transforming indirect spending across the entire business in three ways: by embracing a cross-functional approach that incorporates category-specific demand levers, digital and analytical tools, and better collaboration with suppliers.

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“In doing so, retailers are shaving as much as 10 to 15 percent off their annual indirect spend, capturing impact worth 1 to 2 percent in return on sales, and seeing a more than fifteen-fold return on the cost of their NFR sourcing team,” McKinsey said.

When it comes to solutions, McKinsey consultants recommend a comprehensive transformation of the way NFR procurement is managed. In particular, change will have to come from outside of the procurement team. Management teams utilizing a cross-functional approach will be needed to “break down silos, pose tough questions about what the business really needs, and make balanced trade-offs,” according to the report.

This cross-functional approach can create a unified system from the top-down. Teams will not only be focused on price, but excessive spending can be controlled by setting standards and focusing on process-management as a key to procurement success, instead of simply maintaining the status quo. Research also indicates that this can enhance a retailer’s negotiating power via organized cycles of purchasing and review.

However, more than half of all potential savings from indirect spending can be found by concentrating efforts toward demand-management.

Cross-functional procurement teams tasked with optimizing demand-management can be used to redesign entire distribution networks by analyzing areas of need and judiciously assigning logistics spending. Sometimes this can mean raising the cost of certain services for better returns, an action that would rarely be taken in a system with simple, “costs-down” incentives.

The use of digital tools can be beneficial within NFR procurement, too. Many companies have started using connectivity technology to raise spend visibility within their organizations. The use of AI to completely personalize a spending approach (with a degree of accuracy unheard of, until recently) can lead to immediate savings, some retailers have found. Creating a company-wide network of information or IoT can also have tremendous value when looking to lower expenditures.

Digital technologies have a place in many different arenas that can affect procurement efficiency, whether it’s for resale or not. The ability to accurately judge consumer insights through internet surveys and “crowdsourced competitor benchmarks” will be key to procurement, going forward.

These concepts can also be applied to manufacturing, with factories gaining the ability to “shave off” costs through AI-assisted designs. McKinsey consultants found that a retailer was able to lower the cost of its shopping bags using this strategy, paring down the amount of material used by 25 percent without affecting quality in a meaningful way.

Any change, no matter how beneficial, must be properly communicated throughout an organization in order to see its full potential realized. That’s why it comes highly recommended that an organization, with these strategies in mind, create a “clear case for change” that will resonate throughout the entire procurement structure. Each employee must become a stakeholder with a personal connection to this change and that commitment must come from upper management.

“Most retailers have significant opportunities to reduce indirect costs,” McKinsey said. “The first step is to acknowledge that the potential exists, then conduct a thorough diagnostic to quantify it. Though challenging, a transformation in indirect spending can yield greater profitability, funding for growth, and competitive advantage.”