Defining spend leakage: why the traditional definition isn’t enough
We recently held a webinar with Spend Matters about ways procurement organizations can put a stop to spend leakage. Before explaining how to stop it however, it is important to define what it is – and why traditional definitions may not be enough.
Read on or watch the short clip below to learn about some common definitions of spend leakage from our Chief Strategy Officer, Steve Griffiths, and our VP of Automotive Practice, Amarish Kapadia!
STEVE: The traditional definition of spend leakage actually refers to the extent of category spend with suppliers that don’t feature on the pre-approved supplier list. Usually, this denotes a percentage of the total spend, and that’s predominantly experienced in indirect categories, where stakeholders opt to offer business to alternative sources.
So that’s a pretty narrow definition. It’s basically saying, “I’m not giving the spend to my preferred suppliers.” But we know from experience that the issues are a lot broader than that.
In fact, if we go to the true economic definition of what spend leakage is, leakage is an economic term that describes capital or income that escapes an economy or system.
So what that really means is, spend leakage could be any number of things where:
- I have not taken advantage of the best pricing
- I’m not living up to my contracts
- I’m not managing my suppliers well to meet their continuous improvement commitments
There’s a whole lot of things that spend leakage could mean.
So what we’ve done is we actually provided a much more comprehensive definition of spend leakage, because spend leakage is going to happen in a lot of places. Spend leakage is any spend, that is sub-optimized, either through action or inaction by requesters, buyers, and suppliers.
“Spend leakage is any spend, that is sub-optimized, either through action or inaction by requesters, buyers, and suppliers.”
This includes excess demand for a product or service. You know, if I’m over-ordering, ultimately that’s going to be wasted money. And it’s dollars out the door early, so I’m actually wasting my insurance capital.
AMARISH: So for clarity on this topic, traditionally, the definition of leakage that people would understand is: if you move spend to a different supplier than what was originally sourced, that is considered leakage. But what you’re saying is that’s not the whole definition. The definition also includes if you’re ordering more from your preferred vendor than what was forecasted or what was in the budget, that is also considered leakage. Would that be a correct statement?
STEVE: Yeah, that’s exactly right.
AMARISH: So for example, say I am buying chemicals for an organization. But I flushed out the tank, for whatever reason – maybe I had some issues with it – and I had to buy more chemicals for that month than what I initially anticipated, that would be considered leakage.
STEVE: Absolutely, because it’s money lost out of the system.
AMARISH: So it’s a much broader definition than just saying having the parts or services being sourced through a supplier that was not originally contracted.
STEVE: Exactly. Other examples would be:
- You’re not actually sourcing the whole spend. So it’s not that I’m leaking money out from my current contracts, I’m leaking money because I haven’t contracted.
- I could fail to capitalize on standardization opportunities to get better leverage on pricing on particular items.
- I could fail to take advantage of the contracts (which is the traditional definition)
- I could actually fail to let my suppliers effectively drive savings or meet their commitments. My suppliers are a partner in this process. They are our partners in this system, and they need to be able to use data to effectively drive the savings and hold them to what they committed to do for you.
The next step
It’s clear that there are many definitions of spend leakage, and they’re all right – to some extent. It’s important to understand that both the traditional and economic definitions are too narrow. If you’re only going off of a narrow definition, you’ll always be leaving excess money on the table. To really be able to stop spend leakage, you need to include all aspects that contribute to it.
Now that you have a better understanding of what spend leakage is, the next thing you can do is take steps to stop it. Find out what those are by watching the full webinar!