Spend and forecast analysis, supply market analysis, and segmentation are key steps in product category management.
1. Segmentation of product category strategies
Portfolio analysis is commonly used to assign product categories to one of four quadrants (routine, leveraged, bottleneck, strategic) in the Kraljic matrix based on the level of supply risk and value or impact of the category to the buying organization (ISM Glossary 6th edition). The quadrant then defines the product category strategies that would be most appropriate. Monczk et al. 2016 suggest the following generic strategies for each quadrant:
- Strategic (High risk/high value): Form strategic partnerships and collaborate with suppliers.
- Leverage (Low risk/high value): Consolidate spend with a few suppliers, but maintain competition.
- Bottleneck (High risk/low value): Ensure continuity of supply by expanding the number of qualified suppliers.
- Routine (Low risk/low value): Simplify and automate the sourcing process.
2. Spend and forecast analysis of product categories
A spend analysis examines the historical purchasing patterns within the buying organization (ISM Glossary 6th edition). A spend analysis answers questions such as what was purchased, by which departments or divisions within the buying organization, and from which suppliers. The spend analysis is used to identify the value of the category to the organization, and it can be used in the segmentation process. The data for a spend analysis are gathered from the organization’s ERP or e-procurement systems. However, data from these systems typically must be cleaned and organized before doing the spend analysis (Falgione et al., 2008). Although spreadsheets can be used to do spend analyses in small organizations, many large organizations use specialized software that is part of their e-procurement systems.
A spend analysis provides a historical view of what the buying organization has purchased in the past. When identifying categories and developing strategies, it is important to take a forward-looking view. Will the spending patterns continue in the future, or will there be changes based on changes in products, sales volumes or technologies? Therefore, forecasts of future spend need to be used to adjust the spend analysis to reflect the buying organization’s future spend to develop appropriate category strategies.
3. Market information of Product categories
An important part of product category management is developing a deep understanding of the current and future market forces, and cost drivers in the category. The market analysis should examine the following, as well as any other relevant information:
- Current and potential suppliers, their capabilities, and geographical locations.
- Total supply capacity and potential expansion or contractions.
- Changes in technology and innovation in the category.
- Pricing and cost trends, and underlying cost drivers.
- Supply chain risks and potential for disruptions.
- Laws and regulations affecting the category.
An extensive amount of research is needed to do a thorough market analysis. Trade journals, conferences, industry and government reports, supplier annual reports, and websites can be sources of market information. Suppliers are also excellent sources of information about industry trends. Suppliers are sources of cost and price information as well. Some buying organizations use external experts as consultants to conduct the market analysis rather than internal supply management professionals.
4. Establishment of product category responsibility
Successful category management requires that internal customers agree with and comply with the product category strategies and action plans. With the category manager, key internal customers should be given responsibility for ensuring compliance with the plan and demand management (Falgione et al., 2008).
5. Direct vs. indirect spend of product categories
Product Category management is appropriate for both direct and indirect spend. Direct spend is for costs directly used to make a product or deliver a service. For example, for an automotive company, steel, windows, and seating systems would be direct spend. When developing a market analysis for direct spend, a total cost approach should be used. Also, the entire supply chain should be examined to identify supply risk at all tiers.
Indirect spend is for costs of normal operations, but are not directly inputs to the product or service (ISM Glossary 6th edition). Maintenance supplies, advertising and phone services are examples of indirect spend. When performing a market analysis for indirect services, labor is most often the key cost driver, and the underlying factors affecting labor markets, such as unemployment rates, technology, and location, should be analyzed (Falgione et al., 2008).
Establish and Prioritize Product Categories
The first step in the category management process is to establish and prioritize the categories that should be managed based on a spend analysis, an assessment of the organization’s future needs, a supply market analysis, and category segmentation.
Conduct a Spend Analysis of Product Categories
In many organizations, different units at various locations make the same types of purchases from different suppliers, using different contract terms and at different prices. Thus, the first step in product category management is to gain visibility in spend across the organization. Spend analysis is defined as the “analysis of the historical spending patterns in an organization, usually by commodity or category” (ISM Glossary 6th edition). A spend analysis analyzes the buying organization’s financial transaction data to determine: what is being purchased within the organization, in what quantities, at what price, from which suppliers, and by whom within the organization.
Most organizations use commercially available software for spend analysis that is either stand alone or part of the buying organization’s ERP system.4 Although not ideal, in smaller organizations, Excel spreadsheets can be used to do a spend analysis. The first step in a spend analysis is extracting data from an organization’s various information systems such as e-procurement systems, p-cards, and ERP systems. This can be especially challenging when many different groups within the organization are doing purchasing. The next step is cleansing the data to remove errors and differences. For example, unless cleansed and standardized, in a spend analysis, purchases from “GE” and “General Electric” would be considered as purchases from different suppliers. Then, each purchase is categorized using a standard classification scheme. For example, the category of “facilities” might include all spend related to building maintenance, cleaning services, waste management, and cafeteria services. This can be challenging however as different groups within the organization may use different types of codes for purchases. At this stage, the data may be enriched with other relevant information.
The next step is to identify which categories account for the highest level of spend. A Pareto analysis (also called ABC analysis or 80/20 rule) identifies the highest spend categories, which may be ones that should be closely managed. A Pareto analysis is “the process of determining the small minority of a population that accounts for the majority of a given effect” (ISM Glossary 6th edition). Applied to category management, approximately 20 percent of the categories will account for about 70 percent to 80 percent of the spend. Based on spend, these items are the most important to manage and are classified as “A” categories. Typically, “B” items account for 15 percent to 25 percent of the spend, and most of the categories account for less than 10 percent of spend and are classified as “C” items.
Product Category examples
An example of a product category is Pareto analysis for the spend categories identified at State University is shown in Figure. In this case, printing services and office furniture account for about 70 percent of spend and are considered to be the most important to manage considering spend. This process can also be used to identify which suppliers are accounting for the highest level of spend within a category and which departments are accounting for the highest level of spend within the buying organization.
The results of a Pareto analysis are typically shown graphically in a combo bar chart with percent of annual spend on the left y-axis and percent of cumulative spend for all categories on the right y-axis. Figure 2-3 shows a Pareto chart for the spend categories for State University.
Figure: Pareto Analysis for Spend Categories for State University
| SPEND CATEGORY | AMOUNT ($1000S) | TOTAL SPEND (%) | CUMULATIVE SPEND (%) | CLASSIFICATION |
| Printing Services | $4,438 | 36% | 36% | A |
| Office Furniture | $3,922 | 32% | 68% | A |
| Transportation | $2,229 | 18% | 86% | B |
| Scientific Equipment | $641 | 5% | 91% | C |
| Office Supplies | $620 | 5% | 97% | C |
| Sports Apparel | $425 | 3% | 100% | C |
Figure : Pareto Chart for the Major Spend Categories for State University
It is also important to identify which categories of spend are “addressable,” those where supply management professionals can make changes to sourcing and supply management strategies, and which categories are “nonaddressable,” those where supply management professionals cannot currently influence. For example, in the state of Ohio, the spend for social programs, public safety, and education are outside the control of the state’s supply management professionals and thus are “nonaddressable.”5 However, with top management support, policy, and procedural changes, nonaddressable spend can become addressable. The results of a spend analysis may lead an organization’s top management team to support changes to make more spend addressable.
Retail product categories and subcategories
The spend analysis provides a historical view of what spend has been in the organization. Retail product categories and subcategories management is forward looking and strategies may take several years to fully implement. Thus, it is important to know how spend may change in the future by understanding the organization’s strategic directions and objectives. It is important to talk with internal stakeholders to understand how their requirements may change in the next three to five years. For example, are they developing new processes, products, or services that change the importance of categories or require totally new categories?
For example, as shown in Figures, historically, printing was the highest spend product category at State University. However, State University has a strategic goal of being more sustainable and reducing costs for students. It has implemented digital course management software and is providing incentives to faculty and students to use digital documents. With the move to digitization, spend on printing should be dramatically reduced. However, as spend on printing declines, software licensing is likely to become an important spend category.
Analyze Shopping Products Fundamentals
In addition to understanding Shopping Products characteristics and future requirements, supply management professionals must develop a deep understanding of supply market fundamentals and expected changes. This involves gathering and analyzing supply market intelligence. Market intelligence is “the process and result of gathering and analyzing information about the aggregate forces (including economics) at work in trade and commerce in a specific service or commodity” (ISM Glossary 6th edition). Although some organizations gather and analyze market intelligence internally, others d use third-party service providers or subscription services to provide data and analysis. A number of companies offer market intelligence solutions and services combining machine learning, data analytics, and data visualization.
In-depth knowledge of supply markets can be used to prioritize categories and support the development of product category strategies. Market intelligence typically includes information about the following:
- Expected changes in supply and demand.
- Supply market structure and intensity of competition.
- Total supply capacity, capacity utilization, and potential expansion or contractions.
- Changes in technology and innovation in the category.
- Laws and regulations affecting the category.
For many purchases, especially those involving raw materials, components with high raw material content, or transportation, the relationship between supply and demand influences price. For example, as supply contracts and demand increase, prices generally increase. Thus, it is important to understand the underlying factors that influence supply and demand and how those may change.
Consumer product categories
Another important consideration is the supply market structure and intensity of competition in the industry of consumer product categories. As suggested by Porter’s Five Forces Model, competition in the market can range from intense to mild.6 The degree of competition in the supply market may be full and open, limited, or technical. Full and open competition exists when many suppliers are available. Full and open competition in the supply market typically places the buying organization in a strong position and is often the case for mature products or services. Limited competition exists when few suppliers exist, reducing supply management professionals’ choices in supplier selection and creating less pricing flexibility. New products and services that are early in their life cycles are often less competitive, because fewer suppliers are available.
Technical competition exists when, for a special product, technology, or patent reasons, only one or very few suppliers are available. For example, Samsung and LG are typically the leading suppliers for mobile phone components based on their investment in leading-edge technology. In another example, because of the technical complexity in design and production, for years only two companies worldwide, Boeing and Airbus, produced large commercial airplanes. The China-based COMAC developed and delivered its first mid-sized plane in late 2015, but faces many regulatory and other hurdles before it has customers outside of China.7
Mergers, acquisitions, spin-offs, and break-ups also affect the intensity of market competition. Mergers and acquisitions reduce the number of companies in an industry and typically reduce competition. Antitrust concerns over reduced competition and increased prices are reasons the U.S. Justice Department reviews mergers and acquisitions. For example, during the last two decades there has been consolidation in the U.S. airline industry, reducing competition. Conversely, when organizations spin off or break up, the opposite condition occurs; there is more competition within the supply market.
Excess capacity in an industry typically drives prices lower. A product’s or service’s life-cycle stage affects its industry’s capacity utilization. For new products and services, capacity, which is the maximum output or producing ability, can limit supply relative to demand, leading to higher prices. Rapid sales growth typically increases utilization, reducing excess capacity and increasing prices. However, with rapid sales growth, a supplier’s actual costs may even decrease because of increases in productivity caused by the learning curve. The learning curve effect is most common in complex assembly processes such as consumer electronics assembly. Rapid sales growth and high profit margins tend to attract other organizations to enter the market. Over time, as sales begin to slow and decline, capacity utilization, the percent of available capacity that is being used, typically decreases. When capacity utilization decreases, suppliers are often willing to lower prices to gain sales at the expense of their competitors.
The type and rate of technological change is also an important consideration. New technologies and services (for example, digital streaming) make old technologies (such as the DVR) obsolete. During the phase-over period of overlapping product life cycles, these products often compete as substitutable products. In many industries the rate of technological change is accelerating so supply market changes can happen quickly.
Government regulations can affect the market as well. For instance, government subsidies in China, Germany, and the U.S. fueled rapid growth in the solar power industry in the early- to mid-2000s. Supply management professionals need to understand government regulations and changes that are relevant to the products and services being purchased, and the influence that governmental actions may have on the supply market.
In addition to macro-level market intelligence, the analysis should gather information about specific products, services, and suppliers to identify opportunities to increase value for the organization. Information should be gathered about the following:
- Current and potential suppliers, their capabilities, and geographical locations.
- Pricing and cost trends, underlying cost drivers, and should-cost models.
- Supply chain risks and the potential for disruptions.
To be most useful, the analysis of market intelligence needs to go beyond describing what has happened in the past to providing an understanding of what may happen in the future, which is referred to as predictive analytics.8 A SWOT analysis is a forward-looking tool used in strategic management to determine the strengths, weaknesses, opportunities, and threats based on internal and supply market data.
Sources of Market Data for Product Categories
Supply market intelligence can be gathered from many different sources. The most frequently used sources of data include information provided by suppliers in response to RFIs.9 Other sources of data include company websites, 10-K and annual reports for publicly traded companies, news articles, company press releases, industry studies, and government publications. For example, D&B Hoovers is a source of industry analysis and company profiles.10 Government agencies and nonprofit organizations are also excellent sources of data. For instance, the U.S. government’s Bureau of Labor Statistics (www.bls.gov) and Energy Information Administration (www.eia.gov) are excellent sources of data. The European Commission’s Eurostat website is a source of data on industry, agriculture, and energy, as well as other economic statistics.11
Market intelligence also can include data gathered through benchmarking which is “a process by which selected practices and results of one organization are compared to those of one or more other organizations to establish targets for improvement” (ISM Glossary 6th edition). Benchmarking data can be gathered by direct interaction with another organization or through data gathered and analyzed by third-party organizations. For example, CAPS Research (www.capsresearch.org) conducts benchmarking studies for several industries and issues.
Using Segmentation for E-commerce Product Categories
The information gathered in the spend analysis, assessment of future needs, and supply market analysis should be integrated and analyzed to identify the E-commerce product categories that offer the greatest opportunity for adding value. Portfolio analysis is commonly used to assign categories to one of four quadrants (routine, leveraged, bottleneck, and strategic) in the Kraljic12 matrix based on the level of supply risk and value or impact of the E-commerce Product Categories to the buying organization (ISM Glossary 6th edition). The quadrant then defines the category strategies that would be most appropriate. Monczka et al. (2016) suggest the following generic strategies for each quadrant:
- Strategic (high risk/high value): Form strategic partnerships and collaborate with suppliers.
- Leverage (low risk/high value): Consolidate spend with a few suppliers but maintain competition.
- Bottleneck (high risk/low value): Ensure continuity of supply by expanding the number of qualified suppliers.
- Noncritical (low risk/low value): Simplify and automate the sourcing process.
Although traditionally portfolio analysis has focused on avoiding risk in a category management context, it is important to focus on the opportunity for effective category management to increase value for the buying organization. Figure 2-4 illustrates an application of the risk/opportunity and value matrix for a retail bank.
Figure: Risk and Value for Retail Bank
Source: Adapted from P. Kraljic (1983).