Spend Taxonomy – Vital Component in Spend Analysis
Before understanding the spend taxonomy, let us first understand what is spend data classification. Spend data classification is an activity that is carried out generally in the procurement and finance departments.
This activity involves listing down everything an organization has bought from its suppliers over a certain period.
What is a spend taxonomy?
A spend taxonomy is nothing but a hierarchy or a categorical spend structure customized for your business.
This hierarchical structure of spending can take a lot of time and effort to get built but a robust category structure will benefit the organization’s spend management in the longer run.
For a solid spend classification, a thorough taxonomy plays a vital role. Because without a good taxonomy, spend classifications will become weak, and the organizations won’t reap valuable insights from the resulting reports.
It is imperative to extract usable information from the company’s past spend data. Theoretically, it sounds easy, however, in practice, it is not that easy. Below are the three levels of spending analysis.
- Data Acquisition- In this phase, you gather all the data related to spending from internal and external sources.
- Data Processing- This phase involves cleaning the data, classifying it, and enriching it.
- Reporting and Analysis – This phase involves extracting the data and gathering usable insights to make strategic decisions in the future.
Remember to have a firm foundation, the information you generate from the raw data should be complete and error-free. Now let us dig deep into understanding more about the spend taxonomy.
We know that the spend can be classified from general to specific. This classification depends on a hierarchy of categories. The hierarchy of categories has different levels ranging between 3 to 6 based on the granularity.
This hierarchy is called a category tree or a taxonomy which plays a crucial part in the activity of spend categorization. Have a look at a simple example of a taxonomy of manufacturing.
What importance does spend categorization play in strategic sourcing?
Spend categorization or taxonomy is very important because it helps organizations to classify the data accurately. This will help the stakeholders to view the overall spending, where those spends are allocated, and what is the scope of cost-saving.
Remember, spending data accumulated from internal and external sources must be complete, cleaned, and must be kept in meaningful buckets. Also, categorization shouldn’t be too complicated as it will create confusion and not too simple for the opportunities to get missed.
Expert recommendations to consider while designing a taxonomy
- Align the categories with the business needs.
- The hierarchy should contain enough sub-categories such that saving opportunities are not missed due to the fewer subcategories.
- The hierarchy shouldn’t contain more than the required number of sub-categories where a small amount of spending becomes time waster.
- The hierarchy must contain unique categories and sub-categories. In other words, each sub-category must be mutually exclusive. For example, if auditing comes under the category accounting, then it shouldn’t come under financial services.
- The hierarchy must contain the categories which are clearly defined, agreed upon by related stakeholders, communicated, and documented thoroughly.
- The hierarchy can have categories and sub-categories with numbers or naming conventions as a part of standardization.
- It is recommended that the hierarchy must not have a category named ‘others’ because this can cause confusion. All spend belongs somewhere.
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