The unpredictable nature of the Maintenance, Repair, and Operations (MRO) spend category creates numerous sourcing challenges. More often than not, a large percentage of the items purchased change from one year to the next. This creates added complexity in developing a sourcing strategy that will effectively establish year-over-year cost savings.
One way to develop your strategy is by analyzing previous purchasing trends. Leveraging past purchases and purchasing patterns can help formulate a representative "market basket,” an effective strategy for sourcing MRO.
Developing a market basket is a common best practice industry-wide. The term refers to the process of creating a representative sample that allows you to evaluate the competitiveness of a supply base. Typically, this involves applying the Pareto principle, more commonly known as the 80/20 rule.
Economist Vilfredo Pareto suggested that there is an “unequal relationship between inputs and outputs, stating that 20% of the invested input is responsible for 80% of the results obtained.” When applied from a sourcing or procurement perspective, this typically means 80% of the spend is within 20% of a company’s supply base.
Taking it a step further to the category level, we can observe that 80% of spend is spread across 20% of items. Within many product-based categories, creating a representative market basket is as simple as reviewing purchasing history and applying the 80/20 rule. Generally, there is little value in inundating the supply base with the bottom 20% of spend which can include hundreds (if not thousands) of items with a significantly lower average annual spend per item. The reduced market basket allows the supply base to focus on the items that are most important to your organization. This will allow you to effectively drive negotiations and center contracts on what really matters.
In MRO categories, however, creating a representative basket can be a bit more complicated. As previously mentioned, due to the high volume of unplanned purchases, previous purchase history may not necessarily be representative of future purchases – at least not at the item level. MRO requires a deeper level of analysis, which requires data cleansing. Your team must carefully scrub its purchase history on a line item basis to establish manufacturers, part numbers, normalized descriptions, and units of measure. They also need to distinguish each item with the appropriate category and subcategory.
After cleansing the data, you must then review it in multiple ways. When applying the 80/20 rule, the goal is to identify high-spend recurring purchases, but high-spend purchases that aren’t actually recurring can easily fall into the mix. Ensure that you are reviewing purchase frequency as well as quantity. Low frequency and low quantity items tend to signify a limited purchasing pattern, and focusing your time on negotiating these particular items probably doesn’t make sense. In most cases, these items can be removed from your market basket.
Following the first pass, it’s important to review spend by subcategory and spend by the manufacturer. Make sure your market basket accurately represents top manufacturers and top subcategories compared to your holistic data set. This is important because it builds negotiation leverage for steeper manufacturer discounts or subcategory discounts. The concept here is to ensure you are able to effectively negotiate competitive discount structures for the areas in which you commonly purchase. Although you may not purchase the exact same item again, you typically utilize a preferred manufacturer or experience recurring repair needs within particular areas and subcategories.
Market baskets are a common sourcing best practice for a reason. Developed correctly, they can provide an effective means of securing year-over-year hard dollar cost savings. Each market basket is unique to each particular spend category, and you should adjust your efforts accordingly. Information such as forecasts can heavily alter the data you want to include within your basket, so it’s essential to create each market basket carefully.