Apr 05, 2021
Spend Matters welcomes this guest post from Jack Freeman, Principal at PeakSpan Capital who is a growth-stage software investor.
In a previous post titled “Investor perspective: The Rise of Verticalized Supply Chain in Large Enterprise SaaS,” we discussed the merits of focusing on a single end-customer vertical. While there were light references to category solutions like Yapta, we didn’t give nearly enough airtime to the rise of category spend solutions. Key difference being in the last post, the focus was more around deeper supply chain functionality for specific end-customers (hospitals, CPG, pharmaceuticals companies, etc. ) whereas here we are more concerned with serving any type of company but with a solution centered around a specific type of spend.
Legal is a nice concrete example. While increasingly, plenty of software platforms exist to serve law firms (as the buyer of the software), legal spend management as a category solution is more of a horizontal play given every Fortune 500 enterprise has legal spend to manage (so, serving corporate legal departments). Whether you are in pharmaceuticals, healthcare, manufacturing — everyone has legal bills! Further (and to the point of this post), legal spend is extraordinarily nuanced and is best left for a best-in-breed category spend solution to manage (versus horizontal procure-to-pay platforms that attempt to cover all spend).
The various flavors of category spend are not hard to uncover and rarely change (legal, travel, services, etc.). There are rare examples of new categories, but these typically take decades to mature. One such example of a “changing”/“evolving” spend category is software — given enterprises weren’t buying tons of software 10-20 years ago (but they sure are now!).
There is no better evidence of this than Vendr, a provider of SaaS procurement software (that is, software that helps with the procurement of … “SaaS”). Vendr just raised $60 million from Tiger Global at a $600 million valuation. Please note — this is a higher valuation than WorkDay paid for the acquisition of ScoutRFP — recognizing we are in an unprecedented market environment.
We could write an entire blogpost simply recounting history — including acquisitions such as Yapta, financings such as Vendr and a slew of other emerging market leaders across the category spend universe. While there is no denying the emergence of players attacking specific categories of spend — the better questions are 1) why does this matter, and 2) how will they fair?
The spend in a category is reflective of the nuances seen in the category itself. If you want to offer best-in-class spend management solutions for logistics spend, you must understand the intricacies of how transportation is procured. This is why indirect spend digitized first.
To use a classic example, if we are talking about office supplies, these products and processes are incredibly easy to digitize. Office supplies are not mission critical to any value chain, require less configuration and look and feel very much like a consumer filling up their shopping basket on staples.com. Similarly, the market for indirect spend is vast. Nearly all businesses have indirect spend. Everyone needs a chair … or a standing desk.
Direct Procurement, on the other hand, is where category-focused solutions become very interesting (albeit — the two are not mutually exclusive). When the spend is central to the offering (makes up a large percentage of COGS), are you going to roll the dice on a generalist provider? Or not digitize this process at all? Gross margin is one of the top indicators of valuation multiple as it reflects the scalability of a business.
Let’s take the healthcare or pharmaceuticals verticals for example. Both insatiably nuanced — between configuration, regulation, insurance-related considerations and overall product complexity, there’s no SAP instance on the planet that can act as an effective procurement platform for medical devices (although I’m sure some try…).
Conversely, while some hospital spend can flow through SAP, any spend associated with the delivery of care is what we like to call “high stakes spend.” Simply put, if the device, drug or service does not arrive on time, it can be detrimental for all parties involved, especially the customer (in this case the patient).
Similarly, given the volume of medical-related services, supplies, drugs, etc. flowing through a hospital each and every day, the impact on margin is far greater than the office chairs being procured via a generalist eProcurement solution.
Category solutions in indirect procurement
Services are a great example of why category-centric procurement platforms are critical, even in an indirect procurement setting. To help compare and contrast direct vs. the various flavors of indirect, let’s unpack a corporate P&L:
|COGS||Direct Materials: Discussed above, any products, parts, services, etc. that directly impact the company’s offering. Given the variable nature of COGS, refinements here are the most impactful over time and are strategic to the company. Tesla, for example, must balance cost and quality sourcing materials for the Model S. The vast majority of spend in COGS would be considered direct procurement.|
|S&M||Marketing Services: Procuring marketing services from advertising agencies is not as simple as buying a few more office chairs — the value chain is involved and nuanced spanning sourcing, evaluation, contracts, milestones and measurement. ROI is the name of the game when deploying marketing dollars. Procuring marketing services should involve both procurement and marketing professionals — but from a technology perspective, requires a system tailor-made for the value chain. While direct materials procurement is of high importance and high leverage, S&M spend is equally critical but different reasons — strong execution with sales and marketing spend leads directly to revenue uplift. Growth rate and gross margin are the top two indicators of valuation multiples.|
|G&A||Legal Services: Again, distinct from general indirect procurement, direct materials procurement, and marketing services procurement. For large enterprises especially, legal spend is a necessity and can vary widely, leading to material impacts on the bottom line. Contracting, pricing, budgeting, visibility, etc. — the best example/use case is budget/cost tracking which is typically a black box. Because legal services are typically based on expensive hourly rates, and “hours” are impossible to predict, understanding what you are “spending” on legal services in real time is a must.|
|R&D||IT Spend Software: “Every company is a technology company” nowadays. Corporations are spending more and more on technology at every level (cloud hosting, infrastructure, busines applications, consumer-facing technologies, etc.). Disclaimer — we very liberally put these in the “R&D” bucket in our illustrative P&L, which is incorrect as these costs will be scattered throughout the P&L (COGS, S&M, G&A, R&D) depending on what they relate to or who is buying them. The key with software procurement is the fundamental shift of power from IT teams to best-in-breed point solutions. Flash back 10 years, a company may have been using SAP and then just a few other platforms which was fine to manage old school style. Today, the average sales team is leveraging 43 sales technologies and the average cybersecurity team is using 75! Simply keeping track of software spend is becoming impossible without digitization.|
These are just a few examples — other category-spend solutions we’re evaluating include veterinary supplies, medical devices, “gig” services, logistics spend, travel spend, food & bev, private aviation, automotive, heavy machines/equipment, insurance, chemicals, raw materials, facilities management, corporate fleets, packaging, professional services, and utilities.
Similar to how “software” spend will tend to scatter itself throughout the P&L (especially so given there is now a category of software for everything and everyone (customer success software, facilities management software, etc.), we are also seeing a rise in the freelance workforce.
Increasingly, companies are turning to external workforces to complement their traditional W-2 employees. With this, enterprises are faced with a whole host of challenges from sourcing, to compliant onboarding to tracking and engagement, all the way through payment. The entire source-to-pay process but with people rather than goods. Depending on the type of business, these external workforces may even be found in COGS, but more often will be helping with software development, design, marketing, etc. — and either case are naturally important to the business given they were proactively hired to fill a specific void!
To compare and contrast, for all the challenges associated with procuring physical goods, just think of the additional nuance involved when adding actual people into the mix! With strong sourcing, tracking and orchestration of external people resources, enterprises can avoid the Tom Smykowski’s of the world.
To bring things full circle, we see two really interesting paths for procurement (and supply chain) software specialization: 1) verticalization (offer end-to-end functionality) to a specific vertical/type of customer, 2) category specialization (offer the best-in-breed solution for managing a specific category of spend for any type of customer).