How to create a category structure for your business

Classifying, or categorizing, spend provides you with more control, better overview and detailed insights. In addition, it's a vital part of category management and strategic procurement.

Classifying your spend into categories is important for several reasons. One obvious reason is the prioritization of resources. Large spend categories with a significant potential for cost reduction should naturally be prioritized, compared to smaller categories with a lower potential.

What are Spend Categories?

A spend category, or category, contains similar types of purchased products or services. In other words, a category should support the market classification, and thus reflect the supplier market and what we are buying.

In general, it's common to distinguish between direct and indirect spend categories. Direct spend refers to purchases of goods and services that are directly incorporated into a product (or service) being manufactured. Indirect spend refers to expenses incurred for materials, services and maintenance required to operate the business. Some organizations also choose to use investment as a level one category.

The overall categories are further divided into sub-categories to best reflect the underlying supplier markets, which together constitute a category structure. For example, such categories could include building and property, machinery and equipment, raw materials, finished goods, consulting services and so on. A spend category at the lowest level should correspond to a unique supplier market.

Please note that a category structure will vary from company to company. However, indirect categories and subcategories will often be relatively similar across businesses and industries.

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What Data do You Use and How do You Classify Your Spend?

The category structure is based on spend/procurement data, i.e. transaction data from the ERP system. On a general basis, more detailed data provides more possibilities for classifying spend.

The available data varies from business to business. As a minimum, all companies have data at the invoice level, while some companies have article level data (typically for direct spend). Manufacturing, industrial and retail companies, as well as public companies, more often than not have article data easily available. Please note that even "limited" invoice-level data provides critical procurement insights.

There are several ways to classify the spend data into the different categories ("classification rules"). The different options will depend on the degree of detail in the data. It is most common to classify spend by using accounting or supplier information, or article information if this data is available, e.g. article names and products or services codes.

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Sykehusinnkjøp HF, for example, has created a category structure by using UNSPSC, a taxonomy for products and services. You can find their category structure here (page in Norwegian).

Introduction

How to create a category structure for your business

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