Spend Management for High Growth Companies

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Venture capitalists today fund start-ups that show financial responsibility backed by strong performance metrics.

An entrepreneurial companies challenge lies in the ability to know the difference between needful and wasteful spending while moving on trying to achieve more profit.  Companies like Uber and Airbnb took huge risks with investor money, but it paid off and they were rewarded with market share and growing revenues. However, we see the other side of the coin through start-ups such as Home Joy, an on-demand housekeeping service aggregator in the US that spent over $40 million of venture funds only to bleed money with no sustainable returns.

Start-ups that survive on quickly burning investor funds to fuel growth and then ask for more are most likely to re-think this strategy in lean times of limited capital. For start-ups that aren’t yet profitable, “rapid growth” has turned out to be another way of saying “spending venture funds fast”. During lean times, “spend conservatively” is the best advice for start-ups.  The question isn’t if firms need to slash the burn rates when capital dries up, but about how much and where. Different companies are in varied stages of their existence and this means their cash-burn needs are also different, but they all want to get the most out of their spend.

The basic factors determining if the expenses are on the right track for a start-up include:

  • Understanding the gross and net burn rates
  • Priority on short-term profitability
  • Long-term vision of growth
  • Availability of capital
  • Future expectations about valuations
  • Current and future market trends

With the rise of cost effective cloud software, there are now clear-cut metrics that help business leaders take the right decisions on the budget, channel, and strategy.  They’re just a fingertip away! High growth start-ups and companies around the world are data-driven and diligent in the way they regulate and manage their spending, which makes them look at spending in a proactive way.

Reviews from recent ITSMA research show major differences in investments on spend analytics made by high-growth companies in the year 2016.  Nearly 80% of high growth companies are increasing their budget on management and reporting tools to track their marketing performance, compared to only 22% of the companies that have a low or no growth.

Maverick Spending

Maverick spending includes all expenses from purchases made outside of agreed contracts, purchases that break rules established by corporate procedures and their spend culture, or purchases that don’t really help the company grow or net more profits.

As companies grow in size, these expenses become unmanageable due to the growing list of vendors and transactions that happen. This is exacerbated by new employees coming on board that don’t have the tribal or formal knowledge of how their new organization spends, and the proper process to follow for effective spending.

Maverick spending often happens because companies run into growth opportunities that require spending now, especially in marketing campaigns, and by newly onboarded employees. Tracking these purchases can be beyond frustrating, since maverick spending transactions usually only make up a small percentage of overall expenses, but a larger percentage of the total number of transactions.

If growth is the focus but there’s no easy process to track or document company spending, it’s easy for unaccounted for spending to slip through the cracks. That can be an expensive thing to overlook, to say the least!

What really matters to the CMO?

Asset-light business models such as e-commerce marketplaces, SaaS & others spend a main chunk of their capital on marketing to acquire and retain customers.  No company should spend more than what it makes—that’s common sense. Having systems in place makes managing burn rate much easier and less time-consuming. The key metrics that matter the most here are Cost of Customer Acquisition (CAC), Customer Lifetime Value (CLV) & Marketing Return on Investment (MROI).  Marketing ROI may be the most critical.  It’s a key measure used by companies to identify the return on investment from money spent on marketing.  This number is the dividing line of whether your company’s strategy is working or not.

The cost of customer acquisition helps you decide how much money is spent to acquire new customers. A few examples of customer acquisition strategies from some well-known companies include getting discounts and a free first ride on signing up your friends to Uber, earning cash back while transferring money using PayPal, or getting free gym time for referring friends to 24 Hour Fitness.

Customer lifetime value is the money spent by a single customer over the lifetime of a business. If the CLV is lower than your CAC, it should be a huge red flag for you because it means your company is draining its wallet. Do people make a one-time purchase from your store and never return, or do they come back and spend more money? Lifetime value is what gives meaning to the cost incurred in acquiring a new customer.

The Rogue Marketer

Building a customer base fast is a must for a scalable business model during the growth phase, otherwise your company can never get ahead of its competitors and stay in the race to be the market leader. This requires substantial investments in marketing & promotional activities, which also presents a need for watchful spending with a focus on measurable returns.

Maverick spending on promotion happens when the marketing budget and activities are not aligned with the long term goals of the company. A marketer’s priorities are always focused on getting more customers, generating sales, and responding quickly to opportunities when they come. Unless they’re equipped with the right tools to stick with the company’s financial goals, it’s likely they’ll overspend by a large margin, which affects finances KPIs. Without finance and marketing being on the same page, both team’s KPIs and the company's overall health is in jeopardy.

Finance and operations tend to experience this pain when it comes down to managing requisition spending and three-way matching processes for marketing-focused spending. Without easy-to- learn, accessible and auditable systems and processes, marketing spending can easily turn into maverick spending. Purchase orders approved and lost in long email threads cause a lot of frustration when doing the accounting. In addition, manual errors like misallocated and incorrect line items are hard to correct, hard to catch, and are a pain for the finance team as they try to maintain order for invoices and expenses. Lastly, fraudulent invoices could easily slip through the cracks and cause a company to pay thousands of dollars that they never even spent.

Real life examples of well-funded companies that keep burning more than what they could in the name of growth insinuate us about the repercussions of blindfolded spending.

Case Study: Groupon’s Growth to South

Groupon, launched in 2008, was one of the most innovative start-ups to gain colossal traction and go public in the year 2011. The company makes money through commissions earned from selling discount coupons curated from restaurants, spa-salons, and experiences across the globe. Now here’s the problem…

The revenue growth that Groupon is currently experiencing will be short-lived and reversed when the current marketing spend is withdrawn. Revenues, EPS, and EBITDA (calculation of top line earnings) all look attractive, even though profitability is still non-existent.  Optimists are applauding the important outcome of acquiring active users that drove revenue growth year over year. If they stop giving those steep discounts, they’ll lose their business. They’ve had great success, but it’s not a sustainable business model for your company.

Groupon offers a discount on every order placed—a discount on top of discounts. These aren’t limited time offers, but a cut in the final checkout price for its customers on a regular basis. The amount spent on order discounts was 40% of the total marketing budget for Q3 2016 (on a 12-month trailing basis). This strategy has helped the company in acquiring new active users. However, the incremental marketing spending directly resulted in declining cash flows for the company.

The chart below shows a rapid fall in operating cash flow (trailing 12 months) over a two-year period, starting from the Q3 2015.

As the marketing spend ramped up, there has been a rapid decline in the free cash flow year over year. The next figure shows free cash flow (TTM).

The negative free cash flow through first half of 2016 was the worst performance so far, and the cash balance fell from $ 1.1 billion at the beginning of Q3 2015 to 639 million in Q3 2017.

When we look at the company’s product offerings and the evidence from their financials, we see that the model of constant discounts and price-cutting to entice new customers is a move poised for failure. This is the same strategy that killed the on-demand housekeeping service Home Joy.  

Where did their marketing spending turn into runaway maverick spending?  The promotional price of $19 was offered on an on-going basis for a 2.5 hours cleaning service while every other professional cleaning company charged nothing short of $85. The startup paid dearly for its growth, as these discounts only led to one time purchases rather than organic or referral traffic that is much more valuable, and the result was virtually no repeat customers.  Calculating the long-term outcome of a marketing strategy can help decision makers in steering or re-engineering their spend allocation to avoid losses.  This requires a management culture and system in place that integrates operations and finance team in a common networked loop to achieve everyone’s business goals.

Integrating Finance and Operations

It’s common to see that operations and financial results aren’t on the same page when both departments having their own set of performance indicators. These are some of the reasons behind operational plans and financial results falling in the same line are:

  • Increased insight and control for senior management
  • Higher predictability of financial results for the financial managers
  • Increased insight and predictability add clarity to the organizational procedures to be more transparent and compliant with regulations

Since financial data contains useful insights that are critical for operational leaders, there must be a two-way integrated approach where information goes both ways instead of only being used for external reporting and decision making.  In general, most operations managers have a fairly decent understanding of P/L statements, but it’s a different story when cash flow statements and balance sheets come into the picture. The financial reports intended for financial experts often aren’t very clear for operational managers.

Some of the ways that operational managers are provided with relevant information include:

  • Standardizing financial reports so everyone receives data in the same format
  • Providing variance between actual and budgeted numbers
  • Providing break up of operationally relevant data (product, market, sales channels, etc.)

With creative efforts, operational managers can be empowered to gain insights into how their actions will affect the company’s financial outcome.

Let’s take a look at some examples of financial data and their specific operational uses.

One disconnect commonly found in many organizations is between the ways a business operates and how the sales force is incentivized. We can measure sales team performance in terms of revenue, while the CFO measures performance based on profit and margin. Consequently, higher discounts given by the sales people may put pressure on the margin and lead to a point of conflict. If the company managers make their decisions based on the margin, then this approach needs to be standardized across sales operations too.

If sales people are incentivized based on profit margins, their decisions on positioning products and deals will fall in line with the company’s goals. An indirect contribution by one company department that may affect others is an important variable that often goes unnoticed. For example, imagine a telecom company that sells triple bundled subscriptions that include internet broadband, TV & telephone. All the teams involved get the same credit because it’s hard to separate each department’s contribution to the value proposition. Non-financial information like number of units sold, pricing details, employee headcount, etc., should and must be available to financial managers.  They need operational insights so they can accurately forecast the financial outcomes of company operations.

For companies who have a limited runway before they need to raise more money from investors, real-time indirect budget tracking is just as important. This is so the organization and the finance team both get as much accuracy as possible on when it’s time to get more funding, so the rest of the teams can continue to focus on driving growth.

The bottom line here is that financial managers need access to data regarding company operations for accurate forecasting of financial results.

Operational managers need this financial data to best understand the impact of operational decisions, so they can optimize the overall results in line with the company’s goals.

How spend management software changes the game for employees

Businesses with high growth prospect thrive on innovation and they allocate a huge share of their revenues on new product development.

While spending on technology solutions that contribute to the creation of new products and services, companies stare at the make or buy decision. Hi tech industry has never constituted more than 15% of the outsourcing market which includes banking, finance and insurance, and accounted for 40%; telecom, 17%; and manufacturing, 12%.  This is justified by the trend that we see with startups being the only segment in technology industry that outsource core development to third party partners. Well-funded firms in the growth phase resort to selective outsourcing of specific phase in new product development such as testing or ancillary development activities.

A strong spend management software can really change the game for a company’s employees, from the executive team down to the operatives on the floor.  Procurement processes in the IT industry normally start off with a CIO making requests for technology to the IT department.  The IT department then takes care of the purchase, development, and delivery of software, and hardware solutions.  Thanks to new cloud deployed technologies, the procurement process now requires fewer technical resources than ever before. While CIO’s embrace this model to take advantage of the lower maintenance cost and CAPEX, the cloud model is a major game changer for companies because cloud technologies are easy to use and require little or no hardware.  Employees simply sign in to the company’s accounts in the cloud.

The rise of cloud deployed technologies like Iaas, Paas, etc., offers new opportunities for decision makers to procure technology.  This led to the rise of what’s often called as Shadow IT, which refers to the software and hardware solutions outside of the control (and sometimes the knowledge) of the IT department.  When the CIOs are unaware of the technology spending, it becomes practically impossible for them to effectively budget and plan for the company’s technology and operational needs. A smarter allocation of funds becomes difficult to do when there’s almost no visibility for CIOs to how the SaaS application and IaaS platform are used.  Some people may disagree, but we at Procurify think that CIOs not knowing how company technology is used is a bad thing…  

This is especially prevalent in startups with large marketing and sales expenditures, as these teams will often purchase a large amount of SaaS that they have to implement, maintain, and negotiate themselves. That requires not only the IT department running around like mad men, but it also requires rank and file employees having to take time out of their day to learn about how to describe their SaaS/IaaS problems.  When they’re losing time doing things that aren’t their job and aren’t what they were hired for, company employees are immediately less productive.  Procurify’s interface is simple, user-friendly, and so much easier than training and retraining staff members on some intricate financial software!

High growth companies that don’t use strategic sourcing are vulnerable to higher production costs, which translates into losing out new product innovations to competitors. Sophisticated procurement software with web services API allows tech companies to hook up their existing workflows or even develop customized solutions by directly using the API.  

Sourcing Components How a Spend Management/Procurement Software will make a difference?
Ecosystem
  • Easier to collaborate on financing and sourcing
Risks & Regulation
  • Provides data securityProvides data security
  • Manage supplier and price risks
Categories
  • Compliance management
  • Enables tail spend purchasing
Suppliers
  • Tracking life cycle of suppliers
  • Analyzing supplier performance
Sourcing
  • Assistance in negotiation
  • Facilitates spot purchasing
Legal Contracts
  • Ease of contract administration
Payment requisition
  • Order to pay and receipt management
Cloud Management
  • Track cloud spend, utilization and unit cost KPI’s
  • Justify cloud spend with accurate allocation at scale

Growth in tech companies depends on their ability to design and launch new products at lightning speed. But still, new product development happens at a snail’s pace in many tech and biotech companies. This often happens when sourcing professionals get involved in the process only after the sales team meets the clients to understand their needs, and the product specifications have been prepared by the engineers. Sourcing and procurement divisions at most tech and biotech companies still operate with a cost-only mind set, when the real focus should be on growth.  Growth requires the company to be able to really satisfy the customers’ needs.

Only if the sourcing team works in close ties with the engineering and sales team can it protect future revenues, shorten the time required for the product engineering cycle, and increase new lead closures. The greatest benefit here is the supplier collaboration that lets companies to utilize their suppliers’ expertise and insights at just the right time. Apple Inc, is a great example of a company that keeps its R&D costs minimal while its peers spend huge amounts of their revenue on product innovation. This is ensured through Apple’s emphasis on supplier collaboration that encourages them to present ground-breaking ideas and products, and their market share is second to none.  

Well-integrated spend management software with a hybrid structure that centralizes procurement services across different departments will empower the sourcing team to be more agile and productive on a global basis. Meanwhile, they’ll still be able to while serving the demands of the local market in a more efficient manner.

Awaken Your Strategic Sourcing Potential

For years, technology companies with high growth prospects considered their sourcing and purchasing functions merely as supporting activities with prime focus on transaction efficiencies and cost reduction. However, today’s business environment demands far superior solutions that depend on supply chains spread across the globe and integration of cloud technologies. In this exciting fast-paced world of global commerce, sourcing departments need to expand their scope and value propositions.

Business leaders and decision makers have to realize that well-managed sourcing and procurement practices, with the help of some new technologies, is a state-of-the-art form of gaining a competitive advantage in their industry.

The Cruelty of Ambiguity

People are unpredictable.

Expecting your employees to be reasonable can sometimes be unreasonable.  The idea may sound inspiring when the leaders advocate a democratic set up where in employees are given a sense of ownership through freedom on spending decisions.  But in reality, this freedom often leads to indecision, fear, and abuse without proper guidance and real empowerment.  Even the most well intentioned can end up questioning their choices which results in too little or too much of spending. This is not limited to the typical T&E, entertainment and software purchases but also extends to policies such as unlimited vacation, free food and limitless days for work-from-home.

Maverick purchases usually account for a small percentage of the overall indirect spending.  However, this can adversely affect the bottom line of any organization in a significant way. This is particularly true when it’s encouraged or owned from leadership. Beepi, a Californian based company that offered an online peer-to-peer marketplace for buying and selling used cars, is a perfect example of how rogue spending can be a silent killer.

According to Techcrunch, Beepi was spending $7 million a month when their headcount stood at three hundred employees, shortly before laying off two hundred staff members as a part of its attempts to sell to Fair.com. Gross salaries and overtime pay accounted for a substantial part of this huge burn. Expensive office furniture purchases, lavish company lunches, and even paying the utility bills for CEOs’ significant others, were just some examples of abusive unauthorized expenses that helped sink the company.

Beepi went bust in 2017 with a complete shutdown of operations and a necessary sell-off of parts to repay its creditors. They raised too much money in too little time by sailing through the optimism wave of investors over transportation startups and marketplaces. When a business is run primarily to raise money the way Beepi did, spend management will always be an alien idea. When times are good, the open tap of money in a startup community motivates companies to pay premium for their employees, splash more money on renting fashionable offices to attract these employees and investors, and this leads to an environment where there’s no motivation for saving pennies and making better decisions.  

Startup success is often measured by glitzy figures that can be deceiving by showing tangible growth. Just like how Gross Merchandise Value (GMV) signifies revenue growth without any regard for profitability, Headcount Growth shows workforce strength year after year without considering the productivity of each employee. This may give a healthy image of the organization to the outside world. But if they come along with increased spending in the form of perks and other wasteful expenses, it could extremely damaging to the company.

Soundcloud’s massive 2017 layoff of 173 employees and shutdown of its offices in London and San Francisco reminds us of how things can go out of control with increased headcount and accompanying costs.  The company had a turnover of €21.1m in revenues in the year 2015, while its operating losses widened to €48.6m and net losses accelerated to €51.2m.

In 2015, total staff expenses at the company (including wages and other employee related expenses) amounted to €35.6m. This accounted for around 59% of Soundcloud’s total operating expenses for the year, which stood at €60m. Also, Soundcloud’s figures show that it spent €2.25m on operating lease rentals for land and buildings in 2015, up from under €1m in the previous year.

Another part of the problem here is created when employees include personal expenses, accidentally or deliberately, as company expenses in the expense reports. In 2012, a survey by Robert Half Management Resources was done to include responses from around 1,600 American and Canadian CFO’s.  The findings revealed that there were many unusual items such as pet food, lottery tickets, cosmetic surgeries, and wedding anniversary dinners written off as business expenses.  While these expenses may look funny on the surface, they represent a serious issue that can have a very toxic impact on a company’s bottom line. Only when there’s zero uncertainty about your co The operating loss for Soundcloud before taxes was €48.6m in 2015. If the company had been more proactive with their spending, and realized that long term growth required being more effective with spend, they may have continued growing without a bailout.

These numbers show neither any boundaries nor benchmarks established before spending happened. This kind of situation makes startup companies blind to any non-productive expenses that restrict growth, while they could have prevented it from happening in the first place.  Business Insider offers us an example in the company Dropbox.  In March 2016, Dropbox pulled the plug on its lavish employee benefits like free laundry services, shuttle buses, and permitting unlimited guests at the office’s free dinners, etc. The company was having an approximate headcount of 1500 employees and spending over $25,000 per person on perks each year.  There are fewer better examples of bleeding money through a simple lack of spend control and visibility, which software services like Procurify can help withmany’s expense policies can you weed out the unauthorized purchases often made by employees.

However, this shouldn’t come at the cost of sacrificing the flexibility of an employee’s freedom to stick with their duties and contribute to the growth of the business. For example, a sales executive could be permitted to spend the company’s money on taking a prospective buyer out for a meal. It’s the same with non-profit groups who might wine and dine a potential big donor.  But taking your significant other to a lovely anniversary dinner is not a business expense. A company can get ahead of this by requiring pre-approved spending practices, so an approval chain can ensure that spending is in the best interest in the company, before it’s spent.

Netflix has an out-of-the box expense policy which asks its staff to “act in the best interests of Netflix.”  This means that there’s some flexibility, but every purchase must still be justifiable and relevant to organic company growth.  Every startup can implement similar policies depending on their culture or philosophy, and define the expenses that are covered and excluded.  The key to all this is keeping company spending policies simple and straightforward, with systems in place to carry them out efficiently.

Defining Yardsticks and Guardrails

The cases of start-ups we explored points out that growth must be value driven rather than money driven.

This requires setting yardsticks and guardrails to make sure money isn’t wasted on unwanted assets or services and unapproved expenses. Rogue spending that we see today in well-funded companies can only be avoided by embracing a spend culture that’s self-directed using benchmarks and authorized limits to improve the quality of decision making.

To set these kinds of standards, employees need to investigate what goods and services really cost, including prices from other suppliers as well as the average cost from your company’s previous purchasing history. Ambiguity can be avoided when there’s perfect knowledge on suggested budgets, and also when comparisons of potential spending are easy to do using organizationally available spend management software like the kind Procurify specializes in. For instance, if a company has an unlimited sick day or vacation day policy, there must be widely circulated information on the average number of days off taken to help new employees in keeping it reasonable when taking certain liberties.  
Similarly, when it comes to taking clients or donors out to lunch or dinner, not knowing the maximum limit can scare an executive into choosing a mediocre restaurant. At the same time, run-of-the-mill chain restaurants like PF Chang’s and TGI Friday’s won’t guarantee you a sale. Transparency on the average cost of a dinner will remove the prevailing confusion over the available choices, while maintaining efficiency in picking venues.  

Knowledge of all minimum and maximum approved spending limits—yardsticks and guardrails—can help employees make better-quality decisions. In the above example of sick and vacation days, there will also be employees who take little or no time off from work.  Management doesn’t want that either, since overworked employees increase their risks of depression and cardiovascular diseases, and some may just look for another job.  That’s why it also makes sense to have a minimum amount of vacation days, not just a maximum.  

How The Right Software Can Make a Difference

High growth companies usually find it difficult to stay in pace with the rapid increase in the number of purchases, vendors, total invoices, and new employees.

Meanwhile, growing problems occur in accounts payable like duplicate payments, paying for fraudulent invoices, late payment fees, automatic recurring subscriptions no one opted out of, etc. There’s a real need for an integrated spend management software solution that’s easy-to-use and requires no training for employees and suppliers.

A user-friendly platform that lets you confirm approvals directly through emails. By not requiring a login to the system, it will help to increase the volume of transactions and the number of invoices processed. From paying invoices, and other spend related functions, operational efficiency will be improved, resulting in better, more streamlined and compatible processes. Less time taken for creating purchase requisitions and an improved approval cycle wait times are common among firms that adopt the right spend software.

The strength of a company’s financial reporting depends on the accuracy of information on its liabilities. If the outstanding commitments haven’t been accurately invoiced by the suppliers, it’s next to impossible to correctly report on the liabilities. Such a situation can be avoided simply by ensuring that procurements are made against the purchase orders, and the corresponding invoices are submitted through the software in use.

In today’s fast-paced world of global markets, the investment community expects accuracy and transparency in financial reporting to ensure that money invested in a company is spent wisely, and that the road to profitability is safe and secure. An effective spend management software will enable managers and executives to manage their company’s spending in smarter ways.  

Budget compliance is usually a tedious task for companies that experience a high rate of change. With the help of the right software, managers can know for sure that spending is on-Order and on-Contract, and avoid any uncertainties that can create problems later. Comparison of real spending and budgeted spending with real-time reporting will help managers make better decisions. With smarter, improved use of negotiated discounts and better-informed and readily available approvals of purchase requests, wiser spending of company funds is guaranteed.

A smart spend management software, in all of these ways and many more, will help high growth companies and startups in managing their bottom line and improve the long term value for investors.

If you’re looking to gain the benefits of smarter spending without slowing growth, contact us today to learn how Procurify can help you. Procurify has helped companies spend over $7 billion more efficiently and with fewer losses.

Before Procurify it was difficult to understand where we were going to end up financially and how much purchasing was being done.

KEVIN BROUGHTON - DIRECTOR OF IT AND DEVELOPMENT, CENNOX