How to Build a Great Commodity Code Taxonomy

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🎣 The Catch Up

Hi Readers,

January! You know what that means?

Companies all over are launching their 2024 ProcureTech projects!

If you’ve got a Digital Procurement project on the docket this year, I’ve got something for you.

Rich Sains invited me onto his podcast, The Procurement Conversation, to discuss how you should craft your team for a ProcureTech implementation (regardless of scope).

I asked Rich to join in on the conversation since he’s so well versed in the topic as well. You can listen to the 34 min conversation by clicking one of the links below:

Otherwise, this week’s note is about something you can work on right now, even if you have zero project budget: your purchasing commodity codes.

I give you the 3 things you need to address to ensure you get quality commodity data for your spend analysis activities.

Have a great week ahead.

Best,

Joël

P.S. In case you missed it, here was my most popular LinkedIn post of the week:
The Ups and Downs of 2023

🌙 Sunday Night Note

A good spend analysis is greatly facilitated by high quality spend data captured at the source (directly by the requester).

Sure, tools exist to “normalize and enrich” bad spend data with business rules such as:

• “Normalize vendors X, Y and Z into a single vendor”

• “If X vendor with Y description is used, enrich the transaction with Z commodity code”

This works pretty well for normalization but enrichment is limited by the quality of the source data. For example, if I only have a cost center, General Ledger account, description “see quote” and vendor name, it’s very hard to determine what was actually purchased at scale (sometimes it’s hard when viewing the transaction manually too 😅).

Inevitably, this leads to putting in manual work to complete the data classification so your spend is clean. And even then, you’re working on assumptions…

To get high quality spend analysis, you never get out of the need to work on data quality at the source (e.g. with requesters/buyers filling out transactions).

To get high quality at the source, you need 3 things:

1. A good commodity code taxonomy (list)

2. Good commodity capture processes (user friendly)

3. People who know and care about picking the right commodity codes

Let’s quickly cover all 3:

1. How to Craft a Good Commodity Code Taxonomy

Principle #1 - Keep the Commodity Code List as Simple as Possible

If a code exists in your taxonomy, it’s because it has a purpose. Subdividing spend into the listed commodity must have value for someone in the company from a Procurement standpoint.

For example, does subdividing tax advisory services into further subcategories give you information that gives you an edge at the negotiation table or not? Typical users of a spend taxonomy are category managers, budget owners and finance, at a minimum.

This usually means you should end up with a 2 or 3 level taxonomy (as opposed to the UNSPSC’s 4 levels which is too granular in my opinion).

You might get pressure to include more granularity in the list from other stakeholders (e.g. finance or maintenance are typical culprits). Resist the urge to succumb to these requests.... Maintenance should use material classification and characteristics to satisfy their needs while Finance has the General Ledger (GL) structure.

The Commodity Code Taxonomy is a Procurement tool. It should be used as such and Procurement should be the only owner of the taxonomy. Other tools exist for other functions.

Principle #2 - Keep Your Organizational Structure Out of It

Ideally, goods/services should only logically reside in one spot in your taxonomy and your organizational structure should not influence categorization.

For example, if you run a construction company that does both new builds and renovations by different business units, all services and construction materials should converge into a single list of commodity codes based on what is being purchased. The purchases can then be subdivided by business unit/division with another organizational element in your system (department, plant, company, etc.).

Here’s an example of a level 1 hierarchy for a manufacturing firm. If you don’t manufacture, you could remove the non-applicable levels.

• Production materials and supplies

• Facilities, Logistics & Warehousing

• Construction & Maintenance Services

• Construction materials

• Spare Parts (MRO)

• Professional Services

  • Consulting

  • Marketing agencies

  • Legal

  • Etc.

• Information Technology (Software and Hardware)

• Employee and Office Expenses

• Banking and public services

You would compose the additional levels (2 & 3) according to the spend profile of your company.

Principle #3 - Tailor the List to Your Business

This is a follow-on to principle #2. Organizational structure shouldn’t influence your codes but organizational culture can influence verbiage.

Your commodity code list needs to be useful to you in your company’s context, according to how you manage your purchasing categories… Sure, you can start from an available list like the UNSPSC or SCTG Commodity Code List. You can even ask Chat GPT for a list… But I would only use these tools for brainstorming and drafting of your own, personalized commodity code list.

Context is king. This holds true for this particular business problem as well.

Don’t Copy/Paste if you want great results.

Principle #4 - Privilege User Experience

Your commodity code list is not perfect when it contains every single possible code for what you may purchase… Your list is perfect when users can easily and quickly find the appropriate codes for their transactions while giving you the data quality required to run meaningful spend analyses.

What does that mean?

Test your commodity code structure and wording with various transactions from the past year. Ask yourself if a user will be able to easily find the proper code. Change the structure as needed.

Get requesters to test it. Ask for feedback and change terms that don’t resonate with your user base and company culture.

For example, “Facilities” may mean nothing to your user base. Find a term that does (Building Maintenance Services? Real Estate Maintenance? Whatever term resonates most with the business, use it…).

Make the list as easy to use, understand and navigate as possible.

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If you respect these 4 principles, you’ll be well on your way to having a great commodity code list.

2. Crafting Good “Capture Processes”

Once armed with a good commodity code list, you need to embed it into your existing purchasing processes. This means:

• Using catalog items with pre-assigned commodity codes for the items where possible

• Pre-determining commodity codes in web forms if using a Guided Buying or Intake Management solution

• Assigning commodity codes to materials in your ERP

• Making the commodity code field mandatory for your non-stock, no material requisitions

• Creating a mandatory field on your non-PO invoices to capture the commodity code during coding activities (at the same time as the GL and Cost Center).

• Etc.

Go over your list of purchasing channels and identify the best way to embed your commodity code list into the process. Requesters/Coders should be the ones filling it out.

Most Procure-to-Pay modules will have existing fields and functionality for this but others unfortunately won’t. Don’t be afraid to develop an exportable custom field for this. It’s too important.

You may have to work your list a bit depending on the system constraints (e.g. flatten your 3 levels into a single level list) but it’s always doable. The end objective is to be able to export all spend data (PO/Invoices) with commodity codes assigned to your reporting tools.

3. People Who Know How and Care About Commodity Codes

This is probably the hardest of the 3 points… Why? Because you can do #1 and #2 without talking to anybody 😂

As you roll out commodity code fields and information into your purchasing channels, you need to work just as hard if not harder on the Change Management plan.

Whatever you do (meetings, trainings, internal webinars, conversations, etc.), you need to communicate these 4 things to requesters and stakeholders:

• What is a commodity code?

• What is it used for?

• Why is it important that it be correct?

• What’s in it for you?

You already know the answers to the first 3 questions… The answer to the 4th question is that you can share their detailed spend reports with them (and budget owners).

They may not see the value at first but ask them to trust you on this… Then deliver. You’ll give them what they could never see via looking at financial statements. They will immediately start asking questions. And you will start to grow your influence right away.

A new field may not seem like a big change that requires change management but you want it used correctly don’t you? Think of the data quality!

Last point… Keep checking in on your taxonomy over time. Look at your “Other” buckets. What’s in there? Does it warrant adjustments of categories? Retraining of certain coders?

If you don’t stay on top of it, data quality will start degrading again over time for everything input by humans...

With the above, you’ll identify opportunities that will payback the cost of putting this in place in no time. But high quality spend data is a labor of love… You need to keep it alive.

Go forth and be lovely.

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