Understanding Tail-Spend Management
Below is an abstract of “Understanding Tail-Spend Management”, a GEP whitepaper.
World-class organizations today have a good level of control over most of their cost structure. As this visibility and control increases, eventually a point is reached when the effort required to go further appears to be greater than the benefits. At this point, a number of challenges arise:
- Poor data visibility
- Lack of effective controls
- Little market leverage
- Low potential savings
- Lack of interest from other stakeholders
- Lack of category expertise in the very high number of categories remaining
Organizations often find it difficult to define and execute a unified approach with the goal of capturing this last portion of sourceable spend. Traditional strategic sourcing approaches need to be flexed and made more resource-efficient, and technology and transactional procurement processes also have a critical role to play. Attempts to address this challenge have led to the appearance of a new vertical within Procurement departments; Tail-Spend Management (TSM). In challenging economic conditions, where Chief Financial Officers (CFOs) are leaving no stone unturned in the quest for cost reduction, TSM is becoming a hot topic in medium- to high-maturity procurement organizations.
Definition of Tail-spend
The term, “tail spend”, is derived from the Pareto principle, which states that only 20% of your suppliers will account for 80% of your spend. Accordingly, 80% of your suppliers will account for 20% of your spend, and this ever-thinning series drawn in a block graph looks like a tail. Note that the Pareto principle works more or less exactly depending on data sets, while the 80/20 ratio will vary from firm to firm depending on a number of variables. In some firms, 80% of suppliers may account for more or less than 20%, but in most cases the true figure will be close to 20%.
Tail-spend is unaddressed spend
Many organizations, and many external consultants, develop an approach to tackle only the “theoretical” tail-spend, which fits criteria such as the bottom 20% by value, low Purchase Order volume, non-contracted spend, and so forth. A theoretical definition often makes the isolation of such spend a daunting task in itself. GEP prefers to use a different, wider definition based on the realities of the challenges faced by our clients over the years. For GEP, tail-spend is quite simply unaddressed spend, by which we mean spend on commodities and categories that have not been formally addressed by Procurement in the last two to three years. (If you have not addressed those categories accounting for at least 60-70% of your spend in the last two to three years, it is unlikely that your focus is going to be on tail spend anyway.) By using this definition we believe organizations can avoid wasting time on theoretical definitions and can much sooner get to work tackling the real issue; unaddressed spend and new savings opportunities.
Qualities of Tail-spend
The large number of categories within tail-spend varies from firm to firm, but regardless of the specific categories, tail-spend displays a number of common characteristics:
- It rarely includes direct materials
- It contains a disproportionately high percentage of spend from the furthest-flung subsidiaries of the organization
- It often contains suppliers that no one in the procurement team has heard of
- Non-compliance and maverick spend often lurk here
- A majority of it is either not low-price, or not low-volume
This last point may seem surprising, but it is one of the most important things for organizations to understand when considering tackling their tail-spend for the first time. Significant parts of tail-spend can be addressed using well-established sourcing techniques. The key, especially given the challenges we listed right at the very start, is how to execute effective sourcing strategies while maximizing efficiency. The low value of tail-spend categories means that return on investment (ROI) is always going to be lower than for core categories. Successful approaches will have an eye on both sides of the efficiency/effectiveness equation.
Approaching tail-spend management
There are many ways to approach tail-spend management and the best results are achieved by following a variety of approaches simultaneously. Like other types of sourcing, an iterative loop is involved, whereby data is constantly reviewed in the light of previous sourcing activities and changing business requirements.
1. Spend analysis
The starting point here is data. Best-in-class spend analytics software will accept data from a variety of sources, such as Accounts Payable, General Ledger, ERP systems, etc., and typically classify around 95% of those data at the first iteration, already deep into a 20% tail. Over time this classification can improve even closer to 100percent; indeed proactive TSM will actually improve data classification over time. Best-in-class spend analytics solutions will allow you to drill right down to the line item level, critical in the next stage, which is classifying tail-spend data.
Deep-dive data analysis will support filtering and re-classification of tail-spend so that appropriate strategies can be employed by category. We typically use filtering models to ensure that different types of tail-spend are addressed in an appropriate manner.
Some tail-spend categories will be identified as appropriate for more traditional sourcing approaches. Here the key is efficiency. Online eRFx and eAuction tools can hugely improve efficiency by leveraging standardized templates and engaging multiple vendors simultaneously. The time, effort, and number of vendors included can also be flexed in line with value and sensitivity of spend.
Accelerated sourcing projects match effort to reward and ensure that a higher volume of projects can be run simultaneously by TSM resource. Of course, carrying out sourcing projects on tail-spend categories drives an ever-higher percentage of spend under contract and has many benefits in terms of risk management and sustainability as well as cost savings.
4. Spot buys
Whilst the approach so far has been top-down and data driven, bottom-up approaches to addressing spend at the point of requisition are also excellent methods for realizing benefits from proactive tail-spend management. Spot buys will frequently follow an even more accelerated sourcing process, and here again filtering and classification is essential to proper prioritization and optimal results.
If spot buys are channeled through Procurement, then repeat spot buys in low-volume categories can be identified and driven onto contract through sourcing over time, while ongoing spot buys can benefit from accelerated sourcing techniques such as 3-bid and buy.
And finally, also in terms of a bottom-up approach, driving as much low-value spend onto technology platforms such as P-cards, online catalogues and punch-outs gives Procurement much greater visibility and control over tail-spend and greatly reduces manual effort. Best-in-class purchasing modules will manage all of these platforms in one place. As more spend is driven online, data quality is improved, so that when spend analysis is refreshed an ever-greater percentage of data visibility is achieved and the iterative loop can start again.
Critical success factors
A good understanding of the nature and challenges of tail-spend is not difficult for procurement professionals to grasp, but given an expectation of low ROI, data challenges and at best lukewarm interest from the rest of the organization, knowing what to do and how to do it is not so clear. GEP has been working with global clients on TSM for the last ten years, and our experience demonstrates that the following are the three critical success factors:
- Procurement Technology
- Simplify processes and increase control
- Establish dedicated resource and manage performance
With tail-spend management, take unaddressed spend as your starting point and deploy a variety of approaches to reduce this spend and bring it under control. Having the right tools and processes in place are vital in tackling tail-spend, but having dedicated and specialist TSM resource is equally crucial. Making significant advances in data visibility and contracted spend will help you further your risk management and sustainability objectives over time, while a difficult economic environment is paradoxically the perfect time to tackle your tail-spend. Do it now, before someone remembers the Pareto Principle again.
Ramachander Raja, Associate Director, Consulting, GEP
Matthew Bardell, Senior Director, Consulting, GEP