Sourcing and procurement departments are under immense pressure like they’ve never been before. They are responsible for purchasing during a time of volatile commodity prices and supply market risks. And like other corporate functions, they are supposed to get more done with less funding. At the same time, alongside other parts of the supply chain, they are tasked with delivering business value through flexible and innovative operations.
While dealing with these pressures, most procurement organizations understand they could be leaving money on the table and using their resources inefficiently with low-value spending known as tail spend.
Few organizations, however, understand just how much money is involved, let alone how to manage tail spend in a way that realizes potential savings to deliver more business value to the company.
What is Tail Spend & How Can You Manage It?
Tail spend refers to any business purchases, such as software or professional services, that fall outside of the typical ongoing and large purchases an organization makes. The purchases are often too small to go through procurement, and don’t happen often enough to be included in the cataloged systems. Following the Pareto principle, 80% of suppliers represent just 20% of an organization’s spend.
The most difficult part of managing tail spend is lack of data visibility. This happens as a result of multiple factors, often because procurement and contract management run on separate systems, silos within the organization that may be using the same vendors and other resources, using a high number of suppliers, and operating under decentralized policies.
Most companies believe they have their high priority purchasing categories under control, and as a result tend to neglect the tail spend, with a considerable portion of their total spend made of purchases under a certain threshold – which varies from one company to the next.
Step One: Identify It
Tail spend can include anything from misclassified purchases to maverick spend. That’s why it’s important to define tail spend (the definition can and does tend to vary slightly depending on the organization) and determine where it is happening within the company.
To start finding it, you’ll need to retrieve your spend data from all sources then analyze it. From there, you’ll define tail spend as it relates to your company. Then, you’ll calculate your tail spend based on that definition.
At this point, you’ll segment tail spend commodities, and start to look for savings opportunities – in the form of both cost reduction and cost avoidance – at both the transaction level and the spend level.
Most commonly, organizations approach analyzing tail spend by calculating the ratio of spend to suppliers – classifying tail spend as “all purchasing with vendors other than the 20% with whom they have the highest spend.”
- Hidden Tail: This is the segment where the company’s biggest suppliers are, and these are generally dealt with as a part of strategically managed spend, where there are professionally negotiated and monitored contracts in place. However, some of the spend with big suppliers isn’t always covered by contracts, because those contracts don’t always cover the specific materials or services being purchased, or because of non-compliant spend.
- Head of the Tail: In this segment, you’ll find the spend that isn’t strategically managed, though the spend supplier could be anywhere from $50,000 to $1 million per year.
- Middle of the Tail: In this segment, you’ll have purchases that include a large number of suppliers – that may be in the $2,000 to $200,000 range per supplier. The middle of the tail isn’t strategically managed because the spend per supplier is too small.
- Tail of the Tail: This segment contains suppliers with less than $2,000 spend. The spend is highly fragmented and transactional, because it includes many one-off purchases with a large number of suppliers.
Step Two: Work to Streamline Internal Processes
To better manage tail spend, it’s important to streamline internal processes so you have better data visibility, reduce the number of overall suppliers, and keep a close eye on spending. Ideally, you should be using an e-procurement system that requires employees to fill out formal purchase requisitions for approval before converting them to purchase orders. The system should have a list of approved vendors and products to choose from, in an effort to curb spending outside any strategically managed contracts.p>Implement a three to six month “spot buy reduction” program for all segments of the tail. The focus should be on moving tail spend into strategically managed spend, and channeling more spend, whether it is strategically managed or not, into catalogs or other automated buying channels.
The recommended sourcing strategy framework for tail spend management is five steps:
- Develop the methodology you’ll use for determining supply exposure or business risk.
- For each commodity, list the spend and the supply exposure score.
- Map each commodity on a 2×2 matrix with spend on X-axis and exposure on the Y-axis
- Identify the procurement goals for each quadrant
- Develop plans to meet each of the goals.
This way you can address which commodities you want to focus on managing first, and which ones can wait. You’ll also be able to determine sourcing plans and strategy from the matrix.
Step Three: Make Your Data Work for You
After you’ve streamlined your processes by deploying relevant and complementary procurement solutions, such as PLANERGY, in your organization, it’s time to work on sourcing and contracting to ensure most of your company purchases are handled strategically. Once you begin procurement this way, you’ll want to measure improvement in your tail spend performance with various metrics – such as cost reduction and avoidance, transactions costs, and improved spend visibility.
Benefits of Managing Tail Spend
Savings by Increasing Strategically Managed Spend
Companies that focus their efforts on effective tail spend management can realize 10 to 20% savings with spot buying.
Organizations will also see another benefit, because the increase in strategically managed spend typically allows for a one-time savings of 10 to 15% when addressing the spend for the first time, with a continued 2 to 5% savings for every year after. Generally, companies should aim to have at least 86% of their total spend in the strategically managed category.
Increased Efficiency and Productivity
Because the company is consolidating the supplier base, efficiency increases. This not only reduces the number of suppliers that procurement has to deal while reducing costs, it also allows procurement staff to focus on the larger contracts that add more value to the business. Adding more catalog coverage and self-service procurement also allows the procurement team to spend more of their time on value-adding tasks. The tail spend management process can also help the company identify opportunities for continuous improvement. As a result, the procurement function can increase productivity by up to 20%.
Increased Compliance and Reduced Risk
There’s also the benefit of increased compliance with business policies and contract terms, both on the part of business users and vendors. Removing unreliable suppliers from the base also reduces risk, while providing a more transparent procurement process to prevent and detect fraud. Tail spend management programs are meant to control, monitor, and track transactions as they occur, meaning exceptions can be found as they happen and addressed before being sent to the supplier. These programs are highly effective at preventing rogue spending and providing the organization with detailed insights into spend behavior. Managing tail spend can ensure up to 95% of purchases are compliant with policies and contracts.
Better Internal Customer Satisfaction
Internally, customers are often more satisfied because the systems are easy to use, there is clarity around who is responsible for what, and who the contact person or people are for various issues. It also helps to reduce process cycle times, and up skills procurement resources.
With these benefits and the methods for getting a handle on your tail spend to boost your bottom line and improve your organization’s strategic purchasing capability, there is no excuse for allowing tail spend fatigue to cause procurement to fall behind.
Through careful tail spend segmentation, aiming for spot buy reduction in an effort to move more of your spending into strategic management, using automated channels, and using segment-specific solutions throughout all sections of the tail, you can learn to manage the tail spend in ways that allow you to save a significant amount of money. It will also bring new and unexpected ways for procurement to add to the value they deliver to the business.