Assessing the True Cost of Tail Spend
Gain control over tail spend so it doesn’t “wag the dog” when it comes to your company’s profitability.
The internet and globalization have made today’s business environment more competitive than ever before. Increasing an organization’s revenues is not enough to achieve and maintain profitability; now every function within that organization must also account for every dollar spent. That can become a challenge for Procurement when it comes to indirect spend and an even bigger challenge when it comes to tail spend, which occurs when an employee, perhaps with the best of intentions, goes outside the normal process of procurement to acquire needed items and services.
Direct spend (those items and services necessary to produce the company’s core product) is usually well managed, with procurement controls and protocols in place. However, when it comes to indirect spend (those items and services unrelated to the core product but necessary to run the day-to-day business), processes and protocols may be minimal or simply ignored…if they exist at all. If you don’t think this is something to be concerned about, here’s a disturbing statistic. According to Deloitte’s CPO Survey 2018, overall transparency within the supply chain is poor, “with 65 percent of procurement leaders having limited or no visibility beyond their Tier 1 suppliers.”
This can cost a business more than you might imagine since, according to a ProcureCon 2015 benchmarking study, over 40 percent of U.S. businesses spend over 40 percent of their total procurement on indirect goods and services, including office and cleaning supplies, uniforms, IT services, furniture and more. For larger companies with multiple locations, decentralized purchasing and a lack of oversight can lead to overspending, duplicate or unnecessary purchases, and non-compliance. And these problems are exacerbated when it comes to tail spend.
How does tail spend differ from indirect spend?
Tail spend is a subset of indirect spend. As noted above, indirect spend covers all goods and services not necessary for the production of core products sold to end customers. Although oversight may not be as disciplined as it should be, the organization may still have a list of preferred vendors and contracts that employees are expected to use for indirect products.
Tail spend (also known as maverick spend, rogue spend, and dark purchasing) often this takes place on an as-needed basis when there are no policies in place to direct the purchases. Adding to the problem is that the buying function for these kinds of purchases is often dispersed within the organization, among such areas as the following:
- senior department heads
- operation staff
- accounts payable staff
So in a time where businesses are required to manage and account for every dollar spent, tail spend is virtually unmanaged. Besides the problems I listed above (duplicate purchases, overspending, etc.) an even bigger penalty of unmanaged tail spend is that, by being “off the grid,” there is a total lack of visibility into these purchases, which makes planning and forecasting difficult and likely inaccurate and can make early payment discount capture literally disappear.
Identify the scope of your tail spend problem
If you don’t have visibility into the purchase process, how do you know you have a problem? One of the quickest ways to measure your problem is by looking at your vendor list and understanding the “80-20 rule.” The 80-20 rule asserts that while 80 percent of a company’s spend comes from 20 percent of its suppliers, the logical and realistic conclusion is that 20 percent of its spend comes from 80 percent of the suppliers.
Spend Matters, in its study, “Fix the Tail to Propel Procurement: Attacking the Tail Spend Problem in B2B,” identifies this as a much larger issue. The study found that 35 percent of respondents identified managing tail spend as a major priority, noting “The biggest problem based on total economic value is that, on average, procurement professionals spend the majority of their time on the 80%-90% of the suppliers that represent less than 5%-10% of spend and business value.
Regardless of whether it’s 80/20 or 90/10, however, the fact is that tail spend takes up far more time and resources than it should. But there are ways to measure how much of a problem this presents.
Too many vendors means too many issues
Look at your vendor list. Are there too many falling under these low-value, non-recurring transactions? Could you consolidate these vendors to create a smaller list of preferred vendors? Doing so would not only reduce the number of vendors; it would also give you greater leverage since you would be able to offer a greater volume of purchases to the vendors chosen. There are a number of problems that follow with too many vendors:
- The possibility that many suppliers may not fall under the preferred list, meaning they may not meet company standards and KPIs.
- Too many transactions which translate to too many invoices and ultimately higher costs and too much time spent by employees approving and paying these invoices.
- When so much time is spent with so many suppliers for so many low-value purchases, your most important resources…your people…are strained and underutilized for more strategic tasks.
- Savings are lost when lower volume per vendor means less possibility for early pay discounts.
When do you have a tail spend problem?
- When two-thirds or more of your suppliers supply only 5 percent of spend
- If less than 70 percent of orders are negotiated by procurement
- If fewer than 50 percent of transactions are with preferred suppliers
Use teams and technology to gain control over your tail spend.
There are two issues that create the problem of tail spend to begin with. First, a low priority for indirect spend management within the business is the most commonly cited impediment to organizational management of that spend. This problem is closely followed by the organization lacking resources to effectively source indirect programs. And this stems from the fact that for still too many organizations, procurement is looked upon as a tactical, not a strategic, function. In order to gain control over tail spend, procurement must follow certain steps:
- Identify uncontrolled spend areas
- Create a plan to prioritize and address those areas
- Assemble a budget
- Appoint someone within procurement to oversee that budget
- Select suppliers that suit your corporate goals (and your customers)
- Negotiate contracts
- Process all procurement through a single, streamlined payment portal
A procurement team should be tasked with managing and controlling tail spend. But the ability to do that is hampered if you do not avail yourself of automation technology. Automation addresses an organization’s inability to capture and quantify the multitude of purchases that are made every day, both direct and indirect. Companies can waste hundreds of thousands to millions of dollars annually on uncontrolled tail spend; however, work stream-specific automation solutions can reduce noncompliant purchases by up to 90 percent.
Without automated, electronic indirect spend controls in place, purchases can’t be efficiently monitored. As a result, there is no means of quality control and measurement. Plus, due to the nature of the purchases, delivery is usually not captured in your ERP system and key data that could be used in forecasting and analytics isn’t generated. Technology will also help in negotiating supplier contracts as all parties will have visibility into contract terms and pricing. That will not only add accuracy, it will eliminate time-eating disputes over late payments and exceptions. An automated solution should also include an analytics function that will enable procurement to look directly into purchasing and deliver actionable intelligence on organizational deficiencies.
“I can save HOW MUCH?”
Visibility, accuracy, control: in the end, it all boils down to dollars and cents. And those dollar figures are impressive when you implement automated, paperless processes and well-negotiated contracts. The Hackett Group estimates that by managing tail spend better, companies can realize an average savings of 7.1 percent. Even a five percent savings on tail spend can be the equivalent of a 10 percent increase in net profit. It’s time to gain control over your tail spend. This is one tail that you don’t want wagging your company’s profits.
Download our white paper, “Defeating Dark Purchasing” to discover how a strategic digital approach to procurement can result in greater visibility into your spend.