Assessing the True Cost of Tail Spend
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 an organization must also account for every dollar spent. That can become a challenge for the Procurement function as it relates to indirect spend and an even bigger challenge in terms of tail spend.
When it comes to indirect spend (items and services unrelated to the core product but necessary to run the day-to-day business), processes and protocols may be ignored and not viewed as a priority by stakeholders. If you don’t think this is something to be concerned about, consider this: 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 spend visibility beyond their Tier 1 suppliers.”
That lack of transparency can be costly to your bottom line. 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 to produce core products sold to 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 (a.k.a. maverick spend, rogue spend, and dark purchasing) occurs when an employee goes outside the normal process of procurement to acquire needed items and services. This often takes place on an as-needed basis with 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. Those who now have the responsibility for purchasing can be senior department heads, operation staff, accounts payable staff, and finance.
In a time where businesses are required to manage and account for every dollar spent, tail spend is virtually unmanaged. Aside from the problems listed above, 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. It can also make early payment discount capture and cost savings non-existent.
Identify the scope of your tail spend problem
If you don’t have visibility into the procurement 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 pareto principle, or “80-20 rule.” This 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.
The Spend Matters 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, 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.
The importance of supplier management
Look at your number of suppliers. 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?
Failure to evaluate your supply base and implement vendor consolidation can result in several problems:
- Many suppliers may not fall under the preferred list, meaning they may not meet company standards and KPIs.
- Too many transactions can translate to too many invoices and purchase orders, which ultimately leads to higher costs and excess time spent on menial tasks.
- Your most important resource, your people, can become strained and underutilized for more strategic tasks.
- Lost savings: A lower volume per vendor means less possibility for early pay discounts.
Simply put, if two-thirds or more of your suppliers supply only five percent of spend; if less than 70 percent of orders are negotiated by procurement; and if fewer than 50 percent of transactions are with preferred suppliers, then you have a tail spend problem.
How to get the most out of tail spend management
The root of a tail spend problem is usually two-fold. First, a low priority for indirect spend management within the business as an impediment to organizational management of that spend. Secondly, a lack of resources to effectively source indirect programs, which stems from the mindset that procurement is a tactical, rather than a strategic function.
To gain control over tail spend, procurement must follow certain steps:
- Identify uncontrolled spend areas
- Create initiatives to prioritize and address those areas
- Assemble a budget
- Appoint someone within procurement to oversee that budget
- Vendor consolidation -select suppliers that suit your corporate goals (and your customers)
- Negotiate contracts
- Process all procurement through a single, streamlined payment portal
Additionally, a procurement team should be tasked with managing and controlling tail spend. But the ability to do that is hampered if you do not adopt 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 metrics that could be used in forecasting and analytics isn’t generated.
Technology will also help with contract management as all parties will have visibility into contract terms and pricing. This provides accuracy, eliminates time-consuming disputes over late payments and exceptions, and improves supplier relationships. An automated solution should also include a spend analytics function that enables the procurement department to access spend data to identify savings opportunities and deliver actionable intelligence on organizational deficiencies.
Big Sourcing Savings
In the end, it all boils down to dollars and cents, and when you adopt a strategic sourcing process that includes paperless processes and well-negotiated contracts, the potential savings are impressive. The Hackett Group estimates that by managing tail spend better, companies can realize an average savings of 7.1 percent. Even a 5 percent savings on tail spend can be the equivalent of a 10 percent increase in net profit, and who doesn’t want that?
It’s time to take control of tail spend. Whether you leverage Corcentric’s tail spend support as a one-off engagement or part of an end-to-end Spend Management solution, we’ll ensure your tail spend is no longer an afterthought, but a dependable source of hard dollar value. Get started today.