Procurement professionals are responsible for managing spend across an organization. Most of their efforts are focused on the top 20% of their supplier relationships as this typically accounts for about 80% of their company's spend. But what about the rest of it? A lot of Sourcing Heroes tend to disregard this seemingly invaluable amount of spend even though those transactions take place with the majority of their suppliers.
We believe there is an opportunity to capitalize on the untapped value that is held in this forgotten category commonly referred to as tail spend. In this article, we'll cover the following:
- A brief definition of tail spend and who manages it
- The Pareto Principle and spend thresholds as they relate to tail spend
- Characteristics of tail spend and why it's worth managing
What is tail spend?
Tail spend typically refers to the many high-volume, low-value transactions that take place in an organization that are typically unmanaged by procurement.
In most companies, nobody actively manages tail spend at all. The procurement team may set up processes, policies, or systems for buyers to follow, known as a “set and forget” approach.
“Buyers” in this respect means anybody in the organization who makes a low-value purchase using company money – this may be someone in marketing ordering pizzas for a team lunch, an accountant ordering a new mousepad, or an HR professional arranging accommodation for a business trip.
Low-value purchases like these often take place on third-party websites, or via email and phone, which means they are unclassified and “invisible” to the procurement team. Tail spend includes purchases that are one-off or don’t happen enough to be included in an online catalog.
The 80/20 rule & spend thresholds
The Pareto Principle or 80/20 rule provides a useful guide for understanding tail spend.
- An organization’s top 20% of suppliers typically account for 80% of total spend and are considered strategic
- The remaining 80% of suppliers combined only account for 20% of total spend, are considered tactical, and thus belong to the spend tail
Most organizations establish spend thresholds to determine which purchases are actively managed by the procurement team. These vary depending on company size. For example, a small to medium-sized business might have a spend threshold of $10,000, while very large companies may have a threshold of $1 million or more. Thresholds may be lowered in times of financial stress (such as the COVID-19 crisis) to reduce unmanaged spend.
Sub-threshold purchases take place without the involvement of procurement. Maverick spend occurs when somebody in the business makes a purchase over the threshold without involving procurement, or otherwise do not follow policies or rules.
The problem with segmenting spend by cost is that even low-cost purchases can carry risk or societal impacts. For example, choosing a very low-cost caterer could potentially lead to a sub-standard meal being served at a corporate event (risking reputational damage) or even risk food safety breaches.
Tail spend categories & characteristics
Tail spend can occur in any category but is particularly common in office products, print, packaging, business travel, business services, professional services, marketing, facilities, and temporary staffing. Being uncategorized, these transactions are not included in cost-savings initiatives such as bulk purchasing agreements arranged through a Group Purchasing Organization (GPO).
In general, tail spend is:
- Not actively managed by the procurement team
- Decentralized to buyers in the business
- High-volume but low-value, but can also include low-volume or one-off purchases
- Tactical, not strategic
- Under the spend threshold
- Almost always indirect procurement
- Invisible or difficult to track and analyze
Is managing tail spend worth it?
If you had asked this question 15 to 20 years ago, the answer would have been no, because procurement simply couldn’t hope to track such a high volume of transactions manually. But with so many procurement technology solutions on the market place, it is now possible to achieve granular visibility of every transaction that takes place in real time. Artificial Intelligence and Machine Learning are rapidly getting better at categorizing spend, which enables advanced analytics and subsequent benefits including:
- Cost savings
- Risk and waste reduction
- Quality control.
Keep in mind that 20% of total spend in very large organizations can add up to billions of dollars going out the door in unmanaged, low-value transactions.
Alongside cost and risk, there are other potential sources of value hidden in the tail such as small, innovative suppliers who could (if engaged directly) come up with game-changing ideas for your organization, or environmentally conscious or diverse suppliers who could help contribute to your enterprise sustainability goals or CSR targets.
In part two of this article, we will discuss in more detail why it’s worth managing your tail spend, how procurement can get it under control, and reveal the benefits of outsourcing tail spend management to a GPO.