Increasing transparency in tail spend

September 17, 2019

Increasing Transparency in Tail Spend

The lack of transparency in procurement has been widely talked about in recent years and the need to change things in order for businesses, organizations, and government bodies to cut their spending. As an integral yet usually “invisible” component of procurement, tail spend is particularly problematic. Although often unmanaged, it accounts for 20% of a company’s total spend and 80% of their purchases.

Prompted by the need to cut unnecessary expenses and save money, the governments of the United Kingdom, India, and Jamaica, to name a few, have all recently proposed reforms to public procurement in their respective countries. Other countries like Argentina, Ukraine, and Chile have already launched online platforms that allow government employees to track the procurement process – including tail spend – in a transparent and easily accessible way.

It was this global wave of initiatives to make the procurement process more transparent that motivated a team of US-based researchers to examine the effects of increased transparency on the process itself.

About the Study

The team consisting of Ignacio Rios and Daniela Saban, both from Stanford University, and Ruth Beer from Indiana University focused on the role of peer effects in the procurement process. They observed these effects in organizations that have already taken steps to make the process more transparent. Their findings were published in a working paper titled “Increased Transparency in Procurement: The Role of Peer Effects”.

To conduct their study, the researchers developed a model of an organization that consists of a director and two employees with identical wages. Both employees were tasked with purchasing identical items from one of the two suggested suppliers, one more expensive than the other.

Purchasing from the more expensive supplier would give the employees access to certain personal benefits, but it would also increase the overall cost of procurement for the organization. While the director would have complete insight into their employees’ procurement decision, they could neither overrule those decisions nor punish the employees for choosing the “wrong” supplier.

The authors also wanted to better understand how employees would act in different situations, which is why they developed two experimental settings. They first examined the employees’ actions in a baseline setting where they would both make their decisions simultaneously, without having an opportunity to observe each other’s actions. After that, they would have to decide in a peer setting where the second employee to choose a supplier would be able to see which supplier their colleague had chosen.

Two Behavioral Considerations

Beer, Rios, and Saban predicted that the actions of the employees would be based on two behavioral considerations. First, they assumed that the employees would have reciprocal preferences toward the employer, meaning that they would choose the cheaper offer and renounce the personal benefits to save their company money, but only if they thought that they were fairly compensated for their services.

However, if one employee saw that the other opted for the more expensive supplier and gained financial benefits, the authors predicted that the employee in question would also choose the more expensive offer. As they explain, this is the result of peer effects. More precisely, the second employee would be motivated by the perceived income inequality to make a decision that would put them on even ground with their colleague.

How Peer Effects Are Shaping the Procurement Process

Unsurprisingly, the results of the study were in line with the authors’ predictions.

Focusing on the peer model, they managed to prove the existence of the so-called “negative spillover”, where the second employee would be driven by income inequality to choose the more expensive supplier if their colleague did the same. The same two employees would be more likely to choose the cheaper offer in the baseline model where they wouldn’t have any insight into their colleague’s decision.

Interestingly, the authors also noted a complete lack of a “positive spillover”. Namely, even if the first of the two employees (the one whose actions would be seen by their colleague) chose the cheaper supplier, the other employee (the one whose actions wouldn’t be seen by their colleague) would still be more likely to choose the more expensive offer.

There was one more thing that the researchers couldn’t predict. According to the findings, the employees in both models were generally less likely to opt for the more expensive supplier if they knew that their actions would be visible to their peers. This shows that, in addition to peer effects, the employees’ decisions were also driven by social norms, i.e. what is perceived to be most appropriate.

Procurement Transparency Tips for Managers

In the conclusion to their study, the authors highlight the key findings that could help managers reduce their organization’s procurement costs:

  • Reciprocal employees with higher wages will be more likely to save their organization money and opt for the cheaper supplier.
  • Online procurement platforms should be carefully designed to eliminate the “negative spillover” that could stem from peer effects like income inequality.
  • To reduce overspending and reduce the “negative spillover”, managers should also emphasize that the employees’ decisions will be observed.
  • Organizations should make an effort to reinforce their employees’ perception of appropriate spending behavior, thus mitigating the risk of overspending.

To learn more about the study, be sure to check it out here.

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