What is tail spend and how can we manage it?
Tail spend, a concept that is common in procurement departments but rarely optimized, is finally getting its time in the spotlight. By having a sound tail spend management strategy, a procurement department can become a key competitive advantage for an organization. In a down economy when cost-cutting is a high priority, the best savings opportunities lie in areas of indirect spend, which have been relatively unexplored in comparison to overly-negotiated direct materials.
The 2019 Gartner Procurement Diagnostic Suite Survey found that procurement teams that managed predominantly indirect spend delivered a higher ROI than procurement functions that managed direct or hybrid spend. Additionally, these teams also delivered a higher savings rate to the business, proving that tail spend can be a gold mine for cost savings.
In this post, we will cover the following:
- What is tail spend?
- What is maverick spend?
- What are the different ways to define tail spend?
- How do you manage tail spend?
- What are the benefits to managing tail spend?
What is tail spend?
Tail spend is often defined as the money a company spends on purchases that account for roughly 80% of total transactions, which makes up about 20% of the company's spend by volume. There is no one size fits all definition for tail spend across different businesses, or even across one business, simply because every organization and business unit’s spending is unique. What is considered tail spend in one category may not be the same in another. These purchases are often too small to go through procurement and are not frequent enough to be included in cataloged systems.
Tail spend can have many definitions, and none of them are right or wrong. Tail spend can include anything from maverick spend to misclassified purchases, so it’s important to identify what tail spend is and define what it means in your organization. It’s also important to define the length of the tail in relation to your organization’s core, strategic vendors.
What is maverick spend?
Maverick spend is spend that is not under contract, not managed by procurement, and is noncompliant (e.g., there are not 3 bids if 3 bids for a buy is corporate policy). Also known as rogue spend, maverick spend is a type of tail spend that can be a major cause of bloated spending at a company. P-card purchases are often a major source of maverick spend. These type of purchases usually are part of tail spend, but require a different set of strategies to get under control.
What are the different ways to define tail spend?
Here are some of the most commonly adopted definitions:
Defined based on spend threshold: Any vendor with an annual spend below an arbitrarily defined number. This can range anywhere from $100k to $1 million, depending on the size of the company and its spending.
The 80/20 rule or the Pareto principle: Procurement departments always have more incentive to focus on large, multi-year contracts because of the larger savings realized. Yet this leads companies to basically ignore almost 20% of their budget. This unmanaged spend is a more traditional definition of tail spend and is typically considered the 80% of transactions that constitute 20% of a company’s spend, otherwise known as the Pareto principle. Some organizations may be at 70/30 or 90/10 but the pattern is generally the same.
Not actively managed spend: Tail spend can very simply be defined as any vendor that is not being actively or strategically managed by procurement.
It doesn’t really matter which of these you pick, just as long as the business is aligned and in agreement with the definition.
The best, and more advanced approach to defining your tail include the following:
- Get a visual representation of cleansed, normalized spend information to the best of your ability.
- Add the risk stratification so you know what spend to go after, why you want to attack that spend, and what the potential cost-savings and value add is.
- Factor in your industry-specific dynamics.
How do you manage tail spend?
When you boil it down, the most difficult aspect of tail spend management is the lack of data and visibility. This can happen for a number of reasons such as procurement and contract management running on separate systems, siloed subgroups within the same organization (when they may be using the same vendors and resources), a large number of vendors, and decentralized policies. Download our full eBook on tail spend management fundamentals for a comprehensive guide on how to begin optimizing and managing your tail spend successfully.
Identify your tail spend
As mentioned, tail spend is different for every organization. Identify and define what tail spend means for each business unit at your organization so procurement can take the appropriate steps to effectively manage it, optimize it and measure it.
Streamline internal processes around tail spend
In order to save money and gather relevant data, it is imperative to have centralized processes and ensure they are enforced. Streamlined processes mean better payment terms with preferred suppliers across departments and can lead to more strategic buyers within your organization.
Put your procurement data to work
Once you’ve streamlined your internal processes, organizing, classifying, and analyzing spend data will lead to greater spend awareness, informed purchases, and business decisions.
One study conducted by The Hackett Group estimated that 7.1% savings on average can be achieved by better managing tail spend, which often comes along with a reduction in time spent per purchase and increase in bids per RFQ.
Use a crawl, walk, run approach
Develop a solid plan that includes a crawl, walk, run approach. Begin by identifying one business unit that has a tail spend issue and roll out a tail spend management program. Ensure key stakeholders are bought in and aligned, and technologies, such as automated sourcing platforms, are connected to your P2P or ERP system. Socialize the importance and successs of the program to stakeholders and end-users.
Eventually, increase the scope within that business unit. Start introducing more automation to ensure you have structured data and a positive feedback loop. Then, you can begin further leveraging the data and get stakeholder buy-in for a larger rollout. Once you have proven your business case, roll out to all business units, and fully automate tail spend management to give your procurement team time back in their day to focus on more strategic initiatives.
What are the benefits to managing tail spend?
By properly managing tail spend, some of your biggest cost and time savings can ultimately come from your smallest purchases. Utilizing digital technologies, such as intelligent sourcing, to source, track, and manage your tail spend, the result is greater cost savings, risk reduction, and efficiency.
According to Boston Consulting Group, companies that used digital data to manage tail spend cut annual expenditures by up to 10%. Gartner shared that procurement teams that successfully managed their organization’s indirect spending in 2019 delivered a return on investment of 6.88x and a savings rate of 6%. But teams managing only direct spend delivered a procurement ROI of 5.46x and savings rate of only 4%.
Additional benefits of managing tail spend include:
- Cost savings
- Increased spend under management
- Reduced risk
- Improved data quality and reporting
- Improved SLA & compliance enforcement
- Increased productivity per FTE
New and innovative technology that leverages automation, artificial intelligence, machine learning, and structured data is transforming the way buyers are purchasing and optimizing tail spend. By having a sound tail spend management strategy, a procurement department can become a key competitive advantage for an organization and allow the company to beat out competitors lacking a tail spend management practice.