Why the 80/20 rule should be the beginning—not the end—of tail spend

August 12, 2020

We all know the old marketing axiom that “80% of sales come from 20% of customers.” You might also know that this “law of the vital few” came from Italian economist Vilfredo Pareto, who first noticed the dynamic by observing in 1896 that 80% of land in Italy was owned by 20% of Italians.

It’s an incredibly versatile principle that experts have applied to a wide array of situations—80% of property crime happens to 20% of properties, 80% of investment portfolio gains come from 20% of holdings (and 80% of losses come from presumably a different 20% of stocks). For the sports fans among us, 80% of Major League Baseball game wins can be attributed to 20% of a team’s players. The list of examples is seemingly endless.

And of course, the Pareto Principle is also a great rule of thumb for understanding your company’s purchasing habits and identifying and cutting procurement costs—80% of your expenditure will likely come from 20% of your purchases, or 80% of your suppliers will account for around 20% of spend. There are plenty of ways to produce cost savings using the 80/20 rule.

But there are two significant dangers when considering the 80/20 principle. The first is that it is little more than a rough guide rather than a universal truth, yet people often accept it as the latter. The second is that we’re better off looking at the 80/20 rule as the beginning—not the end—of cost-cutting exercises. Stopping at the 80/20 rule leaves a lot of potential savings undiscovered.

The 80/20 principle: A rough construct for tail spend

Remember that baseball statistic? Around 80% of MLB wins come from 20% of players? When sportswriter and former Texas Rangers pitcher Jeff Zimmerman did the math using baseball’s Wins Above Replacement statistic, one year it was 15% of players responsible for 85% of wins. Another year, it was 10% of players for 80% of wins.

An Arizona State University study found that crime didn’t follow an exact 80/20 split, either. At least in Jacksonville, Florida, 85% of property crime happened on 20% of properties.

The point is not that the 80/20 principle lacks any utility—it can be an incredibly powerful tool. But the devil is in the detail—and in the current environment where incremental wins matter, the specifics could hide the difference between an organization thriving or just surviving. Or worse.

A starting point, not the be-all and end-all, of tail spend 

Procurement departments on the hunt for cost savings usually have more incentive to focus on their large, multi-year contracts. According to the 80/20 rule, that’s where they’ll find the most significant savings.

But concentrating on these so-called “big savings” is a missed opportunity because it ignores a potential gold mine of savings you could enjoy simply by examining your tail spend.

When procurement professionals usually think of tail spend, they think of their unmanaged spend—smaller items and non-strategic purchases like pencils, paper, and little widgets—and the other items probably purchased on Amazon Business or other online stores. These tail spend items are the incidental and day-to-day purchases.

But tail spend is much more than just office supplies. It can be Software as a Service (SaaS) solutions. It can be mowing the campus lawn or washing the windows of your office tower. Tail spend includes a range of expensive items—from temp labor and IT purchases to Maintenance, Repair, and Operations (MRO) functions.

If you define tail spend as the spend that the procurement department doesn’t manage directly, then it probably accounts for around 30-40% of your total spend—and up to 95% of your total purchases. Suddenly the 80/20 rule doesn’t seem like such a wise place to stop cost-cutting exercises.

Tail spend is particularly significant in a down economy, when sales are flat or declining, and there are fewer buyers around to market to. But even in a buoyant economy, companies that properly manage tail spend can cut annual expenditures a further 10%.

Why do procurement teams stop their cost-cutting initiatives after they’ve dealt with the 80/20? Because they think they lack the resources—both human and digital—to analyze their tail spend effectively. Going beyond the 80/20 takes time and effort—although it’s much easier if you have access to the right data. But the savings can be surprising—and significant.

So, if you’ve already trimmed the procurement fat using the 80/20 rule—well done! Now the real work begins finding a wealth of further savings hidden in your tail spend.

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