The Spend Uncertainty Principle

Spend Matters welcomes this guest post from Paul Blake, of GEP.

Sometimes the certainties in life can suddenly seem anything but. We’re not talking here about the classical “death and taxes” certainties attributed to Benjamin Franklin, but those things known to be “just so,” turning out to have a surprising degree of fuzziness about them.
Take the geometry we all learn at school. Despite however many intervening years there may be between school days and the present, I’d wager a good percentage of procurement professionals could still offer an instant answer when asked for the formula for how to calculate the circumference of a circle.

2πr — simple. If we know the radius we can calculate the circumference and vice versa. Then there’s the area of said circle, πr2, and the volume of a sphere, 4/3 πr3 and so on. If we can remember the formula, then the rest is simple calculation.

But there’s a funny thing about all this that rather defies rational thinking. Pi is one of those curious numbers that can’t be pinned down exactly. You’ll probably remember this as well. Pi is a bit more than 3. A bit more than 3.1, actually. Or rather a bit more than 3.14. To be precise, it’s a bit more than 3.141592653589. In reality, it’s a bit more than that. However many numbers one adds to the right of the decimal, friendly old pi is, well, it’s just a bit more than that.

What this means, of course, is that for a circle with a radius of 10 cm the circumference is a bit more than 62.8 cm. It’s a bit more than 62.83185307 cm. Actually it’s a bit more than a bit more — forever.

But surely that’s not possible? It’s a circle! It must have a definite length! It can’t just be “a bit more!”

Let’s do it in reverse then. Let’s say we take a piece of string precisely 62.83 cm long and form it into a perfect circle. We then calculate the radius as being just a bit more than 9.999705074 cm. Again, just a bit more — forever.

But surely that’s not possible either? It’s a straight line between two points on a perfect circle, how can it possibly be always just a bit longer?

And what on Earth has this got to do with procurement?

Quite a lot, as it turns out.

The pursuit of an absolute answer to a seemingly trivial problem can result in one falling down the rabbit hole of confusion. In geometrical terms the measurement of diameters and circumferences can never be carried out with absolute precision. The one can be calculated from the other but the precision of measuring tools is simply insufficient to permit that absolute resolution.

But in every practical sense — and this is important — getting to a certain percentage of the “truth” is perfectly adequate.
Applying that insight to our procurement experience, we can get to thinking about tail spend and about cost management. Software tools exist today to provide you with unprecedented visibility of spend across the enterprise, categorized with high accuracy to your chosen sourcing taxonomy. It is reasonable to expect to have more than 90% of your spend classified in a way that lets you make qualified, intelligent decisions about where to look for savings opportunities and the like.

Following the Pareto principle, it won’t come as any surprise to know that, of that 90%, a good majority will be represented in just a few supplier dealings and perhaps in just a few transactions.

The chances are, then, that the majority of the transactions (orders, invoices, whatever), or at least a high minority of them, will fall into the segment that is hard to analyze, tough to define, difficult to categorize. And this can cause some concern.

If your spend analysis solution is only correctly categorizing 50% of your transactions, then surely it’s not working. But if 95% of your spend is categorised correctly, then surely it is working.

Dedicating effort and funds to classifying the final 5% might very well serve to satisfy the intellectual need for complete spend visibility, but what impact will that new knowledge have on savings realized? Probably negative, I’d wager.

Like the procurement equivalent of Heisenberg’s uncertainty principle, you can either know enough about your spend for that knowledge to deliver ROI, or you can know everything about your spend but derive no ROI whatsoever. The trick is to know where to draw the line.

This is where we reach the confluence of spend analysis and tail spend management. Spend analysis is emphatically not an intellectual exercise, despite the brainpower behind the algorithms and classification rules. It is a practical exercise, designed to achieve one goal: revealing opportunities for improvement.

Tail spend management is about reducing the noise in that final block of data, for however insignificant the spend may be in the tail, the overhead in terms of processing costs can be huge.

A final thought is that adding a structured, controlled and easy to use P2P system can serve to not only reduce that processing overhead but prevent the tail from growing again.

Combining spend analysis, tail spend management and a solid purchasing system can reduce the uncertainty. It’s fair to say you’ll never reach the “real” answer, because as basic school geometry shows us, it’s just not really real at all. Of that you can be certain.

For more creative thinking on procurement, visit the GEP Knowledge Bank.

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First Voice

  1. Bill Kohnen:

    Certainly there is no organization that has 95% category accuracy as the reality is even world class purchasing organizations struggle even to get access to comprehensive spend data.

    Sure most CPOs will say they have something (mostly out of embarrassment) but reality is most are still using homegrown partial data extracts dumped into excel and even then only for their most critiCal items.

    Everyone knows from experience the big ERP solutions are no help and it has come as an unpleasant surprise that cloud solutions are not much better. In fact many cloud solutions require so much data prep and interaction with the cloud provider team (often in India) that it feels like a manual process still, at least initially.

    Perhaps some of the “big data” solutions deployed in other parts of organizations will ultimately be a better answer and even help look into the tail spend “weeds”

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