What’s the Cost of Having a Long Supply Tail, and How Do You Determine the ‘Right’ Supply Base?

tail kozorog/Adobe Stock

We recently put up an interactive Ask Spend Matters box so that you, our readers, can tell us about the topics you want us to investigate. One of the first questions that came in was about tail spend:

“What is the cost of having a long supply tail, and how are organizations determining the ‘right’ supply base (number and percentage) as relates to spend?”

“This is a great question, but it’s a bit tricky to answer,” says Spend Matters Chief Research Officer Pierre Mitchell, pointing to the different kinds of costs associated with tail spend. “If cost simply means the cost of procurement resources spent on managing suppliers in the tail, and to what extent can we reduce those costs, that is one efficiency-oriented question that is easier to answer.”

Tail Spend: A Primer 

The term “tail spend” refers to low-value spend that is outside of core spend categories and often unmanaged by procurement, and it can include anything from office snacks to taxi rides. A concept based on the Pareto Principle, tail spend generally makes up 20% of a company’s spend — often including non-compliant or maverick spend — and 80% of its suppliers.

Due to the high volume of suppliers, the perception of low savings potential and limited visibility into these transactions, tail spend tends to fall off of procurement’s radar. But in recent years research has shown that initial tail spend management efforts can produce savings of up to 15% and category savings of 10%–30%, according to Michael Lamoureux, a Spend Matters analyst.

In a 2016 report, The Hackett Group found that tail spend management brought average savings of 7.1% to survey respondents. After the more glaring cases of maverick spend have been brought under management, less mature sourcing organizations can expect 3%–5% in savings and more advanced ones can expect 1%–3%.

The ‘Right’ Stuff

Naturally, there has been growing interest among organizations to tackle this oft-hidden opportunity.

“After a concerted consolidation effort in the tail spend, some organizations will end up at the point where 33% of suppliers account for 80% of spend and 66% account for 20% of spend,” says Lamoureux.

As Lamoureux explains, if an ordinary company has 10,000 suppliers, 80% of spend would go to 2,000 of those suppliers and 20% would go to the other 8,000 suppliers, according to the tail spend concept. Then, after tail spend management efforts, the company might still have 80% of its spend going to 2,000 suppliers, but 20% would be spread among only 4,000 suppliers, reducing the total supplier headcount to 6,000.

Here’s another example with numbers, this time from Mitchell:

“It you have roughly $1 billion in indirect spend, then you probably have about 9,000 indirect suppliers on average. You also likely have about 8,000 of those suppliers that are in the tail and represent almost 10% of your spend. If you can reduce 8,000 down to 2,000 through good old-fashioned p-cards and aggregators such as e-marketplaces, GPOs and category aggregators, you can free up almost half a million dollars in process costs and lay off a handful of transactional staff.”

Considerations Beyond Spend

Tail spend can also be a source of risk, non-compliance and lost savings.

“You can manage the tail, especially the mid-tail, through better tactical sourcing approaches,” Mitchell says. “This squeezes out a little extra value from the tail.”

“And more important,” he continues, “you focus the transformation on freeing up not just technical resources but also strategic resources to attack the larger spend-related opportunities (e.g., demand management and specification management) and risk reduction. For example, you’d have way fewer third parties accessing your IT systems. Now you are talking 100 to 500 basis points (1%–5%) of savings rather than five basis points (0.05%) from headcount reduction.”

On the flip side, tail spend provides an opportunity for corporate social responsibility (CSR) initiatives such as sourcing from small, minority- and women-owned businesses enterprises (SMWBE).

“The savings opportunity might not be as high,” Lamoureux says. “But due to the high overspend percentages, the organization [would] still find some savings, typically 5%–10% instead of 10%–15%.”

Sourcing directly from SMWBEs would not reduce the tail, of course, but as Lamoureux points out, companies can “score a lot of brand value in the process, which can often be worth considerably more than saving a few fractions of a percentage point off the bottom line.”

The Bottom Line

To determine whether your company has a tail spend problem, there are numerous factors you might look at in order to get an overall picture, such as the number of suppliers you work with, the percentage of spend under management or the percentage of automated purchases.

“Whether your tail spend is 40% of your supply base or 80% is totally irrelevant,” Lamoureux says.

“If less than 80% of spend over a given threshold has been ‘sourced,’ there is a tail spend problem,” Lamoureux continues. “For example, a sourcing team would never conduct a strategic event on a category of less than $1 million in an average midsize or larger organization, as the savings expectation on a category even that size would only be $50,000 to $100,000, and the work involved would likely be $10,000 to $50,000.

"If typical overspend in the tail is more than 10%, that means that even $10,000 categories hide more than $1,000 of savings that add up for every 10 you do.”

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