The new normal has brought a paradigm shift in business priorities, the biggest one being to reduce cost. Enterprises are paying a premium to find a reliable and continuous supply of goods or services, thus putting more pressure on margins. While battling these pressures and risks, procurement teams can put money back on the table by addressing the tail spend.
Companies are careful about how they spend money on raw materials, packaging supplies, non-routine maintenance, etc. Sometimes, when prices rise or there are risks in the supply chain management, they might even try to cut back on bigger purchases and focus on smaller value purchases. These smaller value purchases, known as tail spend, are usually ignored as these can be large in number and seen as insignificant. But if it’s paid attention, companies will realize they can optimize these and save a significant amount of money. By focusing on getting the best deals from verified suppliers and vendors, paying them on time, using software and automation tools for supplier contract management, and tracking every little direct and indirect spend, tail expense management can make every dollar spent count.
In this article, we discuss:
What is Tail Spend?
Tail spend entails small purchases that different business units make, such as spending on software, office supplies, professional services, etc., which do not constitute a part of their routine purchases. These purchases, called ‘spot buying,’ aren’t made using the regular procurement process as they are small, occasional, or one-time purchases that are not recorded in the company’s spend management systems.
Examples of these small, one-off purchases include advisory or legal fees, temporary labor and other service providers for short-term projects, employee expenses, and marketing collaterals for physical events like trade shows. Procurement professionals use the Pareto principle—the 80/20 rule, to calculate tail spend. Per this principle, 80% of company spending is done with 20% of vendors, and these include large expenditures. The remaining 20% of spending, which is the tail spend, is done with 80% of vendors.
How do you define tail spend?
The definition of tail spend has changed over the years, but today, the term is used for ad hoc spending for different business processes and uncategorized supplier purchases that have a low volume, are infrequent, or might not have much value. Tail spend has other names, too, such as rogue spend and maverick spend. Since tail spend involves small, often ‘invisible’ expenses of a company outside the purview of main expenditures, it is usually not factored into procurement cost savings analysis that forms part of the business spend management process.
Tail spend does not always only include high-volume and low-value transactions. In some companies, it can even be used to refer to significant high-value purchases that may be made one-time but are needed to fulfill a specific business requirement. These purchases are made outside of supplier contracts and might pose challenges for procurement, warehouse, and finance teams as they’ll need to look into the paperwork, who made the transaction, and manage the arrival and storage of the purchased goods. While we may understand what tail spend generally means, it can mean different things to different organizations.
Challenges of Tail Spend Management
Managing tail spend can be difficult for procurement teams across organizations simply because this category of company expenses involves a large number of transactions done with several suppliers. These purchases are made outside the procurement framework via telephone, email, apps, or third-party websites, so tracking and accounting for them becomes tricky. Here are some more challenges faced while managing tail spend:
1) Lack of data visibility: As most of these tail spend purchases take place on a one-off basis, adding details of purchase orders to cataloged systems becomes difficult. Even if these are added to the system, classifying them becomes a task without a proper procurement software solution. Tracking tail spend using traditional manual processes like Excel spreadsheets is also burdensome, so this creates a lack of clear data sets that procurement and accounts departments can refer to.
2) Lack of spend control: When tail spend purchases are made without proper workflows and policies, they fall within the category of maverick spend. These purchases result in the company losing control over its budget and staying profitable.
3) Fragmented processes: While some teams in an organization might go through the procurement department and secure approval for small purchases they make, others might just make such purchases on a whim. Without a single, unified system and spend management tools to record such tail spend purchases, the process of tracking and accounting for these purchases made across the organization becomes chaotic and fragmented.
4) No negotiating power and performance metrics: When small, infrequent purchases are made with several suppliers, the company loses its control over negotiating the prices. When supplier performance can’t be tracked using a strong management platform (because so many suppliers are involved), supplier management suffers, and the ROI on these transactions can’t be calculated.
Why Is It Important to Manage Tail Spend?
While tail spend expenditure may seem insignificant when it comes to saving costs, tracking and calculating several small-value purchases with proper spend management software can unlock opportunities for significant cost savings. It is crucial to maintaining a competitive edge in today’s volatile economy.
Unchecked spending, whether small or big, can complicate planning, forecasting, and carrying out financial assessments. When company costs and supplier relationships are managed well, it contributes to bottom-line profits and helps organizations adopt various cost-saving strategies and optimize their operating costs. Managing tail spend proves instrumental in regulating quality, circumventing potential compliance issues (especially in regulated industries), and helping a company’s procurement and sourcing professionals stay productive.
What are the benefits of managing tail spend?
When an accurate spend classification is created, the benefits of spend management process can be extended to tail spend purchases. A robust tail spend management strategy offers a competitive advantage, no matter how small and insignificant a purchase may seem.
Additional cost savings
Organizations that emphasize tail spend management can achieve cost reduction with initial savings of around 10-20% and additional annual savings of 2-5% thereafter. That said, it is advised that companies maintain at least 86% of their total spend in strategically managed spend categories using advanced management systems. So, migrating tail spend management to strategically managed e-procurement systems can help with tracking expenses and saving significant amounts of money using clear category management. With accurate spend analytics, companies can partner with quality suppliers who offer better prices and higher quality.
Increased efficiency and productivity
By consolidating the supplier base, companies can maximize the efficiency and productivity of expensive resources and redirect their efforts to more value-adding tasks. When the number of suppliers is reduced, the procurement and strategic sourcing departments only need to deal with key suppliers, facilitating their supplier interactions and relationships. Additionally, extending self-service procurement options for end-users in the form of e-catalogs and other automated buying channels can move tail spend expenses from unmanaged to managed categories. This consolidated approach of categorizing not only streamlines and simplifies the procurement process but also empowers teams to focus on business-building processes for continuous improvement, boosting their overall productivity by almost 20%.
Reduced supplier risk
Eliminating unreliable suppliers can help mitigate the risk of compliance issues and fraud while also enhancing the transparency of the procurement process. A tail spend management system is put in place to control rogue spending by monitoring and identifying any unauthorized transactions with real-time visibility. Implementing programs that govern these practices proves highly effective in ensuring that business policies and contract terms are not violated in the purchasing process while also ensuring risk management by removing unethical suppliers from the system.
Improved stakeholder satisfaction
Stakeholders seek transparent guidelines and spending limits as well as easy-to-use software tools and streamlined processes to know who is responsible for what and who is the right party to contact in case they need to make a purchase. So, when a rationalized supplier database is maintained, especially for tail spend, it reduces errors and accelerates cycle times, helping increase the efficiency of everyone across the organization and creating a more agile operational environment.
How to manage tail spend
To manage tail spend purchases effectively, it is necessary to follow a well-thought-out spend management process, such as the one covered in these steps:
Identify your tail spend
First, you should define tail spend in your organization to be able to effectively manage and optimize it. If the task feels overwhelming, take a targeted approach, like understanding what it means in departments where you can identify the issues. This can help you set a foundation for building a broader understanding of where tail spend takes place in the organization and chalk out an improvement plan.
Streamline internal processes
Establish clear and transparent procurement processes and make sure they are properly communicated and followed. Engage stakeholders in the discussion to identify tail spend areas and formulate management strategies in order to secure their ongoing support. If clear explanations for managing the tail spend and what benefits it offers are not provided, end-users may not participate in the improvement projects wholeheartedly. So, make sure all stakeholders are aware of the reasons they’re being involved.
Organize the data
Once you scope the work involved in tail spend management projects and identify business systems that store this data, the next step is to organize the data. Cleanse, classify, and analyze total tail spend data to create greater spend awareness and facilitate informed decision-making. The cleansing process must include standardization of field formats such as dates and currencies and normalizing supplier names. Implement innovative spend management solutions for extracting, analyzing, and tracking the tail spend as it will make life easy for every person involved.
Actually use the insights
Use formal spend analysis processes and software tools to generate expense reports in dashboards that provide both numerical and visual representations of the tail spend, Derive actionable insights that help you identify cost-saving opportunities by industry sector, division, location, and commodity. Remember, this needs to be more than just a one-time process. To monitor the success of your tail spend management efforts, establish KPIs such as cost savings against benchmarks, productivity improvements, and the percentage of spend under strategic management vs unmanaged spend and regularly track them.
Why Digital in Tail Spend?
Tail spend or long tail spend is typically 20% of the spend value that accounts for 80% of the purchases and supplier base. At an organization level, the tail spend could run high (in millions) and have a combination of the following characteristics (or) issues:
- Unmanaged spend, not strategically managed by the organization
- Irregular way of dealing with suppliers (as opposed to contracts, catalogs, P-cards or RFX)
- One-time high price purchases (or) recurring low-value purchases
- Maverick spend or spot buys (non-preferred vendors and buying channels)
- Unclassified or misclassified
- Improper KPIs to track their quality and performance
- Compliance, legal and financial risks
- While most enterprises are familiar with the listed issues within their businesses, addressing the tail spend is laborious and time-consuming. As organizations are grappling to manage tail spend, identifying saving potential could be daunting, especially when there are thousands of transactions that make even the scroll bar in the spreadsheets look tiny. Conventionally, the focus is on strategic direct spend and very little attention is given to the tail spend due to the poor reward ratio to the quantum of work. However, with the advent of digital technologies, it can deliver measurable value in tail spend through better visibility, prices and control of compliance risks.
- According to BCG, firms that use digital solutions to manage tail spend can cut their annual expenditures by 5% to 10% on an average—a significant amount, especially for global companies with total expenditures in billions.
Frontier of Spend Visibility
The Achilles heel to bringing tail spend visibility is having proper data classification. Any procurement personnel would know that tail spend data lacks classification and harmonization. While a majority of the organizations have the top 80% of the spend classified, it is time to take over the herculean task of classifying the rest. Erstwhile, the classification is unwieldy and manual. With Artificial Intelligence (AI) and Machine Learning (ML), spend can be auto-classified based on the UNSPSC (United Nations Standard Products and Services Code) or custom standards with minimal human effort. Minimal human effort is required during the initial cleansing and classification to aid the learning of AI/ML, which also improves the accuracy/errors over time. AI/ML can detect similar or minor variations in material descriptions making it easy to remove or consolidate duplicate items, giving better spend transparency. After the initial classification of existing tail spend data, the new addition of data will be incremental and an instant activity.
Cost Savings to Cost Avoidance
With tail spend classified, bringing visibility is a matter of finding the right analytical tools that can show the distribution of suppliers and spend across items and categories. However, the buck doesn’t stop there. What you do with the visibility determines the potential savings you can bring. Traditionally, this is an uphill climb, given the thousands of low-value transactions that must be analyzed across multiple source systems. The power of AI/ML can open opportunities highlighting value-saving avenues in terms of:
- Flagging cases of higher-price purchases
- Alternatives for existing suppliers
- Supplier base consolidation to get better price points
- Scope for making high-value tail item purchases a catalog or contract buy
- Cost avoidance, in simple terms, means ‘A penny saved is a penny earned’. The procurement department has created a cost-conscious culture to not just cash in on opportunities to save money but also avoid unnecessary spend as well. Using AI/ML you can find unusual patterns that cause process inefficiencies, non-compliance, and fraud. These patterns, if not addressed, impact productivity and hence consume more effort and time which further translates as a cost to the department. In extreme cases, this could also pose a financial and business risk.
Reactive to Proactive
In retrospect, humans and machines are equally wise to point out what went wrong. So, why invest in an AI/ML or advanced analytics product? The answer is you can proactively prevent it from happening. All tail spend purchase transactions could be monitored 24×7 in real-time to proactively avoid purchases at higher prices, flag out unusual transactions, and avoid any delays within the P2P cycle. Organizations have slowly started looking at tail spend as a huge area of opportunity to invest in digital technologies. According to Research and markets, the spend analytics software market is expected to grow at 18.2% CAGR between 2021 to 2026. Thus, it’s a no-brainer that organizations are very keen on reducing undesired spending, making AI/ML a must-have capability in all organizations.
Digi’tail’ Spend Management with ignio
At Digitate, we have developed ignio Cognitive Procurementignio Cognitive Procurement, an AI-based continuous spend monitoring solution that screens purchase transactions in real-time to proactively avoid spend leakages and mines behavioral patterns driving process inefficiencies and noncompliance. ignio customers have realized millions in savings in their tail spends. To know how they did it and how you can too, reach out to us.
