In a down economy, sales are flat or even declining, and there are fewer buyers for companies to market to. Sales and marketing as a means for a company to dig itself out of a hole will result in the classic law of diminishing returns: spending more and more effort (and money) to go after an ever smaller prize.
Whereas sales may be the business growth heroes during the good times, procurement often acts as the savior during a recession.
However, organizations all too often turn to squeezing the lemon that is direct materials and purchased parts. There’s a perfectly logical reason for this. It’s always historically been where organizations have staffed their procurement departments most heavily and with their best talent. These are the categories of spend that organizations typically understand best.
What many companies don’t realize though is that in the words of those great philosophers Taylor Swift and Ed Sheeran, everything has changed.
You see, direct materials have been negotiated to death. The best opportunities now lie in areas of indirect spend which have previously been relatively unexplored.
Direct materials no longer yield the 3% year-over-year savings that can be squeezed in an old school, pure-play price negotiation.
Yes, Supplier Relationship Management (SRM), supplier partnerships, and alliances will deliver ongoing value over the long term and are an absolutely essential piece of ammo in every large organization’s arsenal.
But they’re not the right levers to press for some quick wins.
Indirect spend offers the biggest percentage savings opportunities because many categories or contracts have never been interrogated by a procurement professional. Even if they have, then it’s usually just been a global frame contract issued by someone in corporate procurement.
These are usually full of legalese but very light on actual monitoring or follow-up with stakeholders in plants and regional headquarters across the globe, in order to determine how much spend is actually being managed under the terms of this agreement.
Enter tail spend and its golden goose eggs
Tail spend has many definitions, and none of them are right or wrong. It’s really down to the philosophy of any specific organization, as well as the length of the tail in relation to the core, strategic vendors.
I’ll therefore go with the most commonly adopted definitions:
- Any vendor with an annual spend below an arbitrarily defined figure. This can usually range from $100k to $1 million, depending on the size of a company and its vendor spend.
- The classic 80% of the total vendor count which according to Pareto’s law makes up 20% of total vendor spend. Your organization may be at 70/30 or 90/10 but the general pattern is the same.
- Any vendor which is not being actively managed by procurement.
It doesn’t really matter which of these you pick.
The opportunities are varied, abundant, and usually easy to pick out if you’re able to extract reasonably good data from your ERP system...which is a whole different topic in itself! I’ve covered this on my podcast at length.
Now, before we extol the virtues of fishing for savings in your tail spend, there’s an important issue we need to consider. CFOs tend to be more apathetic towards measuring and validating expenditure in these categories because it’s usually not a predictable, repeatable purchase in the same way that production materials are.
You’ll need to align with them how you’ll measure the benefits first of all. Savings on indirect categories can’t usually be measured as Purchase Price Variance (PPV) against a standard or average price which can directly impact the bottom line.
It’s also worth noting that stakeholders are also more likely to engage with you when economic conditions are tough because they will be acutely aware that the company needs to drive savings, and that your work could directly help to save their job!
Here are 5 ideas of ways to extract real savings from your tail spend:
1. Eliminate maverick spend
Implement a no PO, no payment policy to eliminate true maverick spend.
Once this is in place, you can then work towards tackling some of the milder forms of spend infractions. For example, those when stakeholders just bypass procurement’s preferred vendors and order from other suppliers who are still active in the system.
2. Implement a competitive bidding policy
One time purchases (such as project spend) take up a lot of procurement time.
There are 2 issues here.
- These requirements are not well negotiated because as long as the stakeholder is within budget, he/she doesn’t care much about the cost.
- On the flip side, it’s a lot of administrative work to help the stakeholder with negotiation and RFQs to deliver something within budget.
Having a threshold for competitive bidding facilitates two possible benefits.
Firstly, you have visibility of any spend requests above a certain amount before a PO is created, which allows you to help stakeholders obtain 3 quotes and negotiate with the best vendor.
Secondly, it also enables you to free up your time and not get involved in all of the low spend requisitions, where the workload necessary to negotiate a small saving is often greater than the sum of the overall benefit. If a Category Manager is spending 2 hours negotiating a few hundred dollars saving, the opportunity cost of that time being spent on a more productive task is significant.
Using software such as Fairmarkit to power an automated sourcing platform for non-core items can unlock savings that would previously have been a massive time suck for procurement teams having to do this manually.
3. Consolidate spend with key vendors
If you have several suppliers for simple, noncomplex items, then you’re not leveraging the commercial and administrative benefits of buying more of this from one vendor. This could deliver rebates, opportunities for admin reduction, and leveraging the resources of the supplier to help you with demand control and consumption reporting.
A great example of this is the use of vending machines for general industrial supplies and PPE, as a means to reduce theft and frivolous consumption.
High volume, low complexity, low-value items such as office supplies, industrial operating supplies, and IT peripherals don’t have complex supply chains—they’re off the shelf items. Risk is zero. You don’t need multiple vendors.
It’s often worth paying a little bit more for certain products to have more spend under one vendor. The overall advantages of this approach make it worthwhile.
4. Delete or block inactive vendors
Why not delete or block vendors in your ERP system who do not have any active POs or invoices over the previous 12 month period? You will need to check and align with stakeholders first though, to ensure no critical vendors are being removed. This is especially important if reactivating a vendor involves a lot of red tape.
Deploy your buyers to work on more added-value tasks with the time that they have saved through not having to deal with all of the day to day admin associated with having a long tail of nonstrategic vendors.
Each additional vendor you have is one more late delivery, unpaid invoice, change in VAT number, delivery discrepancy, or price increase request.
You may not see savings immediately, but by working smarter, not harder, you will soon see the benefit through the white space this creates in your team’s workload.
5. Implement catalogs to increase compliance and spend visibility
Catalogs are a win-win solution. The supplier will always gladly work with you to set these up because it usually means increased revenue for them, as spend is channeled through their catalog as a preferred vendor.
For the buyer, they are a great way to improve compliance, spend visibility, and data quality. For noncomplex items where it doesn’t make sense to create material master data, using a supplier catalog will reduce the amount of free text POs and the poor descriptions these often contain which can make your spend data a mess.
It will enable you to have deeper insights into your spend and consumption, directly have an influence over pricing, as well as determining the SKUs your stakeholders are able to buy.
Do they really need a Bosch screwdriver, or is a private label brand just fine at 20% saving?
Catalogs can either be internally hosted on your server or as a “punch out” solution hosted by the vendor. The approach you take will depend for example on available IT resources, the category of spend, and the number of users who will need access.
Conclusion
Of course, there are many more ways how tail spend can drive less obvious expense reduction opportunities. I hope these have provided a taster of why looking more closely at, and having a clear procurement strategy for how you tackle your tail spend should be a high priority for your organization during these uncertain economic times.
