We’re releasing a series of articles to answer your questions about tail spend, starting with the basics to help you understand what tail spend is and progress along the spectrum to help you manage it. To get up to speed, read our prologue on what this tail spend series will help you accomplish.
The term “tail spend” has become a common term in procurement-speak because in our minds we like to visualize all of our spend fitting on a nice curve with suppliers on the X-axis and spend per supplier on the Y-axis, something like in Figure 1 below. The suppliers with the lowest spend are plotted to the right and we think of that as the tail. A shorter tail implies we’ve done a better job of consolidating our spend among fewer suppliers. Since supplier consolidation with the goal of cost savings was the raison d’etre of early sourcing groups, the shape of this curve feels like an indicator of success.
In reality, most procurement organizations have done a fairly good job of supplier consolidation by now. The Hackett Group’s benchmark shows that the typical company has consolidated 80% of spend with 6.2% of suppliers. The best companies, those that we deem “world class,” are down to 5.3%. So, we’re far beyond the 80/20 rule when it comes to consolidation. What we really mean when we think of a long tail is that we have too many small suppliers. The complementary metric to consolidation is supply base size, with typical companies averaging around 6,000 active suppliers per billion U.S. dollars in spend while world-class organizations have pushed this to fewer than 2,000 per billion (Source: Procurement Benchmark, The Hackett Group, 2019).
The next question to ask is whether low-spend suppliers are inherently “bad.” While traditionally the answer was yes – companies wanted to consolidate as much as possible with the largest one-stop suppliers – I have seen this trend shift in recent years. If I talk to some of the most leading-edge companies in high-growth industries like pharma and high tech they tend to see value in finding the up-and-coming suppliers in their industry. These suppliers may be small, they may be start-ups in a garage, and we may start the relationship with very little spend, but they offer the innovative technologies or processes that could rock our industry and we want to partner with, nurture and grow them for a market advantage. Beyond the technological advantage, many companies have diversity goals that include community impact. Working with small businesses in local communities can be key to this mission.
To push this a bit further, most sourcing organizations don’t have the bandwidth, or maybe even the interest, to strategically source 100% of their spend. Strong category managers are in demand and their time should go to the highest value impact. Once 85% to 95% of spend is managed we tend to hit a point of diminishing returns. That’s why most organizations have a spend threshold for sourcing, in which deals must be over $100,000, or in some cases even $1 million, for sourcing to put resources on them.
So, is there a place for low-spend suppliers in our spend curve? Yes, provided they are selected intentionally, vetted and transacted within a way that minimizes risks. It’s not the entire long tail that should bother us. What we don’t like is spend that falls into either of two categories:
- Maverick (or rogue) spend: Procurement has a supplier, contract and pricing for this item, but the purchaser used a different source, buying channel or price.
- Yet-to-be-managed spend: Procurement hasn’t yet sourced this category and we think we should because it meets our strategic criteria.
With this in mind I think we’re really talking about unapproved supply sources when we talk about problematic tail spend. The rest we can accept as part of our ecosystem, albeit in a sub-optimized process. But tail spend is a cuter name, so we’ll stick with it for the purpose of this discussion.
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Ms. Fong is a Principal in The Hackett Group’s Procurement Executive Advisory program and Program Leader for the Purchase to Pay Advisory Program. She has more than 20 years of experience in both industry and consulting with a focus on procurement, supply chain and organizational effectiveness. Amy helps business leaders to improve source to pay processes, manage complex supply chain partnerships, and mature their organization’s service delivery model. She performs extensive primary research on the source to pay and operations space and has authored numerous publications. Ms. Fong holds an MBA from Vanderbilt University and a BS from Syracuse University.