Procurement Services. white paper. Heads or tails? The relative benefits of targeting tail-end spend

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1 Procurement Services white paper Heads or tails? The relative benefits of targeting tail-end spend Simon Woodcock Xchanging Sourcing solutions manager

2 Heads or tails: the relative benefits of targeting tail-end spend It is often cited within the procurement industry that the first 20% of suppliers of any organization, ranked in order of spend from highest to lowest, will account for 80% of the total spend. Experience shows this to be reasonably accurate. The associated and generally accepted theory is that the procurement department should concentrate their efforts on these strategic suppliers if they want to deliver big savings. This leaves the tail end the remaining 80% of the suppliers who only make up a combined 20% of spend underaddressed. This theory is not without logic. Two key factors to consider when reviewing the addressability of a contract are the size of spend and the maturity of the contract. Map these against each other and you get an addressability matrix (Diagram A). Diagram A Optimization Starting point Spend Maturity For the purpose of this paper, let s assume all organizations begin with no procurement department. Map such an organization onto the matrix and they should sit around about where the red line appears on Diagram A contracts of various sizes but all of a low maturity. The ultimate goal of procurement is to reach a position of optimization of the highest maturity in all areas of spend, whatever their size. The key assumption here is that maturity equates to value; the more a contract has been reviewed and re-tendered, the more value is delivered. Achieving procurement optimization Optimization can be achieved by first addressing all spend of a low maturity, whatever the contract size moving from right-to-left across the matrix or addressing all high areas of spend first, whatever their maturity moving from top-to-bottom on the matrix. The default strategy of procurement is to approach the situation from the top-right, addressing the biggest and least mature contracts first. This theory is not disputed in this paper the question arises when you discuss the relative merits of next addressing the bottom-right quadrant or the top-left Xchanging 1

3 Heads or tails: the relative benefits of targeting tail-end spend Experience shows it is at this point that the large spend areas, or top-left quadrant, gets priority, and a topto-bottom approach is adopted. It may well transpire that the bottom-right quadrant never gets addressed. There are a number of reasons for this. Best practice dictates that contracts should be reviewed every three years or so. In reality, many procurement departments don t have the resources to do that for every contract, so they prioritize. Naturally, their priority is the big contracts. This is assuming the existence of a procurement department within an organization. But even those organizations that have been behind the curve developing an internal procurement department and have not outsourced, will likely have addressed big areas of spend. If the level of spend is big within the market then the market will do this for them. Think about personnel moving from supplier to rival supplier. They take knowledge with them and, consequently, suppliers compete for these big pieces of business without the organization actively going to the market. Does high spend equal high reward? As highlighted above, it is easy to justify a strategy that tackles the big areas of spend first and when it goes well, can result in savings that would never be possible if you were concentrating on the tail-end. But it can also be complex; months of data gathering, a lengthy RFP process, multiple stakeholders, stringent due diligence, multiple geographies or locations, numerous SLAs, etc. All of this costs time and money. Not to mention it can be risky; a project can gain momentum and problems can easily become compounded. If the savings are not as high as expected, or if they are as good as expected but it has taken too much resource, too long to realize, that resource and time may have been better allocated elsewhere. Is there an alternative? Tail-end spend is so named because its position following a Pareto analysis of suppliers (Diagram B). In this context, procurement tends to approach the situation in the direction shown by the arrow on Diagram B, addressing the tail end last. But this doesn t consider the maturity of the contract. Map the tail end onto the addressability matrix and it features predominantly in the bottom-right quadrant as these are small accounts that are unlikely to have a high level of maturity (Diagram C). Applying the recognized procurement approach of tackling this matrix from the top right, there soon becomes a point where the low-hanging fruit big contracts with low maturity have been picked and there is a genuine trade-off between continuing to address large areas of spend, albeit with higher maturity, or addressing the tail-end. All too often this choice is not even recognized. Procurement professionals can be drawn by big numbers and start projects to address large areas of spend without considering whether they could achieve equal savings by addressing several areas of tail-end spend, at less effort and risk Xchanging

4 Diagram B 100% Tail end Spend 0% Largest Suppliers Smallest Diagram C A Spend B Tail end Maturity Diagram C shows an example trade-off between points A and B. Point A is a contract of high value and high maturity for this example, let s assign it a value of $2M and say it is almost out of contract and was tendered three years ago and Point B is a contract of low value and low maturity let s say $100K, this contract has never been addressed and the supplier has been in place for years. Deliver 10% savings against both of these contracts and it is clear which would provide the most value but within the tail end there are opportunities to deliver bigger saving percentages, sometimes considerably so. A 10% savings may be a realistic and acceptable outcome on a contract such as Contract A, whereas there is a chance that savings of 50% could be delivered in the tail end. Assuming that the amount of effort dedicated to tendering a contract is proportionate to the size of the contract, there becomes a clear relative benefit to addressing the bottom-right quadrant the tail end Xchanging 3

5 A case study in tail-end spend management This customer spent $200K annually on a daily van run to transport documents between four offices in the same region. The supplier had been in place for more than ten years, the drivers were known and liked by security and facilities at each office and the service could not be faulted. The service itself was mission-critical. A pre-defined schedule was in place and if the van were to not turn up at one office for a collection, there was a risk that the next office would be left without work to process in the absence of a new batch of documents. The operational stakeholders associated the success of the service to the supplier and the price was not really an issue. This was the case to such an extent that the service had never been tendered or benchmarked, nobody knew if value for money was being delivered. An initial desktop benchmarking exercise by procurement identified that the price could potentially be too much for what amounted to, no matter how important the service was to the stakeholders, one man in a van carrying boxes form one office to another. A mini-rfp was held to gather indicative quotes from three suitable suppliers, which each of whom there already exists a relationship. These vindicated the decision to review the contract, showing a big saving possibility. This also drew the attention of the stakeholder, improving engagement with the project and allowing a conversation to ensue about the relative simplicity of the service in order to justify the sizable cost reduction. Within one month, an agreement was in place to switch supplier. The new supplier contracted to provide the same service for $70K, a saving of $130K or 65%. Due to the smaller size of the contract, there was less governance and a much easier tender process. The end result also proved for a much better relationship with the stakeholders and almost no apprehension towards a switch of supplier. Conclusion In summary, it is not suggested that common procurement practice is abandoned in favour of addressing the tail end, simply that more consideration needs to go into the decision making process. It is a given that when addressing contracts of a similar level of maturity, the bigger contracts can deliver the higher savings but all-too-often the maturity is not considered and big contracts are addressed without thought for whether there is a relative merit in addressing multiple smaller contracts within the tail end. As procurement as a practice has itself developed, there is a growing recognition that tail-end spend management is now an important piece of the procurement puzzle Xchanging

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