Surpassing the Pareto Principle in Procurement

Originally appeared in SDC Executive

Open the procurement playbook and in Chapter 1, you’ll find a process that looks something like this: understand your spend, identify your top spend categories and suppliers, hire a couple category managers, and get after it – applying strategic sourcing process and best practices to eliminate non-compliance and generate savings. After some success with this process, procurement will win the hearts and minds of the organization. In time, the function may get some additional headcount or a new technology to continue working its way through the top 80% of spend.

Prioritization is necessary for any organization, but it’s especially crucial for the resource-constrained and stakeholder-dependent procurement function. As procurement matures within an organization, however, sourcing starts to yield diminishing returns. In turn, objectives evolve to include metrics beyond savings (such as risk and efficiency). This all means that simply applying the Pareto principle to your spend profile is no longer good enough. To continue adding value procurement needs to – at some point – address the messy, uncomfortable, and inconvenient problem that is tail spend.

As organizations grow, that 20% of spend that gets cast off as low value / low opportunity begins to resemble the hidden underbelly of an iceberg. Spreading massive inefficiencies across the organization, hiding a mess of unmanaged suppliers, and leaving savings opportunities on the table, it grows into a category unto itself. If each individual category manager takes a similar 80/20 approach to their respective categories, you end up with a tale of two tails. P-card policies put in place to address the nuisance of tail spend only exacerbates the problem, provoking unchecked purchases across managed and unmanaged categories alike. Soon, an organization’s “tail” spend could approach 35% simply through prioritization and misguided policies.

What’s the problem with leveraging the 80/20 rule?

Opening Pandora’s Box and taking a closer look at unchecked tail spend will uncover a multitude of opportunities. Where to begin?! Many might start with spend, transactions or suppliers (or some combination thereof), sorted in descending order, and draw a line once 80% is reached – declaring everything under it “tail spend.”

I’d argue for a new, broader definition of tail spend: any addressable spend that goes unmanaged. If you apply that definition, it’s prudent to take a more holistic, hands-on approach to tail spend, too.

Upon compiling the unmanaged spend across the organization, the next step is to segment accordingly.  This mess that typically reveals a slew of missed opportunities, such as:

• Compliance issues due to buying from the wrong supplier
• Compliance issues due to buying from the right supplier at the wrong price
•  Compliance issues due to buying the wrong items from the right supplier
• Opportunities for spot negotiation (3 bids and a buy)
• Opportunities for new preferred supplier agreements
• Opportunities to update existing preferred supplier agreements

If you dare to take on the daunting task of assessing the processes associated with tail spend, you’ll uncover additional costs. These include:

• PO processing cost (if one is generated)
• Invoice processing costs (often with manual entry and approval)
• Payment processing costs (often via checks to one-time suppliers)
• Supplier administration for one-time suppliers (in addition to polluting your ERP system)

What can be done?

First, an organization needs to aggregate and dissect its tail spend. The longer this spend has been left to languish, the longer this process will take. In some cases, it might make sense to bring in an outside firm to organize priorities and guide the initiative. Use this opportunity to understand why you’ve left certain sections of your spend profile unmanaged and how each segment of spend can be better addressed. Which spend is core to the organization? What can be added to existing strategic initiatives? Which should be handled tactically? What belongs on a PCard? What can be automated?

Once you have answers to these questions, you can build your roadmap for taking a new, more sustainable and strategic approach to tail spend. You might consider one or all of the following:

• Re-write your policy. Define what is truly unaddressable and for everything else determine what needs to be managed strategically, what the thresholds are for tactical purchasing and what can be placed on a Pcard (along with who should have them in the first place).
• Leverage group purchasing organizations (GPOs) for non-strategic, low-spend categories to help manage one-off purchases and save some money through aggregated demand.
• Outsource tactical, 3-bid-and-a-buy purchases to a managed services organization that can triage requests and facilitate the supplier administration, quoting (RFQ) and analysis processes, while also serving as a compliance check should preferred supplier agreements or catalogs exist.
• Leverage technology to automate processes wherever possible. E-catalogs are great enablers of compliance and downstream efficiencies. Automation of approval routing, PO disbursement, invoice digitization, invoice matching, and payment greatly reduce the time you’ll spend on low-value tasks.
• Speaking of payments – payments to one-time suppliers are a huge administrative burden for AP. They’re costly when it comes to not only processing the payment, but also creating those suppliers in your system and maintaining that data. Consider a payment facilitator that can aggregate these payments on behalf of your organization and consolidate to one invoice for AP to manage.

How this plays out in any given organization is dependent on one step: committing to addressing the problem, which means putting in the work to identify and segment true tail spend and developing the roadmap to address it. The key to any solution is ensuring that the right balance of process, resources, and technology enablers is in place to maintain sustainable impact and ensure you don’t slide back into willful ignorance.