Category Archives: Cost Reduction

Addressing Tail-End Spend Management

Today’s guest post, which is part two of a two-part series, is from Gonzague de Thieulloy, a Managing Director at Xchanging Procurement who manages tail-end spend management programs at Xchanging’s largest European customers.

In yesterday’s post, we defined tail-end spend, which is the 20% or so of spend with the organization’s non-strategic suppliers that, due to its complexity, is typically left unmanaged and which, unaddressed, presents the company with significant risks of the financial and brand variety. In today’s post, we discuss the solution for tail-end spend management which will address the complexity, reduce the risk, and present the organization with an additional savings opportunity.

The Tail-End Spend Solution

Because of the high degree of complexity and risk involved with tail-end spend, companies are increasingly looking at support from specialist external providers to manage their 20%. It’s more efficient to subcontract the management of this tail-end spend rather than to manage it internally and, due to economies of scale, it makes more financial sense.

Key Success Factors when Managing Tail-End Spend

There are several success factors to consider when managing your tail-end spend. Here are three primary ones to consider:

  1. C-suite buy-in — Senior buy in and support is imperative to the successful implementation of a tail spend management program;
  2. Visibility and collaboration — The team responsible for implementing the change management process needs to ensure the new strategy is communicated clearly to the rest of the business, as well as ensuring the team is visible and on-site at least 50% of the time to help with any queries. In order to increase the success and adoption of the new processes put in place, they need to advocate it;
  3. Utilizing procurement expertise and technology solutions as an integrated and managed service — The level of procurement support given to customers throughout the change management process is critical to ensure procurement and processes are fully connected.

Reaping the Benefits

When rolled out properly, a tail-end spend management solution can generate 15-17% savings, which can make a huge addition to the 5-10% savings typically generated from managing traditional spend. But the benefits go much further than just cost savings. Tail-end spend solutions typically:

  • Improve supplier management – A large supply base can be paired down to a few approved suppliers, with improved terms and associated cost savings, as well as reduced risk of working with unknown companies;
  • Increase spend visibility – Expanding the range of spend under management helps to create transparency around where the money is spent and what it is spent on, and results in new spend rules that strengthen the overall business;
  • Enhance spend efficiencies – Although categories of tail-end spend are often low value/high frequency transactions, they also always include high value transactions; managing this spend creates opportunities for companies to effectively allocate and control budget spend from previously unmanaged areas;
  • Streamline procurement processes – The key value-add of a tail-end spend management solution is it streamlines the entire tactical buying process associated with low-value spend.

It took more than ten years for leading companies to get the majority of their strategic 80% spend fully under control. We’re just in the early days with tail-end spend management, but by understanding the unique challenges of this 20%, it will take far less than ten years to have 100% of external spend under management.

More information on Tail-End Spend Management can be found on Xchanging’s Tail-End Spend Management page.

Thanks, Gonzague!

The Importance of Tail-End Spend Management

Today’s guest post, which is part one of a two-part series, is from Gonzague de Thieulloy, a Managing Director at Xchanging Procurement who manages tail-end spend management programs at Xchanging’s largest European customers.

Tail-end spend management is finally becoming a procurement priority, and for good reason. Historically, procurement organizations have been focused on trying to manage their strategic spend, the 80% of spend that represents around 20% of their suppliers. While companies have been striving to manage those strategic suppliers, they’ve left the myriad of smaller suppliers — the ‘tail-end’ of the spend — unmanaged. But that is starting to change.

Until recently, you would have been hard pressed to find any company managing their full strategic spend properly. Ten years ago, most organizations were only confidently managing 40-60% of that spend, at best. Now, due to procurement’s increased visibility and greater strategic role, many companies are managing their entire strategic spend effectively — the full 80%. This has left more than a few companies wondering what they can do with the remaining 20%, not least because of the financial benefits. Everest Group suggests that inclusion of tail-end spend increases procurement outsourcing savings potential by 1.5 times. But this is just one reason to manage tail-end spend.

Complexities of Tail-End Spend

However companies are discovering that they can’t use the same procurement methodologies for tail-end spend as they have for their strategic spend. For one thing, tail-end spend is far more complex than strategic spend: there are many more suppliers, the spend is very fragmented, and there are a lot more individuals buying. Tail-end spend “buyers” are end-users: people in HR, marketing, finance, IT, and so on — ordering goods and services as needed. They are not professional buyers, in the traditional procurement sense, which means trying to manage this spend requires change management — an added layer of process. As long as the total cost is less than the agreed threshold for tail-end spend, then these “buyers” can place orders with whomever and however they want.

Tail-End Spend Risks

Not only is the 20% tail-end spend complex, it can also be very risky, which is another reason organizations are now starting to pay attention to it. With the 80% spend, companies typically have an experienced buyer managing key suppliers and auditing those suppliers on a number of different aspects. The company that is on the ball knows everything there is to know about their strategic suppliers: whom they work with, their values, their practices, their working conditions, who their suppliers are, etc. With unmanaged tail-end spend, nobody is looking after these suppliers. Companies have no idea who they are buying from, making them susceptible to a number of risks.

One such risk is the potential damage to a company’s reputation. With all of the corporate sustainability issues now in the spotlight, unmanaged spend means companies may be doing business with suppliers that violate their own CSR principles. Imagine the harm it would do to your brand if it were discovered that one of your suppliers was using child labor or heavily polluting the environment. The damage could be irreparable. Beyond brand damage, you would also be responsible for supporting companies carrying out these practices. The reputational impact alone could put your company into a tail-spin.

Another type of risk that is common of unmanaged tail-end spend is a best practice risk. When companies let people from across the business buy from whomever they want, there is a chance that they will just buy from a personal connection, or from a supplier with whom they have a historic relationship. This often results in individuals overpaying for what they are buying which is, of course, financially damaging to the company. But more seriously, they may be in breach of fair practice regulations, putting the company at risk of being sued.

Companies that fail to address this complexity and risk are leaving a lot more on the table than they think. In tomorrow’s post, we will discuss the tail-end spend solution.

More information on Tail-End Spend Management can be found on Xchanging’s Tail-End Spend Management page.

Thanks, Gonzague!

If One Wants to Avoid Cost, Then One Should Avoid Cost At All Costs

One would think this would be obvious by now, but it’s not. Most organizations still talk about savings, savings, savings long after there are no savings left to be had instead of cost avoidance (and the successor topic of value generation). The best way to save money is not to spend any in the first place.

More specifically, it’s great if you negotiate the cost of a case of paper from $50 down to $40 but it’s even better if you don’t buy the case in the first place! That’s a 100% savings instead of a 20%! Now, it’s probably safe to say that paper spend can’t be eliminated, but most printing goes into the recycling at most companies the day it is printed, and that certainly can. How? Look at why people feel the need to print reports, articles, invoices, etc? Is it because they are in AP and they have to manually enter data coming in on a scanned PDF that can’t be properly parsed with OCR into the AP system, and they only have one monitor? Is it because the sales team / executives only have a small laptop screen and can’t see the report details adequately? In the first situation another standard monitor for $150 will eliminate the need for the AP staff to print out paper every day and save you cases on a monthly basis for years to come! In the second, spending $300 to $500 on a large screen will save the executives from having to print.

And SI is really glad to see it’s not the only blog taking up the cost avoidance cause. In a recent post by the maverick on the new CPO site (in which the doctor is currently doing a lot of collaboration to define what a CPO is, what she needs to know, what she needs to do, and what no other site will tell you) in which he addresses how Most Firms Ignore Cost Avoidance [And] Destroy Economic Value, we find out that it is just important, if not more so, because, to be blunt, cost savings is just a special cast of cost avoidance where you avoid paying the supplier more than you need to in order to acquire the product (while insuring the supplier is still sustainable).

At the end of the day, it’s all about spending as little as possible to get what you need in a sustainable manner. This essentially says it’s all about avoiding as much spend as possible while still getting what you need in a sustainable manner. Cost Avoidance is key, regardless of what your definition is.

Just What is “Best Value”, Part Deux!

In yesterday’s post, we discussed an article in a recent edition of Purchasing Tips (by Charles Dominick of Next Level Purchasing) that asked What is Best Value Procurement where he stated that “best value” should be a hard metric measurable in financial terms and expressed in units of currency and not a soft metric where factors other than price are used in determining a supplier and/or product to select for purchase (as that is weighted average supplier/product scoring).

We noted that SI tends to agree, but that there are often issues with trying to assign a(n exact) hard dollar revenue increase or cost decrease to an event that has not yet happened. Even the illustrative example used by Mr. Dominick in trying to choose between machine A and machine B to automate a production line is not cut and dry. For example, if the organization stops manufacturing a product before production line end of life or has the option to lease vs. buy the machine, the calculations get complex. But this is just the beginning.

When it comes to making an IT purchase, the “best value” calculations become a bit of a nightmare. First of all, there is system cost. Depending on whether you want to go with a true SaaS, hosted ASP (which might be wearing a cloud disguise), or on-site hosted solution, as discussed in our classic series on the Enterprise Software Buying Guide (Part V: Cost Model), there are anywhere from four to eleven core up-front and on-going costs that need to be considered (plus ancillary costs for complex or special systems). (And even with the free calculation template provided in the classic SI post on uncovering the true cost of an on-premise sourcing/procurement software solution, the calculation is still a nightmare. How confident are you in the integrator’s estimate? How secure do you feel about the amount of training time (and budget) that will be required? How reliable are the ongoing support level and associated cost calculations.)

Assuming you can work through the system cost equation, which can be quite a doozy (doozy, not doozer, although you will likely need doozer cooperation levels to make any new IT system work these days), you then need to work through the value equation. Just how much value can be expected from the system over the timeframe, and how accurate is that prediction. There are multiple components to this calculation.

  • Throughput Increase
    if the system increases the number of invoices that can be m-way matched, increases the number of sourcing events that can be run, or automates the production of trade documents, this needs to be calculated first as these numbers are need to compute the savings
  • Efficiency Savings
    how much manpower is saved (and how much can therefore be reassigned or eliminated) and how much is the HR expenditure accordingly reduced
  • Cost Savings
    how much cost is expected to be avoided either by increased throughput or the increased performance offered by the system (such as defect reduction, which reduces repair costs)

Obviously, these calculations are not straightforward. In the case of efficiency savings, since every resource (and type) has a different cost (based on salary and associated benefits), the best you will be able to do is estimate an average cost for the manpower by hour (or day). In the cast of cost savings, it’s more than just an industry average, it’s an industry average for a company at a similar stage of competency, with a similar sized workforce, and a similar production or spend pattern. Let’s take spend analysis. If the company is a leader with close to 80% of spend under management, has been sourcing against industry benchmarks, and has used advanced negotiation (and optimization) techniques on high value or key categories (with the help of a third party, if necessary), the company is likely not only aware of its top n categories, but has likely strategically sourced the majority of next n categories as well and the untapped opportunities would represent less than 20% of its spend. This company would only expect to see the industry average 11% savings on roughly 10% of its spend and would likely only see a few percentage points on the spend under management in the current economy. In comparison, if it is an average company only had 45% of its spend under management, had not used advanced sourcing techniques in the past, and only sourced a few categories against benchmarks, it might expect to see the industry average savings of 12% on 40% of its spend and 5% to 6% on the rest. The up-front savings potential (over 1 to 3 years) for this average company on a new spend analysis system would be four times that of the industry leader! It might be the case that the industry leader might need the new system to properly monitor and analyze its spend going forward more efficiently to help it avoid bad decisions in the future, but now we are in cost avoidance territory, and fuzzy territory at that. In hard dollar costs, all one can argue is additional manpower reduction.

And we still haven’t dived to the bottom of the iceberg. In other words, the best definition of best value is a hard dollar metric, but it might be the hardest metric of all to calculate.

Just what is “Best Value”?

In a recent edition of Purchasing Tips over on Next Level Purchasing, Charles Dominick asked What is Best Value Procurement? In the article, he notes that many people use the term “best value procurement” to describe purchasing decisions where factors other than price are used in determining the supplier and/or product to select for purchase and states that he believes that this is “weighted average supplier/product scarring”, which it is.

In his view, value should be measurable in financial terms and expressed in units of currency. I tend to agree, but there are issues with trying to assign a(n exact) hard dollar revenue increase or cost decrease to an event that has not yet happened.

In his illustrative example of choosing between machine A and machine B to automate a production line and reduce the labour needed to keep it running (in an effort to, hopefully, allow the organization to either redeploy the personnel on higher-value tasks or, if not possible, replace those jobs with jobs that could generate more value for the organization down the road), it seems cut-and-dry. Just compute the value-to-cost ratio (where the value, as defined by the estimated labour savings, is divided by the cost of the new machine, which should include purchase, installation, and additional maintenance costs over the expected lifetime). In this case, one machine will generate a higher value-to-cost ratio and that is the machine you should purchase for the organization.

Assuming, of course, that you are sure the machine will have the indicated lifespan and will be useful to you for that lifespan. For example, what happens if you stop making the product in three years but your value calculations are for five years, the expected lifetime of the machine. The value-to-cost calculations will still rank the machines in relative order (as only the value changes), but the return might not look so enticing. And what about the situation where you can instead lease one of the machines from a third party (instead of buying it) and, because that machine in particular is made to a higher quality standard, get an annual lease that is only 1/10th, and not 1/5th, of the purchase cost? In this situation, a machine that cost twice as much would not only have the same value-to-cost ratio but, if you had to sell the machine you bought after three years, the leased machine would have a higher value-to-cost ratio since you’d likely not get the full undepreciated book value for the machine you bought.

And this is just a “best value” calculation on a simple piece of machinery. Consider the difficulty when trying to compute a “best value” on a technology platform purchase, where such platform is intended to improve your sourcing, procurement, supplier relationship management, or similar supply management process. It’s not just up-front cost. It’s implementation. It’s maintenance. It’s operational manpower savings on tactical tasks. It’s efficiency improvements (which have a value in terms of more events or throughput, which translates into generated value) and it’s additional cost reductions identified through the platform (which can be estimated based on benchmarks, but not predicted). How do you do that “best value” calculation? What number do you use? Do you compute a range and use the middle? Do you identify all platforms with a minimum acceptable value-to-cost ratio in terms of guaranteed hard-dollar savings and then select the best-value using the platform with the maximum value-to-cost potential?

There are no easy answers and costs alone don’t always tell the whole story.