Managing tail spend remains a headache for most procurement organizations.
This article is part of a two-part series. In part 1 I described why tail spend remains a headache and what an ideal process would look like. In this article I will describe what savings can be obtained with this ideal process.
We will see that the ideal tail spend process combined with a correct categorization of all spend can save up to 7% in procure-to-pay costs. That is 7% savings without any improvement in processes, just applying the right process to the right type of spend.
Different spend requires different cost savings strategies
All organizations carefully manage their procurement and payment costs, especially with the high levels of inflation we have today.
However, each cost savings strategy also brings costs itself. As we will see below, it can cost $1k per year to onboard suppliers and $25 to pay on invoice. It is therefore important to apply the right cost savings strategy to each type of spend.
Commonly used spend categorizations are direct versus indirect spend, spot buying, tactical buying, maverick spend, petty cash and expenses. These categorizations are based on characteristics such as purchase channel, payment method or approval process.
In this article you will see that when it comes to choosing the right payment process, spend should be categorized based on processing costs only.
To explain why, let’s first look at typical cost saving strategies.
Typical cost savings strategies
There are three main strategies to save costs in procurement:
- Negotiating better deals with suppliers: this is the most obvious and largest cost saving strategy. Research shows that regularly running a RFQ or RFP process for tail spend can save 5% - 10% of costs [1]
- Extending payment terms. Paying suppliers on 30- or 60-day terms improves cash flow. If your cost of capital is let’s say 8%, this would mean you save 0.67% for every 30-day of payment term extension.
- Reducing processing costs: processing costs include the (mostly people) costs of onboarding suppliers, approving POs, collecting receipt notes, data entry of invoices, 3-way matching between POs, invoices and receipt notes, doing payment runs and exception handling for wrong or disputed invoices.
Let's look in more detail at the processing costs.
Supplier and invoice processing costs
We will distinguish between two process types in this article: the “PO-invoice” process which incurs the full processing costs and the “Tail spend” process described in part 1.
The cost for onboarding suppliers can range from $1k-10k and and sometimes much higher for Enterprise customers [2]. In this article we will use $3k as the average. That means $1k per year assuming an average supplier lifetime of 3 years.
The average cost of processing an invoice is around $10 [3]. This analysis did not include PO approval and 3-way matching for which we will assume another $2. Finally, we need to amortize the $1k supplier boarding costs. Taking a generous assumption of the supplier sending 6 invoices per month that more than doubles that cost.
In this article we will therefore use a fully loaded cost for the “PO-invoice” process of $25 per invoice.
The cost of processing an expense claim is around $15. Assuming an average expense claim has 10 - 15 transactions on it, the fully loaded cost for expenses is around $1 per transaction. The tail spend process requires a little more work from employees so we will use a fully loaded cost for the “tail spend” process of $3 per transaction.
Spend categorized by processing costs
Based on these cost savings strategies we can distinguish between 3 categories of spend:
Table 1: spend categories by savings strategy
|
Tendered Spend |
Non-Tendered Spend |
Self-Service Spend |
| Definition |
The savings on negotiating better deals with suppliers are greater than the cost of running regular supplier selection processes |
Spend that does not fall into any of the other categories |
The cost of the PO-invoice process is greater than the financial return on negotiating payment terms. The ideal tail spend process should be used |
| What that means |
It makes sense to run regular supplier selection processes |
In between |
It makes no economic sense to onboard suppliers and raise POs the traditional way |
| Indicative threshold |
$100k - $150k annual spend per items in scope of the tender [4] |
N.A. |
Invoices of less than $2,000 - $6,000 [5] |
The thresholds shown here are indicative and will differ per organization based on your supplier onboarding costs, invoice processing costs, cost of capital and cost to run a regular supplier selection process.
The Non-Tendered Spend is defined as all spend that is neither Tendered Spend nor Self-Service Spend. Tail spend can be Tendered or Non-Tendered Spend
It's all in the mix
The biggest untapped procurement savings opportunity in advanced procurement organizations is changing how spend is classified.
The goal is to make the “Non-Tendered Spend” category as small as possible by doing two things:
- Reducing the size of the other the Non-Tendered Spend category. See below how to do this
- Applying the ideal tail spend process to all Self-Service Spend. See the first article in this series how to do this
Doing both of these can save you up to 7%. For a detailed illustration of these savings, see the appendix to this article. That is 7% savings without any improvement in processes, just applying the right process to the right type of spend.
How to reduce the size of the Non-Tendered Spend category
Reducing the size of the Non-Tendered Spend category means increasing the size of the other two categories.
Increase Tendered Spend through more efficient supplier selection processes
The size of the Non-Tendered Spend can be increased by decreasing the cost of running a supplier selection process.
In table 1 we used $5k as an indicative cost of running a supplier selection process which meant it was only cost effective for suppliers with which you spend $50k - $100k annually. If you can reduce that to $2k, running a supplier selection process would be cost effective for suppliers with which you spend $20k - $40k per year which would greatly increase the size of this category.
E-sourcing platforms and again e-marketplaces are two ways of reducing this cost.
Increase Self-Service Spend by making it suitable for all invoices below a certain threshold
Most businesses already have a self-service process for expenses. However, they have an outdated definition of the word “expense”. It is usually still associated with travel and entertainment.
The ideal tail spend payment process described in part 1 of this article series should be applied to all invoices below around $5,000, see the appendix to this article. That assumes no payment terms are applied. If payment terms are applied, this process can be applied to all invoices where the aggregate spend for this suppliers or category is below $100k so running a tender process is not cost effective.
About Yordex
It is possible to implement this ideal payment process today.
At Yordex we work with many organizations to implement their ideal tail spend payment process. To find out more, please contact us.
Appendix: Cost Savings Illustration
Let’s look at a simplified example of $40k worth of invoices. The organization’s cost of capital is 8% and their payment terms are 45 days. When everything is on PO and nothing is tendered, their total spend could be $40,700, see table 2.
Table 2: all spend is non-tendered
|
Tendered Spend |
Non-Tendered Spend |
Self-Service Spend |
| Invoice costs |
|
4 invoices at $5k each ($20k) + 40 invoices at $500 each ($20k) |
|
| Processing costs |
|
44 x $25 = $1,100 |
|
| Cash flow savings |
|
$40k * 1% = -$400 |
|
| Total costs: $40,700 |
$0 |
$40,700 |
$0 |
When optimizing the mix, the total spend would be $38,400, see table 3.
Table 3: optmized mix
|
Tendered Spend |
Non-Tendered Spend |
Self-Service Spend |
| Invoice costs |
4 invoices at $4,500k each ($18k) |
|
40 invoices at $500 each ($20k) |
| Processing costs |
4 x $25 = $100 |
|
40 x $3 = $120 |
| Cash flow savings |
$18k * 1% = $180 |
|
|
| Total costs: $38,400 |
$18,280 |
$0 |
$20,120 |
That means optimizing the mix will result in 7% cost savings.
Notes
- See https://www.bcg.com/publications/2019/taming-tail-spend
- See https://www.epiqtech.com/supplier-onboarding-process.htm
- How the next payments frontier will unleash small business. Goldman Sachs, September 2018
- Based on an assumed cost of onboarding the supplier and running a frequent vendor selection process of $10k and resulting cost savings of 7% - 10%
- Based on $20 cost per invoice, 45 days payment terms and 8% cost of capital. 45 days at 8% is 1%. $20 divided by 1% is $2,000. If the credit card company offers 30 day payment terms the incremental savings would be 15 days only. 15 days at 8% is 0.33%. $20 divided by 0.33% = $6,000. This threshold would be much higher for suppliers that send few invoices. If the $1k annual supplier onboarding cost has to be amortized over a single invoice, it would only make sense to onboard the supplier if that invoice was over $100k.
.png)
