Cutting off procurement “tail spend”

Tail spend accounts for about 20 % of non-core expenses, which are not easy to manage due to limited in-house resources and a high volume of transactions and suppliers. As a rule, these are one-off or low value purchases, which is why the procurement department does not devote enough attention to them. However, due to company policy, it is necessary to address the issue of tail spend, where present.

The most common tail spend categories are office and store supplies, spare parts, production consumables, maintenance and repair. For example, an FMCG company reports over 1,200 orders per year, covering just spare parts and consumables, with around 8.5 thousand items of over USD 1.7 million (over 50 % of the costs are imported spare parts).

 

Breakdown of costs and suppliers of indirect procurement categories, Accenture report “Getting a Grip on Tail Spend”

I’ll focus on tail spend management bestpractices in my next article but for now let’s discuss THE THINGS TO AVOID. Here’s a list of the main issues associated with tail spend management that companies face:

  1. A large company with an annual spend in excess of USD 100 million on average requires 500-700 new suppliers a year for indirect procurement. The process of aligning new contracts takes time and effort on the part of the requestor, procurement and finance departments, while it does not have a high return.
  2. Some suppliers are difficult to approve as they don’t meet the internal requirements of the company. For example, a supplier might spoil the statistics on average days payments outstanding (DPO) while satisfying other commercial terms.
  3. There is no single classification or statistics on purchased supplies which creates more challenges for spend analysis. It is also possible that the ERP system won’t allow for enough detail to be recorded and all expenses may have to be saved under the same category (for instance, as Consumables in a short description of the purchase order).
  4. There is no consolidation between business units: different client branches purchase different goods and services required to address the same tasks. Processes are doubled and labour costs are increased, while spending is inflated due to split volumes.
  5. Purchases are made by requestors without involving the procurement department or only involving them at the final stage which increases the cost of such purchases.
  6. On top of organising the purchase, a lot of processes need to be handled such as delivery, storage, customs clearance and so on. These all take up a lot of resources should you be dealing with multiple contracts.

At the same time, the dream scenario of a typical purchaser looks like this:

  • The company places all one-time purchase orders with a single contractor who then places small purchases with tier-2 suppliers. Procurement departments call such contractors consolidators or “trade houses”. Instead of working with many small suppliers the client has only one contractual party – the trade house. This scheme is different from the classic procurement outsourcing model where the provider executes (and gets paid for) the procurement process and does not act as a subcontractor.
  • The trade house not only selects suppliers, it also processes all the documents.
  • The trade house consolidates the volumes from all the company units, involves other major clients and, as a result, gets a discount from OEM which is then reflected in the client’s payments.
  • The trade house analyses expenses, streamlines the procurement process and creates a standard classification of goods and services on tail spend (for example, on spare parts) used by all clients.
  • The client avoids the bureaucratic processes of registering a new supplier, managing multiple invoices and contracts for low value/one-time purchases.
  • The trade house provides a delay of payment as required and fulfils requirements of all corporate procedures, facilitating approval of contracts.
  • The trade house gets a percentage of the processed expenses or fixed-fee compensation for each transaction.
  • The trade house provides the company with relevant reports, including pricing information, volumes, payment terms etc.

In other words, ideally, all procurement activities and document preparation are performed by the trade house, while the client saves time, money and effort by means of a high level of service coupled with low administrative costs and lower spending. PrECA is often approached by large companies with regard to setting up a similar operating model for them. However, we decline the offer and here is why:

  1. The trade house is not motivated to reduce costs since they do not benefit from this. On the contrary, the intermediary is actively interested in increasing the costs, particularly if they get a percentage from the purchasing spend.
  2. Such schemes are not transparent enough. How do you understand whether an offer is competitive enough? What criteria have been used to select the supplier? The client won’t get this information. In the best case scenario, they will know the final price and the supplier, in the worst case it will be just the total value of the goods/services. Managing such spend is difficult, hence, sooner or later the client wises up to the trade house or takes up issues with them which will result in conflicts.
  3. From time to time the trade house will have to compete with the requestor and/or procurement department which will negatively affect business relationships. The client will start looking for other suppliers that offer more favourable prices and try to force the trade house to cooperate with them, even when their terms do not meet the trade house’s requirements.
  4. The trade house covers the supplier and liability risks (penalties for supplying low-quality products, incorrect quantity/specification, working with grey market companies, prepayments to the contracted supplier, extended DPO by the client and other risks) in the service charge. It is very likely to include a considerable bonus, since it is the trade house who sets the final cost.
  5. The trade house has no time or inclination to classify procurement data or optimise procurement processes. The trade house’s task is to deliver an order ”on time in full” and to process the entire transaction: sign the contract, deliver the goods, obtain payment, etc.. That is to say, the trade house is mainly busy with ‘plugging the holes’, only not with the analytics or optimisation that would allow for a more systemised approach. This is particularly valid for Russia where supply chain risks are high due to sanctions, currency fluctuations and poor financial conditions of some small companies.
  6. The trade house is an extra link between the client and supplier. All information is communicated via an intermediary; the delivery process is slowed down, while the chances of malfunction go up: it only takes one person to forget to pass on an important detail and the whole chain would collapse. The supplier is not happy with the extra link, either, since they lose direct access to the client (which is important when dealing with large companies), experience payment delays and don’t trust the trade house as much as the client.

One of the most important things is that this scheme integrates two tasks which are not recommended to be combined in the slightest: the outsourcing of the procurement process (including its optimisation) and the actual delivery of goods. The trade house is definitely not an outsourcer as such, but instead it is a clear-cut intermediary. Optimisation of the procurement process with the main focus on transparency, analytics, systematisation and standardisation had better be left to the client personnel or external specialists, who specialize in procurement and business process outsourcing. Meanwhile, delivery of goods and services would be safer with a designated company (which could also be sourced by the external specialist), for example, a spare parts dealer or supplier of consumables.

However, it has to mentioned, that in some cases it is worth working with a trade house:

  • When purchasing one-time and low-value goods, specific to the trade house; i.e. when the trade house acts not only as an intermediary, but also a supplier of a specific service;
  • When spending small amounts (for instance, less than 10,000 roubles);
  • The client selects a supplier, but the payments are made via a trade house, i.e. the intermediary only performs the function of processing transaction documents.

How viable, do you think, is the ”trade house” model? What pros and cons can you identify? Can you think of other situations when it is worth dealing with a trade house? Could you tell us about you experience of working with a trade house?

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