The Pareto principle, also known as the 80/20 rule, is commonly used to break down data sets because of its relative simplicity and eerie accuracy. 80% of a company’s spend is with 20% of their suppliers, and 80% of purchase transactions stem from 20% of the company’s buyers. These are both good news and ease spend management. But are 20% of your company’s transactions taking up 80% of the hands-on management time?
The benefit of working on a Pareto basis is that a team is able to focus their efforts on a relatively small subset of data and yet still have a significant impact. Companies often take an 80/20 approach to spend, suppliers, and transactions by sorting from the top down and – using the total value – drawing a line in the ‘sand’ once 80% is reached. This assumes, however, that the information is centralized, easily accessible, and as straightforward as knowing how much spend is associated with a line item.
What if the 80/20 split you are trying to achieve is not numeric but based on transaction status? Or worse, what if it is a ‘reverse pareto’ where a minority of transactions are commanding a majority of the team’s time to manage?
That is where ‘management by exception’ comes in.
Management by exception allows a company to instantly isolate the subset of their transactions that do not abide by a set of specified conditions. Purchases that are missing a PO number, that don’t have the required approvals, or that buy from the wrong supplier, etc. become as visible as if they were the only transactions conducted. All of the transactions that abide by the company’s rules and guidelines don’t need to be managed. More importantly, they can easily get in the way. The longer it takes to identify the exceptions and reconcile them, the more onerous the process of correcting them becomes.
An exception is anything other than what was expected, and in most cases they refer to breaks from policy. But exceptions can also be breaks from the budget or plan governing anticipated spend or demand volume. Step one is to find them, and step two is to respond – at the very least to learn more. Accelerating the process works best when the plan itself is available centrally via the same system that the transactions are processed through. That way, not only is the information infinitely more accessible, it can also be monitored centrally and reported on enterprise-wide for greater visibility and faster resolution.
Exception reporting is great, but unfortunately it is a corrective action. When a change needs to be made in response to adjustments in demand, the company is likely focused on the business conditions causing the change in plans. Does anyone think to notify suppliers? Unfortunately, all too often, no one thinks to notify affected suppliers until it is too late for them to alter their own planning. No one in the supply chain expects full predictability during the life of a contract, but suppliers are trying to manage their costs, too. It is hard to achieve or maintain favored customer status if suppliers are constantly being left in the dark, and you can be sure that future negotiations will have padding added in to cover the additional costs that result.
If we return to the Pareto principle, chances are that a small percentage of a company’s transactions are exceptions – maybe even less than the 20% mark. Although they are a fraction of the total spend and purchase volume, they can be a huge problem for buyers and suppliers alike. Being able to zero in on exceptions through reporting and automated messages can ensure that 20% of the company’s purchase transactions don’t take up 80% of their time to manage.