A Brief Introduction
Simply put, procurement outsourcing to a Procurement Services Provider (PSP) is the transfer of specified activities relating to sourcing, supply, and supplier management to a third party.
Some Advantages of Procurement Outsourcing
It is a well known fact that businesses that outsource (well) grow faster, larger, and more profitably than those who do not. When done right, this is especially true for procurement as it can generate additional value through sourcing and compliance savings as compared to the savings opportunities from most outsourcing arrangements, which are generally limited to efficiency improvements and headcount reductions. In addition, it is a transformational type of outsourcing where a portion of the savings generated from an initial endeavor can be used to finance and expand the transformation.
One reason to outsource would be if the procurement of certain categories, such as indirect or non-critical materials, or the management of certain procurement processes, such as requisitioning and compliance tracking, were not core competencies since outsourcing provides an opportunity to increase efficiency, lower costs, and increase savings. Outsourcing in these situations is often much more economical than trying to build the competence internally.
Another reason to outsource is to keep organizational top performers happy. A first class sourcing professional wants to focus on strategic core purchases where she can have the greatest impact, not tactical indirect categories where savings opportunities are limited and impact minimal. By transferring manual and tactical tasks and low-impact indirect categories and class-C commodities, organizational top performers have more time to focus on what they do best and what benefits the organization the most. On the flipside, what once were low-volume non-strategic indirect categories are now high-volume strategic niche categories in the hands of a PSP who can aggregate volume and, more importantly, expertise across clients to the point where niche professionals focused on that category can be hired and kept happy by the sheer volume of opportunities.
A final reason to outsource would be if procurement is an area that, if managed properly, could drive significant value to the business but it is not an area that the organization plans on investing significantly in or increasing focus on internally. In this case, an organization could consider full spend management outsourcing, but it is not something the authors would normally recommend unless the organization was in an industry where all goods and services procured on a regular basis were non-strategic indirect or commodities. A hotel chain would be one example of a firm where full spend management outsourcing might make sense as the vast majority of goods and services procured on a regular basis are commodities.
The Basics of Procurement Outsourcing
There are essentially three basic levels to the outsourcing of procurement functions: infrastructure transfer, tactical process transfer, and strategic category transfer.
At a basic level, the organization is simply moving, or augmenting, staff, technology, systems, and supplier management to, or with, the PSP. At the next level, the organization is moving certain processes, such as requisitioning or procure-to-pay, that are easily automated and tactically oriented. At the highest level, the organization is transferring responsibility for entire categories and expecting the PSP to undertake strategic sourcing initiatives with respect to those categories.
At a basic level, the PSP will manage e-Procurement systems that automate and streamline manual purchasing processes and transactions and provide the organization with improved spend visibility, compliance, and process efficiencies. At a higher level, where the organization transfers tactical processes and control of indirect or commodity categories, the PSP will support day-to-day activities in supplier management, order and pricing compliance management, and policy enforcement and provide the organization with improved services levels and reduced costs. At the highest level, where the organization transfers strategic categories or full spend management, the PSP will provide on-going end-to-end strategic management of these categories, implement strategic sourcing best-practices, and drive continuous process improvements that should eventually lead to significant cost savings, or cost avoidance if raw material prices are steadily increasing in commodity categories.
Managed Services is Not Traditional Outsourcing
Don’t be fooled by a traditional outsourcing operation that offers to take over the entire procurement function under the proposition that procurement outsourcing is just like human resources outsourcing or financial services outsourcing. Unlike human resources or financial services outsourcing, where the value comes in headcount and fixed cost reduction, the value in procurement outsourcing comes in the form of increased savings and significant impacts to the top and bottom lines, and this value should dwarf any process or headcount savings the organization may want to acknowledge.
The following are some significant differences between traditional function outsourcing and procurement outsourcing to a PSP with a best-in-class managed services offering:
- Traditional outsourcing focuses on labor and process cost savings rather than the maximization of category and compliance management opportunities
- Traditional outsourcing is built for an “all or nothing” approach whereas a PSP only takes over the areas in which it can achieve (better) results (than the organization it is serving)
- Traditional outsourcing views procurement transformation as simply the use of a third party to drive savings opportunities for non-strategic purchases whereas a PSP will look for a solution that is right for the client across spend categories
- Traditional outsourcing solution providers will often confuse their opportunity with their customers’ opportunities; their opportunity is to take over the entire function, which they will generally not be well equipped to handle, while the organization’s opportunity is for a provider that can take over the right categories and attack them with the right solution
This may cause the reader to ask how a traditional outsourcing offering can be distinguished from a managed services offering from a real PSP. The answer is to look for warning flags, and if they are found, dig deep. Some warning flags that indicate a business process outsourcer is trying to sell a traditional outsourcing offering, which will not give the organization the biggest bang for its buck, are:
- The provider tries to re-engineer the entire procurement process; the best results are obtained through the application of the right strategies and tactics that should be in-line with the organization’s current procurement practices and goals
- The provider tries to transfer or hire new employees; a real procurement provider should have the right team already on staff and should realize that an organization achieves the greatest benefit when its current staff are freed up to focus on the strategic categories they are best suited for
- The provider promises to run the process more cheaply using IT; although every provider should be using best of breed eSourcing and eProcurement technology, the biggest savings come not from process cycle time reductions but negotiated and realized savings
- The provider promotes low-cost country labor as a benefit; the last thing an organization wants is cheap labor running the most valuable opportunity the organization has for significant cost savings, reduction, and avoidance – the value of a true managed services provider is their ability to identify significant savings on multi-million dollar categories that can add up to multiples of what outsourcing the function costs the organization, even with highly compensated people on the payroll
- The provider relies on a few dozen “expert” practitioners to “transform” the procurement function; true savings do not come from one-time initiatives, but continuous, well-managed, strategic endeavors that continually reduce cost and increase productivity in a realizable fashion
- The provider promotes transactional cost reduction; just like the last thing an organization wants is cheap labor, the last thing the organization should be worried about with respect to procurement is transactional cost, which normally will not exceed a few hundred dollars, on a multi-million dollar buy; after all, not only will the right buy save hundreds of thousands of dollars, if not millions, but the wrong buy could cost the organization millions of dollars if a quality or production issue rears its ugly head
- The provider focuses on its consortia spend aggregation capabilities; although this can be an opportunity for cost savings, especially in indirect categories like office supplies, how much is the organization really going to save by cutting an extra few percentage points off of it’s pen, paper and toner purchases (unless it is a printing company)? The reality is that most categories will not be as amenable to clumping as a traditional outsourcing provider or low-capability service offering would have the market believe. And in the manufacturing space in particular, lumping together different custom part buys, even if they use the same materials and processes, is just as likely to backfire and cost the organization a potential supplier as it is to get a volume discount as most suppliers could have great difficulty calculating a discount they could afford on an apples, oranges, and pears bid request, when the supplier does not even fully understand what kind of apples, oranges, and pears are being sought (due to the lack of expertise on the part of the traditional outsourcing provider)
- The provider touts its niche category expertise; just like a few dozen “experts” cannot fly in, play superman, and generate lasting cost savings for the organization, niche category providers cannot make any significant impact on typical organization spend either; “niche” categories are niche for a reason, in most organizations, they are not a significant amount of spend, and, therefore, not a significant savings opportunity. There will, of course, be exceptions, but such solutions are only valuable in the context of a large supply chain strategy.
- The provider claims it has a “complete” service offering, but the only examples presented are indirect or services categories. Although such an offering could be valuable to a company with a weak procurement function, it is still only valuable on the indirect and services side, and for a manufacturing organization, that still leaves the significant, strategic, direct spend opportunities untouched!
The value of outsourcing lies in the provider’s ability to bring strategic sourcing to categories where the internal team lacks expertise, transactional activity management where the in-house systems fall sort, and rebate and overpayment recovery where the accounting and ERP systems are unable to recognize that a target threshold was reached.
Some Expected Results
The value associated with procurement outsourcing is extensive. In addition to the year-on-year cost savings documented by numerous studies, obtained by way of the PSPs in-depth market knowledge and volume aggregation capability, the organization can maximize its return on its existing procurement capability by freeing up its sourcing professionals to focus on the most strategic categories. This reduces cycle times and increases the capabilities available to end users, but, most importantly, it provides the sourcing team with total indirect spend visibility as a PSP will be able to benchmark practices and prices and apply a standardized process to each category it manages.
In their 2004 Benchmark Study that surveyed 750 senior procurement, supply chain, and CFO professionals, Aberdeen found that enterprises outsourcing procurement recognized rapid and measurable reductions in cost structures, improved spend leverage and control, and gained operational efficiencies. In particular, they found that, even in the early stages of procurement outsourcing, on average, companies could reduce prices paid for goods and services by 18%, improve contract compliance by 60%, halve sourcing and transaction cycles, reduce administration and automation costs by over 25%, and improve rebate and volume discount capture by up to 20%.
Aberdeen also found that 43% of enterprises already outsourced select procurement processes or spend categories and that an additional 15% planned to outsource procurement functions by 2007.
The Procurement Service Provider Landscape
The Procurement Service Provider (PSP) landscape can be confusing, with a host of providers coming from many different backgrounds. There is traditional business process outsourcing and IT outsourcing behemoths that have invested in procurement skills, recent startups with procurement outsourcing as their sole vision, and specialist firms that concentrate on a handful of related spend categories. The result is a cloudy map of skills and capabilities ranging from transaction focused providers specializing in automation, through category specialists to comprehensive procurement service providers.
Considering that value comes from selecting the right partner with the right skill set, expertise, and experience to match organizational needs, it is very important that the organization is capable of properly evaluating all of its options and choosing the provider that is right for the business!
Identifying a Good PSP
A good PSP will have access to the latest web-based e-tools, use a center-led procurement model, be driven by operating metrics, and have tools and processes in place to closely monitor compliance. It will also have a significant number of sourcing and category experts on staff who are up to date on best practices, experienced in the relevant industry sector(s), and engaged in regular training and knowledge sharing endeavors designed to ensure they maintain world-class status. It will be based in a robust purchasing facility with integrated process and co-located teams, already have a pre-existing supplier network and supplier intelligence in the outsourced categories, extensive change management and knowledge transfer capabilities, and the flexibility to change as organizational corporate goals change.
Furthermore, the PSP will have a number of referenceable long-term customer relationships where they have been providing comprehensive spend management services across a significant number of companies and categories with a track record of success across industries, a solid balance sheet, a growth plan, and a commitment to maintaining operational excellence in procurement. Procurement will be its primary, if not only, focus.
The following can be used as a basis of a checklist to kick-off a PSP evaluation:
- Does the PSP have deep expertise (on staff) in the categories they are proposing to take over?
- Does the PSP have overall project leadership and management capability?
- Has the PSP demonstrated its ability to define and put in place overarching spend management programs consistent with the goals and objectives of its client organizations?
- Does the PSP have the ability to transfer best practices to the organization?
- Does the PSP have best of breed on-line e-Sourcing and e-Procurement platforms?
- Does the PSP have appropriate technical event management processes in place to make the best possible use of its e-Sourcing and e-Procurement platforms?
- Has the PSP demonstrated significant ability to achieve efficient cycle times for the categories it claims expertise in?
- Do the PSP on-line platforms have the ability to handle tens of thousands of suppliers, and hundreds in any given event?
- Has the PSP been successful at attracting suppliers to the platform?
- Does the PSP have the ability to train current suppliers, as well as newly identified suppliers, on the platform?
- Does the PSP have a recruitment and management program in place to continue to attract and add new suppliers to the platform over time?
- Does the PSP have a great data management solution?
- Does the PSPs data warehousing solution have the ability to cleanse, integrate, and standardize to a consistent classification, data from disparate sources?
- Does the PSPs data platform have the capability to provide the organization with spend visibility across all outsourced purchases?
- Furthermore, does the PSPs platform have the capability to provide the organization with a single, detailed, electronic invoice at the end of the month with on-line drill down capability into any category, sub-category, line item, and transaction?
- Does the PSP have standard templates and processes for the categories it is offering to manage for the organization?
- Furthermore, can the PSP customize these category specific templates to meet the unique procurement requirements of the organization?
- Does the PSP have geography-specific and category-specific knowledge in these categories based on aggregate current market conditions; and is the PSP able to apply this knowledge to benefit the organization’s goals?
- Does the PSP have a deep benchmarking capability?
Selecting Categories for Outsourcing
Procurement outsourcing normally generates the largest returns when applied to non-strategic indirect categories and direct commodities of limited strategic value. In addition, it generates the largest return when the PSP has enough volume to identify significant savings opportunities. Therefore, it is important to select a PSP that will allow the organization to go beyond simple infrastructure transfer and process support. (However, the organization should still be cautious and not to go too far with the outsourcing initiative, since strategic sourcing dictates that strategic categories are managed carefully.)
Indirect purchases are ideal for procurement outsourcing because they are typically transaction driven, not part of the core business, and so varied that they generate considerable process inefficiencies for purchasing staff, especially when most information systems are designed for direct material categories. Furthermore, due to the sheer number of categories and variations therein, many buyers will lack the time and means to apply best practices such as cost breakdowns and benchmarking to these categories. Thus, a PSP with the right skill sets could be invaluable.
Established Procurement Service Providers focused on sourcing are usually market leaders that have a number of inherent advantages which include a larger supply base, higher levels of expertise in niche categories, and the ability to aggregate spend on a larger scale. In addition, they can often tap more economical labor sources in regional markets and implement new sourcing processes and technologies more efficiently.
A PSP reduces the headcount an organization needs to perform certain manual and tactical processes or to manage certain indirect or non-strategic categories that are not a core competence, freeing up the procurement team to spend a much greater percentage of their time on strategic activities and strategic categories and generate a larger return on organizational investment.
Remember, the overall value creation offered by a PSP comes from the combination of expertise, technology, and process and not from headcount reduction, cycle time improvements, or simply technology enablement. Results come when the organization chooses a PSP that fits within the organization, complements the business model and supply chain strategy, has expertise in those categories where there is insufficient in-house expertise, and where the PSP is able to take on basic functions that free up the organization’s top talent to work on strategic categories where they can have the greatest impact.
Preparing for Outsourcing
Managed properly, a relationship with a PSP is very beneficial. However, before an organization enters into such a relationship, it needs to prepare for success.
The very first thing an organization needs to do, even before it makes the decision on whether or not to outsource part of its procurement function, is to gather data on the current state of the procurement practice. Do a spend analysis by category and location to determine high-volume vs. low-volume categories. Work with product development to determine strategic vs. non-strategic commodities. Understand transaction volumes and associated processing times. Document processes and average sourcing times by category. Determine what currently falls under procurement, what does not, and what should.
The next step is to analyze this data and determine direct and indirect savings opportunities by outsourcing low-volume or non-strategic categories, transaction management, and process execution. Procurement outsourcing only makes sense if considerable year-on-year savings opportunities exist, especially since the greatest savings will not be realized until a year or two into the relationship. Furthermore, a good relationship is driven by a Service Level Agreement (SLA) that specifies mutually agreed upon targets and goals, and incentives for the PSP exceeding those targets goals, and reasonable values for those targets and goals cannot be set unless there is a basic understanding of current spend and internal performance.
Once the analysis has been finished, the organization needs to decide what will actually be outsourced, what the scope of the arrangement will be, how the responsibilities will be split, and how the relationship will be managed. A governance council will need to be established to maintain control over what is being outsourced and monitor performance and compliance. The council will be key to aligning stakeholders and insuring a single cohesive message is always delivered to the PSP.
A single senior executive needs to take responsibility, coordinate the deal to the point of closure, and oversee the initial implementation. The executive is also responsible for making employees aware of the plans, overseeing the creation of the transition approach and timing, and explaining the benefits to the procurement function and the organization as a whole.
One of the keys to success, the SLA must define a formal governance and oversight structure, risk-and-gain sharing policies, staffing parameters, operating specifics, and response times. It should be based on key metrics, and measurements against these metrics should be taken and communicated regularly. It should include incentives for exceeding targets and penalties for sub-par performance. It must allow for bilateral transfer of methods, processes, and knowledge and encourage continuous process improvement.
In Conclusion ...
Once the SLA is nailed down, the specifics of the relationship need to be addressed. It should be a multi-year agreement, preferably at least two or three years, with proper incentives, a well defined governance model, appropriate categories and risk management processes, and methodologies for the transfer of best practices. It should also identify and account for any important or relevant legal issues up front to prevent issues down the road.
Remember that the most significant benefits often do not materialize until the second or third year of the relationship, when it has matured to a smooth, natural process and that it takes time to collect enough data to not only measure performance and results, but improvement.
Make sure to not only link the agreement to explicit benefit targets, and continuous, step-change performance improvements, but to include rewards if the service provider exceeds those targets. Incentives drive everyone, partners included.
Then, when the contract is in place, measure performance regularly, insure issues are escalated when appropriate, and confirm that spend visibility is available to every user. Transfer best practices on a regular basis and work together for continuous improvement.
The measurements should include, but not be limited to, Savings Targets, Process Compliance, Supplier Compliance, Supply Base Consolidation, On Time Delivery, Transaction Accuracy, (PSP) Staff Retention, and Quality of Service.
A Selected Bibliography
(The) Benefits of Selectively Outsourcing Procurement by Flavien Kulawik, 2004
(The) Case for Procurement Outsourcing by Donavon Favre, Charles Findlay, & Jeffrey C. Zaniker; July 2003
Mid-Market Must Balance Strategy, Costs in Procurement Outsourcing by Rick Saia, August 2006
Outsourcing Comes of Age: The Rise of Collaborative Partnering by PriceWaterhouseCoopers, 2007
Outsourcing Service Provider Performance: Study 2007 - BeLux by Morgan Chambers, 2007
Outsourcing Strategically for Sustainable Competitive Advantage by Robert M. Monczka, Willam J. Markham, Josepth R. Carter, John D. Blascovich, & Thomas H. Slaight, 2005
Outsourcing Strategies and Implications by Roberta J. Duffy, October 2005
Procurement: Are You Ready to Outsource? by Andrew Bartolini of Aberdeen Group, August 2006
Procurement Outsourcing: A Pathway to Value or a Road to Nowhere? by the European CPO Club, March 2006
(The) Procurement Outsourcing Benchmark Report: Accelerating and Sustaining Cost Savings by Tim Minahan; Aberdeen; March 2004
(The) Procurement Outsourcing Benchmark Report: Moving Beyond Cost Reductions by Rick Saia & Sudy Bharadwaj of Aberdeen Group, May 2006
Procurement Outsourcing Roundtable: How fast, how far? by European Leaders in Procurement, May 2007
Procurement Outsourcing: The 10 Things Finance Professionals Want to Know by Jason Gilroy, May 2006
Supplier's Prescription for Success: Deliver More and Serve as a Lifeline When Necessary by Beth Ellyn Rosenthal
To outsource or not to outsource? by Anna Cooper, May 2007
Michael Lamoureux, PhD of Sourcing Innovation
David Bush, Pro to Know