Procurement outsourcing gains boardroom attention

Cost and staffing pressures are forcing companies to pass the baton for procurement spend to third parties. But despite the benefits of outsourcing, some are reluctant to hand over control of sensitive business processes, writes Malcolm Wheatley.

On 23 February, fashion retailer Liz Claiborne announced it was outsourcing almost its entire global apparel and accessories procurement activity, retaining only the sourcing of jewellery products and clothing for its Mexx brand in-house.

For everything else, the New York-headquartered business was turning to Li & Fung, a $15bn, 106-year old trading company. The Hong Kong-based organisation already carries out sourcing and supply chain operations for US-based retailers such as American Eagle, Tommy Hilfiger and Wal-Mart.

According to Liz Claiborne CEO, Bill McComb, the deal with Li & Fung covers up to 90% of the company's total spend - an amount significant both for its extent and scope. And indirect spend, it isn't, he stresses. "It's basically what we sell to the consumer," he says. "It's what shows up in the accounts in the 'cost of goods sold' line."

The logic makes perfect sense, says McComb. "With Li & Fung as a partner, we'll have access to a vast, worldwide network of manufacturing partners and best?in-class systems, management and talent, which gives us more flexibility and a better competitive position. Greater buying power will enhance our margins and disciplined execution will improve our speed to market."

Under Liz Claiborne management, he adds, the company's international purchasing operation had become complacent - leading him to doubt its objectivity and willingness to continually engage with suppliers to reduce costs and improve performance.

It's a development that cuts to the heart of the debate over procurement outsourcing. Transaction outsourcing no longer raises eyebrows - for most large western businesses, offshore employees working for one of the outsourcing specialists can offer a cheaper solution.

But as outsourcing makes inroads into procurement, obvious questions arise. How far do you go and in the pursuit of which objectives? What and where are the limits to procurement outsourcing, if there are such limits?

"There are often no right or wrong answers," says Johan Denekamp, group chief executive at procurement services provider and consulting firm 4C Associates. "Much boils down to how the business feels about the issue. Even within individual categories of spend, there are different views - for some clients, we'll manage the whole category, for others, we'll manage just the 'tail'."

Expanding contracts
The present economic downturn is also placing a fresh focus on procurement outsourcing. In early March, outsourcing specialist ICG Commerce announced that its spend under management had increased by 50% since 30 September last year. Driving this sharp increase had been new or expanded contracts with companies such as Whirlpool, Teva Pharmaceuticals and Goodyear, taking the total value of the contracts managed by ICG to $10.2bn.

Even so, observes Carl Guarino, ICG Commerce chief executive, there are limits to what the company is being asked to take on. "We cover direct spend categories, but it's largely categories of indirect spend that are being outsourced." Most exceptions to this are where ICG has specialised procurement expertise, or other resources in-house that it would be uneconomic for customers to retain on staff.

A similar story emerges from Accenture. "Over the past six months, we've seen a surge of interest in procurement outsourcing," says Greg Spray, executive director of procurement business process outsourcing services. "Companies want to reduce their procurement headcount and cost, but aren't willing to give up the procurement savings they have enjoyed."

But look closely, and there are huge differences between organisations in terms of the categories and types of spend they are comfortable outsourcing.

At international tourism group TUI Travel, high-level procurement analysis has been outsourced to Mumbai-based outsourcing specialist WNS. "We've offshored the analysis activities that support the procurement function - analysing vendor bids, doing market analysis and tracking market trends," says Mary Coyne, the company's head of IT procurement. In other words, the activity of procuring categories such as hardware, telecommunications and bespoke software is onshore, but the analysis activity which underpins it has been moved offshore.

The function she heads doesn't undertake transactional procurement, and it's considered important for the business-facing people within her organisation to be precisely that. "Our people in strategic procurement roles need to be on-site to take part in supplier negotiations and it's difficult for them to do that if they are located offshore."

Public sector procurement bodies are another instance where the potential of more extensive procurement outsourcing is constrained. The city of Helsinki recently moved to an electronic procurement system from BasWare. Purchase orders are now made electronically, explains Helsinki's purchasing director Jorma Lamminmäki, with BasWare responsible for entering suppliers' products and product catalogues into the system.

But the ROI is chiefly restricted to reduced transaction processing costs. Apart from relatively minor activities such as electronic tendering and spend analysis, the city has reached the limits of procurement outsourcing, says Lamminmäki. "As a public body, we're constrained by European Union law," he explains. Public sector procurement must go through rigorously-audited processes of open tendering and open evaluation, and the business of supplier selection cannot be devolved to a third party. "We can't buy as a private sector company might choose to," he says.

Defence contractor BAE Systems is one such private sector company. And of the business's £1bn of indirect spend each year, says group procurement director Jim Robinson, £235m is handled by outsourcing specialist Xchanging.

The gains have been very evident, he says. "Outsourcing offers capability, capacity and aggregation, as well as potential speed in terms of getting to benefits faster than the business could achieve on its own." Aggregation, to extract cost reductions through economies of scale, have been particularly significant.

Limited appeal
But there are limits. "Most of what we've outsourced has high aggregation potential and low complexity in terms of stakeholder management," he says. "It's categories such as travel, contract labour, office supplies and office equipment."

And direct spend remains firmly off-limits. "We take the view that anything which goes into our products has critical quality and safety requirements and requires close links to our engineering and development activity," he says. "And the decision isn't one that has been taken by the purchasing function alone, but has been the collective view of the complete community of engineering, quality, and development: managing the procurement of direct materials ourselves is better than handing it to a third party."

It's a distinction that makes perfect sense to Rachael Stormonth, vice president at Boston-based procurement and outsourcing advisors NelsonHall. "We've seen a clear lack of correlation between areas of spend with which companies are dissatisfied and their consequent willingness to outsource that spend," she says.
It's a bonus when there is that correlation, of course - with the procurement of temporary labour being the classic example, she notes - but on the whole, it seems outsourcing isn't being regarded as either a way to eliminate problems with a spend category, or cut the cost of managing that category. It can help, but it's not the whole picture.

Indeed, when it comes to procurement outsourcing, the distinction between indirect spend and direct spend may be something of a red herring. A better way of thinking ?about it may be to distinguish between spend that is strategic and spend that is not.

Inevitably, argues Sammy Rashed, head of sourcing for global sites at Novartis, procurement outsourcing vendors - by combining economies of scale, specialisation and offshore location - can be expected to undertake procurement activity more effectively than many individual businesses. That, in short, is why it is happening at all.

Internal pressures
Facing internal pressure to deliver even more value, procurement functions must migrate up the value chain, getting closer to the decisions that matter and optimising the linkage between the demand that the business experiences and the resources procured to meet that demand. Ultimately, the tendency will be for smaller procurement teams focusing on what is strategically important to the business - with everything else handed to specialist outsourcing providers.

The trend is already evident. At UK mobile telecoms business O2, procurement outsourcing is 'business as usual', stresses Alastair Eadie, head of UK procurement. Around £200m of indirect spend is outsourced to 4C Associates - a natural evolution from using third parties to conduct sourcing projects where O2 lacked either the relevant expertise or the resources to conduct them in-house. "We'll willingly outsource to third parties where we think they can do a better job than we can," he says.

But the determination of what gets outsourced is based on its strategic value to the business. If it's strategically important, it's kept in-house. And the definition of 'strategically important' straddles both direct and indirect categories, emphasises Eadie, and large areas of indirect expenditure are off-limits, too. "We want direct control over anything that impacts brand effectiveness or brand integrity," he insists.

The senior management of Liz Claiborne and Li & Fung are working closely to deliver that control. And in boardrooms and procurement functions around the world, people will be watching. More rides on the deal than the individual prosperity of either business.