Procurement Outsourcing: Time for Transformation

The market for procurement outsourcing is proving something of a disappointment. It is failing to live up to the buzz created by industry pundits. Everest, Aberdeen, IDC, and other research firms have long heralded the strong demand for procurement outsourcing services and forecast average annual growth rates in excess of 20 per cent over the next few years.

Yet, with only a handful of large-scale procurement outsourcing deals signed to date, this optimism seems remarkably overstated. A recent survey by Aberdeen Group found that 51 per cent of respondents had no plan to outsource any aspect of procurement within 24 months, and those that do, generally would not include the full available scope.

The benefits of procurement outsourcing are generally accepted by even the most critical managers. But major corporations, including those accustomed to outsourcing, continue to resist procurement Business Transformation Outsourcing (BTO).

The reasons cited include perceived loss of control, belief that procurement is a core competency, prior investments in procurement tools, the inability to build a credible business case or measure benefits, concerns about provider fees, and insufficient stakeholder buy-in.

However, a closer look at customer and service provider trends reveals that while  the benefits from procurement outsourcing remain essentially unchanged, providers have begun to align their offerings with emerging CPO priorities.

Further, customer environments are often not well suited for a broad-based transformation of the procurement function. And finally, service providers may also be partially responsible for the lukewarm procurement outsourcing marketplace.

There are several benefits that customers can realise quickly from procurement outsourcing, particularly if transformation is a focal point – Business Transformation Outsourcing rather than a straightforward “lift and shift” Business Process Outsourcing – and the right solution is implemented with a capable partner.

Historically, experts have cited the magnitude of savings, the fact that outsourcing can serve as a catalyst for change, and the desire to refocus procurement organisations on more strategic matters. But the relative importance of these and other advantages on CPOs’ agendas has evolved over recent months. Increasingly critical today are the acceleration of cost savings, the ability to easily develop or leverage global supply markets, and supplier risk mitigation. Procurement outsourcing is
well suited to meeting these needs.

The financial reward is the most critical benefit. The ultimate reward of procurement BTO, far more so than transformations in other outsourcing projects, is the acceleration of strategic sourcing and spot buy savings. Procurement outsourcing can yield a financial improvement of 30-50 per cent or more over internal transformations. This level generally exceeds the rate expected by CFOs when considering projects.

Procurement BTO may require upfront investment in solution design and build, systems implementation, change management, and severance costs. These costs have become difficult to avoid for customers and service providers alike due to increasingly stringent accounting practices. But a good business case will endeavour to offset early investments with an acceleration of strategic sourcing and spot buying savings due to improved spend capture and visibility.

Beyond financial gain, many CPOs are interested in the synergies made available by working with a single supplier in multiple markets or increasing leverage with a supplier within one or more markets. Consortium buying has been largely abandoned by top-tier corporations, but several multinationals have recently launched programs to identify or create global supply  markets for themselves by encouraging strategic or otherwise successful suppliers in one region to expand their operations to deliver goods and services globally. Some service providers are offering prospective customers multi-client agreements. Although relatively untested to date, this approach may be somewhat more successful than the consortia of old.

Those in closely watched businesses – whether observed by government regulators or the public’s watchful eye – may also benefit from reduced supplier and financial risk. For instance, depending on the agreed scope, a service provider may be able to more thoroughly screen a customer’s supplier base using a stringent corporate social responsibility policy or leverage a robust contract management process to mitigate risks associated with expired agreements. During a recent transition effort, one provider identified and recommended termination of a major Asian promotional items manufacturer that had previously been accused of employing child labour, thereby saving the customer potential embarrassment. In early 2006, another provider flagged three expired supplier contracts that, without immediate remedy, would have required disclosure under Sarbannes-Oxley, perhaps resulting in a time-consuming investigation.

Growing awareness among mainstream corporate employees of the importance of applying procurement techniques and tools to everyday purchases was highlighted in an interview with Ariba CEO, Bob Calderoni, (ELP, issue 4) who called this mindset “procurement science”. Unfortunately, this recognition can be entirely erased by the lingering image of procurement as “unsexy”. The combination of the two views can produce ambivalence toward the function and its transformation, even in organisations which prioritise outsourcing.

Unfortunately, procurement BTO, which can impact every end user in, and every supplier of a company, involves more change management responsibility than some senior officers are willing to accept. This issue is made far worse if no strong spokesperson for the procurement function exists. One example is a leading consumer goods company, which decided to outsource several functions including procurement.

But procurement had no leader. So although the financial case for procurement was by far the most compelling, it received the lowest prioritisation on the global rollout agenda, the least resources, and little commitment to global governance.

Why? Senior management simply did not take the function seriously. To them, procurement was the most unappealing of back office functions, and there was no-one to convince them otherwise. Given the massive organisational change and transformational business case involved, procurement outsourcing should be a board level or C-level agenda item in order for it to succeed, and a strong advocate is needed to get it there. He or she can contribute meaningfully to the success of procurement outsourcing in most large corporations.

Particularly when there is little sponsorship for an initiative, large companies operating in Europe and other regions with strong pro-labour laws and customs often shy away from the prospect of facing an angry and vocal labour union. Companies and even individuals have sometimes paid a heavy price. In one case, Unilever’s CEO was publicly chastised in an open letter by one such works council late last year when a series of outsourcing and shared services deals were announced. But other firms, such as Deutsche Bank, have had more success agreeing a win-win proposition with these groups, and this may serve as encouragement for those attempting the same path.

Not having a strong CPO causes two further complications. First, scope and scale may be greatly compromised because spend control may not be centralised. The bulk of budget ownership at major investment banks, for example, tends to rest with regional or business unit management, while central management often merely co-ordinates cross-company activities. Consequently, several individuals must agree to relinquish control of their purchased goods and services expenses in order for the purchasing function to be outsourced. Often this is not easily accomplished, and scope is reduced in response to individual requirements, yielding a poor business case.

Second, those procurement executives who are not prepared to stake their reputation on a major BTO, or who have already been denied the privilege of taking such a risk, may be compelled to explore outsourcing on a smaller scale. These supposedly competitive offerings can provide a stopgap, but also compromise the ultimate business case for full procurement outsourcing in the future.

Several entrants into the procurement outsourcing delivery market have combined their supply chain consultants with internal procurement resources to serve their current clients, then translated the results into a standardised, multi-client offering. Commonly known as “utilities,” these offerings are today being marketed as “on demand” products, the development of which has been largely funded by “first tenants” and the integration of which will be charged to future customers.

There are benefits to this approach, particularly for smaller businesses, in, for example, being able to achieve reduced operating costs and ready access to bestin-class processes and tools. Many large corporations, however, have dismissed this rigid approach. While most providers continue to seek clients for their “utilities” in order to maintain a relatively high level of profitability, those that tend to be accepting of unique requirements might be a better fit for discerning customers.

Another problem can occur when a service provider wins a deal and the sales and negotiation representatives are then replaced by a delivery team, which frequently cannot deliver what was sold, let alone drive continuous improvement over the contract term. Therefore, even if a solution is best-inclass at transition, it is unlikely to maintain this standard. Limited incentives for delivery staff beyond the account leads, insufficient strategic resources and, occasionally, a lack of motivation and sense of ownership are to blame for overpromising and under-delivering.

Customers should endeavour to manage these factors by selecting the right service provider, focusing on the importance of customised solution design and developing a rigorous governance framework.

But although there are a number of customer and service provider factors contributing to the limited demand for procurement outsourcing services, the mid-to-long-term outlook for the industry is strong. As customer organisations become better at promoting “procurement science” and driving widespread change, marketplace offerings mature, and new entrants improve service levels, accept risk, and reduce fees, a track record of successful deals should increase demand.

In the meantime, today’s ambitious procurement executive should seek to set the right expectations with senior management and, if given a window of approval, work with independent experts to select the right, highly motivated partner to deliver a best-fit solution for years to come.

Robin B. Shahani is a project director at EquaTerra, New York