CRM SHOPPER

Latest Trend in SCM: Outsourcing Procurement

Procurement has always been the low-hanging fruit when it comes to corporate cost savings. As any sourcing or procurement executive knows, purchased goods and services account for a little more than half of every dollar of revenue, and 80 percent of the cost of these goods and services is set by the end of the design and sourcing cycles. In short, sourcing can represent the single largest opportunity for an organization to reduce costs.

Yet, by and large, most companies do not handle procurement or sourcing very well when left to their own devices. On average, enterprises have applied strategic sourcing principals to less than half of their overall spending, according to a new Aberdeen Group report on the subject, “You Will Outsource Procurement: Here’s Why and How.”

Nearly 70 percent of companies continue to make sourcing decisions at divisional or site levels instead of adhering to an enterprise-wide strategy, the study also found. Worse, one-third of all purchases are off-contract or “maverick” buys — that is, they are the result of an employee ignoring negotiated contracts with preapproved vendors and buying what he wants from whom he wants.

Propelling Reasons

It is for all these reasons that outsourcing of procurement activities is on the rise. Aberdeen estimates that revenues for outsourced procurement services will grow from US$4.8 billion in 2001 to $9.7 billion in 2005, a 19.3 percent compound annual growth rate.

Cost savings will be one driver: Research shows that outsourced management of specific business processes or specific categories of spending can achieve cost reductions that average between 10 and 25 percent, topping 30 percent in some cases.

Another driver will be cost-effective access to the latest e-procurement and e-sourcing technologies without the hassle of maintaining them in-house — in short, the reasons that propel any firm to outsource or host an application.

From Integrated Suppliers to Demand Aggregators

Yet, outsourcing a procurement operation — or, as is most likely the case, a part of a procurement activity, such as spend analysis or sourcing — means a whole set of considerations for an organization.

The business models range from integrated suppliers or distributors — such as WW Grainger or Ingersoll-Rand, which also can act as outsourcers — to firms whose primary role is to aggregate demand (that is, to pool the purchasing power of customers to cut the best deals with suppliers), such as ICG Commerce (ICGC).

Some vendors in this particular market space are well-established firms, such as IBM’s Leveraged Procurement Service. Others are relative newcomers, such as ePlus.

How You Buy Vs. Where You Buy

As in any category, vendor viability is a strong consideration, but AMR Research director Pierre Mitchell told CRM Buyer Magazine that “the main guideline companies want to follow when evaluating outsourced procurement providers is, how easily can you separate how you buy from where you buy?”

According to Mitchell, “It doesn’t matter who it is. Any supplier or source of supply would love to hard code themselves into a back office by providing your hosted e-procurement — aka the on-ramp — as a vehicle to do that.”

This is not necessarily a bad thing, he said, but a company needs to make sure that the third party has its best interests in mind, “especially when they are acting as both an on-ramp and source of supply.”

Poster Child

Some integrated suppliers may not allow their proprietary technology to hook into competitors’ applications. On the other hand, a hosted e-procurement provider might offer a firm the flexibility it needs to buy wherever it wants, but may not offer the demand aggregation or other value-add services that make outsourcing procurement worthwhile in the first place.

The ideal structure, Mitchell suggests, is to craft an e-procurement application, or on-ramp, to work with multiple sources of supply. “The best way to do this is to understand your service provider’s business model and to what extent they will monetize your relationship with them.”

ICG Commerce, a subsidiary of Internet Capital Group, is the poster child of the burgeoning outsourced procurement industry — not to mention a good illustration of the complex business models that have developed in recent times, he said. “They are a group purchasing organization — in a sense, a hosted e-procurement provider — and also have 300 sourcing professionals on staff. They bundle these services all together to evaluate your spending, then serve up the hosted e-procurement on-ramp with appropriate pricing.”

Serving Up Customers to Suppliers

IBM’s Leveraged Procurement offers a slightly different twist along the same lines. “What they do is basically use other tech providers to be the hosted e-procurement application to provide access to their preaggregated contracts,” Mitchell said.

The main value-add in this service is the contracts IBM has negotiated, he continued. “They have taken their own corporate contracts and served them up to the masses. This is a model they pioneered over five years ago in the electronics area: using their buying power and group contracts and serving those up to suppliers, thus saving the suppliers money and taking a cut of those savings for themselves.”

ePlus is a best-of-breed vendor whose service may be the best deal for a company that wishes to structure an outsourced procurement operation on a la carte basis, according to Mitchell. “They have separated their various business units — such as requisitioning, sourcing, inventory control, asset-tracking, in-bound goods fulfillment, etc. — to allow customers to go outside the organization when they want, but they also offer integration internally, as well.”

Managing the Risks

Of course, outsourcing comes with all the risks one would expect when placing a business process integral to a company’s operations — and sourcing and procurement surely fall into that category — in third-party hands.

However, a few basic precautions can shelter companies from the worst of these exposures, Deloitte Consulting partner Nidal Haddad told CRM Buyer. For example, an enterprise can put in place specific service-level agreements. In some cases, investing in the business processes, training or actual facilities is another strategy to consider, although this is more a suggestion for major outsourcing initiatives, such as transportation or logistics, or, to a lesser extent, call center operations.

Finally, or rather first of all, using a detailed RFP (request for proposal) is important, as is carefully evaluating the potential vendor’s technical and managerial capabilities — and in the case of e-procurement outsourcing, the pricing methodologies underlying the demand aggregation that the provider delivers.

This will not always be easy, Mitchell warns. For example, ICGC clients told AMR Research that while they like many aspects of the service, they were frustrated with the lack of transparency of its SKU-level (stock keeping unit) pricing and markup and the inability to monitor these surcharges on an ongoing basis.

Vendor-Selection Questions

To get a better handle on these and other issues, Mitchell recommends asking the following questions of any prospective group purchasing entity:

  • How do I know I am getting a good deal? What does it cost to do a spending baseline project? If I do this, can I then compare it to the group purchasing organization’s pricing? How can I be assured that cost-savings benefits are passed on to me?
  • What categories, suppliers and committed volumes are you running? What are the fees and structures, minimum volumes and cancellation policies? How can I bring committed volumes in new categories, and what do I get in return?
  • How am I provided with detailed reporting for current orders, order history, invoice summaries, price charges, exception reporting and cost savings by SKU level, category level, end-supplier or cost center?

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