Purchasing Outsourcing

“The Challenges and Opportunities associated with Purchasing Outsourcing”

by Jimmy Alyea

Outsourcing of procurement activities is on the rise and is being broadly adopted across many industry segments (Morphy, 2012).  The current economic environment has increased interest in purchasing outsourcing as companies look for new ways to sustain profits through increasing operational efficiencies and make significant reductions in their cost structures.  While outsourcing of HR and F&A (finance and accounting) is a common practice, procurement outsourcing is becoming increasingly accepted as a more viable strategy for both cost and performance improvements.  A strategic approach recognizes that the primary benefit, however, is not in reducing costs of the procurement organization, but of creating value from corporate spend.  Since the early 2000s, leading organizations have changed their perspective of procurement organization from that of a cost center to a profit center, which has given a new dimension to procurement as  a “game changer.”

Background of procurement outsourcing. 

Traditionally, the  focus of procurement outsourcing has been on transactional purchasing activities that involve select portions of  indirect spend.  These include processing purchase requisitions and purchase orders, managing simple RFQs, and invoice matching and payment.  However, the increased availability of global skills in terms of process and technology has created the opportunity not only to standardize and automate procurement processes, but also to leverage improved performance and best-in-class services by moving value-added activities to a third party specialist.  With companies increasing their focus on core business processes to gain a competitive advantage, they are more open to outsourcing strategic procurement efforts such as contract management.  Areas within the procurement process can be categorized as core and non-core activities and selected ones identified as individual opportunity areas to be outsourced.  The supply base has developed significantly in recent years and features a number of major service providers like IBM Global Services and Accenture that are capable of supporting high-quality outsourced strategic procurement efforts.

Vendor services and selection. 

With the wide range of service provider skills and offerings currently available, selecting the right procurement service provider (PSP) presents a major challenge.  There are many new entrants in this immature and confusing market, and in some cases such as category-specific specialists, offerings are still under development.  While a firm that engages a call-center vendor can feel secure about the services to be provided, the same cannot be said of the procurement manager who is considering outsourcing strategic sourcing or category management.  Exercising “buyer’s caution” is the strategy to be followed when evaluating the specifics of services offered and vendors’ competencies.  Vendors should be assessed in such areas as category expertise and use of best practices, technological tools and degree of automation utilized, size and appropriateness of supplier network, ability to analyze spending patterns and aggregate spend, level of supplier management provided, track record/references for handling processes of similar size and scope, and willingness to sign a carefully constructed Service Agreement (SLA), among other things.

Contract formulation. 

Just as vendor solutions vary widely, so do contract methods, and the ultimate success or failure of an outsourcing agreement may very well lie in the contracting process.  A detailed contract should include SLAs that define responsibilities and service-level expectations, as well as  provide process-specific metrics and milestones,  a clear statement of the value-based pricing by which solution fees are determined, a dispute resolution process, and an exit strategy in the event of an unforeseen situation such as bankruptcy.  At the present time, there are no standardized contracts for the three categories of PSPs:  transaction-focused providers; category specialists; and comprehensive service providers, such as IBM and Accenture, which offer business process outsourcers and procurement specialists.  The many different types of procurement contracts and the variety of options for each provider classification represent a major challenge in the outsourcing decision and vendor-selection process.

Other challenges.  

Outsourcing a procurement operation or activity to a PSP presents other considerations for an organization, such as a need for transparency in pricing/costing.  Depending on the extent of outsourcing,  significant change management is often required.  Firms need to manage carefully the transition of business processes to PSPs to facilitate continuity and to ensure that internal employees do not feel threatened and are motivated to make the process work.  Supply management professionals worry about losing direct contact with suppliers and staying up-to-date on new procurement technology and current trends in the marketplace.  Data integration raises concerns about the use and ownership of proprietary information and technology.  In short, procurement is not as easily outsourced as other functions because procurement results tie directly into a firm’s cost of goods sold and profit and loss statement.

Opportunities. 

Purchased goods and services account for a little more than half of every dollar of revenue, and 80 percent of their cost is set by the end of the design and sourcing cycles (Morphy, 2012).  Thus, sourcing can provide  the single largest opportunity for an organization to reduce costs.  Procurement outsourcing is well suited to companies faced with increased global competitive pressures and rising demands to cut costs and improve shareholder value.  Industry research by the Boston-based Aberdeen Group reports that procurement outsourcing can provide dramatic improvements in procurement efficiency and effectiveness as follows:

• an increase of 28% in average savings from sourcing
• an increase of 18% in spend under management
• an improvement of 31% in contract compliance
• an increase of 32% in the percentage of suppliers enabled

In addition, operational costs can be reduced 15 to 20 percent through process improvement, staff right-sizing, labor arbitrage, and achieving economies of scale (qtd. from Huber & Minahan, 2011).  Aberdeen’s research into U.S. and European companies’ sourcing, procurement, and supply management practices indicates that even the largest firms do not have the skills, expertise, and infrastructure required to effectively manage procurement across all spending categories.  In general, because most companies do not handle procurement very well when left to their own devices, companies of any size—small, medium, or large—could utilize some level of procurement outsourcing to their benefit, particularly for indirect goods and services.           

Conclusions. 

Senior management must realize that viewing procurement outsourcing as a long-term endeavor and making substantial investments in sourcing policies will produce tangible results.  Adopters  need to assess carefully the comparative costs and risks of insourcing versus outsourcing specific procurement activities, manage potential risks, and put sufficient effort into process design and optimization.  It is critical for supply management professionals to understand that outsourcing the management of procurement activities does not release them from responsibility and that outsourcing procurement must be managed on a continuous basis.  Because the procurement outsourcing market is a “buyer’s market,” firms should  work with PSPs to devise the solution that best fits their business environment and strategic objectives. 

Copyright 2012.  James L. Alyea.  All Rights Reserved.

For more information, please contact Jimmy Alyea:

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Works Cited

Aberdeen Group.  (2006).  You will outsource procurement:  here’s why and how.  mThink Knowledge.   Retrieved from http://mthink.com/content/you-will-outsource-procurement-  heres-why-and-how

Huber, B. & Minahan.T.  (2011).  Procurement outsourcing:  not an all or nothing value proposition.  TPI Information Services Group.  Retrieved from www.tpi.net/.../papers/Ariba-TPI-Procurement-Outsourcing.pdf

Morphy, E. (2012, July 27). Latest trend in SCM:  outsourcing procurement.  E-Commerce Times. Retrieved from http://www.crmbuyer.com/story/19783.html

Key Steps to Designing an Effective Supply Strategy

Identifying the key steps to designing an effective supply strategy

by Jimmy Alyea

Developing a supply strategy is a process that when integrated with a firm’s other business processes, contributes to a firm’s overall goals of competitive advantage and profitability.  A simple, but effective purchasing portfolio model may be constructed using a supply segmentation technique that classifies products or services to be sourced in order to formulate distinctive supply strategies for each.  Although  the specific supply strategies, tactics, and supply management approaches developed will be balanced and  tailored to an individual firm’s needs, certain basic steps are common to their development.

Preliminary analyses. 

The first step is to categorize the types products and/or services to be sourced.  Products are evaluated on the basis of the internal “risk” a company would encounter if the item were no longer available or of low quality, followed by an assessment of each item’s “value” (both monetary and intrinsic) to the company.  The value of a relatively low-cost item might be high when it adds significant value to the organization’s output.  This could be because it makes up a high proportion of the output (for example, raw fruit juice used by a fruit juice maker) or because it has a high impact on quality (for example, the cloth used by a high-end clothing manufacturer).  A detailed “spend analysis” that is aggregated across  divisions, strategic business units, and suppliers should also be developed for all sourced items.  This helps define key spend categories and assess impact on a firm’s profitability.

Market analysis. 

The next step is to graph each unit or group of units on a chart on the basis of two dimensions:  supply market complexity and the cost/value of each unit.  Each dimension has two possible values, “high” and “low.”  The horizontal (X) axis represents cost/value (measured as the total annual dollar amount spent on each) and the vertical (Y) axis represents market complexity.  Market complexity is determined, in part, by the number of suppliers, available capacity,  product specifications (unique or standard), and availability of substitutes.  An upscale specialty jeweler such as Tiffany’s would face a highly “complex” market with few suppliers, limited capacity, unique product specifications, and no available substitute products, whereas a mall-environment jewelry store would deal in a simple or low- complexity market with numerous suppliers and substitute products available. Market analysis helps a firm assess the current supply market structure and available purchasing options  and supply risks, as well as analyze trends and forecast future supply problems.

Supply segmentation analysis and supply strategy development. 

After completing the market analysis, the previously classified products/product groups can be segmented on a purchasing portfolio matrix consisting of four quadrants that represent distinctively different supply environments:

Quadrant I, “tactical” (low market complexity,  low cost/value);

Quadrant II, “leverage” (low market complexity,  high cost/value);

Quadrant III, “critical” (high market complexity, low cost/value); and

Quadrant IV, “strategic” (high market complexity, high cost/value).

 The items in each quadrant require development of specific supply management goals and strategies of varying complexity.  For example, the supply management focus on items in the strategic quadrant is on increasing competitive advantage through strong buyer-supplier relationships such as strategic alliances, joint ventures, and sole sourcing and through medium- to long-term supply contracts.  Mutual trust provides access to new technology that is important for developing value-ads that increase customer satisfaction and loyalty.  In contrast, the standardized, generic products in the high-volume leverage quadrant do not require long-term supply contracts or supplier partnering strategies because products and suppliers are interchangeable and supply risk is minimal.  With a goal of decreasing unit costs and increasing profit margins to contribute to corporate profitability, managers can utilize traditional supply strategies.  These include aggressively seeking lower-cost suppliers from a large supply base, finding substitute products,  and leveraging buying power to obtain volume discounts and competitive bids.

Distinctive differences may also be found in the supply market characteristics of the critical and tactical quadrants, with a corresponding adjustment of  supply management goals and supply strategies.   To illustrate, the supply risk of items in the low-value critical quadrant is high, so management’s goal is to minimize supply disruptions even if additional cost is required.  Strategies to assure supply may entail keeping extra stock and developing contingency plans to deal with  unexpected situations.  When possible, ways should be found to move critical items into the tactical quadrant to reduce their supply risk.  In the tactical quadrant, which consists of low-value, non-critical items, supply management’s emphasis is on reducing acquisition costs  that may consume up to 80 percent of a purchasing department’s time.  Strategies include utilizing integrated supplier relationships such as electronic data interchange and supplier-managed inventory systems to reduce transaction and logistics costs in this category.

Importance of the stages and the process. 

Each stage of the supply segmentation technique is an important building block in the systematic process of constructing a purchasing portfolio analysis model based on the relationship between market complexity and cost/value.  The portfolio matrix forms a simple, but clearly focused framework for analyzing supply environments in order to develop feasible supply strategies for the sourcing of products in each quadrant.  This model presents a multi-stage process of developing supply strategies that minimize a firm’s supply risk and highlight opportunities to improve a firm’s overall buying position not only in the short term, but also in the long term.  As such, it encourages CEO’s to look at the “big picture,” and it changes the traditional operating perspective of “purchasing” to one of strategic supply management.

Copyright 2012.  James L. Alyea.  All Rights Reserved.

For more information, please contact Jimmy Alyea:

Email, LinkedIn, Twitter, or Blog