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Procurement outsourcing: Can third party providers really set you free?
Lisa Wichmann
Like a captain last to leave the ship, procurement managers have watched human resources, IT, finance and accounting functions being outsourced to third parties. Many are now wondering if procurement’s turn has finally come. Consultants, providers, and buyers alike say ‘yes’, pointing to the phenomenal benefits outsourcing can yield.
But instead of recommending a dramatic leap, they’re calling for a
cautious decent down the ladder, with full view of the risks, reluctant staff and nebulous budgeting they’ll encounter along the way.
“We do believe it’s going to grow as a market, but the biggest question is how quickly,” says Jim Mikell, a consultant with sourcing advisory firm Everest Group Canada. “We’ve seen a steady
upturn in 2006...and we have a sense that 2007, though it’s still early, could be a better year.”
According to Everest research, in 1994, there was only one signifi-
ant procurement outsourcing deal. In 2003 there were seven global deals; and in 2006—a landmark year—there were 15. Some of the companies who took the plunge include Colgate, Unilever, and Kimberly-Clark.
They approached outsourcing with a similar goal—getting indirect spending under control. This area of procurement is often “fragmented, decentralized, and prone to maverick spending,”
Mikell notes.
Because some of these categories aren’t sourced very often, it’s difficult for organizations to maintain internal expertise for these areas. That’s why the lure of bringing in professional help is so appealing. These third parties offer category expertise, industry
benchmarking, and better compliance with established contracts.
Though it was a relatively new concept in the 1990s, there are now
plenty of established providers of procurement outsourcing services,
with Accenture, Ariba, IBM and ICG Commerce in the leadership spots,
according to Mikell. Other players include CGI, CapGemini, EDS and
several India-based organizations, including Infosys.
They have their work cut out for them. Though the US has seen a few
high-profile outsourcing deals, the number in Canada can be counted
on one hand, partly because we don’t often have the same massive volume of indirect spend to make outsourcing worthwhile. But why else are organizations holding back?
“It’s primarily three issues specific to Canada,” Mikell notes. “One is the difficulties leaders have in understanding the complexities involved in this particular arrangement, compared to IT outsourcing, or more transactional functions like finance processing.”
In those situations, the major benefit is clear: labour arbitrage. Head count can be reduced or sent offshore for a cheaper operating budget. But in the case of procurement, the potential gain is more conceptual—leveraging the expertise of a third party to source more strategically. The dollar savings do follow, of course, but leaders must look further ahead (and across various functions) to see the promise.
“The next issue, frankly, is the resistance of procurement leaders themselves,” Mikell adds. “There’s a natural tendency for a procurement vice-president to see this as a potential threat to
their business by admitting that they need some outsourcing assistance...that they don’t have the ability within their own organization...And they try to find many ways to suggest that they can do the same things and all they need are the additional skills and resources.”
But many a procurement manager has asked (and failed to get) requested resources. For many organizations, procurement is still not seen as an investment priority. “They almost always have a shortage of resources,” Mikell notes. Bringing in a third party would
allow the manager to tap into a vast new source of procurement expertise.
With the indirect spending under the control of a competent third party, the procurement team can then turn its attention to high-level strategic sourcing issues.
But they shouldn’t be too quick to wave off the indirect, Mikell cautions. The internal team will still be required to interface with the third party. In fact, failing to do so is one of the biggest
risks involved.
“This is not a situation where you just hand over or throw over the responsibility to the outsourcer and say ‘source my commodity and then manage the spend’. They require a lot of interface with the business to make sure the [provider] is comfortable with the vendors
that are being sourced, that they understand the dynamics.”
Experts on staff
The thought is echoed by staff at ICG Commerce, one of the leaders in the procurement outsourcing space. ICG hasn’t managed to win over Canadian customers yet, but in the US, it has signed deals with Goodyear, Timken and Kimberly-Clark.
“By selecting ICG Commerce, Kimberly-Clark’s sourcing and supply management staff will focus their expertise on such critical business
purchases as raw materials and packaging supplies, while leveraging
ICG Commerce’s market knowledge, sourcing strategies and procurement
expertise to reduce costs and improve efficiency,” said Ian Maginnis, vicepresident of business support delivery with Kimberly-Clark, in a press release announcing the decision.
ICG Commerce paints an appealing picture of the synergy that can be
gained in such a relationship. Simply put, organizations finally get the help they sorely need on indirect spending such as professional services, marketing, office supplies and maintenance.
“Typically, these indirect products and services have been underinvested in at these organizations to begin with,” says Jason Gilroy, president of procurement outsourcing with ICG in Chicago.
“Most of them have spent a lot of time investing their resources and their training and dollars on that direct side since it is so critical to their organization.”
For instance, one of ICG’s customers is a large tire manufacturer. The manufacturer devotes a lot of attention to the material used in its core product. But it has handed other sourcing over to ICG.
“We don’t do rubber or the rims for the tires…But we do all of the supporting things like marketing, the whole maintenance repair and operations that keep plants and facilities running,” Gilroy says.
Marketing, in particular is a tough nut for many internal procurement
teams. For years, purchasing managers have tried to get those costs under control, or at least get more value.
Marketing has been reluctant to listen, mainly because it didn’t trust the procurement team to know what’s best. Hiring a marketing expert only to use them every nine months at contract renewal
was too expensive, Gilroy says. That’s where third-party providers can really make an impact.
“We’ve gone out and hired expertise from industry who have either worked in the supply market for marketing agencies, media companies and design agencies. We’ve trained them to be procurement experts, as opposed to the inverse, which is taking a procurement individual and having them learn all the nuances of marketing. That was not
a very successful model in the past.”
With those experts in place at ICG, they’re used across multiple customers, ensuring they’re fully utilized and constantly exposed to the dynamics of their category. ICG’s customers are no longer required to ‘dabble’ in these indirect categories, so they can put
their resources to better use.
“We’ve had customers that have been able to reallocate a lot of their
individuals to go work on activities that are more in line with that they do as a company,” Gilroy says.
“We’ve had a lot of the individuals who were strong players and
good change agents within their own procurement group now…working
alongside us, managing our relationship and helping us break down the
barriers. Because when you outsource it’s not just a matter of throwing it over the wall.”
These individuals now act as liaisons between ICG and the various functional areas within their own companies. As procurement outsourcing firms proliferate, purchasers might even consider joining their ranks for a completely different career opportunity.
As it stands now, some internal purchasers are transferred over to
ICG, to create a closer relationship.
Gilroy says each customer’s sourcing information is carefully protected, but there is something ICG is happy to share—industry pricing benchmarks.
“We’ll say, in your industry, here’s how your pricing compares to theirs. And here’s the reason that it’s higher… it’s because of these six requirements you have. And that’s really the power of the information we have...to drive potential change to the requirements,”
Gilroy explains. “Strategically, they may have requirements that
they’re not willing to change. So not having the absolute lowest price is not necessarily a bad thing in all cases.”
That kind of data would be next to impossible for an organization to gather on its own, since it requires insight into what other companies are paying the same suppliers. That’s a strong selling
point in itself, but it doesn’t overcome all the hesitancy to outsource in the procurement field. One of the major sticking points is the cost and fees associated with outsourcing.
In order for the ICG arrangement to succeed, the organization’s internal procurement budget has to actually increase—anywhere from five to 40 per cent, Gilroy says.
The cost to work with ICG means more money spent on procurement,
but the end result is significant savings in the organization’s functional areas—IT, office supplies, services and maintenance.
“So the value proposition is we’re going to save $50 million and that
$50 million is going to come out of IT’s budget; or marketing’s budget is going to go that much further for the dollars they do spend. It’s going to come out of the travel and entertainment
budget. So it’s not necessarily the procurement functional operating budget that gets reduced. In most cases it increases. But it’s been under-invested in the past…and it’s taken a while for that [cost model] to be accepted and understood within the marketplace.”
Reluctance might also be caused by the lack of labour arbitrage in procurement outsourcing. Unlike other functional areas, it’s not as simple as relocating a purchasing team to India where labour is cheaper. Much of strategic sourcing is conducted at a regional level, and requires educated, highly-skilled professionals.
“It’s more about changing the way and the process with which you do
procurement. We’re not necessarily going to be able to do that by having lower-cost people do the work, but because we bring in deeper expertise and more focused expertise that it’s never made sense for an organization to invest in internally.”
As for fees, they’re usually paid monthly and arranged in 12-month
increments. ICG had previously tried “on-demand” billing where customers would be charged as they called upon the service, but managers didn’t like that model since there was no way to budget. The current billing system is more predictable.
The relationship effect
Logically, all those arguments make sense. But on an intuitive level, it’s still hard for procurement managers to give up control, says John Simke, president of the Centre for Outsourcing Research and Education (CORE) in Toronto.
“There’s a feeling within organizations that relationships with vendors are important, and that you wouldn’t want to lose the relationship with the vendor, which you probably would do if you outsourced procurement,” Simke says.
“The other aspect is organizations feel they need to control the reliability of supply. If you give it up to somebody else, then you might find supply becomes less reliable and don’t have your hands on the levers so you can’t really do anything about it.”
He doesn’t see either risk as a valid reason not to outsource. But before companies do, they should at least take stock of what they have—and what they want to achieve. It would be a costly mistake to fumble into a procurement outsourcing deal without that knowledge.
“It’s not so much of a risk as it is a foregone reward,” Simke says. “A lot of organizations don’t procure stuff very strategically. They don’t leverage purchasing power within the organization. There’s a lot of rogue procurement going on… Organizations can solve a lot of that internally, without outsourcing and probably, if they outsource prematurely, they’ll give
up a lot of the gains they could have achieved internally.”
In other words, they’ll be paying top dollar to a third party to achieve the ‘low-hanging fruit’ they could have accomplished internally, he explains. “Now there’s another level of gain that
they can’t achieve internally and that’s leveraging the spending power of multiple organizations. It really is the main reason an organization should consider outsourcing procurement.”
Once the decision is made, how should the procurement team prepare?
On that question there are two opposing views, Simke says. Some say
fix it up as much as you can before outsourcing.
“The alternative is to say, ‘look, we’re never going to fix it internally. We’re not going to get management attention, we’re not going to get the capital from the organization because the capital is going to get allocated to more important things. So if we wait to
fix it internally it will never happen’. So you have to decide, based on your organization’s own circumstances, as to what the right answer is.”
In some areas, consultants have concluded it’s challenging for procurement teams to go it alone. Deloitte Consulting, for instance, has worked with clients to implement strategic sourcing models and best practices.
“But the challenge is [we] then pass it back to the client to implement, own the systems and sustain the savings they’ve found, and we don’t always see the clients putting the right tools in
place or investing in the software they need,” says Michael Hart, a leader in the outsourcing advisory services practice of Deloitte Consulting.
Plus, maintaining the programs over such a wide variety of indirect spend is challenging—even more so when employees aren’t complying with them. “They continue to prove they can’t do it,” Hart says. Outsourcing providers are expert at getting visibility of spend, getting the contracts in place, and ensuring employees adhere
to them.
In the public sector, a third party could also improve transparency of procurement, adds Lino Casalino, a partner with PricewaterhouseCoopers in Toronto. “If you go about this in the
proper way, one of the benefits should be that you gain greater control and more visibility,” he says.
“So going from a decentralized process where you’ve got a lack of
control happening around your procurement, this would—given the value
proposition of new technology, new processes and new people—theoretically give you more control over your procurement process, compliance and accountability.”
Selling the concept on an individual level is easier. The vice-president of procurement will likely see his or her department shrink and have fewer people to supervise. That might be unwelcome
news to many. But in Simke’s words, “If you can become a higher
value-added player, focusing on what’s really important—policy, strategy—with our most important strategic vendors, that warrants a seat around the management table,” Simke says.
Clearly, there are considerations for both the organization, its supply base, and its individual employees. But if this slow-starting trend of outsourcing procurement continues, the rewards might far outweigh the risks. b2b
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