Procurement Outsourcing Is Hot — Even for Hybrid Strategies

Procurement outsourcing is the least understood but fastest-growing outsourcing story. The market is heating up and there is a lot to learn. What should you outsource? What should you retain — and why?

If you decide to outsource, what should you do internally before outsourcing? How can you implement a hybrid strategy in your procurement process? How can you ensure outcomes create a competitive advantage?

Direct procurement

Direct spend typically represents 60 – 70 percent of total spend and consists of raw materials, production inputs, and transportation services necessary to manufacture and deliver a final product or a service.

In manufacturing, retail, health care, pharmaceuticals, utilities, and consumer packaged goods there is a clear “line in the sand” between direct procurement and indirect procurement. The direct procurement team is horizontally integrated with production. The CPO has a “seat at the table;” the company expects him or her to drive measurable, bottom-line impact and a competitive advantage.

Outcomes should create differentiation or competitive advantage. Therefore, the direct procurement team is a strategic corporate resource. If this is not the case or there are some important categories where they cannot generate top-tier results, consider outsourcing.

Here are two real-life case studies of successful outsourcing direct procurement:

A “best of breed” strategy: One of the largest spend categories for a newspaper is paper. This publicly traded commodity requires highly specialized procurement expertise. It may seem counter-intuitive to outsource procurement, but outsourcing to a recognized specialist is a good way to get access to top talent, targeted expertise, and plenty of buying power.

A “top-tier provider” strategy: Healthcare procurement outsourcing is a large and rapidly growing specialty. In the United .States, companies outsource over 70 percent of direct procurement in healthcare to a third party. In Canada, this number is 12 percent but growing fast. In a recent large-scale healthcare procurement outsourcing project, ONTALA’s client cited access to top talent and the specialized expertise necessary to drive 12 – 17 percent cost savings as the catalyst for change. The buyer will achieve savings by leveraging the scale and scope of the provider.

Indirect procurement

Indirect spend in manufacturing, retail, healthcare, pharmaceuticals, utilities, and consumer packaged goods includes categories such as office equipment and supplies, facilities, technology and telecom, contingent labor, HR and finance transaction processing, commercial print, media buy, third-party legal, MRO, and travel. Indirect spend typically represents 30 – 40 percent of total spend, but investment in indirect, non-core procurement is often a fraction of the direct procurement organization.

With 30 – 40 percent of total spend in scope, it is obvious that indirect procurement actually is important. The resource-starved indirect procurement team is often short of top talent and influence. Hmmm…this looks like a golden opportunity in the making.

And what about services companies like banking and insurance, engineering, or marketing firms where virtually 100 percent of third-party spend is indirect goods and services? Or is it? Arguably 60 to 70 percent of total spend also consists of inputs necessary to produce services sold to customers. So doesn’t that mean that 60 – 70 percent of indirect procurement spend has strategic importance? Yes, most but not all.

How much is your company willing to invest in attracting and retaining top talent internally? Objectively analyze the strategic importance of indirect spend categories. How do results compare with external benchmarks? Are these results sustainable? What is the outcome of a pragmatic analysis of internal procurement capabilities versus what is available externally? Have you done a comprehensive financial business case on a category-by-category basis and as a whole? Do you know if and which categories are candidates for procurement outsourcing? What is the payback — short and long term?

Here are two real life case studies of successful outsourcing indirect procurement:

A “hybrid” strategy: Sourcing technology and telecom in a financial services company is a good category to implement a hybrid strategy. There may be a mature sourcing organization that understands internal business drivers but only sources this category every three years. They will not have current benchmark data and best practices sourcing strategies. This may be a good case for hiring an advisor and/or purchasing benchmark data and research.

A “top-tier provider” strategy: ONTALA recently developed an outsourcing strategy for indirect procurement for utilities sector companies. Indirect spend represented less than 20 percent of total third-party spend. There was a scarcity of top talent and obvious savings opportunities but insufficient capacity to effectively pursue. In short, indirect procurement was an under-resourced poor cousin to the strategically important direct procurement team in a rapidly changing industry. The solution was outsourcing indirect procurement.

Some helpful tips:

1. Determine whether, if done well, the spend category or categories could become a competitive advantage.
2. Realistically identify important bona fide risks of outsourcing some or all procurement functions. Then do the math, ensuring financial benefits significantly outweigh risks.
3. Objectively assess skills, capacity, capabilities, results, and the strategic importance of your company’s procurement organization. Look at this on a category-by-category basis and as a whole. To be strictly objective about the assessment, you may want to hire a qualified third party. Would outsourcing some or all categories drive greater value than maintaining status quo? Is the best approach a hybrid solution consisting of outsourcing and upgrading internal capabilities and/or hiring advisors on a case by case basis?
4. Selectively outsource to a best-of-breed provider with a proven track record in the specific category and/or outsource to a top-tier provider, with deep, reference-able expertise in both the category and your industry.
5. Develop a viable exit strategy, before you outsource.

Conclusion: Proceed, with caution

Linda Tuck Chapman and ONTALA Performance Solutions (www.ONTALA.com) are expert advisors in outsourcing, strategic cost management, and governance. Contact Linda at (416) 452-4635 or by e-mail at [email protected].