The price of paperclips
Think back to the good old, bad old days of dot com madness. Back then there was a new business to business (B2B) phenomenon known as e-procurement. This was to be the dot com age’s answer to the wasteful paperchase that goes on inside organizations of all shapes and sizes, and makes purchasing a potentially costly business.
At the time, a powerful example was conjured up to illustrate the need for a new approach to procurement. The story told by the now-defunct Slough-based software firm Infobank was a simple one, but a very effective ‘word picture’: If an office worker is sent out to WH Smith in the high street to buy a packet of paperclips, it might cost around 80 pence. However, if a purchase order has to be raised for that packet of paperclips and time devoted by staff to processing the purchase order, then by the time the paperclips are delivered to the desk of the person who needs them, they could end up costing £80.
— MPU —
You can argue about the precise figure, but Infobank at the time claimed that the average cost to business of making a purchase through traditional channels is between £80 and £150. This added up to a total cost to UK Plc in excess of £100 billion a year. When energy company National Power installed an e-procurement system built on Infobank’s software, it estimated that the cost of processing an order dropped from about £80 to £14.50.
Rogue buying and spiralling costs
Add to this the temptations of ‘rogue buying’. If you’re sitting waiting for a piece of minor procurement to go through official channels, the temptation will be to nip down to the high street and put it on your corporate card. This makes a mockery of any attempts to try and control spending and standardisation of suppliers within a company. Procurement costs risk spiralling out of control.
In the early days of the New Labour government, Prime Minister Tony Blair took the cost of purchasing on the UK’s bottom line seriously enough to try to lead by example, mandating a day when all public sector purchasing would be done online. Unfortunately, his next move was to put ‘E-minister’ Patricia Hewitt in charge; ten years on, the supposed 100 percent online procurement has yet to arrive.
With the dot com collapse, e-procurement has rather fallen from favour, although there are still specialist firms who offer solutions in the field. But while in-house e-procurement has been on the wane, the outsourcing of procurement activities has attracted more and more interest.
Companies are either contracting with outside providers to extend their procurement capabilities, or are considering doing so, suggests a survey of 180 executives conducted by the Economist Intelligence Unit and sponsored by Ariba, one of the survivors of the dot com collapse. Just over half of all survey respondents — and close to 60 percent of all c-level executive respondents —say that their companies already use outsourced or managed procurement services, or are willing to consider them.
Transforming procurement abilities
The need to cut costs remains the primary driver behind tackling procurement processes. Respondents believe that managed procurement will benefit their company by transforming procurement capabilities and increasing net income more quickly than would be possible by relying solely on internal capabilities. Over half of the survey’s respondents believe that outsourcing procurement will result in an increase in net income, and half believe that procurement services providers can achieve savings more quickly than would be practical internally. In general, companies believe that the extended procurement abilities provided by outsiders will help transform the procurement function, as well as rapidly affect their bottom line.
Survey respondents said they would prefer to retain some procurement activities in-house and transfer others to third-party providers. Most companies consider reducing direct costs to be the procurement function’s most important goal and as such direct costs are regarded as strategic spending and such need to be kept in house. But paperclips have yet to become a mission-critical agenda issue.
Outsourcing indirect expense
The areas most likely to be outsourced to procurement services providers are indirect expense categories, such as office supplies, travel, temporary labour, printing services and facilities management, and transactional processes, such as requisition, ordering, invoicing and payment — which makes sense given the track record of outsourcing in other transactional areas such as human resources, payroll, payables and information technology.
But there are downsides and inhibitors as well. Respondents are concerned about loss of control, and change-management issues. Just over half of survey respondents fear that working through a third-party provider could be cumbersome in the event of a problem with a supplier or a transaction, while just under half think that the use of managed procurement services could threaten the position of managers used to exerting total control over indirect expenses.
There’s also the danger of over-hyping by the vendor community. It’s an inconvenient truth that return on investment (ROI) has been notoriously difficult to measure in so many areas of outsourcing, and procurement is no different. That is certainly the industry’s challenge. One in six respondents to the survey is openly sceptical of whether their company would be able to realise the savings promised by their procurement provider.
Nevertheless, spending on outsourced procurement is on the increase. According to research from the Everest Group, which publishes an annual study on procurement outsourcing, the sector exceeded $380 million in 2006.
“Procurement outsourcing has the potential to become the biggest ‘game-changer’ in business process outsourcing,” says Michel Janssen, managing research director at Everest Research Institute. “Our findings indicate that procurement outsourcing will achieve five times the savings multiples of other BPO domains, including HR, IT and offshore outsourcing, delivering a potential bottom-line saving of up to two percent of sales. Procurement outsourcing is dependent on sector and functional expertise, with savings coming from smarter sourcing decisions, effective relationship management and legal compliance.
“Procurement outsourcing directly addresses the bottom line, and is a high impact decision. It offers great opportunities for partners to share gains, which many are embracing. But its transition to a rapid growth market will depend upon suppliers’ ability to create an effective marketplace, by integrating sourcing expertise and niche technology along with broader BPO outsourcing experience.”
Why is the trend growing so rapidly? While labour arbitrage is the key lever that suppliers use when purchasing outsourcing, the most important value driver appears to be access to expertise. “By asking an outsourcing provider to manage indirect spend, buyers gain access to category experts with sourcing expertise across indirect categories,” explains Phil Fersht, vice president of the BPO Research practice at Everest. “While category expertise and market know-how for indirect categories is typically low for most buyers, we find that a top-notch purchasing outsourcing provider would have nearly 16 category experts with six-plus years experience on an average for each broad category head. The average external spend managed for each category is around $560 million. That kind of expertise is clearly something that an individual buyer cannot normally afford, and can only be gained through a procurement sourcing engagement with a supplier.”
The good news on that front is that it’s very much a buyer’s market at the moment, meaning there are good deals to be struck as they are in a position to become “marquee clients” for prominent outsourcers, such as IBM, Accenture, Ariba and ICG Commerce —all of whom are all expanding their outsourcing capabilities and, together, represent 80 percent of the procurement outsourcing market.
Interestingly, the ‘maverick buyer’ bogeyman figure who was so often cited in the e-procurement days is no longer an issue. Controlling maverick spend is a minor issue for procurement professionals, according to a study by research firm NelsonHall earlier this year. Only 23 percent of the 326 global companies surveyed said controlling maverick spending was a major issue, with the top three reasons for outsourcing indirect procurement being reducing process costs (cited by 84 percent of companies), accelerated sourcing times (79 percent) and improved ability to manage supplier performance (78 percent).
Rogue buying and spiralling costs
NelsonHall analysts said that a lack of investment, expertise and interest meant indirect procurement was still at “a low stage of process maturity”. In most companies it is not centralised, with only a third of firms using a shared service centre, although a majority 70 percent of companies said they wanted to implement one before the process is outsourced.
So is procurement outsourcing worth purchasing? “Many companies around the world are realising the business benefits and potential financial return resulting from an improved procurement process,” says Hap Brakeley, managing director of Accenture Procurement Solutions. “Procurement outsourcing provides businesses the opportunity to increase control of their procurement functions and leverage proven tools and capabilities to help provide substantial value to the bottom line.”
Originally published in Outsource Issue 12, Summer 2007 p66