Article. Procurement Consultants what s their value? Procurement Professional June 2012

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1 Article Procurement Consultants what s their value? Procurement Professional June 2012 by Denis Henry grosvenor management consulting a level collins st melbounre vic 3000 t (03) abn e grosvenor@grosvenor.com.au w grosvenor.com.au

2 Procurement Consultants what s their value? Many large enterprises and indeed a number of smaller enterprises have established or are establishing in-house procurement operations. These in-house procurement groups are typically tasked to deliver procurement services from the front end of the procurement cycle i.e. the initial business case through to contract execution. Let s call that contract acquisition. Usually the contracts are then handed off either to a specific business unit or to operational contract managers for ongoing management and delivery. An organisation committing resources to building up its internal procurement expertise may well question the value and relevance of external procurement consultants. This article explores not only the true cost of in-house procurement resources, but how to get the best value out of outsourced procurement advisers through effective engagement models. The TCO of in-house procurement The starting point for the value consideration must be a recognition of the real cost of in-house resources. Far too frequently the cry from inhouse is that consultants are too expensive; just look at those daily rates. These same in-house procurement staff are in effect internal consultants, indeed some organisations quite specifically identify them using this language. In our experience, it is only very infrequently that the notional daily rate of an internal procurement consultant is calculated. Undertaking such an exercise, albeit relatively simplistically, often produces surprising results. Example: take a mid-range strategic sourcing manager in a large private sector enterprise on a salary package of $135k add other employment related on-costs (e.g. bonuses, study payments) of 30%: $175k identify the working days in a year (weekends) 20 (annual leave) 10 (sick leave) -11 (public holidays) 272 days Article procurement consultants grosvenor management consulting 2

3 take out 40% non-productive time such as promulgating corporate info and communications, team-related activities, internal reporting and managing staff productive days i.e. directly and solely working on procurement activities; say 165 days add in other employment costs, recruitment, IT, property occupancy, other corporate support; 40%; total $245k so the approximate notional rate is $1490 per day While there may be some variation of the figures used in this calculation, a more rigorous TCO-based approach will deliver up a similar number. Internal procurement staff are often surprised by how this consideration of their true costs to the organisation lifts them into the price paradigm of external consultants. More on this below. Strategic/tactical/transactional where is the right spot to use them? As the demand for procurement advice has matured, the need for a clear understanding of the various roles across the strategic, tactical and transactional domains has grown. Internal procurement groups have an intimate understanding of the protocols, policies and processes of the organisation and find they are deployed to bring that knowledge to procurement projects. The subject matter expertise is often provided by staff from other areas within the relevant domain eg IT, Engineering. The challenge for both groups is the infrequency with which their organisation procures the specific goods or services. A three year facilities maintenance contract with a couple of one year options means it could be five years before the internal staff have to do it again. In that time much may have changed; the market capability, the providers, the cost and performance models and, the risk appetite. It is also highly likely that the enterprise s staff involved in the original process have moved on. Article procurement consultants grosvenor management consulting 3

4 From such a situation, rebuilding the intellectual property internally which ensures that the new contract reflects better practice is a substantial challenge, particularly in light of the challenge most organisations find themselves facing; too little time to contract expiry to start with a clean sheet. It is our contention that procurement advisers, as distinct from providers of temporary contract staff, add value in the tactical and strategic space, examples include: knowing how to build in innovation and gainshare models that actually work having a deep understanding of the cultural attributes of suppliers designing performance management frameworks that avoid the disappointment gap dealing with the issue of where the volume/price risks land bringing domain expertise which reflects the deep understanding of suppliers commercial drivers Conversely, even given the apparently minor difference in daily rates detailed above, using procurement advisers in the transactional element of procurement rarely represents value for money. Activities such as managing the project, providing routine reporting, wordsmithing specifications, participating in evaluations and negotiations, ensuring compliance with policy and protocol, and many similar roles sit solidly in the operational space. The myth of cheaper daily rates Most procurement professionals understand the folly of relying on quoted daily rates for the assessment of value in the provision of professional services. A firm charging $1800 a day only needs to deliver the outcome in one third fewer days to match the firm charging $1200 a day. Far too infrequently this paradigm remains untested. There is often an assumption that the quality of a consulting deliverable eg. a service specification; particularly when it has been spelled out in the RFQ, will be broadly the same irrespective of the chosen firm. Article procurement consultants grosvenor management consulting 4

5 Similarly this misconception can apply to the decision to use internal procurement personnel rather than engaging an external who, on first pass, appears to considerably more expensive. Many experienced practitioners in procurement now recognise that the size of the prize in procurement projects can substantially outweigh the transaction costs. Contemplate outsourcing the provision of facilities maintenance for a national portfolio of properties which includes commercial offices, data processing centres, retail premises and residences with a flow through spend of say $350m per annum. The size of the price will reflect a number of considerations for example: on the upside: cost savings the one-time benefit from a competitive procurement process innovation the continuous extraction of costs through the contract term capturing and analysing data never before trapped by the enterprise operational risk reduction on the downside: risk the risk of cost blow outs, performance failures, compliance and legislative breaches internal user dissatisfaction. In making the decision to use internal, external or even a mix of advisers, the buyer must assess the relative prospects of each, optimising the extraction of benefits. Furthermore, this size of the prize perspective gives buyers of procurement advice a pointer to pragmatic engagement models. Engagement models that work show you (the client) the money In the scenario above, the gap between the upside and downside is very significant. Some of it will be apparent at contract execution but, in the main, most of it won t be apparent until well after the signatures are dry. Even those benefits, read cost savings, apparently identified at contract execution can prove to be not only elusive but also in some instances, mythical. Article procurement consultants grosvenor management consulting 5

6 By connecting the advisers to the outcome of a procurement rather than the deliverable documents, buyers are far better positioned to get the best advice for their money. This connection must be aligned with the timeframes required to evidence the benefits. Executing a contract which on the day of execution represents a 15% saving over the current baseline is a long way from being genuine evidence. Interrogating the General Ledger at the end of the first year is far more convincing. Experienced, professional procurement advisers with a reputation they cherish, both understand and welcome this connection. With this perspective in mind, the buyer and the adviser can quickly establish a mutually beneficial engagement model. The first step is to understand the real objectives of a specific procurement; save money? Reduce risks? Improve service? These are the attributes of the prize and each has a value to the organisation. As posited above, the procurement adviser should have the strategic and tactical knowledge of the services/goods to be procured and they will therefore have a sense of the size of the prize. The buyer can implement an engagement model without knowing the actual size of the prize by understanding: what would be a very good result that the company would be very happy with how long will it take to be entirely sure the expected benefits are indeed being achieved that they must apply sufficient governance over the process to ensure that the model does not incentivise the adviser to sacrifice some other aspect of the contract what is a reasonable risk/reward for the firm that helps me achieve that; a reduction over rack rates which respects the costs of the advisers but forgoes profit a gainshare percentage that will earn the adviser back its profit and then rewards them above that for sharing the risk how long is it appropriate for the adviser to wait for that reward Article procurement consultants grosvenor management consulting 6

7 a cap on the gainshare payment that the buyer s organisation and the adviser find acceptable There have been numerous examples in the past which have shown that both parties can conclude an engagement with an extremely high level of satisfaction. Summary The progress of procurement from purchasing to strategic sourcing over the last 15 years has been characterised by among other things, increasing professionalisation and the emergence of experienced and highly capable in house procurement operations. Alongside this development has come the increasing numbers of external procurement advisories. Buyers can harness the necessary strategic, tactical and transactional expertise offered by both groups of advisers to optimise procurement outcomes. It should, however, be done with an understanding of both the true costs and the complementary nature of their competence and experience set. By adding in an engagement model which genuinely, rather than notionally, aligns the interests of the adviser with the buyer s objectives, value will rapidly emerge which represent a significant multiple of the adviser s costs. Article procurement consultants grosvenor management consulting 7