Cost Reduction and Cost Containment Initiatives: Not an All or Nothing Value Proposition By Gary Friedman, President, Cost Containment Specialists

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1 1 Cost Reduction and Cost Containment Initiatives: Not an All or Nothing Value Proposition By Gary Friedman, President, Cost Containment Specialists Troubling economic times require attention to the basics: cutting costs, eliminating waste and redundancy, investing prudently, providing flexibility and reducing risk. These competencies are important at any time, but in these economic times, they can become vital to ensuring the survival of the organization. Procurement outsourcing has increasingly become an effective approach to achieving these objectives more quickly and more effectively and is being adopted broadly across most industry segments. The current economic environment has only increased interest in procurement outsourcing as companies look for new ways to sustain profits through more efficient operations and significant reductions in their cost structures. Why Outsource Procurement? Industry research by Aberdeen reports that procurement outsourcing can provide dramatic improvements such as these in procurement efficiency and effectiveness: An increase in average savings from sourcing of 28 percent An increase in spend under management of 18 percent An improvement in contract compliance of 31 percent An increase in the percentage of suppliers enabled of 32 percent Additionally, procurement outsourcing can achieve a reduction in operational costs of percent through process improvement, standardization, staff right- sizing, labor arbitrage and realization of economies of scale. Corporations that approach procurement outsourcing strategically recognize that its primary benefit is not reducing the cost of the procurement organization, but of improving the realization of value from corporate spend. Accordingly, many approach procurement outsourcing as a tool to improve capabilities and effectiveness within the same budget, effectively accomplishing more for each dollar invested in procurement capability. Procurement Outsourcing: The Impetus to Change One of the greatest benefits of procurement outsourcing is that it can provide the greatest hurdle to procurement transformation: change management. Outsourcing procurement or any business function entails a significant investment in terms of time resources and culture. As such, outsourcing any business proves typically captures senior executive attention and support. Top executive support is often lacking from internally managed improvement initiatives such as procurement transformation that are often viewed as functional programs and frequently lack full support or attention across functions or from frontline employees.

2 2 Procurement or what many call spend management is one of the few processes that supports and crossed nearly every function across the enterprise. Depending upon the good or service being purchased, specialists from a wide range of functions from engineering for direct materials, to marketing for print and advertising spend, to IT for hardware and software purchases can be engaged in defining purchase specifications, placing orders, and interfacing with external suppliers. Making improvements or changes to this process or engagement model can often meeting resistance from these stakeholders not to mention within the procurement function itself. Other challenges to procurement transformation are resource constraints, a lack of real- time visibility into spend, and difficulties rolling out best practices across broad areas of enterprise spend. Problems can arise from issues that include decentralized procedures, manual processes, inconsistent terms, lack of spend coverage, limited expertise and insufficient organization clout. Procurement organizations often struggle to provide credible data at the right time and at the right level of the organization to influence behavior. From a resource perspective, the challenges of constantly chasing after spend that has already been committed result in a focus on compliance rather than strategically shaping the company s spend as it occurs. Commonly, internal procurement initiatives result in gaps between savings identified and savings realized, with the result of slower than desired time- to- value. In our view, the key to overcoming these challenges can be found in an efficient mechanism to roll out tools and processes that enable better business intelligence, and to do so in a manner that will not exhaust the key budgetary and human capital resources available to procurement organizations. If such a mechanism can be put into place, the role of procurement can shift to an increased focus on overall category management, supplier performance management and innovation. In this scenario, procurement would be able to focus its talent on shaping more strategic relationships and addressing areas of unique but differentiating spend ranging from the sourcing and management of complex services such as capabilities sourcing or systems integration on the services side to improved supply chain management in environments such as manufacturing. Achieving these goals relies on effective change management influencing how the culture of the enterprise approaches key requirements definition, decision making, risk analysis and collaboration across its supply and services chain. Internal procurement often faces credibility challenges and is perceived as bureaucratic with inconsistent service levels. This often provides a roadblock to a more strategic role, and procurement organizations need to dismiss this perception. At an executive level, procurement must develop and mentor relationships across senior management that will ensure that procurement has a meaningful involvement in planning and decision making. At an operational level, procurement must be able to ensure that processes are executed efficiently and consistently to provide a high level of reliability, accuracy and customer service a set of activities that requires significant training for processors and end users, systems and proves support, and monitoring of processes to ensure that they are achieving critical service levels.

3 3 How Outsourcing Can Help Procurement outsourcing can help to achieve these objectives in multiple ways: 1. Process optimization and change management: Outsourcing can mitigate many of the challenges associated with change management, providing a objective rollout of improved processes. This is often easier than retraining internal employees who are more comfortable approaching certain procurement activities the same way that they have always done it. In fact, procurement outsources are specialists in approaches that enable ongoing process efficiencies, resulting in shorter cycle times and reduced internal resource requirements. Many of these procurement service providers also have designed their practices to meet standards and other regular requirements and goals. 2. Executive alignment: Outsourcing also enhances the procurement process to an executive and companywide initiative, providing access to and support of senior executives and alignment with company goals and incentives. 3. Economies of scale: Procurement service providers also offer economies of scale, enabling them to share resources across multiple clients, thereby helping them to meet changing demand for category sourcing, supplier enablement and ad hoc buys. This provides balance sheet flexibility and reduces the burden on organizations to invest in permanent resources that ultimately increase overhead expense. 4. Cost- effective operations: Outsourcing service providers have incentives to continue to invest in their capabilities to ensure that they are able to provide the most competitive services to the marketplace. 5. Category expertise: Outsourcing service providers can lend extensive commodity expertise in common categories through their visibility across the spend of many companies. These companies commonly source these areas on an ongoing basis providing real- time market insights into price points and capabilities that would be difficult for a single buying corporation to sustain. This means that for many categories, savings through sourcing can be accomplished more quickly and often more effectively than through internal sourcing teams. 6. Formalized service levels: Outsourcing service providers are measured and compensated on the basis of their ability to sustain critical service levels and maintain a service level culture as part of their corporate DNA. This often provides the best mix of incentives to achieve operational consistency more quickly and more reliably and less expensive. 7. Access to additional lower- cost capabilities: Procurement outsourcing provides access to procurement knowledge process outsourcing capabilities such as risk analysis and contract compliance. Procurement Outsourcing Doesn t Have To Be All or Nothing Unlike other areas of business process outsourcing, procurement outsourcing is not an all- or- nothing proposition. In fact, most companies begin by tapping outsourcers for expertise on a particular group of spend categories to manage execution of discrete subprocesses such as

4 4 sourcing execution; to provide localized support to establish supply; or to set up an international purchasing office capability. A more accurate way to define procurement outsourcing is that it is about creating the optimal mix of internal and external resources for maximum spend coverage, compliance and performance. As such, many companies have used procurement outsourcers to fill gaps in their knowledge or execution infrastructure, either for specific processes where they lack internal scale or for spend categories where they lack internal knowledge. For example, optimization of the analyze- to- contract capabilities of a company in today s economy can become a strategically differentiating proposition. Many corporations phase in procurement outsourcing gradually, expanding capabilities on an incremental basis as the approach is demonstrated within their environment. This approach allow the strongest internal resources to focus on those areas presenting the greatest opportunity for their talents and to better operationalize those processes that provide transactional efficiency and better spend visibility. Ultimately, procurement outsourcing is a tool that, if used effectively, can improve the involvement of procurement leadership in managing the overall spend and contracting activities of the corporation. Which Procurement Outsourcing Model is Right for You? As discussed above, companies utilize a variety of approaches to procurement outsourcing: by process, by geography, by business unit and by commodity category. The procurement outsourcing market has matured to the degree that it has become a buyers market, and companies are able to work with service providers to craft the solution that best fits their business environment and strategic objectives. A common place to start is through a combination of transactional processing, sourcing of select categories, user support and supplier management. Action Plan How to Proceed With A Procurement Outsourcing Relationship Procurement outsourcing should be approached within the context of overall procurement strategy. Those companies who embark on procurement outsourcing simply to reduce their cost of procurement tend to miss the larger opportunity to transform the role of procurement within their companies into a strategic competency. A plan of action of companies interested in procurement outsourcing should include these steps: 1. Understand the range of service provider capabilities currently available in the market and experiences that other companies have had with procurement outsourcing. 2. Define objectives for procurement and the role that both outsourcing and internal resources can play in attaining these objectives. 3. Educate company leadership on strategic options and the benefits and risks associated with procurement outsourcing and develop a high- level business case.

5 5 4. Conduct a market analysis and competitive sourcing project to select the best solution for your company. Ensure that the sourcing project incorporates a contractual statement of work and service level structure that will provide clear accountabilities and meet your strategic objective. Contingency fee based firms will address this requirement. 5. Develop an implementation plan, change management strategy and governance program to ensure the success of the project. 6. Ensure that all of these areas are in place, with appropriate commitment from management, prior to executing a savings initiative with the third party service provider. About Cost Containment Specialists Cost Containment Specialists is a national expense reduction firm that provides advisory services to organizations to assist them in reducing their indirect operating expenses. We engage Subject Matter Experts (SME) that have specific expense expertise in over 20 spend categories to analyze and negotiate our clients current and alternative vendors to realize savings greater than can be done internally. Since 1998, CCS has helped hundreds of businesses and organizations find undiscovered cost savings. Our fees are success- based, so you do not pay us until we produce savings. Contact us at x 10 or at gfriedman@cost- containment.com.