Top 10 Best Practices in Procurement Outsourcing (PO)

Transcription

1 2012 AN EVEREST GROUP REPORT Top 10 Best Practices in Procurement Outsourcing (PO) r e s e a r c h. e v e r e s t g r p. c o m Copyright 2012, Everest Global, Inc. All rights reserved.

2 Introduction After witnessing a vacillating adoption for over a decade, the Procurement Outsourcing (PO) market is finally coming of age with steadily increasing adoption in the last few years. Years were the best ever years for PO with 50 or more new contract signings in each year. The multi-process PO 1 market has reached a critical mass of over 300 contracts and service providers are managing over US$190 billion for their clients. The cost base for PO is fundamentally different and significantly larger than other BPO segments. Unlike other BPO segments, PO engagements impact the procurement spend, not just the operational costs. As a result, the potential bottom-line impact that PO can create is high. This large cost base makes the PO value proposition attractive but it also makes realization of value complex. The objective of this research is to describe the top ten best practices in PO that will help current and prospective PO buyers realize value from their PO engagements. This study was funded by GEP 1 PO contracts with a minimum of three procurement processes, over US$1 million in Annualized Contract Value (ACV), and a minimum contract term of three years. Typically, managed spend is greater than US$50 million. r e s e a r c h. e v e r e s t g r p. c o m 2

3 What is Procurement Outsourcing (PO)? PO refers to the transfer of ownership of some, or all, procurement processes or functions to a service provider. The scope of PO is typically defined across two dimensions: 1. The process scope for PO covers the end-to-end, Source-to-Pay (S2P) process that comprises Source-to-Contract (S2C) process and transactional Procure-to-Pay (P2P) process as illustrated in Exhibit 1. E X H I B I T 1 Procurement pyramid (non-core spend) PO process scope S2P strategy Procure-to-Pay (P2P) Sourcing 1. Spend data mgmt. 2. Strategic sourcing 3. Vendor management 4. Demand management 5. Day-to-day purchasing 6. Performance management 7. Accounts payable Source-to-Pay (S2P) 8. Procurement systems 2. The second dimension of PO is the category scope. This includes the various spend categories such as, IT/telecom, marketing and sales, facilities, office supplies, travel, logistics, contract labor, and maintenance, repair and overhaul (MRO). Beyond the process and category scope, a PO relationship is also defined by the geographic scope and the value of procurement spend, that the service provider will be responsible for managing, on behalf of the client. r e s e a r c h. e v e r e s t g r p. c o m 3

4 PO Adoption and Value Proposition The cost base for PO is fundamentally different and significantly larger than most other BPO segments, as PO impacts the procurement spend in addition to the operational costs that are addressed by most BPO segments. Everest Group estimates that a PO engagement spanning the entire S2P process can address a cost base that could represent 5-15 percent of an organization s overall revenues. This is significantly larger than the operational costs addressed by most other BPO segments (typically less than 1 percent of the overall revenues). As a result, the potential bottom-line impact that PO can create is higher. Everest Group s benchmarking of PO contracts reveals that, on an average, organizations that outsourced procurement realized 5-10 percent savings on their outsourced procurement spend. Most of the PO engagements are at a minimum self funded with a potential of high ROI s in the initial years of the engagement. This translates into a rapid pay-back period of around 1 to 2 years. However, the value in PO is predominantly driven by unit price reduction, demand management, and supplier/price compliance. These are complex value creation levers and require all stakeholders across the buyer and service provider to work collaboratively. The large value potential, coupled with a complex road to value realization, has been the key reason for procurement to lag behind some of the other BPO market segments such as Finance and Accounting Outsourcing (FAO) in terms of adoption. However, after witnessing vacillating adoption for over a decade, the PO market is finally coming of age with a steadily increasing adoption in the last few years. Years were the best ever years for PO with 50 or more new contract signings in each year (Exhibit 2). The multi-process PO market has reached a critical mass of over 300 contracts and service providers are managing over US$190 billion for their clients. E X H I B I T 2 Snapshot of new multi-process PO contracts over time Number of new contracts Snapshot of new multi-process PO contracts over time As the PO market matures and more buyers consider PO as a viable model to optimize their procurement spend, the following top ten practices distill the best practices based on buyer and service provider experiences that should be considered, in order to realize the significant value that PO promises. r e s e a r c h. e v e r e s t g r p. c o m 4

5 Top Ten Best Practices in PO Following are the most important best practices in PO to ensure that the significant value proposition offered by PO can be realized in practice: 1. Focus on the end-to-end S2P process PO contracts have typically been either focused on a few activities within operational P2P or within sourcing and category management (S2C). Fewer PO contracts take an end-to-end S2P approach. However, the synergies between these two core procurement processes are significant. P2P-focused contracts deliver operational efficiency while S2C-focused contracts are able to deliver unit-price reduction. However, the lack of integration between upstream and downstream processes more often than not results in significant savings leakage. For example, non-compliance in the P2P process erodes the value generated in the S2C process (Exhibit 3). E X H I B I T 3 Value erosion in PO Value erosion in a procurement organization Percentage Spend baseline Savings profile (actual) Realized value Indexed annualized spend Savings profile (potential) Value erosion Year 1 Life of contract (years) Year 5 2. Involve the CFO in addition to the CPO In order to ensure the targeted savings are fully realized, there must be a tight linkage between sourcing and finance teams to ensure that contracted savings get driven to the bottom line by adjusting budgets. Without this close partnership, sourcing savings are not fully realized, as budget holders most often spend these savings and consume their full budgets, rather than finance selectively reinvesting these savings where they can have the greatest impact on shareholder returns. Additionally, FAO and PO have a clear overlap around the Accounts Payable (AP) function (Exhibit 4). PO is heavily dependent on efficiency and compliance in the AP process in order to derive savings. Significant value created in a PO engagement can be eroded by maverick spend with non preferred suppliers, duplicate payments, and poor working capital management. Hence, it is critical to have finance involved in the PO initiative right from the beginning, along with sourcing and procurement, in order to ensure smooth hand-offs across the two functions. r e s e a r c h. e v e r e s t g r p. c o m 5

6 E X H I B I T 4 Finance & Accounting Procurement of non-core spend Overlap between FAO and PO around AP F&A strategy Internal audit Budget/forecasting Capital budgeting Treasury & risk management Management reporting & analysis Regulatory reporting & compliance Fixed assets Payroll General accounting Accounts receivable Tax Accounts payable S2P strategy Spend data mgmt. Strategic sourcing Vendor management Demand management Day-to-day purchasing Performance management Procurement systems CFO level involvement can often help accelerate and increase savings, particularly within areas of the business where procurement has not traditionally been heavily involved, such as marketing and legal functions. CFOs can be particularly influential here in brokering these partnerships and ensuring that the domain expertise of the service provider is fully leveraged so that all high spend areas are well managed and supported by procurement. Lastly, additional benefits to finance from active involvement with procurement include improved information and data, as finance is dependent on inputs from procurement. More streamlined and integrated processes and data can help reduce the processing time and effort of the finance function that can lead to savings from AP headcount reduction. 3. Classify spend as core versus non-core and not just direct versus indirect There are multiple nomenclatures to classify procurement spend. The most common has been the differentiation of procurement spend into direct versus indirect spend, with the premise that PO typically applies to indirect spend, while direct spend is strategic and hence needs to be managed internally. However, with maturity of the PO market, and the need to drive bottom-line impact in a difficult economic scenario, PO is encroaching on traditional direct spend areas through P2P outsourcing, tail-spend management and specific categories such as packaging, bundled services, and MRO. Also, while the classification of direct verus indirect spend makes sense in a manufacturing setup, it has less relevance to service-oriented sectors such as telecom, hospitality, and financial services. In the current scenario, where service-oriented sectors are also leading adopters of PO, it makes more sense to classify spend as core versus non-core rather than direct versus indirect. All spend that can be outsourced, including all indirect categories and non-core direct categories such as MRO, can be classified as non-core spend (Exhibit 5). r e s e a r c h. e v e r e s t g r p. c o m 6

7 E X H I B I T 5 PO category scope Sourcing and vendor performance management Source-to-pay cycle Procure-to-pay Prevalence of thirdparty outsourcing Low prevalence of third-party outsourcing Core spend Direct spend Non-core direct spend Indirect spend Non-core spend 4. Build a long-term vision but adopt a phased approach to manage risk As discussed earlier, the PO value proposition is fairly complex, and hence buyers need to take a phased approach to manage risk. However, it is equally important to have a long-term vision and not focus on short-term benefits that can erode with time or lead to severely limited options in the future, when the client has a clear need to expand the PO scope. It is fine to start the engagement with just parts of the P2P or S2C function or with certain categories, in order to build trust and create a comfortable working relationship between the buyer and service provider. However, the buyers need to have a long-term vision of how to develop a scalable model for the entire S2P cycle covering all non-core categories. Buyers need to have a strategic vision on centralization, adoption of sourcing models, technology and process transformation, and organizational changes to create an integrated and streamlined S2P cycle. 5. The three value drivers for PO are spend reduction, compliance, and operational efficiency in that order Unit price reduction drives the largest quantum of value in a PO engagement, followed by spend compliance and operational efficiency (Exhibit 6). Unit price reduction which includes savings derived from the S2C process through competitive bidding, global sourcing, contract negotiation, supplier consolidation, demand management, and SKU rationalization accounts for percent of savings in PO. However, an aspect that most buyers fail to grasp is the importance of spend compliance. Compliance drives another percent of realized savings. A strong governance structure with equal participation from the buyer and service provider needs to be put in place to promote compliance and prevent savings leakage through maverick spending, budgetary and demand issues, and vendor non-compliance. Operational r e s e a r c h. e v e r e s t g r p. c o m 7

8 efficiency savings are driven by more standardized and rationalized processes accounting for reduced time and effort leading to savings through headcount rationalization and labor arbitrage and operational benefits like reduced duplicate payments, early payment discount (EPD) capture, and working capital improvements. E X H I B I T 6 Value levers for driving realized PO savings Value levers for driving realized PO savings Percentage End-to-end S2P Spend-unit reduction Compliance Operating efficiency Total 6. Build a win-win partnership by providing the service provider some skin-in-the-game There are multiple pricing models at play in PO. While managed service fee (MSF) is the predominant model in PO, gainsharing has also been gaining traction. While stand-alone gainsharing contracts are rare, hybrid pricing models involving a combination of gainsharing with managed service fee are being utilized, as illustrated in Exhibit 7, to create the right combination of risk and reward for the service provider. A purely managed services fee contract does not incent the service provider to deliver additional savings, while a pure gainsharing contract shifts the risk entirely to the service provider, thereby increasing their reluctance to make upfront investments in delivering savings. The combination of managed service fee and gainsharing can ensure that the service provider costs are covered by the managed service fee, while the gainsharing component can reward the service provider for achieving results. E X H I B I T 7 Distribution of pricing models in PO Distribution of pricing models in PO contracts Number of contracts Hybrid pricing 46% 100% = % Only managed service fee 3% 15% Only gainsharing Only FTE-based The buyer also needs to play a supportive role in PO engagements that have a gainsharing component. Buyers need to be wary of succumbing to the practice of not cooperating with the service provider in the scenario where they believe r e s e a r c h. e v e r e s t g r p. c o m 8

9 that a large gainsharing fee would have to be paid to the service provider due to significant savings being achieved. In the longterm such practices will prove detrimental due to the loss of trust between the buyer and the service provider and ultimately reduce the overall savings impact that can be achieved. 7. Define the contract to drive the right behavior from all stakeholders While there is an increasing awareness of performance metrics and SLAs in PO, there still exist gaps in selecting the right metrics based on the processes being monitored. Ideally, the buyer should opt for outcome- / output-based SLAs, such as vendor rationalization, unit price reduction, EPD captured, and working capital improvement. There is a need to take a balanced scorecard approach focusing on a few key outcome- / output-based parameters for each process rather than focusing on a laundry list of input-based parameters that do not really measure the actual benefits from the engagement. Having too many metrics not only diverts the effort involved in measurement and reporting, but also promotes nonproductive behavior to ensure compliance with metrics that may not necessarily drive value for the buyer. For example, metrics focused strictly on cost savings may disincentivize service providers from contributing fully to categories, where prices are clearly rising, such as in healthcare insurance. Service providers could help the client avoid significant price hikes (cost avoidance) but if metrics are focused only on unit cost reduction then these valuable efforts are not duly rewarded. Some clients may focus heavily on metrics that are easily measured such as turn-around time. However, unless speed is an absolute priority for the firm, it may be far more valuable to take an additional week or two to achieve exceptional sourcing results in a complex project than to quickly wrap-up the deal to meet an artificial deadline. As part of the contract, buyers and service providers need to create a clear responsibility matrix to attribute factors leading to savings to ensure that there is no confusion later, as to what portion of the benefits-accrued needs to be attributed to buyer-owned programs versus service provider-owned programs. 8. Measure realized savings and not just contracted savings There are multiple definitions of savings in a PO contract, based on the process stage at which the savings are calculated. Identified savings. Savings potential based on an analysis of the existing spend base leveraging service provider s benchmarks, industry bestpractices, market intelligence, and category experience. However, the service provider is not responsible for actually delivering these savings and the client is not obligated to select these suppliers that provide the lowest identified rates. r e s e a r c h. e v e r e s t g r p. c o m 9

10 Contracted savings. Savings measured after the strategic sourcing initiative as the price differential between new or renegotiated contracts and the old contracts over the volume of the category purchased. This method is easy to measure and an important metric to indicate procurement value in the sourcing process. However contracted savings is not very accurate and sufficient by itself to measure the true value delivered to the client, as actual purchases may not always be as per contracts, and there are many sources of savings leakage. Realized savings. Beyond the spend analysis and strategic sourcing, the service provider is held accountable for actually realizing the savings by ensuring compliance during the P2P process, analyzing the spend profile with contracted suppliers and monitoring the contracted unit prices. Realized savings is the most holistic approach to measure true savings achieved. However, this requires investment in technology and process innovation to be able to track and measure the realized savings accurately. In a manual process the task of calculating accurate realized savings can be extremely time-and-effort intensive. There exists a time-lag of up to 12 months between measuring contracted savings and realized savings. Hence it is important that the buyer and service provider take this into account while creating the payment schedule. The realized savings may also get eroded entirely, based on buyer business decisions outside the control of the service provider. Also the PO engagement would require inclusion of the entire S2P cycle in order to hold the service provider accountable for realized savings. As a result, the buyer and service provider need to take a practical and balanced approach by using a mix of contracted and realized savings in measuring performance. 9. Domain expertise is the key but also leverage global sourcing and technology effectively It is well known that category or domain expertise is a key value driver in PO, and it is important to select service providers based on their domain expertise with respect to the buyer s categories and processes being considered as part of the PO engagement. However, an often ignored element is the role of global sourcing and technology in successful PO engagements. While it is true that the level of global sourcing in PO is limited compared to other BPO segments such as FAO, there is still significant value to be derived from leveraging a strong global sourcing model. There are various elements in the S2C function, such as spend analysis, and RFP analysis in strategic sourcing, and demand management analytics, which can be driven from lowcost offshore locations. Low Cost Country Sourcing (LCCS) offers strong unit price reduction capability for certain spend categories. Most of the P2P r e s e a r c h. e v e r e s t g r p. c o m 1 0

11 processes can be completely delivered from offshore locations to reduce the overall cost of operations. Buyers typically under-invest in their procurement technology especially around indirect / non-core spend. Many of the best practices that we have already discussed around global sourcing, leveraging gainsharing, measuring realized savings, using outcome- / output-based metrics, and increased compliance require a strong technology support. This is an area where the buyer can utilize add-on tools and technology platforms offered by the service provider to achieve value, without making significant upfront capital investments. Today s cloud-based eprocurement tools combined with the service and support synergies provided by the service provider make the value proposition for investing in these tools far more attractive now than just a few years ago when heavy training and implementation efforts made them more cost prohibitive. 10. Success is a function of change management effectiveness In a recently concluded study by Everest Group, focus on change management was identified in the top three most important management practices to achieve best-in-class performance in BPO engagements with procurement in-scope. 77 percent of best-in-class BPO engagements were able to successfully implement change management plans compared to 34 percent of normal BPO engagements with procurement in-scope (Exhibit 8). E X H I B I T 8 Ability to successfully execute change management plans Able to successfully execute change management plans Number of respondents 100% = Disagree 6% 17% Neutral 50% 83% Agree 44% Normal Best-in-class Ultimately, the implementation of a successful PO engagement comes down to the buyer s and service provider s capability in change management. This requires strong cooperation between the stakeholders and support from the buyer s top leadership to ensure that the complex value proposition of PO can be realized. r e s e a r c h. e v e r e s t g r p. c o m 1 1

12 The main change management challenges (and thus skills required) are: Communicating the strategic aims and specific changes of the PO project Training all affected stakeholders in the new processes and working environment Up-skilling procurement teams to provide more strategic support to their clients now, that non-core activities are not on their plate (just taking work off their plate does not mean that strategic work will follow) Persuading non-cooperative client business units of the benefits of the PO program to encourage adoption and avoid value leakage Enforcing new procurement policies and processes aimed at compliance (often within a non-mandate culture) Service providers require skilled change management and communication practitioners who can assess the business readiness for change, anticipate areas of concern, and build change management plans that are carefully integrated with the overall implementation program such that stakeholders are engaged, involved, and encouraged to participate at key steps along the journey. A typical S2P PO assignment that introduces new best practices in the sourcing, PO processing, and vendor management processes will require strong engagement with hundreds or thousands of stakeholders who are engaged in some degree to these processes. Without careful engagement the risks of both value leakage and, even worse, service disruption are significant. Conclusion The ten best practices listed below are what we believe to be the most important in delivering value in a PO engagement. 1. Focus on the end-to-end S2P process 2. Involve the CFO in addition to the CPO 3. Classify spend as core versus non-core and not just direct versus indirect 4. Build a long-term vision but adopt a phased approach to manage risk 5. The three value drivers for PO are spend reduction, compliance, and operational efficiency in that order 6. Build a win-win partnership by providing the service provider some skin-inthe-game 7. Define the contract to drive the right behavior from all stakeholders 8. Measure realized savings and not just contracted savings 9. Domain expertise is the key but also leverage global sourcing and technology effectively 10. Success is a function of change management effectiveness Beyond these, there are several generic BPO practices that would also apply to PO. However, PO with its unique value proposition among BPO segments requires buyers to focus on these PO-specific practices to drive value and achieve the significant benefits that PO engagements have to offer. r e s e a r c h. e v e r e s t g r p. c o m 1 2

13 About Everest Group Everest Group is an advisor to business leaders on next generation global services with a worldwide reputation for helping Global 1000 firms dramatically improve their performance by optimizing their back- and middle-office business services. With a fact-based approach driving outcomes, Everest Group counsels organizations with complex challenges related to the use and delivery of global services in their pursuits to balance short-term needs with long-term goals. Through its practical consulting, original research and industry resource services, Everest Group helps clients maximize value from delivery strategies, talent and sourcing models, technologies and management approaches. Established in 1991, Everest Group serves users of global services, providers of services, country organizations, and private equity firms, in six continents across all industry categories. For more information, please visit and research.everestgrp.com. About GeP New Jersey-based GEP is a leading provider of procurement consulting, procurement outsourcing and procurement technology solutions, dedicated to realizing significant savings from procurement operations for its clients. Named a category leader in procurement outsourcing by the Black Book of Outsourcing and to the Supply & Demand Chain Executive 100 for six consecutive years, GEP is also ranked as one of the Fastest Growing Technology Companies in Deloitte's Technology Fast 50. The company employs more than 800 people with offices and operations in North and South America, Europe and Asia. To learn more, please visit For more information about Everest Group, please contact: info@everestgrp.com r e s e a r c h. e v e r e s t g r p. c o m 1 3