A Research Paper

on Procurement
Outsourcing
The Time is Right?
Alsbridge Plc, 22-24 Ely Place, London, EC1N 6TE, +44 (0)20 7242 0666
www.alsbridge.eu
1
Organisations typically spend twice as much with their
suppliers as they do on staff costs. As a result, reducing
supplier spend can have a proportionally bigger effect
on earnings than the same percentage reduction in staff
or staff costs. This effect is often further amplied as
supplier savings have a direct earnings benets whereas
staff costs carry other overheads and so do not have a
direct one-to-one effect.
Supplier costs are thus an obvious area for organisations
to address. Despite this, in many cases, when prot
improvements are needed, the main focus has been on
staff numbers and staff costs.
We believe that reducing bought-in spend is the simplest
and least painful way to reduce cost. It also produces
less corporate stress and upheaval than reducing
headcount, can be quicker to realise benets with less
risk than other forms of outsourcing?
In order to achieve supplier cost savings, expertise in
areas such as procurement and change management are
required. And those are becoming increasingly difcult to
nd as competition among different organisations for the
same skills intensies.
One solution that achieves all these
aims is outsourcing or Right Sourcing
of procurement, either in its entirety or
for selected categories.
The growth in the procurement co-sourcing and
outsourcing markets demonstrates that the time has
come for Procurement Outsourcing.
The basic value proposition is very simple achieve
signicant bottom line savings by leveraging the core
competencies of sourcing and category management
(mainly but not exclusively in indirect categories) that
an external, specialist can provide and that a corporate
might not maintain in-house for a wide range of reasons.
This includes a range of value generating capabilities,
such as technology to support category management
and process compliance.
In line with the market, Alsbridge is seeing signicant
growth in Procurement Co-Sourcing and Outsourcing
deals and is advising an increasing number of clients in
this area. It is a concept at a tipping point in terms of
market acceptance and one, we believe, that has now
nally arrived. As a result Alsbridge believed that it
would be timely to carry out some unbiased, objective
research to understand what it means in practice, what
it can and cannot deliver and what the opportunities and
obstacles are. Potential clients will then have a sound
basis for considering whether it will work for them.
Weve researched data sources and weve spoken
to outsourcing service providers, their clients and
procurement specialists to prepare this research
paper, so that organisations can make up their own
mind about Procurement Outsourcing.
We hope you nd it useful.
Introduction
2
Summary of ndings
Procurement Outsourcing is actually a
combination of co-sourcing and outsourcing.
The former is the more prevalent but full
outsourcing is rapidly catching up both in the
number and total value of contracts.
1. Procurement Outsourcing does deliver
signicant benets
In the right circumstances, as a result of a well
implemented deal, clients can realise a 2 to 4 (or more)
times ROI on the service providers fee, or between 5%
and 20% of in-scope spend, with a payback of less than
12 months. This depends, however, on the size of the
in-scope spend. Larger service suppliers will say that
a minimum in-scope spend of 50-100m is required to
make an outsourcing deal really worthwhile, smaller
suppliers will be happy to work with less. But obviously,
the greater the in-scope spend the better.
Below are some indicative saving benets for
three categories:
2. The largest benet (usually about 40%) comes from
sourcing and category management
The chart below summarises the main sources of benets:
Improved compliance and prevention of value leakage
(often through introduction of technology) can also be a
signicant benet, depending on the client. Other benets
accrue from economies of scale across a business. The
other 10% comes from general efciencies and lower
cost processing but the labour arbitrage benet is very
small compared to other forms of outsourcing for the
reasons given above.
Aggregation of small deals into a larger deal may appear
to be an easy win but actually it delivers fewer benets
than might be supposed (and probably fewer than
smarter purchasing). Some years ago it was the accepted
wisdom that Procurement Outsourcers would consolidate
requirements from several clients and thereby get a
better price. However, complications such as difculties
in getting a common specication and different costs
to serve between different clients have meant this isnt
as straightforward as it seems. This isnt to say that
aggregation can never be successful, just that it is one of
several routes to savings and not necessarily the best.
3. Getting the right deal shape and commercial terms
is important
There is a wide range of options regarding pricing
models, with pure gainshare at one end of the spectrum
and xed price at the other. The chart below sets out our
ndings with regard to the basis of pricing mechanisms:
A minority of deals are gainshare only models (i.e. no gain,
no fee). Nearly 50% of deals are on a pure xed price basis
and about 30% include a performance bonus (gainshare
or risk/reward). Often negotiations with a new supplier
start out on a gainshare basis and nish up as risk/reward.
If the extent of realised benets drives pricing in any
way, it is important to consider their timing one client
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
IT/Telecoms Temporary Labour Marketing
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Sourcing
and category
management
Compliance Economies
of scale
Other
30%
Fee plus
performance
bonus
50%
Pure xed
price
20%
Gainshare
only
3
we came across had set the bar too low for benets and
the target was achieved very early on in a ve year deal,
with the result that the service provider wasnt obliged to
deliver any further savings beyond year two.
In general, Procurement Outsourcing deals are 3-5
years in deal term which is a little shorter than other
forms of outsourcing.
4. Procurement Outsourcing seems to be easier to
implement than other forms of BPO
There are lower set up costs, less in the way of transition
disruption (as often only the procurement department is
largely affected), and it seems that the benets dont have
to be worked at quite so hard. This is not to say it is easy
but it may be easier than other BPO options.
5. There is strong growth in the market
Our research indicates that there is signicant growth,
particularly for indirect and tail-end categories.
Everything we have seen and heard in the market backs
this up, especially from service providers already in this
space and perhaps more interestingly from those not
already in it but who are gearing up to enter the market.
Indeed, some service providers are very bullish about
the future and have predicted increases of over 40%,
with an average around 30%.
In terms of industry sectors, the trend of adoption of
procurement outsourcing has varied over recent years
but now seems to be fairly evenly divided amongst
Financial Services, Telecoms, Utilities and Manufacturing
companies. The most common categories of spend
outsourced appear to be IT, telecoms, facilities, HR related
(such as temporary staff) and marketing/sales. The most
active markets considering procurement outsourcing are
Consumer Packaged Goods (CPG) and Manufacturing.
It is also worth noting that within this overall upwards
trend there appears to be a move towards deals focused
on fewer categories, which is thought to indicate a
change in buyer approach rather than a lack of interest
in Procurement Outsourcing.
6. Outsourcing of strategic procurement took a dip in
the number of new contracts about 6 years ago
We suspect that this was because the contracts signed by
the early adopters ran into the problem that the suppliers,
while good at providing centralised transactional services,
were not able to use the same model for sourcing.
Category Managers need to be close to their customers
to understand requirements and to ensure that the supply
deals put in place work for the business (and are adopted).
As a result, two things happened. There was a growth of
co-sourcing where supplier and organisation staff worked
side-by-side in the same category teams ensuring
good expertise was available at the same time as good
client interfaces. Secondly, suppliers grew their regional
and local expertise organically, through TUPE of client
staff and through acquisition. The suppliers are now in a
position to offer regional and local client working and,
as a result, outsourcing is now rapidly growing again.
7. There is a wide and growing range of
service providers
In the course of this work we interviewed a wide
selection of current service providers. These providers
approach the market in different ways some tend to
major on sourcing and category management, others
provide a full set of services and technology applications.
Some promote the leverage of their own procurement
functions which are dealing with huge volumes of
transactions for other parts of their businesses, and for
others their expertise exists purely for client purposes.
Some develop one-t common category strategies for
all their clients; others develop strategies on a client by
client basis. Each option has its benets and drawbacks.
Some seek to provide a full service across multiple
geographies, from sourcing strategy through to
transaction processing, whilst at the other extreme some
specialise in category management in specic regions.
8. The market has matured signicantly over the
past couple of years
Although there are some very good examples of
Procurement Outsourcing, some experienced service
providers and strong demand, the fact is that the uptake
is still relatively low in absolute terms its about where
Finance & Accounting (F&A) Outsourcing was maybe
four or ve years ago. Since then, F&A Outsourcing has
experienced quite a boom in demand it is believed that
procurement will go the same way.
Clients also stated that the benets from sourcing and
category management (i.e. the largest part of the benets)
vary according to the service provider staff involved.
No provider is good at everything and it is important to
recognise this point, not necessarily as a weakness of the
Procurement Outsourcing model but as a fact. Different
categories may require different service providers.
Service providers told us that the main inhibitors to the
uptake of Procurement Outsourcing are a do it yourself
attitude on the part of clients, fear of a loss of control and
a lack of scale.
4
What is the value proposition
for Procurement Outsourcing?
The basic principle is simple the procurement service provider provides expert category management in areas
where the service provider is a specialist and the client organisation is not. This means that the categories in scope for
Procurement Outsourcing are usually indirect i.e. where procurement is not a core competence for the client.
Typical examples of indirect categories commonly in scope are set out below.
IT and Telecom spend
1. Network/Mainframe
infrastructure
2. Computer hardware
(Desktops, Servers)
3. Desktop Software
4. Infrastructure Software
(Mainframe, Network,
Systems management, etc.)
5. Telecom infrastructure
& services
6. Printing management &
Hardware (e.g. printers, copiers,
multifunction, etc.)
7. IT Outsourcing and out tasking
8. PDAs and cell phones
9. IT consulting and
software development
Marketing and Sales
related spend
1. Trade shows/Events
2. Marketing research/
ad-hoc studies
3. Advertising agencies
4. Public relations/
communications
5. Promotional/Direct/
Interactive Agencies
6. Mailing Fullment
7. Design/Pre-press agencies
and services
8. Experimental/
Niche marketing
Finance and
Corporate spend
1. Tax and audit services
2. Consulting services
3. Third party legal services
4. Technology related services
5. Third party outsourced
services
6. Contract labour
7. Facilities/Equipment &
Administrative services
8. Treasury related services
Direct materials
1. Corrugated/Line board
2. Poly lms/Bag
3. Folding cartons
4. Automotive parts/tiers
5. Fuel/Lubricants
6. Metals
7. Bulk and packaged gases
8. Chemicals
9. Fertilizers
10. Capital equipment
HR related spend
1. Executive search/
Recruitment/Relocation
agency management fees
2. HR Consulting
(workforce, benets planning,
compensation planning)
3. Temporary and
contingent stafng
4. Drug screening/job testing/
Background checks
5. Events and recruiting
logistics spend (displays,
collateral, materials)
5
It follows that the key benets are related to
the cost of the categories in scope, rather than
the cost of the people involved, and as a result
they can be very signicant. But this is not the
full story there are a number of different
ways in which Procurement Outsourcing can
generate value:
Expert market knowledge in defned categories
usually generates the largest part of the added value,
and this was conrmed by service providers and
clients alike. A good example is a category where an
organisation does a deal relatively infrequently but
where the market is relatively complex and constantly
changing for example, mobile phones. For many
organisations it is not feasible to maintain specialists
in this market. Procurement Outsourcing service
providers maintain specialists whose full time job is to
research and understand the mobile phone market and
whose knowledge can be leveraged whenever required.
Using technology to help ensure compliance and
to share knowledge. Several of the service providers
we spoke to cited much improved compliance
through technology as a key benet of Procurement
Outsourcing. Many of them provide technology either
as a core part of their offering or as an add on to
facilitate and control the end to end transactional
process from requisitioning goods or services at one
end to payment at the other. Which means that clients
have the ability to either prevent or to identify and deal
with rogue purchasing, resulting in signicant benets.
And clearly theres no point in having great deals if
the organisation doesnt know about them, so sharing
knowledge through technology is also key.
Leveraging economies of scale. Clients who are not
familiar with Procurement Outsourcing might think
that this yields the major part of the benets, but in
general this isnt the case. Although service providers
are able to negotiate deals in certain areas by using the
aggregated buying power of their client base, and in
some cases leveraging their own buying power (usually
derived from their other activities) for clients benet,
there are obstacles. For example, aggregation may
require clients to accept standard specications that
might not be quite right for them and in addition each
client will have a different cost to serve, which makes
it more difcult for the end supplier to provide better
terms. As a result, aggregation appears to be less of a
benet than it was thought to be, say, ten years ago.
Lower cost processes. In the scheme of things this
usually contributes the lowest proportion of the benets
and in most cases on its own is unlikely to be the sole
reason for outsourcing procurement. Nevertheless, over
time a Procurement Outsourcing service provider would
expect to achieve lower cost processes and efciencies
through automation, continuous improvement and the
use of lower cost locations
Indirect procurement is often not a clients
core competency :
Hiring category specialists may be uneconomic.
Why hire a mobile phone specialist when you only do
deals infrequently? Why hire an energy specialist for
the same reason?
Looking around for new technology can be
time consuming and distracting. Why take the
time and resources to research the market when
a Procurement Outsourcing service provider can
provide the technology that is measured on the
service it provides? In addition, many organisations
have already made an investment in e-Procurement
applications and believe that Procurement
Outsourcing means renewing their IT systems.
Putting greater focus on indirects might not be
the best way of management to spend its time.
Organisations might be able to win in the market
through their abilities in procuring direct materials
but no one ever wins because they got a great deal
on consumables.
Marketing Opportunities. In some cases, limited so
far but growing, a service provider has been used as
a back door opportunity for organisations in to start
to form strategic alliances. This can be both with
organisations in different industry sectors and also
the same sector.
6
So what is Procurement Outsourcing, exactly?
There are a number of different elements in Procurement
Outsourcing and clients can take all or (more commonly)
some of them. The diagram below sets out an overview of
the end to end procurement process and indicates the main
areas which can be outsourced.
To keep things simple we divide procurement services
into three functions:
Source
This covers all activities necessary to dene a sourcing
strategy for a category and to enable its implementation,
right up to the point before actual procurement. It covers
activities such as spend analysis, sourcing strategy, market
analysis, agreement of requirements, bid management,
contracting, vendor management and contract and
relationship management. Everything in fact to get a deal
in place that the organisation can use. Sourcing can cover
both strategic (longer term, high volume) and tactical (one
off, more infrequent) deals though Transactional or Spot
Buying falls between Source and Procure as it involves
some negotiating with suppliers. It is also process-driven
as seen in a Shared Service function. How best to handle
this is a key strategic decision to be made as part of the
Target Operating Model. We have also included Supplier
Relationship Management in this denition.
Procure
This function includes all the activities necessary to
requisition goods or services and enable the organisation
to consume them, in accordance with the agreed deal.
As it includes requisitioners communicating with service
providers, in many instances there can be a huge number
of interactions, so this part of the service is often heavily
technology-enabled. Technology can include online
catalogues, requisition management, order tracking and
fullment monitoring. This technology isnt just a way of
keeping track of everything that is happening; it performs
a vital function in disseminating the deal throughout the
organisation and helping to ensure compliance. There is no
point in negotiating a great deal if no one knows about it or
if no one uses it.
Pay
This function generally starts with a fullled order and
takes the transaction right the way through to payment,
including receiving and validating the invoice and making
the payment. As well as paying service providers, this
service also forms a key part of the compliance and
control feedback loop, as transactions with unauthorised
service providers should be picked up at this stage and
appropriate action taken. This part of the service is
more commonly thought of as Finance & Accounting
Outsourcing (FAO) rather than Procurement Outsourcing,
but nevertheless is important for completeness of the end
to end process.
By the way, in these difcult economic times it is worth
mentioning supply chain nance as a nal link in the
chain, although it isnt outsourcing in the usual sense.
Nevertheless it is something that a proactive service
provider could and should be proposing to clients and
even helping to arrange. It works like this:
Companies, especially large corporates, may well squeeze
suppliers by unilaterally extending payment terms,
which increases the possibility of suppliers going out of
business through lack of liquidity. As a result, there has
been increased interest in Supply Chain Finance i.e. how
to provide nance at the right place at the right time, at
the right cost. The obvious starting point for suppliers
is receivables discounting or factoring, which has been
around for a long time. However, more recently other
approaches have emerged whereby the good credit
rating of large corporate customers can be used for the
suppliers benet in funding receivables. Essentially, a
customer would provide visibility of approved invoices
on their system and would work together with a bank to
extend credit to the supplier against those invoices, which
would be at a lower rate of interest than the supplier could
obtain independently by leveraging their own credit rating.
The net effect is that the customer has extended their
payables without placing undue pressure on suppliers.
Spend analysis End user requisition
Day to day
purchasing
Category strategy
Supplier selection
and buying
Accounts payable
Contract and
relationship
management
Catalogue
content and order
management
Performance
management
Sourcing focused Procure to Pay
Source to Pay
Sample for services in a Procurement Outsourcing
Source Procure Pay
7
The commercial aspects of a
Procurement Outsourcing deal
Commercial terms can vary widely but as with any
outsourcing deal it is important to get this right.
It not only determines what the client will pay and
their business case but inevitably it will also drive
service provider behaviour.
Deal length
Typically, Procurement Outsourcing deals tend to be in
the region of three to ve years, which is a little shorter
than most BPO deals. This is because a lot of the
benet, certainly in terms of cost reduction, should have
been delivered within two to three years, after which
savings stabilise.
Commercial model
First of all, it is important to be clear on what kind of
service the client is buying and for example whether
it is outsourcing, co-sourcing or just consultancy
the distinction can be blurred. At one end of the scale,
transaction processing (processing requisitions or
purchase orders) is likely to be outsourcing. At the other
end the service provider may be providing advice that
the client may or may not choose to act on and thats
probably consultancy. In the middle, there is a wide
range of activities which may be repetitive, but which
all come under the heading of Business As Usual
when managing categories. As a result, Procurement
Outsourcing is generally more difcult to categorise
than some other types of BPO.
So how should commercial models work? There are two
main possibilities for Procurement Outsourcing and these
are described below.
Gainsharing Price Model
Given that one of the main objectives of Procurement
Outsourcing is to save costs, at rst sight it would appear
logical that a gainshare mechanism would be a good
approach. Indeed the rst deals in this space followed
this approach to a considerable extent. However, through
experience, a number of drawbacks became apparent.
From the service provider side, it quickly became
apparent that, although clients signed up for signicant
gainshare in the contract, when savings were realised
difculties were encountered in agreeing payments.
Arguments such as we could have done that and
we were going to do that anyway surfaced, along with
disputes about the baseline. In addition, some clients
didnt make provision in the accounts for the gainshare
and so had difculties getting signicant payments
approved. From the client side, there was a fear that,
if the service provider has the opportunity for signicant
reward through cost savings, then there is no surprise
that that is what they are going to focus on, despite other
controls such as quality, service and cost of ownership.
However, this is not to say that a gainshare model is
unworkable, just that it needs to be handled with care so
that both sides, client and service provider, achieve the
right outcomes.
The gainsharing model is strongly preferred by some
service providers, who believe that the perceived
downsides can be managed.
Fixed Price Model
At the other end of the scale from a gainshare model is
xed price, where the service is predened for the various
scopes of work, for example transactional or sourcing-
based. As the scope varies the fee will vary. In general
the fee will be higher in the initial term of contract (as
there is more sourcing) and reduces over time as deals
are set up and savings are realised.
In addition to the xed fee there is often (but not
necessarily) a performance bonus depending on certain
criteria such as savings, compliance, spend under
management and user satisfaction. The performance
bonus can be thought of as a low leverage gainshare
it should be big enough to be interesting but not so large
that it completely skews behaviour.
One senior executive from a service provider told us that
for them the advantage of xed fee plus a performance
bonus model is that it gives ample room for innovation
and gives enough incentive to think in terms of long
term savings. Their view point on gainsharing was that it
encourages short term behaviour as the provider tends to
seek much easier targets but the long term target might
be overlooked. Overleaf is a brief summary of the key
points of the two models.
8
Fixed Fee Pricing Model
(with or without Risk/Reward)
a Outsourcing provider has freedom to innovate
a Customer cannot determine providers prot-
margin and knows little about provider costs
a Negotiations are complex
a Customer offers many incentives to deliver
value-added services
a Relationships are trust-based, i.e., weaker
performance measures
a May cost more due to talent required to provide
added-value
a Issue like re-engineering and dealing with
stakeholders can be handled well
Gainsharing Pricing Model
a Outsourcing provider has freedom to innovate
a Customer cannot determine providers
prot-margin
a Customer offers few incentives to deliver
value-added services
a Customer knows provider costs
a Customer shares gain with provider
a Customer must closely track performance
a Provider might seek to gain some easy targets
Based on our research less than 20% of deals are
gainshare only models (i.e. no gain, no fee). Nearly 50%
are on a pure xed price basis and about 30% include a
performance bonus.
There are also some deals that involve a risk/reward
element where the fee can be put at risk if outcomes are
not achieved. This is a variant on gainshare and often
works well with CFOs who do not wish to share too much
of the benets with the service provider.
There are a couple of other points to note concerning
commercial models:
The rst is the distinction between identied and
realised savings. This may seem obvious but some
clients we spoke to noted that this is a key distinction
to make the commercial model should focus on the
latter, not the former.
Secondly, the timing of savings over the lifetime of the
deal is important. If there is a savings target over a multi-
year deal it is important not to be in the situation (as one
corporate was) where all of the savings were achieved in
the rst year of a ve year deal, because the bar was set
too low. As a result, the service provider wasnt obliged to
deliver any further savings beyond year two. The secret is
to set stretching annual targets to avoid this situation.
9
The challenges
why isnt everyone doing it?
We saw through our research how procurement
outsourcing can deliver real benets that a client could
not have realised for themselves. We also saw that set up
costs can be relatively low and that, per dollar or Euro or
pound saved, it probably causes the least upheaval within
an organisation than any other form of outsourcing.
So, on the face of it Procurement Outsourcing appears
to deliver a relatively painless win if a third party
can achieve sustainable cost savings through their
expertise, and there is relatively little upheaval involved
(at least, compared to shipping whole departments
off to India), why doesnt everyone do it? In difcult
economic times it would appear to be a godsend a
painless and victimless route to lower costs.
The main challenges we identied through our research
are as follows:
The Do It Yourself option. Most Procurement
Outsourcing service providers will say that this is their
main competitor. Because none of the approaches
and methodologies that a Procurement Outsourcing
service provider can bring are trade secrets or rocket
science, any organisation could deploy them, just as
they can mirror what an outsourcer could do in other
elds, such as moving to low cost locations. So, once a
service provider has done a feasibility review, the client
may well try to implement the actions themselves.
This option is of course perfectly valid but is not risk-
free can the client really deliver? Can they deliver in
the timescales? Can they deliver within a budget?
Fear of loss of control. Clients tend to have concerns
around losing control over procurement. This is an
interesting perspective because in fact outsourcing can
actually enhance control and compliance through the
implementation of new technology. We heard from all
sides of one way of mitigating this concern, which is
strong stakeholder management
Lack of scale. Larger service providers will say that a
minimum in-scope spend of 100m is required to make
an outsourcing deal really worthwhile, whilst smaller
service providers will be happy to work with less. But
obviously, the larger the in-scope spend, the better.
Confusion about the market. There is still a lot of
confusion as to what the service providers can offer,
who is good in which categories and which geographies
and also, what types of commercial deals are possible.
Alsbridge can help
If you are interested in exploring Procurement
Outsourcing but you dont have the experience,
Alsbridge can help. First of all we can help you
decide whether Procurement Outsourcing is
right for you and, if it is, how to ensure the deal
is a success. We do this by guiding you through
a process which ensures all of the relevant
operational and commercial issues are
addressed and the outcome is a sustainable
deal which meets your requirements.
Specically, Alsbridge can advise on:
Feasibility of Procurement Outsourcing and what your
business case might be
A strategy and Target Operating Model for your
procurement organisation
The key service providers of Procurement Outsourcing
services and what they can do
Which categories and activities should be in and out
of scope
Should you include transaction processing in the deal
or not?
How to put a Request for a Proposal together
How to evaluate responses and select a service provider
Contractual and commercial terms
Implementation and transition
In short, Alsbridge can help you generate real value from
Procurement Outsourcing.
To nd out more information or to discuss your
requirements in more detail, please contact:
David Eakin
Senior Manager
david.eakin@alsbridge.eu
+44 (0) 7884 183872