Procurement's Future: Outsourcing?
Organizations must uniquely assess outsourcing viability for strategic, commodity, and services procurement and management
By Stan Lepeak
The G2000 organizational model continues to evolve from insular and self-sufficient to open and specialized. Gone are the highly vertically integrated business and organizational models of the early to mid 20th century. No longer does coal and iron go in one end of Ford's River Rouge plant and automobiles come out the other. Newspapers no longer own forests to supply newsprint. More recently, organizations have been getting out of the business of managing their facilities, logistics and back-office operations.
Organizations today are focusing on a narrowing set of core competencies. Already many supply chain functions are being outsourced, including inventory management, transportation services, and even manufacturing.
The reason behind this trend is that competitive differentiation is increasingly driven by horizontal business process expertise and not vertical integration. Organizations strive to excel at one or two core processes (e.g., customer care, R&D) and direct as many resources to those processes as possible. Also, operating in today's global, high-tech and complexly regulated economy has become so complex that no organization can internally possess all the skills it needs to compete.
Driven by these factors, spend on outsourced services has become a huge part of the economy. Today, on average, over 50 percent of a G2000 organization's spend is on outside services, an amount that exceeds $2 billion in a G500 enterprise. This amount will continue to grow 20%+ CAGR through 2005 (CAPS). These services take many forms, from using individual contractors and temporary staff through retainer services, project based services and BPO/business process outsourcing.
The groundwork to enable outsourcing has been in process for many years. Varied mega-efforts of the past decade, from business process reengineering (BPR) to enterprise resource planning (ERP) to e-business have all had their roots in optimizing core processes. A residual benefit to organizations from these efforts is that their processes have been standardized and componentized. Once a process is componentized, an organization can viably "un-plug" it and outsource it to a third party to manage. Increasingly, it is these third party experts who - as a result of focus, skills and resources - have become the most proficient at performing these processes. Advances in information technology and communications have further enabled the outsourcing process.
Processes that were once considered too core, or too sacrosanct for outsourcing are now considered viable candidates. Chipmakers no longer make chips, pharmaceuticals outsource new drug research, the government outsources prisons and apparel firms outsource apparel manufacturing. Going forward, few if any processes or tasks will be viewed as off-limits when it comes to the potential for outsourcing.
One process that has certainly been scrutinized, re-engineered and undergone extensive automation efforts over the past few years is procurement. Procurement of direct materials has been transformed by advances in Supply Chain Management (SCM). Procurement of indirect or commodity materials and services has been the focus of extensive e-procurement efforts. Procurement marketplaces, hyped then hounded, are slowly growing in importance and influence. Most recently, specific services procurement has been undergoing its own transformation via Services Procurement and Management (SPM) efforts.
So, the question is whether procurement automation and standardization are a precursor to outsourcing. It is somewhat ironic that at the same time the procurement group is tasked with improving its capabilities to support business process outsourcing efforts, it is also being considered a candidate for process outsourcing.
Once an organization buys into the outsourcing concept, it needs a process to determine what functions and processes are viable outsourcing candidates. There are two reasons to outsource any business process, procurement or otherwise. One is that an organization cannot perform the process at an adequate level to compete. The second is that the process does not contribute to an organization's competitive differentiation and should either be outsourced, or eliminated to free up resources.
Procurement could qualify for outsourcing under both of these conditions. When considering procurement for outsourcing, however, it is not a one size fits all proposition. Organizations must assess outsourcing viability for each procurement category: strategic procurement, commodity procurement and services procurement and management.
Strategic procurement can provide an organization a competitive differentiation if performed to excellence. Commodity procurement excellence can save organizations money, but rarely can it provide competitive differentiation, at least for any length of time. Rather, commodity procurement can provide a negative differentiation when it's performed poorly. It is a process that only gains visibility when there is a problem. Services procurement and management has both strategic and commodity dimensions.
A second perspective to address when considering procurement for outsourcing is whether excellence can be achieved with internal resources. Whether this can occur is dependent on the resources required, and the availability and capability of those resources within a specific organization. Organizations must define procurement excellence and determine what it will take to achieve it.
There are several requirements for procurement excellence. An organization must determine whether they are available internally when assessing the outsourcing option.
- Product, service and vendor knowledge
- Procurement and business unit alignment
- Defined governance and ownership
- (Active) executive support.
Strategic Procurement Outsourcing
First let's consider strategic procurement. Alignment, governance, executive support and the will to follow a process are capabilities that organizations must develop internally. If they do not possess them, strategic sourcing excellence will be a difficult goal to attain whether insourced or outsourced. A strategic sourcing process, product/service and vendor knowledge are items that organizations can viably obtain through outsourcing. There are third party experts that can deliver them either as an as-needed service or on an ongoing basis. These are the pieces viable for outsourcing.
It would be difficult and unwise for an organization to totally outsource the strategic dimension of procurement or the procurement of strategic products and services. Rather, organizations should view outsourcing as an extension of its strategic sourcing function. The client and outsourcing partner would work collaboratively to enable strategic sourcing. The outsourcer would provide advice and counsel on processes, best practices (e.g., negotiations, pricing, terms), and specific vendor capabilities and offerings. Indeed, this scenario already partially exists in situations where organizations bring in third party experts for select procurement efforts (e.g., major outsourcing effort, contract renegotiations).
Commodity Procurement Outsourcing
Achieving excellence in commodity procurement also requires process, product/service and vendor knowledge, and executive support. These items are less complex and daunting to achieve for commodity procurement when compared to strategic procurement. Another key enabler for commodity procurement is automation. While automation can help with strategic procurement, it is more important for higher volume commodity and indirect procurement transactions.
The good news regarding commodity procurement is that many organizations have already implemented process and automation and steadily improved their vendor knowledge. E-procurement, however oversold, has enabled many organizations to streamline and automate commodity procurement.
The result is that organizations can achieve commodity procurement excellence through internal efforts and without outsourcing. Where outsourcing can provide value is in providing ongoing information and knowledge on vendors and market trends. Organizations that have not yet successfully implemented e-procurement may want to consider the outsourcing or managed service option, minimally to provide the e-procurement application itself.
Services Procurement and Management Outsourcing
Services procurement and management also has both strategic and commodity procurement dimensions. Strategically, given the complexity and importance of outsourced services, organizations need to leverage third party expertise in a collaborative fashion wherever possible. On the commodity side, e-procurement solutions do not adequately support services. Organizations need to make similar investments into services procurement and management solutions, just as they have with e-procurement, to address service's unique needs.
Procurement outsourcing can potentially bring great benefits to an organization. It is increasingly difficult for an organization to excel at procurement and supplier management using just its own internal resources and systems. The goods and services being procured are becoming increasingly complex. The applications and systems that underlie and support procurement are also complicated and expensive to implement and maintain.
Given these trends, organizations should explore the role that third parties can provide in supporting procurement, as well as ongoing supplier relationship management efforts. Procurement outsourcing is a selective, not an all or nothing scenario. Ideally, procurement outsourcing will take the form of a collaborative effort between the client and one or more outsourcers, with each player performing a specialized role.
The client should control the relationship, provide direction and be intimately involved with key sourcing and vendor management efforts. End user buyers, leveraging automated systems and processes, should be able to easily perform their own procurement wherever viable. The outsourcer should provide knowledge and best practices, assist with vendor vetting and management, and potentially manage the underlying systems.
Procurement, being an inherently collaborative process, requires this type of collaborative solution. It also requires that the best experts available are brought into the collaborative loop.
Stan Lepeak is senior director, content and research at service procurement and management specialist Elance. He can be reached through www.elance.com.