Insights on Procurement Outsourcing

A couple of weeks ago, Phil Fersht kicked off a firestorm of conversation with his Horses for Sources article on HR Outsourcing. We shared our opinion on the topic in our article debating the value of HR Outsourcing.

Well, this week, Jason Busch published his opinion on procurement outsourcing on Spend Matters. Jason is one of the preeminent strategic sourcing, procurement, and spend management experts, and we encourage strategic sourcing and spend management professionals to keep a keen eye on his blog.

In our opinion, the value of procurement is more than the output of it’s processes. Procurement’s specialized category and commodity knowledge, as well as it’s deep relationships with customers that takes years to develop to the high level of trust necessary for business executives to allow procurement to be a strategic partner, are the key fundamental core aspects of “procurement”. Vinnie Mirchandani, of Deal Architect fame, comments on this in his recent article, “Procurement Outsourcing Perspectives“.

We simply do not believe that wholesale procurement outsourcing can realize the value of an internal organization because of the entrenched customer relationships that enable and empower strategic sourcing initiatives. A deep analysis of core procurement would show that procurement functions have a few key processes: sourcing, spend management analysis, and requisition/purchase approval. Fortune 100 procurement teams add: supplier diversity, ethical sourcing, supplier performance, and green alternatives. Organizations that allow procurement teams to have real influence, also further differentiate their sourcing expertise by direct versus indirect goods and services.

In our opinion, there is little opportunity to achieve value in procurement outsourcing after analyzing these core processes. Here are a few opportunities:

Application Development and Maintenance – outsourcing application development and maintenance of the procurement/spend management software the team uses. Given the high fees Ariba and similar companies charge for software support, there is opportunity, but there is little offshore expertise in this application, much less knowledge of a strategic procurement function. With more and more companies are using hosted solutions, there’s dwindling value here.

…that’s it, and here’s why:

Not Offshore Compatible – The greatest savings in an outsourcing deal is frequently arbitrage. In this case, the internal customers are highly unwilling to accept the difficulties of offshore accents, culture, and relationships. At the very least, it wont motivate them.

Insufficient Scale – Each of the processes we’ve identified have very small scale, frequently amounting to 5-15 FTEs. For most companies, that’s too small to consider viable. The savings are minimal, too.

Process Improvements – The second greatest savings opportunity, and frequently the greatest savings lever, is outsourcing a function to an expert vendor that can make major improvements to the process due to their domain expertise. The main process of a procurement function is the management of purchase approvals, which is likely already electronic and automated. The costs of moving to a new platform are unlikely to offset the very tiny incremental value of moving to a new platform and the process improvements are likely to be equally small, with the greatest opportunity lying in the ability to provide better and more granular analytics.

Core – Generally speaking, companies should avoid outsourcing core functions. Sourcing direct goods and services that makeup of a company’s product or service is about as “core” as Michael Porter’s “core” gets.

Vendor Management Challenges – Managing outsourcing vendors for results is very, very difficult. Other than ensuring requisition approval processes flow smoothly (and these are frequently slowed by internal customer reviews anyhow), what operational metrics can be established to ensure a smooth running procurement function? There are a few, but they are difficult to track and you will frequently excuse excuse the vendor from paying penalties because your company was at fault for the failure.

Finally, and this is the most important item:

Lack of Vendor Expertise – Review the list of procurement processes and then compare that to the vendors’ expertise and you will see a significant gap. Most outsourcing vendors have little to no expertise in strategic sourcing, domain knowledge, supplier diversity, negotiations, etc. Vendors entering this space will play up their domain expertise in accounts payable and receivable functions. While there is a great opportunity for outsourcing those areas, the type of domain expertise necessary to run a spend management function is not the same. Given the specialization necessary to run this function, CFOs who really consider outsourcing procurement teams, don’t understand strategic sourcing.

Instead of outsourcing procurement functions, CFOs, CIOs, COOs, and CPOs should consider building vendor relationships with niche specialty consulting firms that can assist with specialized and infrequent sourcing activities or that can jump start ethical sourcing or green initiatives. In fact, more and more procurement functions should consider allocating 30%-50% of their budget to consulting or advisory firms to assist with strategic initiatives that their internal teams lack the skills to manage. Outsourcing vendors could not begin to tackle items such as outsourcing and advertising, among many others.

In summary, ignore the hype of outsourcing vendors and their paid advertisements in “research” papers and news articles. Procurement outsourcing is a dud today. However, we look forward to a vendor developing sufficient expertise and internal teams developing sufficiently strong performance metrics to make procurement outsourcing viable some day.

Related posts:

1. Onsite Vendor Management in a Global Outsourcing Environment
2. Human Resources Outsourcing: Where’s the Value?
3. Outsourcing Governance and “Who Owns Supplier Performance Management?”
4. Transformational Metrics: Governing Outsourcing’s Lure
5. Paying Outsourcing Vendors