7 Ways to Create Value Through Procurement Outsourcing in 2021

What Is Procurement Outsourcing (PO)?

Business process outsourcing (BPO) has risen significantly in the last two decades. It has transformed the fundamental framework of many industries. Companies have adopted the system, where they handover activities, processes, or entire operations to third parties. In turn, the expanded BPO industry has a firm footing in strategically significant wings like research & development and manufacturing.

In procurement, the outsourcing process has seen a similar development trajectory, albeit at a slower pace. Outsourcing transactional procurement, like order processing or the management of invoices, is now common. However, outsourcing strategic procurement activities like supplier selection, contract negotiation, or specification management have become popular only in the past decade.

In a nutshell, procurement outsourcing is the process of finding an external third-party supplier to take on the management and provision of a service. The services are generally non-core activities and often utilized when a business may not have the skills or the expertise.

According to McKinseyOpens a new window , strategic procurement outsourcing can become a successful strategy if companies follow these steps:

1. 1. Plan outsourcing strategic buying only for categories that offer clear value. 
   2. Develop a deeper understanding of the value of the sources and how to benefit from them.
   3. Select appropriate outsourcing partners with capabilities to address those sources of value. 
   4. Post partner selection, define and implement agreements that maximize savings.

7 Ways to Create Value Through Procurement Outsourcing in 2021

Before diving in, remember the two pillars of PO:

1. 1. PO process covers end-to-end Source-to-Pay (S2P) process that comprises Source-to-Contract (S2C) process and transactional Procure-to-Pay (P2P) process. 
   2. The second pillar is the category scope, which includes various spend categories like IT/telecom, marketing and sales, facilities, office supplies, travel, logistics, contract labor, maintenance, repair, and overhaul (MRO).

Keeping the two pillars in mind, the following ways will ensure that companies realize PO’s significant value proposition. 

1. Zero-in on the end-to-end S2P process

In a typical scenario, PO contracts either focus on a few activities within operational P2P or within sourcing and category management (S2C). However, very few PO contracts have taken an end-to-end S2P approach. The synergies or the combined value of these two core procurement processes are significant. P2P-focused contracts deliver operational efficiency, while S2C-focused contracts can deliver unit-price reduction. Thus, to provide the best output, the two streams have to form a collaborative integration. But, the lack of integration between upstream and downstream processes usually results in significant savings leakage. For example, non-compliance practices in the P2P process erode the value generated in the S2C process and vice versa.

2. Classify spends as core versus non-core 

The most common segregation of procurement spend is direct versus indirect spend. PO typically applies to indirect spend, whereas direct spend is strategic and hence needs internal management.

However, with the growth, sophistication, and maturity of the PO market, and the need to drive bottom-line impact in a difficult economic scenario such as COVID-19, PO is encroaching on traditional direct spend areas. PO is now targeting spend areas via P2P outsourcing, tail-spend management, and categories like packaging, bundled services, and maintenance, repair, and operations (MRO). The classification of direct versus indirect spend makes a lot of sense in a manufacturing set-up. Still, it lacks relevance to service-oriented sectors like telecom, hospitality, and financial services.

It makes more sense to classify spends as core versus non-core rather than direct versus indirect. All can be outsourced, including all indirect categories, and non-core direct categories such as MRO can be classified as non-core spending.

3. Adopt a phased approach with a long-term vision

The PO value proposition is complex, and buyers need to adopt a phased approach to managing risks. Simultaneously, it is vital to have a long-term vision and not focus on short-term benefits. To build trust and create a working relationship between the buyer and service provider, companies can start the engagement with just parts of P2P or S2C function or with specific categories. However, buyers need to have a long-term vision or plan in place on how to develop a scalable model for the entire S2P cycle covering all non-core categories for future purposes. Buyers need to have arsenals up their sleeves such as:

• • Strategic vision on centralization
  • Adoption of sourcing models
  • Technology and process transformation
  • Organizational changes to create an integrated and streamlined S2P cycle

4. Consider value drivers for PO

A large quantum of PO engagement is driven by unit price reduction, followed by spend compliance and operational efficiency. 

• • Unit price reduction includes savings derived from the S2C process through competitive bidding, global sourcing, contract negotiation, supplier consolidation, demand management, and SKU rationalization accounts for 40-60 percent of PO savings. Yet, most buyers fail to grasp the importance of spend compliance. 
  • Compliance drives another 30-50 percent of realized savings. Therefore, a strong structural framework with equal participation from the buyer and service provider needs to be put in place to promote compliance and prevent savings leakage through unnecessary spending, demand issues, and vendor non-compliance. 
  • Operational efficiency savings are driven by more standardized processes that account for reduced time and effort, leading to savings through headcount rationalization, labor arbitrage, and operational benefits. The benefits can be clubbed into broad categories like reduced duplicate payments, early payment discount (EPD) capture, and working capital improvements.

5. Implement contract structuring  to drive the right behavior 

Though 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 monitored. In ideal scenarios, the buyer should opt for outcome-based SLAs such as vendor rationalization, unit price reduction, and working capital improvement.

There is a need to take a balanced scorecard approach focusing on a few key outcomes or output-based parameters that measure the engagement’s actual benefits. Too many metrics generally divert the effort involved in measurement and reporting and promote non-productivity that may not necessarily drive value for the buyer. 

For example, metrics focused on cost savings. This metric may dis-incentivize service providers from contributing fully to the categories under consideration, where prices are rising, such as healthcare insurance. Service providers could help the client avoid significant price hikes (cost avoidance), but if metrics are focused only on unit cost reduction, these valuable efforts are not duly rewarded.

As part of the contract, buyers and service providers need to have a clear idea of factors that lead to savings to ensure no confusion. Implying clarity on what portion of the benefits could be attributed to buyer-owned programs versus service provider-owned programs.

6. Measure savings

A PO contract has varied definitions of savings based on the process stage at which the savings are calculated. 

• • Identified savings

Savings potential based on analysis of the existing spend base leveraging service providers’ benchmarks, industry best practices, market intelligence, and category experience.

• • Contracted savings

Savings measured after strategic sourcing initiative, i.e., the price differential between new or renegotiated contracts and old contracts over the category’s volume. This method is easy to measure and an important metric to indicate procurement value in the sourcing process.

• • Realized savings

Beyond the spend analysis and strategic sourcing, the service provider is held accountable for 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 actual savings. However, this requires investment in technology and process innovation to track and measure the realized savings accurately. 

7. Domain expertise along with global sourcing and technology

Domain expertise is a key value driver in PO. It is important to select service providers based on their domain expertise regarding the buyer’s categories and processes considered a part of the PO engagement. However, an often ignored aspect of a successful PO is the role of global sourcing and technology.

While it is true that the level of global sourcing in PO is limited compared to other BPO segments, there is still significant value to be derived from leveraging a strong global sourcing model. There are multiple elements in the S2C function, such as spend analysis, RFP analysis in strategic sourcing, and demand management analytics-driven from low-cost offshore locations. 

Buyers typically under-invest in their procurement technology, especially around indirect/non-core spending. To create value for a successful PO requires strong technology support. This is an area where the buyer can utilize tools and technology platforms offered by the service provider to achieve value without making significant upfront capital investments.

In Conclusion

Outsourcing strategic procurement activities can give companies an option to access the expertise and capabilities that they lack in their in-house setup. However, outsourcing also brings with it a significant risk factor. To make the agreements work with the external service providers, companies must ensure that the outsourcing providers’ benefits are clear. The scope and incentive structure of the arrangement is designed to capture value over the long term. Supply chains also need to reflect on the impact that procurement outsourcing can have on their business in the pandemic’s immediate aftermath.

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