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| Tuesday, March 23, 2010 | ||
| Procurement Outsourcing Is Maturing but Getting Riskier | ||
| Pratibha Verma | ||
| Deal terms are slowly becoming mature but risks stemming from internal readiness to comply with new policies and inconsistency in measurement of benefits are yet to be tackled | ||
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Procurement Outsourcing traces its history back to 90s when AT Kearney began selling PO consulting services. Some parts of source-to-pay outsourcing were practiced at that time. It is only in 2000 that PO was in its full swing with all its end-to-end processes and began its journey towards maturity.
Procurement outsourcing deals have risen steadily with a recent trend towards broadening scope, according to Equaterra. Rick Bertheaud, Managing Director, Equaterra says, “There is an expansion in PO cycle which includes sourcing, procurement operation, back-end accounts payable and full source-to-pay. Some people are doing only procure-to-pay, that is procurement operations and payables. There is a significant trend upwards to include the sourcing activity in procurement deals to bring in more business case value.” Larger providers are capitalizing on industry experience base like IBM capitalizing on CPG experience, Accenture continuing to do well in the financial institution segment. The deal activity in 2009 was quite strong. Many were smaller, sourcing-only deals, focused on driving short-term savings. “We are seeing broadening of categories in the market where deals are narrowly focused on some indirect procurement activities but some providers are gaining traction in direct categories e.g., Corbus in manufacturing and, Capgemini in utilities industry. Providers seem to be softening technology push in solutions. Tools are still part of the offering, but a strong push for big technology / transformation investment seems to have waned. The reason is that if it gets delayed, the deal becomes more expensive and clients want quick return on investment.,” he adds. Despite the expansion of procurement outsourcing, the continued lack of standard deal terms suggest that market is still not yet “mature” and yet has a number of risks in it. Risks in service delivery Change management: The largest risk in doing Source-to-Pay Outsourcing (S2PO) is more around managing change internally within the client's organization. This is actually true regardless of the delivery model - whether you are building out a captive or you do it with an outsourcing provider. “In the scheme of things, it is relatively easy to go out, find new suppliers and negotiate better contracts, which is the sourcing part. The toughest part comes afterwards - getting your internal customers within a client organization to buy off those contracts. In fact, non-compliance with negotiated contracts and specifications from preferred suppliers can create significant value leakage. In some companies a culture of “rogue buying” persists where people act on their own, go out and find their own goods and services from non verified vendors, who are not listed in the deal. Organizations that manage compliance well – which can be supported with tools and practices offered by procurement outsourcers, can “plug the leaks.” Rick says. Financial: In addition to change management risk, source-to-pay (S2P) also carries significant financial risk than call center, procurement operations only, or other BPO deals, which rely heavily on labor arbitrage to create value. Rick expands, “S2PO has a very different model. Often times, clients are underinvested in sourcing operations prior to engagement. Such clients may actually invest more to generate larger savings downstream. S2PO is not about reducing administrative cost of the activity, but it is about generating savings from third party spend. In fact often you have to spend more in order to generate healthier savings.” There is an inconsistency in selection of resource units used to allow variability in base charges like FTEs, spend volume, transaction volume, and savings achieved. In S2PO deals there is a lot of focus paid to realizing savings and ensuring deal terms to provide mutual incentives to deliver the desired business case. The challenge is in objectively measuring achieved savings. What seems like a straight forward exercise can quickly get complicated when new products, services, specifications, and suppliers are added to the mix. To this end, it is critical that deal terms with S2PO providers not only include clear targets and incentives for savings achievement, they also need to address the methodologies to be used in calculating savings. Rick adds, “In the end, deal terms will only go so far. Trust and collaboration between client and PO provider is critical to the success of a S2PO relationship.” Not just the absolute savings, but also the relative saving is important. Something might be procured which has already been bought. Much the savings relatively objectively measured, counted and agreed to between provider and client. It is more ambiguous and hence has to be discussed and agreed to as part of the savings calculation methodology between the partners. Considerations for PO Deal terms are maturing, but vary from deal-to-deal. It is to be ensured that contract should contemplate and care for the objectives and risks of the relationship:In terms of savings assurance service levels, there is a trend to shifting from a penalty-only-model to a balanced-gain-and-pain-share model to encourage providers to exceed targets. Both models require clear rules of engagement and, in the end, ensure that savings are identified, calculated and tracked.
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