After a cool start, the market for indirect procurement outsourcing is hotting up. All the major providers, from the IT services giants to the specialist procurement and business process outsourcing (BPO) players, report record levels of interest from prospective clients and promise a string of new contract wins during the remainder of this year. And whereas in the past companies were only willing to hand over either individual categories such as travel or temporary labour or some transaction processing work, the trend is increasingly moving towards deals that cover both the sourcing and management of multiple categories and the underlying purchase-to-pay system required to drive operational efficiency and contract compliance.
It's not just mid-sized, relatively unknown companies with immature procurement functions that are taking the plunge either: in the past six months IBM, which has trumped its rivals in the publicity stakes of late, has announced deals with Unilever, Colgate-Palmolive and Solectron, a big electronics contract manufacturer. In May, Ariba said it had extended its relationship with flagship customer Lucent Technologies, which covers 14 indirect spend categories for its operational sites in North America and Europe. And as CPO Agenda went to press, Xchanging, a "pure play" BPO specialist, was preparing to reveal a new household-name client that will add about 50 per cent to the £500 million it currently transacts annually for BAE Systems, United Biscuits and Boots, the UK's leading health and beauty retailer.
"We've seen a very substantial uptake in activity this year and I don't see that going away. This is the beginning of a new wave," says Hap Brakeley, global managing director of Accenture Procurement Solutions.
The result, he adds, will soon be a broadening of the firm's core financial services client base - most notably Deutsche Bank, but also Lincoln Financial, New Century and Bank of Ireland - into the manufacturing sector, IBM's stronghold. Accenture is also seeing strong interest from utilities and media/entertainment companies, says Brakeley.
This ought to be good news for procurement BPO providers' top lines, if not yet, given the big upfront investments they've had to make in technology and shared service centres, their bottom lines. Analysts are forecasting compound annual growth in fee earnings of 22-30 per cent over the next few years - higher than for other functional areas such as HR and finance and accounting (F&A). In her latest report, IDC analyst Shruti Yadav says she expects the market for procurement BPO globally to grow from $627 million in 2005 (up from $479 million in 2004) to $1.7 billion in 2010.
Early adopters still dominate
However, while the increase in activity is undeniable, what those numbers underline is that the procurement outsourcing market is still very much in its early adopter phase. In a report published at the end of 2005, Everest Research Institute, another US-based analyst firm, identified only 38 deals globally that included both sourcing and purchase-to-pay (P2P) elements. The all-important "tipping point" at which a business model gains mainstream recognition and respectability has just not happened yet in procurement BPO.
Typically that shift occurs when a big-name company signs a ground-breaking deal, as Eastman Kodak did with IT outsourcing back in 1989. But, despite initial expectations, neither Procter & Gamble's (abortive) 2002 deal with EDS covering $4 billion of indirect spend or Deutsche Bank's global deal with Accenture two years later has had the same effect. And it's too early to know whether IBM's five-year contract with Unilever's North American operations, announced last December, will be extended globally and become "the big one".
Rachael Stormonth, research director at NelsonHall, a leading BPO analyst firm, predicts that we won't see the tipping point in procurement outsourcing until 2008.
She attributes the slow take-up to a host of factors, including a lack of understanding about the supplier market and its offerings, (often painful) memories of failed e-procurement and e-marketplace ventures - which, after all, were supposed to be the solution to the indirect spend problem - long sales cycles (typically 9-12 months), a lack of public success stories and resistance from internal functions. This is despite the fact, she notes, that significant and tangible benefits can be achieved - not least, overall savings of 5-8 per cent.
A survey by the Economist Intelligence Unit published in March found that 43 per cent of companies were not considering outsourcing any procurement categories or processes. This compared with 28 per cent that said they were already doing it, 10 per cent that were contemplating it in the next three years, and 13 per cent that said possibly at some point in the future (6 per cent didn't know).
David Rich-Jones, a former purchasing director who heads Xchanging's HR, F&A and procurement outsourcing business, acknowledges that a high level of scepticism persists. "I think only 20-30 per cent of procurement directors are open to this," he says. "I do not expect a majority to suddenly say they are going to outsource." At the same time, he points to a "definite mood shift" among CPOs and others in the past 12-18 months, in terms of being prepared to consider outsourcing at least some indirect spend - what he calls procurement's "third lever" (the other two being in-house efforts and consultancy engagements).
Those who are seriously considering it are doing so for a number of reasons, says Rich-Jones. Three of the most common are: a lack of time and/or resources to focus on all categories of spend; insufficient internal capability to deliver the necessary results; or a feeling that internal progress in particular categories has gone as far as it can, coupled with a desire to move on to other areas.
One CPO he is talking to has run what he calls "a very successful DIY programme" at his current employer, but will be moving on later in the year and doesn't want to devote his energies to the indirect side all over again at his next company.
"I think the pressure is on procurement directors to deliver on more of their spend," Rich-Jones says. "Traditionally you could get away with focusing on a number of strategic projects and getting savings of 10-50 per cent. The question now is how much you are really saving across the totality of the spend."
Setting the agenda
The general consensus among service providers, analysts and other observers seems to be that, with the exception of those CPOs in manufacturing firms needing to slash costs quickly, or financial services firms whose institutional shareholders are keeping an eagle eye on their cost-income ratios, most are not currently facing the sort of internal pressure that would force them, like it or not, to contemplate some form of procurement BPO. However, there is an equal degree of consensus about the need for CPOs to take a proactive stance.
Perry Mulligan, CPO at Solectron, says that although his company operates in "a low-margin environment" there was certainly no burning platform for change. Indeed, the company was happy with what his 30-strong indirect procurement team was achieving. "We were getting accolades for the work being done," he says. "There weren't any questions being asked about work not being done."
Nevertheless, Mulligan took the decision to outsource because he wanted to "encourage people to broaden their horizons and look outside their four walls", to take advantage of IBM's scale and experience, and to focus on direct materials, where Solectron spends around $9 bil-lion annually compared with $1.2 billion on indirect goods and services.
Even if they aren't planning to seize the initiative and approach their board with a BPO business case, procurement leaders need to be prepared for that future moment when either cost pressures intensify or their CEO hears about the results achieved by early adopters and asks the "why aren't we doing that?" question. Service providers say this partly explains why they are receiving a high proportion of inquiries relative to firm orders. And yet ask the same providers in what proportion of cases it is the CPO who initiates the discussion compared with a CFO, COO or other senior executive and the answer you get back is typically less than half, and often as low as a fifth.
For Bernhard Raschke, a vice-president at AT Kearney and co-founder of its CPO club, there is a real danger of unprepared procurement heads being sidelined from the decision-making process or swept along in its wake, especially if their company is considering a broader, multi-function deal. To avoid that fate, he advises them to engage with providers and existing customers now and to revisit their options every six months or so.
"Procurement BPO is very much a buyer's market at the moment," he says, "so CPOs should take advantage of that."
It's a view shared by Jeff Baer, global head of sourcing at Deutsche Bank, who sees procurement outsourcing as "an industry game-changer" and predicts: "It is inevitable that CPOs will have to go down this path. There will be a tidal wave of activity and you need to get in early, as we did, to get the most value."
So how exactly should a proactive CPO evaluate the case for procurement outsourcing in their organisation? In a joint study by CAPS Research and AT Kearney published last year, the authors suggested starting with the following questions:
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What is the current value contribution of procurement to the firm? What additional impact could it have if world-class practices were used? How does this differ by category of purchase?
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What is it costing to deliver that value? What could it cost if efficiency improved? What would it cost to attain world-class levels?
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In what areas could other companies provide procurement services at a lower cost while increasing the value contribution over time?
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What are the risks of outsourcing procurement, and how can they be mitigated?
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Will the company lose competitive advantage and a core competency if procurement is outsourced?
A decision to outsource or not, they argued, should also be guided by the likely "future availability of internal procurement resources" by spend category and the "suitability of specific external providers in the marketplace".
Key success factors
With procurement outsourcing still in its infancy and a lack of solid success stories to draw on, the experiences of both the early adopters and their service providers are a vital source of information for any CPO assessing their options. Among the main lessons learned thus far are the following:
1. Be clear about your objectives
Service providers say some organisations simply aren't clear enough about what they want to achieve from procurement outsourcing. Is the goal to improve efficiency or effectiveness, or a mixture of both? And where are the cost benefits going to come from: Greater leverage? Specific category expertise? Headcount reductions? (In fact, few claim that the latter is a big driver in procurement BPO, since most of the job losses tend to be on the F&A side. Everest Research Institute reckons that 15 per cent of total savings are derived from more efficient P2P systems, with the remainder coming from better sourcing and compliance management.) As always, misaligned expectations are a recipe for trouble ahead.
2. Ensure you have internal support
"We won't sign an agreement unless this is a top 10 issue for the CEO," says Jerry Kurtz, who leads the procurement BTO (business transformation outsourcing) practice at IBM.
Senior executive sponsorship is essential to drive real change in internal users' buying habits. "This isn't optional, it's a 'get on the bus' type of deal," he adds. "We can't tell their people to be compliant without their help."
As well as weighing up the extent to which central initiatives tend to get local traction and a CPO can marshal their colleagues, service providers will also want to know whether the organisation has a mindset that accepts the case for outsourcing non-core activities (and, crucially, whether it can agree on what those are), as well as its willingness to embrace new processes and technology.
3. Understand the different business models
Offerings from competing providers vary, particularly in terms of the means by which they seek to achieve benefits. Aggregation is a particular bone of contention, with some providers regarding it as an important lever and others playing down its value. "Every category and supplier is different in terms of the ability and willingness to consolidate spend," says Kurtz at IBM, which claims to manage annual expenditure worth over $50 billion. "Where we can do it, we are doing it."
Others take a different view. Jim Abery, global head of purchasing transformation consultancy at Capgemini - which offers its own BPO services - describes the aggregation model as "total tosh". Large companies already have economies of scale in most areas, he says, "and could get the benefits themselves if only they got their act together". But it's a proposition that many non-procurement people are likely to find attractive, he suggests.
Another bone of contention is the question of whether it's wise to "outsource a problem" - a spend category for which the in-house procurement team has poor data, for example, or which it has never properly addressed. Abery is adamant that it's a bad idea and that outside help may be required to sort it out prior to outsourcing. Yet other providers and early adopters (including Deutsche Bank) say it's fine to outsource on an "as is" basis, providing your performance measures are clearly laid down and agreed by both parties. "It's a misnomer that you have to ¡(r)spin dry' your categories before putting them out," says Xchanging's David Rich-Jones.
4. Weigh up your attitude to risk and reward
Just as BPO providers' value propositions vary, so do their pricing models. According to IDC, typically there will be a fixed upfront fee plus a monthly service fee and/or a fee related to the value of spend under management. There may also be an element of remuneration based on the savings achieved - so-called risk-reward or "gainshare".
Most providers support this concept in theory and say they are open to discussions with prospective clients about their fee structures, but some also point to the difficulties of making gainshare work (not least, agreeing baselines and defining precisely what constitutes a "saving"), and so in practice are keen to limit their exposure.
Rich-Jones believes that the market's current preference for higher fees and lower gainshare will be reversed (80-100 per cent of Xchanging's earnings are performance-related, he says). What's important about such a model is that the company outsourcing decides on the level of risk it's comfortable with. Some want a stable, guaranteed level of savings from their outsourcing contract, which is absolutely fine, he notes, as they don't mind the provider making higher returns itself; while others would rather take their chances in anticipation of a potentially bigger slice of the savings pie.
5. Choose your provider carefully
"Supplier selection is absolutely crucial," says Julian Coles, director of sourcing and purchasing at Boots. The retailer had already outsourced its IT to a large provider and was looking to hand over some of its HR operations to the same company. This meant there was "a lot of pressure" to use it for procurement outsourcing as well, even though, in his view, "it was pretty clear that they didn't have the capabilities".
Considering a best-of-breed procurement provider is essential, Coles argues, as is due diligence to ensure that there is a good cultural fit between the two parties. "You have to stick to your guns in terms of who you think is best for your operation."
6. Agree roles and responsibilities
Who is going to authorise purchase orders and non-PO requisitions: you or the service provider? And who is going to put their signature to supplier contracts? These are just two of the responsibilities that need to be allocated during the planning and contract phase.
James Gregson, director of managed procurement services for Ariba in Europe, argues that once objectives have been agreed, clients should concentrate mainly on outcomes rather than the means of achieving them. "If you insist on too much control over the detail, it rather defeats the point of outsourcing," he says. "Let the provider decide how to deliver the results."
7. Invest your own time and resources
"Adoption is not solely the responsibility of the provider," says Jason Gilroy, vice-president of outsourcing at ICG Commerce. Handing over categories and processes and then forgetting about them until the contract is up for renewal is not an option; a concerted effort is required internally not only pre-contract, but also during the transition phase and then through ongoing governance procedures, so that specific issues and roadblocks can be dealt with as they arise.
8. Work hard at the relationship
With BPO deals typically spanning 5-10 years, it's important to take a long-term view of the relationship and foster a climate of mutual trust and openness, says Joe Siciliano, senior manager of procurement at the telecoms company Avaya (see case study 1, page 29). "See your outsourcer as a business partner, not a service provider," he advises. While the contract and its service-level agreements are important, they should guide rather than drive the relationship.
"If I have to look back at the contract every day, that's not a relationship I want to be in," says Siciliano.
9. Adopt a flexible approach
When he originally signed the contract with Accenture in 2003, Deutsche Bank's Jeff Baer says he envisaged a clear split: his own internal team would continue to take care of strategic sourcing, with Accenture doing only tactical sourcing. He admits, with the benefit of hindsight, that this view was "a bit naive" and that in practice things have been "much more dynamic", with Accenture's people involved on the strategic side too.
Another area where it's sensible to adopt a flexible attitude, he says, is the question of whether sourcing and transaction processing work is conducted onshore or offshore. Like other global BPO players, Accenture has been building up its client service centres (or "factories", as it calls them) in places such as Bangalore (India), Bratislava (Slovakia) and Dalian (China), where running costs are lower.
10. Consider your exit strategy
Planning in case the worst happens is sound advice for any type of outsourcing arrangement, but with procurement BPO there are a number of specific aspects that need to be considered, say legal experts.
For example, do you have copies of supplier contracts that your service provider has drawn up (and possibly even signed) on your behalf, and which may run beyond the period of your relationship? If not, you need to ensure that you can physically get hold of them during a transition either to a new service provider or back in-house. Asset management is another issue - do you know, for instance, where all those computers that your provider claims to have bought actually are?
A warning of what can happen if such advice is ignored was highlighted in a recent global survey on the state of IT outsourcing by PA Consulting Group. Despite more than a decade of experience, "the success rate of IT outsourcing deals appears to have remained static", it concluded. Ill-conceived sourcing strategies, poorly tailored programmes and inadequate in-house management resulted in "a climate of mistrust" between customers and providers.
However, John Halvey, a New York-based partner at the law firm Milbank Tweed, Hadley & McCloy, estimates that of the 400 or so outsourcing contracts he has worked on over the past 15 years - including the pivotal Kodak IT deal and, more recently, the Deutsche Bank procurement deal - less than 5 per cent have been terminated. High-profile bust-ups such as the one between Accenture and the British food retailer Sainsbury's (in which Milbank Tweed acted for the latter) aside, litigation is actually fairly rare and few companies wind up bringing things back in-house, he says. "Compared with mergers and acquisitions and other corporate deals, outsourcing generally works."
Halvey doesn't underestimate the challenge of making this happen and admits that some of the procurement BPO deals he's worked on in the past couple of years have encountered problems. But he attributes this to the relative immaturity of the market and the fact that early adopters had to take a calculated risk on how it would develop.
With many CEOs pledging to outsource as many of their non-strategic operations as possible, the next few years will see plenty more companies looking for partners to take care of their indirect procurement needs, Halvey believes. In future, the question from board level is likely to be not "have you outsourced?" but "why haven't you outsourced?", he predicts.
"Smart CPOs will have to take the lead, otherwise - and this is the experience of IT outsourcing - it gets imposed from the top down."
Case study 1:
Swinging for the fences
When US telecommunications company Avaya was spun off from Lucent Technologies in 2000, it had a choice to make: either hire its own procurement people or outsource. With the Basking Ridge, New Jersey-based firm keen to keep its support function headcount to a minimum, the decision was pretty easy, says Joe Siciliano, Avaya's senior manager, procurement.
Initially the company worked with Alliente (since acquired by Ariba), but in 2004 it switched to ICG Commerce, one of the longer-established specialist procurement outsourcing providers. Office and industrial supplies, telecoms, travel and marketing are among the categories it manages, accounting for around 40 per cent of the $1 billion Avaya spends annually on indirect goods and services.
For Siciliano, the staff who are employed by ICG Commerce are almost indistinguishable from his own team of 14 indirect sourcing specialists, and provide vital category knowledge. Last year they saved 20 per cent on a telecoms contract by engaging internal customers who had previously not seen a need for procurement's involvement.
Meanwhile, at ICG Commerce's transaction centre in King of Prussia, Pennsylvania, staff monitor requisitions submitted through Avaya's e-procurement system and contact end users who aren't choosing preferred suppliers. This has helped to raise compliance in the office supplies category, for example, from 40 per cent to 85-90 per cent, he notes.
In a fast-moving business like Avaya's, the adaptability of its BPO partner has been particularly important, Siciliano explains. And although the services it provides are likely to change as the capabilities of his in-house team develop, he believes there will always be a place for some form of procurement outsourcing because of the expertise it brings.
"If you hang around a bunch of home-run hitters, you'll start hitting home runs," he says.
Case study 2:
Asia's enduring model
E-marketplaces may have gone out of fashion in the West, but as a means of outsourcing indirect procurement they are alive and well in parts of Asia. In South Korea, for instance, marketplaces linked to big business groups such as Samsung, LG and the steel maker Posco compete to provide end-to-end ordering and delivery services.
Originally set up by 10 of Samsung's companies in 2000, iMarketKorea now manages $1 billion of MRO spend and $1.2 billion of construction materials spend annually - a fifth of it for other large groups such as Hanwha and Daelim, says Man-Young Hyun, its Seoul-based CEO and president. Its online catalogues feature 400,000 items from 1,200 suppliers and it processes 5,000 purchase orders a day, all of which are fully electronic.
Hyun describes the marketplace model as "a shared service that each company can use to get economies of scale". Its enduring appeal in his country owes much, he says, to a sophisticated IT and telecommunications infrastructure and the fact that there is a yawning gulf between huge conglomerates at one end of the corporate spectrum and a plethora of small "mom-and-pop shop" distributors at the other.
Like other varieties of procurement outsourcing, Asia's e-marketplaces are still in the early adopter phase, Hyun notes. That means plenty of room for growth, not only among domestic companies but also among Japanese and Western manufacturers with operations in the region. Another future customer could be South Korea's government, which is currently talking about using one of the existing private-sector marketplaces rather than setting up its own, he says.
Further reading
John Blascovich, Joseph Carter, William Markham, Robert Monczka and Thomas Slaight, Outsourcing Strategically for Sustainable Competitive Advantage (CAPS Research/AT Kearney, 2005), pp43-45 and pp59-68
Understanding Misunderstanding: investing in successful outsourcing relationships (PA Consulting Group, 2006)
Geraint John ( geraint.john@cpoagenda.com ) is editor of CPO Agenda and editor-in-chief of Supply Management
