Should You Be Outsourcing More?
Over 10 years ago I tried outsourcing procurement of specialized parts and supplies. I figured a firm that focused on sourcing relatively esoteric commodities could do a better job than our skilled — but, by nature, generalist — purchasing specialists.
That little experiment didn’t go so well.
Today I know a number of companies who feel procurement outsourcing is a competitive advantage. To see what might have changed in the intervening years, I exchanged emails with Marie Meliksetian, the U.S. Country Manager and Managing Director of Xchanging Procurement Services, North America for Xchanging, Inc.
At one time, business process outsourcing (BPO) was considered almost a necessary evil. Companies outsourced non-strategic and transactional processes to developing countries that could provide low-cost labor. How has the development of technology and wage increases in countries like India impacted the BPO industry?
In the past three to five years, BPO has become a critical strategic component for businesses partially due to the global economic downturn that forced executives to rethink everything from operational strategy to risk mitigation. We are starting to see leaner, lighter-weight companies that focus on their core business and outsource whatever business processes they can in order to move from a traditional Capex approach to an Opex approach.
Today we see a continued appetite for outsourcing, not only of lower-end services but higher-end and complex services as well. The result is increased employment in countries such as India, Mexico and the Philippines, among others… which then has increased salaries, higher costs of living and real estate in those countries… and ultimately, outsourcing cost.
Companies are now looking for a lower cost of labor in emerging markets like Africa and Latin America. Some companies are reconsidering outsourcing to traditional countries such as India, and keeping some of their services in country because unemployment has created new lower cost opportunities through strong talent willing to take a wage cut.
Over the years, many companies looked into outsourcing and decided not to; or they engaged an outside firm and weren’t happy with the results. Has anything changed in the last five years or so that makes it more likely that outsourcing is a good idea… or maybe a necessary idea?
Overall, I think the industry has become more sophisticated in the services that can be delivered and more customer-friendly in the way that deals are structured. The old way of doing things was characterized by big, inflexible, labor-intensive deal structures that spanned up to 10 years. Now, the average contract length is down below five years, which is more palatable to the customer and comes with less risk. And through automation technologies, the work can be far less labor-intensive and cost effective for the customer.
The compensation model is changing as well from a fee-for-service model, which sees customers pay a fixed cost for a pre-defined scope of work, or a time and expenses model, to a consumption- or transaction-based model, where customers pay based on what is actually delivered. The latter is referred to as Business-Process-as-a-Service (BPaaS) and is made possible by new applications of technology to the business process service equation.
Instead of outsourcing just to get rid of a problematic process or because that process is not a core competency, companies are now outsourcing to improve processes and speed and generate meaningful cost savings and customer service impact. The value proposition has become much more compelling.
The benefits of outsourcing procurement are fairly obvious: Contacts, expertise… an overall skill set the average purchasing agent doesn’t tend to have, partly because many cover broad functional areas and tend to be generalists (at best). But are there other less obvious advantages? And are there pitfalls or hidden costs that companies new to the process should avoid?
Outsourcing procurement has grown across many U.S. and global companies because there are so many objectives and advantages when companies outsource their procurement services. Some of them include leveraging the knowledge, experience and scope of the outsourcing company; cost savings opportunities generated through various strategic sourcing projects and the buying leverage of an outsourcer; process improvement and other efficiencies; tapping advanced sourcing and procurement technology; and risk management.
Also, companies benefit from a greater focus on their core business competencies, typically sales and marketing.
There is also a distinction to highlight here concerning the location of Strategic Sourcing resources. These expert resources are often close to the client with specialized and country subject matter expertise. Close interaction with the client and trust based on local knowledge, language, experience and communication skills are critical to a successful Strategic Sourcing outsourcing.
It’s also important to note that outsourcing by itself, when viewed as simply shifting the responsibility to the outsourcing company, is not a sufficient approach to maximize benefits. Potential pitfalls that every company should address include change management; top-down support; strong buy-in from all stakeholders including finance and country leaders; compliance management by both the outsourcer and the outsourcing company in their respective roles; a comprehensive transition plan and a roadmap of how technology will be deployed to support the effort.
It’s a myth to think that outsourcing in the procurement area simply addresses cost savings. Outsourcing procurement should not only focus on cost advantages but also on long term transformation and continuous increase in efficiency and productivity. It’s a journey where the outsourcing company and the outsourcer must work through change, challenges and transformational activities as a single team to overcome obstacles and reach the highest level of success.
As with any customer/service provider relationship, procurement outsourcing is not immune to the danger of hidden cost, and the solution is a comprehensive statement of work with well-defined commercial principles and service-level agreements (SLA).
Companies looking to outsource can help themselves by looking for a less-complex pricing structure — potentially avoid multi-structure models or rate-card pricing — and consider something like a single-fee gainshare model.
Getting early wins is often the best way to gain broader acceptance of a new initiative like outsourcing. Which departments or functional areas tend to have the most low-hanging fruit, or are easiest to address?
You touch on an important point. As I mentioned earlier, change management can be a potential pitfall and one way to avoid it is to generate stakeholder acceptance by delivering successful outcomes early in the relationship. In the procurement outsourcing relationship that means seeking out opportunities in categories of spend that are more susceptible to higher savings and with stakeholder engagement that is easier to coordinate.
Starting with the former: Categories that are more susceptible to higher savings generally have more opportunity because they are in areas that are harder to coordinate. The lack of coordination is a missed opportunity. Examples that spring to mind include Facilities Management or MRO, where the buying community can be dispersed and fragmented. On the other hand, there are categories where there might be a single point of contact — Legal (the GC), Marketing (the CMO) or HR (the HRD) — making coordination easier, but there is less opportunity to drive savings.
Categories that are better to target for quick wins are areas like IT or travel, where there is some element of central coordination but also, from my experience, untapped savings potential.
In addition to considering the department or functional area, there are other factors to consider, like contracts that haven’t been competitively bid in three years or more, contracts that are expiring, contracts where incumbent renegotiation has not been prevalent, a situation where an immediate business need exists…
The most critical aspect for quick wins, however, remains in categories where the company is able to quickly realize the savings against the negotiated contracts. In other words, buying and generating spend against those contracts becomes critical to realizing the savings. Categories with faster compliance opportunities are the best candidates. Those categories often differ from one company to another and, at many times, are affected not simply by the spend volume but equally by the business units’ and stakeholders’ support to change and comply.
On the flip side, what do companies have to do to avoid outsourcing problems – not because of the provider but because of how the company approaches the engagement?
Here’s how to address the most important potential pitfalls:
- Assign a sponsor. Where there is lack of sponsorship and top-down mandate, outsourcing often undergoes challenges and risks to success.
- Develop an operating model and secure a retained organization. Both are critical to support the outsourcing relationship on an ongoing basis.
- Conduct a benefit interlock. It is critical to secure the buy-in from stakeholders and key players, including country leaders and business unit owners.
- Develop a change management plan and a transition/implementation roadmap. Assign individuals in support of both.
- Work as a single team. Lack of a collaborative and single team approach with each team focusing on their individual objectives and approaches can create controversies and conflicts of interest.
- Create flexibility and adaptability on both sides. The teams will often face unknowns, new situations, different information and data than what will be anticipated. Ensuring flexibility, adaptability and innovation are critical elements to gaining trust and success.
- Assign the right project owner for implementation. The success of an outsourcing relationship is often a by-product of the project managers on both sides. Their problem solving skills, client acumen and communication skills are critical to the success of the relationship and successful deliverables.
- Set up a solid governance model. Designing, setting, and managing strong governance allows pro-active management of potential issues and gaps through transition and implementation phases.
Tell me how companies tend to measure success from outsourcing procurement, and just as importantly, how you as the provider determine a successful engagement?
Generally, organizations measure success against defined SLAs, which might include performance against metrics like savings targets, customer satisfaction, turnaround time and timely reporting. A well-executed SLA — meaning defined, measured, proactively monitored and actionable — gives both parties [the customer and the service provider] visibility into performance. This approach fosters a collaborative relationship between both parties, which looks at addressing any gaps expeditiously and in support of mutual success, as compared to making the SLAs of the subject for finger pointing and an opportunity to penalize the outsourcing company.
A successful engagement is about a successful transformation of the procurement function to a best-in-class operation. There are a number of ways to define this end-state, including standardized methodologies and processes, technology as an enabling tool, strong business control and risk management, high spend under management and robust compliance management, among others.
On the softer side of transformation, success is when operational stakeholders throughout the business are able to identify the value of the procurement function and the part that the outsourcing provider plays in that success. Potentially more important is when the stakeholders and business owners identify the outsourcing company and its resources as part of their team.
Give me some examples of customers who have had great success with outsourcing procurement or other processes — maybe not just in terms of dollars, but improved quality, or materials/supplies/component flow, or improved efficiency…