Procurement Outsourcing: The Complete Guide

Before outsourcing strategic supplies, businesses should carefully analyze the real added value generators and the long-term benefits of using a third-party service.

The rise of business process outsourcing has transformed the structure of many industries over the past two decades.

Businesses now regularly entrust strategic activities, processes or operations to specialized companies.

The outsourcing industry, in turn, has evolved to offer an ever wider range of services, including many strategically important services such as manufacturing or research and development.

In the area of procurement, the outsourcing process has followed the same trajectory, but at a slightly slower pace.

Purchasing outsourcing Transactional transactions, such as order processing or invoice management, is now relatively common.

Especially for non-strategic Class C purchases where the advantage is immediately perceived in terms of time saved and therefore money.

Watch our video on outsourcing Class C Procurement for a complete overview of the content of this approach.

It is only in the last ten years, however, that strategic procurement outsourcing, such as supplier selection, contract negotiation, or specification management, has become widespread.

Suppliers say that outsourcing these activities offers their customers a multitude of advantages.

By aggregating demand from multiple customers, they aim to get lower prices.

In addition, large layouts in profitable locations help them reduce the cost of carrying out time-consuming activities like evaluating suppliers or processing tenders.

At this scale, suppliers can also allow their customers to access greater expertise, especially in categories where low expenses make it difficult for customers to maintain the right expertise in these supplies in-house.

Finally, the outsourcing of more or less important categories to a procurement outsourcing company gives buyers more time internally to focus on optimizing the supply of strategic products.

Some organizations have successfully outsourced part or all of their strategic purchases.

Such is the case of this European public body, which has delegated its entire Purchasing function to a procurement outsourcing company for a contractual term of five years.

The supplier involved was able to apply proven business levers as part of its strategic procurement activities — such as group purchasing, introducing new suppliers, and renegotiating with existing suppliers — and was also able to use low-cost processing operations to save on transaction activities.

These changes helped the company reduce overall operating costs by 19% and improve customer service.

However, outsourcing your purchases is not always satisfactory.

A major mining company signed a contract with a procurement outsourcing provider in which the supplier received a percentage of the value per transaction that it managed.

In the end, this arrangement did little to encourage the supplier to reduce its purchasing expenses and the company saved much less than expected.

In another case, a major electricity distributor decided to cancel its decision to outsource purchases due to frustration with its supplier's poor cost control and lack of focus on potential savings.

The company therefore set up an internal purchasing center, using recognized methods, and was able to achieve average savings of almost a third in the first three main categories it targeted.

This company was not the only one to reverse its decision to outsource strategic procurement.

A European bank did exactly the same thing after a multi-million euro agreement with a procurement outsourcing company failed to achieve the desired savings and assume the service it promised.

Another major manufacturer stopped its relationship with a major procurement outsourcing provider because the company was unable to influence its internal user base to connect to the dedicated tool, which ultimately resulted in a poor track record.

We believe that the failure of many procurement outsourcing contracts is from the start in the clauses of these agreements.

A lack of understanding of the underlying drivers of what adds value in the categories they outsource leads businesses to choose the wrong partners, outsource the wrong activities, and accept the wrong rewards that should normally ensure a sustainable economy over the long term.

To successfully outsource strategic procurement, businesses need to adopt a highly systematic approach with three basic steps:

• Outsource strategic procurement only in categories where it offers specific value.

• Have a precise understanding of the sources of this value and how to unlock them.

• Choose procurement outsourcing partners who have the capabilities to address these sources of value, as well as define and implement agreements that maximize the chances of achieving potential savings.

Choosing the right categories

The decision to outsource strategic purchasing in a particular category or not requires the same thought and analysis as any other decision in the business.

What is the strategic importance of the category?

Some categories can be a distinctive source of competitive advantage for the company, or of such importance in terms of quality requirements that subcontracting them would create unacceptable risks for the company.

Can the business effectively manage the category internally?

A company's ability to capture the maximum possible value in a category depends on a multitude of factors, including the size and complexity of the procurement market, the relative influence of the organization in that market, the existence of appropriate internal expertise, and the availability of sufficient capacity to manage the procurement process.

In the case of non-critical categories, businesses need to consider whether another organization might be in a better position to manage that category.

In general, procurement outsourcing is therefore a more attractive option for categories where businesses spend less or buy less frequently, or when they lack the skills or resources to do a good job internally.

In undertaking this analysis, businesses should consider the medium and long-term implications of their decisions as well as the short-term effects.

For example, a recognized agri-food company has deliberately kept the management of a number of non-essential categories in-house.

She used these categories to train junior members of the procurement function, thus helping to ensure succession within the organization.

Where is the value?

Once an organization has established a shortlist of potential outsourcing categories, it needs to determine if it's worth the effort.

To do so, she needs to understand exactly how outsourcing these purchases can provide value in a given category and then choose the right supplier and the right deal that captures that value.

The value drivers available to strategic buyers, whether internal or outsourced, fall into four main categories.

• Volume aggregation: By grouping requests from multiple customers, outsourcing providers can often negotiate better prices, especially in areas where the company's expenses are too low or infrequent to give it a strong market position. However, to capture the benefits of volume aggregation, businesses must ensure that their own specifications and delivery requirements are sufficiently similar to those of the supplier's other customers involved, and that they are willing to accept the benefits of volume aggregation, businesses must ensure that their own specifications and delivery requirements are sufficiently similar to those of the supplier's other customers involved. supplier procurement decisions, for example when making the transition to lower-cost suppliers.It should also be checked whether volume agreements still make sense. We have seen cases where small organizations obtained better prices than much larger businesses since, as niche players, they were not highlighted on the supplier's radar. By selling cheaper to these customers, the supplier would not endanger the overall market price levels, but would still capture additional volumes.

— Expertise: Their size allows some procurement outsourcing providers to offer in-depth expertise and real-time market information across a broad range of categories.

Access to cutting-edge expertise not only provides direct benefits in categories where businesses don't have their own expertise, it can also help them “learn from the best” and improve their own capabilities in other categories.

• Subcontracting abroad: Procurement outsourcing providers offer a combination of scale, standardized processes, and low-cost locations designed to reduce the labor cost of procurement activities.Although outsourcing abroad often offers significant advantages in transactional sourcing activities, the nature of strategic procurement can limit the savings achieved.Many strategic activities — from negotiations around specifications, to contract development, or to the management of procurement ongoing — require close cooperation and often physical proximity to the company's internal customer services. As a result, it is usually the lower-paid internal positions that are outsourced, and the savings are often offset by the increased management costs of the external provider.

Demand and specification management: In the most successful procurement organizations, 40 to 50% of total savings come from changes in internal factors, such as optimizing specifications to minimize total cost of acquisition or controlling demand.

These economies also tend to be the most sustainable in the long run.

Capturing the benefits of demand and specification management, however, requires close and ongoing collaboration between procurement and other departments in the business, which can be more challenging with an outsourced supplier.

The potential power of these various levers varies between organizations and categories.

It also varies over time. Commercial levers, such as volume aggregation, can often generate rapid savings.

On the other hand, if a procurement outsourcing contract is unable to target demand and specifications, the savings may flatten out over time.

This can lead to customer dissatisfaction and ultimately to the termination of agreements made for the outsourcing of purchases.

Businesses also need to make sure that outsourcing procurement is really the best way for them to access the overall advantage they're looking for.

For example, scale is only one factor in seeking price cuts. Many businesses are achieving significant savings through smarter negotiations that are of strategic importance to their suppliers.

Likewise, a business might be able to access attractive prices by joining a purchasing consortium, or by reducing labor costs by opening its own service center in a low-cost region.

Design and execute effective agreements

Once they know how outsourcing strategic procurement can create value, businesses need to take appropriate steps to analyze the results.

Ultimately, the success of any outsourcing arrangement is determined by the preparation and implementation of the underlying agreement.

This, in turn, depends on selecting a suitable supplier, establishing strong relationships between the supplier and the wider organization, and carefully managing the process once it is in progress.

To select the right partner, businesses need to carefully assess the market, including the vendor's experience, expertise, scale, and existing customer relationships.

Different actors in procurement outsourcing have very different value proposals.

Businesses also need to ensure that the geographic reach and culture of the supplier match their needs.

To establish an effective relationship between the supplier and the wider organization, the company must ensure that the proposed agreement meets internal requirements.

Resistance from management or business units can destroy an outsourcing agreement from the start.

Stakeholders across the business should be satisfied with the reasoning that supports the outsourcing effort, and, compliance with internal procurement policies should be applied.

Most businesses find it essential to appoint a procurement outsourcing manager to monitor supplier performance and resolve relationship challenges.

Businesses should also ensure that they treat their subcontractor as a strategic partner — clearly communicating strategic direction and giving the supplier sufficient control of categories and suppliers to work optimally.

Rewards are critical to maintaining the interests of the supplier and the business.

Strong agreements focus on measures that generate long-term savings, such as goals for continuous improvement.

The associated targets should be clearly defined and measurable, and the parties to the contract should understand the goals and expectations, but also know how everything is calculated.

Misaligned rewards can cause supplier relationships to fail by encouraging the procurement outsourcing provider to focus on quick wins or on the cheapest suppliers, for example, service and total cost of acquisition may be compromised.

Finally, businesses must carefully prepare for the transition and implementation phases of the agreement.

They should support the implementation with a strong internal team that can support users through the transition, address issues as they emerge, and guide the ongoing refinement and improvement of the relationship.

For example, a global telecommunications equipment supplier involved its stakeholders in the first pilot projects of a new outsourced electronic procurement system.

Customizing the system based on user feedback helped ensure high compliance when the system was finally deployed across the organization.

Outsourcing strategic procurement can give businesses access to expansion, expertise, and capabilities that they don't have in-house.

But it also comes with a significant risk. For these agreements to work, businesses need to ensure that the benefits offered by procurement outsourcing providers are clear and that the scope and rewards structure offered by the agreement are designed to capture long-term value.

If you want to know more about the ins and outs of procurement outsourcing, Buy Made Easy knows how to precisely study the key factors that will ensure the success of outsourcing your company's procurement in a professional manner.