How to Create Value Through Procurement Outsourcing

How to create value through procurement outsourcing
Supply Chain Digital March 2021
By Sean Galea-Pace

Outsourcing is an increasingly popular trend in procurement. But do the benefits outweigh the risks?

With keeping up with the latest trends of a fast-paced and constantly evolving market both difficult and expensive, many organizations are beginning to turn to outsourcing as a solution. This allows a company to spend more time adapting their operations for long-term change, while the outsourcing partner handles the non-core activities.

There are considerable benefits to outsourcing non-core activities, including:

  • Making more time for internal staff to focus on the business’s core activities.
  • Providing the ability to access expert, high quality services without the need for staff training and operating costs, investment in new technologies etc.
  • Allowing increased productivity and efficiency in outsourced activities.
  • Streamlining of operations.
  • Faster adaptation to change.
  • Decreased issues with team management.
  • Reduced overall operational costs.

In McKinsey’s article ‘Creating value through procurement outsourcing’, the evolution of outsourcing strategic procurement activities, such as supplier selection, contract negotiation or specification management, is shown to have become more widespread. To make strategic procurement outsourcing a success, McKinsey has highlighted three basic steps:

  1. Outsource strategic buying only in categories where doing so offers clear value.
  2. Have an exact understanding of the sources of that value and how to unlock them.
  3. Choose outsourcing partners that have the capabilities to address those sources of value, then define and implement agreements that maximize the chance of capturing potential savings.

What is outsourcing?

Outsourcing is the process of finding an external third-party supplier to take on the management and provision of a service. It is generally used for non-core activities and used when a business may not have the skills or the expertise in-house for a product or service, which is often linked with a lack of critical scale, or an in-house investment is needed which can’t be prioritized or may need to get something to market quickly. Outsourcing allows for scaling up or scaling down according to need.

Indirect outsourcing is goods and services a business needs to maintain and support its own operations. Direct outsourcing is for goods and services relating to the business product or service.

What is the value?

After an organization has created a shortlist of potential categories for outsourcing, it should decide whether it is necessary. In order to decide, organizations must know exactly how outsourcing can deliver value in a certain category and pick the right provider and deal to harness that value. According to McKinsey, the value levers available to strategic buyers – whether in-house or outsourced – fall into four core categories:

  • Volume aggregation

By bundling demands from multiple clients, outsourcing providers can often negotiate better prices, particularly in areas where the company’s own spend is too small or infrequent to give it a strong position in the market. To capture the benefits of volume aggregation, however, companies must ensure their own specifications and delivery requirements are sufficiently similar to those of the outsourcing provider’s other clients and that they are willing to accept the provider’s sourcing decisions, such as transitioning to lower cost suppliers.

  • Expertise

Their scale allows outsourcing providers to offer deep expertise and real-time market insights across a broad range of categories. Access to leading expertise doesn’t only provide direct benefits in categories where organizations don’t have their own expertise, it can also help them learn from the best and improve their own capabilities in other areas.

  • Labor arbitrage

Outsourcing providers offer a combination of scale, standardized processes and low-cost locations designed to decrease the labor cost of sourcing activities. With labor arbitrage often delivering significant benefits in transactional sourcing activities, however, the nature of strategic buying can limit the savings achieved.

  • Demand and specification management

In most successful purchasing organizations, 40-50% of the total savings achieved come from changes in internal factors, such as optimizing specifications to minimize total cost of ownership or controlling demand. Such savings also tend to be the most sustainable over the long-term. Capturing the benefits requires close and ongoing collaboration between the purchasing function and other parts of the business, which could be harder for an outsourced provider.

Iliana Filyanova, Partner for McKinsey’s Manufacturing & Supply Chain practice believes procurement outsourcing spans a range of activities, from strategic to transactional. “Strategic procurement includes Source-to-contract (S2C) activities from market analysis and category strategy development to strategic sourcing and contracting,” explains Filyanova. “Outsourcing of S2C can give companies access to expertise, capabilities, and scale they may not have in-house. Transactional procurement includes routine requisition-to-pay activities (R2P), such as purchase order creation and management, invoice payment, and vendor management. Outsourcing of transactional procurement has become quite common and can render higher process efficiency and compliance through standardization of processes, automation, and the availability of skilled workers.” However, despite procurement outsourcing being seen as an appealing option to many organizations, Filyanova is also mindful of the risks involved. “If companies do not appropriately define the scope and incentives of an outsourcing agreement, they risk losing value over the mid- and long term,” says Filyanova. “For example, if the provider focuses mainly on optimizing commercial levers – from whom to source, at what prices – and does not address demand and specification levers, 40-50% of the value may be lost. To effectively influence demand management levers – what and how much to buy – a provider will need to be able to manage change within an organization and have effective client relationships to influence specifications and consumption decisions. This often appears to be challenging for an outsider, resulting in quickly plateauing savings.”

Malcolm Harrison, CEO of CIPS Group, understands some of the challenges that come with procurement outsourcing. “Understanding the rationale behind what you’re trying to do is probably the most challenging part, but there’s plenty of other obstacles along the way,” explains Harrison. “It’s important to question whether there is sufficient expertise in-house, or additional budget available to bring in additional support or innovative thinking in a new project. Another challenge is ensuring that senior teams and the CEO are on board to ensure the project team can work cross-functionally with the outsourced resource efficiently and effectively, including strong communication links.

“Once a contract for an outsourced supply has been established then this contract has to be managed. Outsourcing often involves a contract for provision of a complex service and to manage this effectively a resource should be retained which understands the complexities of this service. Poor contract management as well as insufficient resources and poor data are frequently cited as reasons for outsourcing contracts not delivering the anticipated value.”

With the worldwide disruption of COVID-19 impacting businesses across the world, Nic Walden, Senior Director, Procurement Executive Advisory Membership Programs and Melani Flores, Associate Principal at The Hackett Group reflects on the impact to procurement in the immediate aftermath of the pandemic. “It’s clear that across different industries the impact is different, but the initial impact has been primarily operational,” explains Flores. “It’s been important to source new goods, such as PPE, to ensure that factories can continue to operate in safe conditions. This is in addition to responding to changes in demand and working with suppliers to look for substitutes for products or services that have been affected by the pandemic.” Walden believes that the COVID-19 pandemic is very different to the financial crisis of 2008. “Although it’s been a terrible crisis for everyone involved, procurement has actually benefited from COVID-19 and has been elevated to a more strategic role,” explains Walden. “However, it’s too early to say how much of an effect the pandemic will have on procurement outsourcing in the near future.”

CIPS – How to build supply chain resilience

– Prioritize high risk sources and do a deep dive into the implications for your business.

– Any businesses single-sourcing from one country need to investigate whether this is the safest strategy.

– Interrogate your supply chains beyond the first few tiers with a particular focus on identifying critical suppliers who may no longer be financially viable.

– Ensure you have real transparency of what is going on in your supply chains

– Evaluate the benefits of investing in systems which provide better data not just to improve efficiency and take faster decisions but also to give greater transparency.

– Use a mix of forecasting tools and develop relationships with suppliers ‘on the ground’.

– Look to form alliances even with competitors to reach a win-win situation for all.

– Ensure you have the necessary capabilities and train / develop your function to meet the increased business requirements.

With the future of the industry in mind, Harrison believes the supply chain must remain vigilant and build resilience to guard against a potential second wave of the coronavirus or any other pandemics over the coming years. “Shocks to supply chains do happen such as volcanoes and tsunamis, and skilled, up-to-date professionals know this. The pandemic may have been the most challenging of all, but risk has always been with us and trained professionals understand resilience is key to keeping organizations afloat,” affirms Harrison. “Any businesses single-sourcing from one country should be one of the first steps as so many were caught out when the virus first hit China.”