Recent cost increases are presenting a continuing and defining challenge for U.S. companies fighting to protect their margins without pushing price increases upon the consumer. But CEOs and other executives in senior management all too often focus on direct material costs and overlook the opportunities to be found in taking a total cost management approach to indirect costs, where dramatic savings often can still be realized.
For supply management professionals, of course, total cost management remains an exciting topic, and many are using a tool that has yet to be fully tapped: the group purchasing organization (GPO), also known as the consortium.
A Traditional Tool Gets More Attention
Group purchasing organizations have a legacy of serving industry micro-segments, and Jason Busch, managing director of consulting firm Azul Partners, points out that GPOs, at least in their current incarnation, have not been well known outside of the healthcare sector, a fact that has helped obscure their broader applicability. "When one hears the word ‘GPO,' it is easy to get the wrong impression," says Busch, who is also editor of the highly trafficked blog Spend Matters. "But modern GPOs can take on any form — industry-specific or not — and often go beyond just leveraging group buying power to drive negotiated prices. Many offer technology, reporting and other benefits to their participants as well."
GPOs also have suffered from the kind of high transaction costs and poor compliance that have plagued enterprise procurement organizations, according to Tim Minahan, former senior vice president of global supply management research for Boston-based Aberdeen and now senior vice president of marketing for supply management solution provider Procuri. "Of course, with multiple, disparate and often competing constituents, GPOs have had this problem in spades," says Minahan, who has tracked the GPO for several years.
Pierre Mitchell, research director for the business advisory firm Hackett Group, suggests that supply management professionals can also evaluate GPOs within the bigger landscape. Beyond the vertical or commodity-specific models and corporate-sponsored examples, organizations such as IBM, ICG Commerce, A.T. Kearney and others have made a GPO part of their supply management outsourcing offerings. "This becomes critical for the customer wanting a complete mix of options in his or her spend management goals," says Mitchell. He cautions that the aggregation component of outsourcing from such vendors has often been problematic and, in response, these vendors have downplayed their consortium efforts.
Busch believes that even for companies with world-class procurement capabilities, GPOs can play an important role for non-strategic or non-core categories where it does not make sense to develop expertise in-house, and where developing a custom outsourcing agreement is not necessary. "In fact," Busch says, "one might say that GPOs are a ‘stealth' outsourcing procurement play — and a model that can make more sense than a traditional outsourcing mode, depending on the buying organization's background and situation." Busch points to Corporate United and ICG Commerce as two proven GPOs with a track-record of cutting across industry and vertical segments.
David Clevenger, vice president with Corporate United, one of the largest U.S. group purchasing organizations, echoes Busch's statements. "This type of procurement is a hybrid outsourcing solution," Clevenger says. "Instead of outsourcing indirect procurement to one provider, consortium buying allows organizations to select specific categories to outsource." A horizontal, third-party provider of group purchasing, Corporate United currently provides 16 different indirect spend contracts to its 80-plus member base.
Quave Burton, principal with A.T. Kearney's buying consortium, called the Leveraged Sourcing Network (LSN), points to LSN members' interest in maximizing on the GPO opportunity by working with A.T. Kearney to identify additional categories to target for channeling through a GPO. "Oftentimes our members are challenged in this area," Burton says. "So a lot of our efforts are working with our members to help them ... gather, analyze and then identify opportunity to help them build the case for change." In addition to the more traditional "white-collar" categories offered by LSN — office supplies, temporary labor, office equipment and wireless — the latest LSN offering is focused on the maintenance, repair and operations (MRO) space (uniforms, safety equipment, electrical supplies, industrial supplies, lubricants, lab supplies and fasteners, among other items). They've chosen this area, says Burton, because traditional MRO categories represent the greatest challenge to most organizations.
Not Just the Tool, But the Greater Sophistication Behind Its Use
Professionals who are including group purchasing organizations in the mix of tools for their cost reduction strategies are taking a realistic, sophisticated approach to using GPOs. First, they don't surrender autonomy, nor are they backing off their involvement, to ensure continued aggregation and effectiveness of the contracts.
One example of this realistic approach: Syngenta. A global agribusiness and supplier of seeds and crop protection products, Syngenta has had great success in achieving indirect spend savings goals over the years. With $8 billion in sales last year, the 19,000-employee company continues to look for ways to drive out costs. As a member of Corporate United since 2003, Syngenta taps into CU's pharmacy benefit management contract, which has saved approximately 8 percent on the organization's pharmacy costs. Syngenta also uses Corporate United's safety supplies contract. Art Carter, purchasing manager in commercial services for Syngenta Crop Protection, says that a contract in a group purchasing situation must be "stronger than what the company can come up with itself and allow for the same level of supplier relationship involvement." Moreover, Carter says that GPO membership is just one component of Syngenta's overall spend management efforts. "Group buying is only a small part of our effort," he says.
Another strategic sourcing professional, who must remain anonymous due to corporate policy, believes the better GPOs increase return on investment (ROI) through increased knowledge and understanding of how certain commodity or spend areas work by collaborating with other companies with more experience in that commodity or spend area. "The fact that Corporate United forms committees staffed with sourcing professionals in certain commodity areas and allows members to participate gives me a brain trust I would not otherwise have," this professional says, adding, "There is expertise within GPOs on spend categories, marketplace status and sourcing strategy that supplements the expertise within the member base. This synergy optimizes the effort to get the best deal possible."
Using Corporate United's office products, copier and industrial supplies contracts, William J. Northup, C.P.M., director of sourcing for Hubbell Inc., says that the greatest return on the investment and effort of getting involved in a GPO is that his sourcing managers now can focus their time on more strategic assignments while retaining the value of the expertise (the outsourcing) on the supplier's pricing strategy with off-contract items — and keeping the pricing in line with expectations on lower overall spend. "For us, using a solid GPO has allowed us to eliminate the need to add in-house purchasing resources," says Northup. "We intend to expand the number of agreements and participate more actively on the teams working with the GPO developing and renewing the agreements."
Michelle Holliday-Levy, director of global procurement for Sigma-Aldrich has been a member of A.T. Kearney's LSN for more than three years. Sigma-Aldrich has engaged in several category spends through LSN, including PCs, temporary services and office supplies. "The reason you go into a consortium," says Holliday-Levy, "is they're doing all the work for you. The offering should be plug-and-play, especially for low-value, high-spend categories." The GPOs offering should include an implementation plan as well as a back-end audit to ensure suppliers are meeting what they said they would do, adds Holliday-Levy, who says Sigma-Aldrich has realized strong savings in most spend categories it has sent through LSN.
How to Get Out of the GPO What You Really Want, Besides Savings
While savings continue to be the major magnet for new members to a GPO, additional benefits cited by those interviewed for this article include speed to market, subject matter expertise, the ability of a new member to immediately join a consortium's master agreement, third-party management of the agreement, opportunities for customization and supplier relationships, and redirection of resources to more critical sourcing requirements.
"Never let GPOs be a distraction," says Hackett's Mitchell. "Stick to your knitting and make sure you are getting out of the GPOs the savings and time saved on contract management you expected. Savings is a good trigger for engaging a GPO, but not a panacea."
One way to make sure you succeed in getting everything you want out of your GPO is to see it as an extension of your commodity buying group, suggests Mitchell. "Someone on your team must proactively manage the GPO relationship as you would any other critical supplier relationship," he says.
Ron Watt, second vice president of Trustmark Insurances' Contract Management Office, has several suggestions on getting the most out of your GPO. "Relying on traditional business process management strategies, go into the effort with four key issues outlined," he says.
Watt's four keys are:
- Know what you want (objectives and deliverables);
- Define how you're going to measure success (performance measures);
- Build incentives for suppliers to deliver (penalties or "incentives"); and,
- Understand what your costs are up front and into the future.
Watt evaluated three group purchasing organizations before picking Corporate United for his company's office supplies contract. "They had better entry costs, allowing us to quickly realize savings. Plus, tapping into the expertise of member companies was a great benefit to us."
Knowing when to use GPOs in the mix of your cost reduction strategies is perhaps the most critical point from the analysts' perspective. Analysts Mitchell, Minahan and Busch reiterate that the GPO's best and most important role exists for non-strategic or non-core but high-cost categories. And, as noted earlier, the GPO must provide services and intelligence that can't be achieved in-house.
Hubbell's Northup gives a pragmatic user's view and highlights several ways a GPO can fit into an organization's strategy. "If an organization is decentralized and does not want to add headcount at the corporate level, a GPO provides an opportunity to leverage spend with minimal additional resource allocation," he says. "If an organization has a reasonable amount of spend in a commodity area, but not enough to fully leverage the spend on its own, the GPO provides the opportunity to combine this spend with similar spend from other companies. Finally, a centralized organization can focus on leveraging the areas of its spend that provide the greatest return and let a GPO handle the less strategic areas of spend."
Adds LSN's Burton: "GPOs are part of a comprehensive approach to managing an organization's indirect spend. Depending on the size, industry and strategic focus certain categories just make sense to let someone else manage. In addition, at the SKU level, group purchasing organizations deliver value through leveraged rates available to their members in categories that are not core to their business."
Corporate United's Clevenger cautions against forcing the GPO into a box and limiting its power. "It is true that matching a sourcing strategy to a category is the most important point when implementing a GPO solution," he says, "but that makes it no different from any sourcing solution. The value of GPOs goes beyond the non-strategic, non-core … high-cost categories. Companies that are utilizing GPOs to manage indirect spend are unlocking value in dozens of smaller-cost categories that have historically gone un-sourced and under-managed. Despite their size, in aggregate the savings [add up to] millions across the enterprise. Furthermore, the GPO is most valuable for its ability to proactively manage agreements, not just for the leverage they provide initially. A GPO that fails to deliver ongoing value is of little to no incremental improvement over managing the category internally."
What Will Be the GPO Future?
When reflecting on GPOs' impact and their role in the market, Tim Minahan gives an insightful overview. "The adoption of GPO services has been accelerated as enterprises look to focus on core competencies — including direct materials procurement — and are more open to outsourcing non-core competencies, such as indirect procurement, to third-parties that can offer greater economies of scale, better performance and improved pricing. In addition, GPOs and other outsourcers often are in a better position to drive compliance due to governance structures that involve C-level executives and business unit heads and that have measurable compliance goals, incentives and penalties attached to them."
Beyond member pricing, users of GPOs have contract category suggestions for the future. Carter, of Syngenta, says, "Group buying could be the most useful for us in the area of employee benefits. However, this is a newly emerging area for group purchasing organizations, and the current offerings are limited." Syngenta is interested in this area as they are a process manufacturing business and their employment level is relatively low compared to most companies with similar sales. As a result, their weakest "buying position" is in goods and services related to employment levels.
Holliday-Levy advocates the same. "I would like LSN to provide other categories for us to spend through, and they're looking at them right now — for example, security," she says. Her company's interest in the GPO was originally driven by Sigma-Aldrich's current chief financial officer, who was previously vice president of her department. "We got started with LSN on a reverse auction and were able to witness immediate cost savings. It made sense to take it the next step."
Hubbell's Northup also suggests GPOs provide more communication about new initiatives and obtain more frequent feedback from GPO members concerning supplier performance.
Several of those interviewed identified two major predictions for GPOs: GPOs eventually will need to leverage offshore outsourcing for non-core "req-to-pay" functions, including purchase order processing and accounts payable entry. Plus, GPOs must focus on value-added opportunities beyond leveraging spend.
All those interviewed indicated they intend to continue pursuing the opportunities of the GPO to retain sourcing staff attention on more strategic and core functions. "As long as we are being adequately serviced by the GPO, especially if it can offer additional value other than pure price advantage, we'll continue to use the tool," says the strategic sourcing professional who wished to remain anonymous.
Part of why GPOs are now thriving relates to supply management's status within companies trying to protect their margins. Those companies that have recognized the value of total cost management in the mix of overall competitive strategies will always elevate the supply management function. Hackett's Mitchell says world class supply management is inherently a business process outsourcing driver. And organizations like Accenture, Ariba, A.T. Kearney, and IBM have pushed business process outsourcing hard as part of their overall supply management marketing efforts.
Dan Willmer, vice president of Spend Management for Ariba describes a market that demands it. "Six years ago the market for reducing costs was all about auctions and catalog management. Now it's about a customer's true problems and how to protect margins and eliminate unacceptable costs. Spend management outsourcing is much more favorable while organizations keep their core competencies. They don't care to be great at everything they do, just great at what counts."
Celebrating its 10th anniversary, Ariba, which as part of its spend management solutions does consortium buying for its customers, positions itself in the market to make available expert spend management services married with today's technology. Willmer adds: "A variety of ways to save money exists. You just have to understand what you're investing in to help you become an expert spend manager. Today, it's not about one single solution."
Despite a marketplace facilitating greater opportunities for effective spend management, GPOs will always face resistance from entrenched organizations. "The greatest challenge for the group purchasing organization," says Syngenta's Carter, "involves moving the organization to the supplier that the group purchasing organization offers. There is always considerable internal resistance to changing suppliers. Often there are significant switching costs. In many areas, like advertising agency services, there may be competitive considerations to preclude a consortium opportunity, even if it were offered."
Mitchell sees a very interesting future for the GPO. He predicts that the mid-market will use GPOs more and that GPOs will tackle more and more strategic categories. "The more complex spend categories with rising costs are a perfect place for GPOs to harness. But one of the biggest problem GPOs face is that member customers' specific requirements are so different from member to member. However, technology can partially help with this because of some of the flexible e-sourcing tools out there that can model this type of complexity."
Like Corporate United, LSN continues to support its members, while continuing to grow the consortium membership by providing value to new members. And Burton confirms Mitchell's prediction and member desires that GPOs will tackle more and more strategic categories. "We are also interested in identifying ways and situations where we can potentially leverage aggregated spend in categories that we do not currently offer," Burton concludes.
SIDEBAR: How Big An Opportunity?
If you don't count the healthcare industry's GPO spend, analysts and industry experts suggest that the aggregated spend through today's procurement outsourcing (with GPOs being a subset of this spend) reaches as much as $556 million. "The numbers we're seeing for global market size from the different analyst groups for procurement outsourcing are from just under $300 million to $400 million for 2005 (Everest Group says $297 million and Nelson Hall says $340 million, while IDC has estimated $556 million), with growth numbers anywhere between 20 percent to 30 percent per year," says Henry Hwong, vice president of marketing for Provade, a provider of managed procurement solutions.
"For 2006, Nelson Hall estimates $420 million and Everest projects $380 million. Compared to other more mature areas of BPO (e.g., human resources and finance and accounting), the procurement outsourcing market is relatively small, but dynamic."
About the Author: Julie Murphree is the founding editor of Supply & Demand Chain Executive. She has written countless articles and spoken on such subjects as negotiations, business management issues, and supply and demand chain management. www.JulieMurphree.com.