The Procurement Outsourcing Imperative, Part II

Aberdeen's Tim Minahan addresses the "how" of sending procurement outside the four walls

Yesterday iSource Business reported on the new study by Tim A. Minahan, vice president and managing director for supply chain research at technology consultancy Aberdeen Group, suggesting that technology advances are driving enterprises toward procurement outsourcing. Today we look at Aberdeen Group's recommendations for getting started with procurement outsourcing.

Tempe, AZ  October 24, 2002  Companies considering outsourcing some portion of their procurement must evaluate their own internal process and expertise limitations and then select a procurement service provider that can "fill in the gaps" in their overall purchasing processes, according to a new white paper from Aberdeen Group.

As companies think about the "how" of procurement outsourcing, a first step is to consider what to outsource, recommends Aberdeen's Tim A. Minahan in his report, entitled "You Will Outsource Procurement: Here's Why and How."

Minahan casts the question of what to outsource as "a classic build-versus-buy decision," suggesting that companies first perform a gap analysis to determine which spend categories and purchasing process are  and should remain  "core" and which can be outsourced.

Such an analysis should take into consideration the strategic value of a good or service, a factor of the impact that it has on the company's ability to manufacture, deliver or differentiate its own products or services. "For a PC manufacturer, Intel's Pentium 4 microprocessor would likely have high strategic value because of its competitive processing speeds and its brand equity in the market," Minahan writes. "However, dynamic random-access memory (DRAM), a potentially large portion of total production spending, may have lower strategic value for the manufacturer because it is a commodity part that is currently in surplus."

Companies should also look at the degree to which they are leveraging their spend in a particular category across the entire enterprise. Writes Minahan: "A company's ability to leverage spend is based upon how much of total enterprise spending on a particular purchase category under contract and how many suppliers are used to support a particular category of spend. The less spending under contract and the more suppliers used for a particular category of spend usually indicate poor spend control." And categories exhibiting poor spend control, such as office supplies and maintenance, repair and operating (MRO) items, are likely to be good candidates for outsourced procurement.

That done, enterprises must assess their own ability and capacity to manage a given spend category, based on such factors as the amount of resources dedicated to manage a category compared to the total spend on that category, or the consistency and sophistication of the company's sourcing practices in place for a category. Comparisons against best-in-class procurement organizations can also be a useful guide.

Finally, companies must think about the cost of a given item and the transaction costs associated with the purchase of the item. Capital equipment may be costly, but the transaction costs are likely to be low when measured against the value of the equipment, while the opposite is typically the case for indirect materials. The former is therefore probably not a good candidate for outsourcing, while outsourcing could well be a viable option for indirect materials.

Once a company has figured out the best categories to outsource, the next step is finding an appropriate procurement service provider (PSP). Here, Minahan recommends considering the depth of a PSP's expertise in sourcing a particular category. An examination of the provider's sourcing, procurement and supply management process methodologies should ensure that they are compatible with the enterprise's own processes. Other factors to consider include the provider's technology, value-added services and support in regions where the enterprise has a presence. Customer references don't hurt, either.

Of course, even once a procurement outsourcing agreement is in place, the process doesn't stop there. "It is critical that supply management professionals understand that outsourcing the management of procurement activities does not relinquish them from responsibility," Minahan advises. "Successful outsourcing requires the enterprise to establish a relationship that provides visibility into procurement processes and spending and that has checks and balances for the outsourcer's performance." Properly managing the PSP relationship, including holding the provider to service level agreements, and managing the changes necessary within the enterprise are critical to continuous improvement in the enterprise's procurement organization.

And one final warning from Aberdeen: "To be clear, outsourcing should not be viewed merely as a way to divest of assets or reduce headcount. Such a narrow view of outsourcing can indeed deliver short-term results. However, this tactical approach to outsourcing has proven to be at high risk of long-term failure if the decision does not support future growth and direction of the business."