Top 10 best practices in procurement outsourcing

2012 AN EVEREST GROUP REPORT

Top 10 Best Practices in Procurement
Outsourcing (PO)

research.everestgrp.com Copyright © 2012, Everest Global, Inc. All rights reserved.

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TOP 10 BEST PRACTICES IN PROCUREmENT OUTSOURCING (PO)

Introduction

After witnessing a vacillating adoption for over a decade, the Procurement
Outsourcing (PO) market is finally coming of age with steadily increasing
adoption in the last few years. Years 2010-2011 were the best ever years for
PO with 50 or more new contract signings in each year. The multi-process PO1
market has reached a critical mass of over 300 contracts and service providers
are managing over US$190 billion for their clients.

The cost base for PO is fundamentally different and significantly larger than
other BPO segments. Unlike other BPO segments, PO engagements impact the
procurement spend, not just the operational costs. As a result, the potential
bottom-line impact that PO can create is high. This large cost base makes the
PO value proposition attractive but it also makes realization of value complex.

The objective of this research is to describe the top ten best practices in PO that
will help current and prospective PO buyers realize value from their PO
engagements.

This study was funded by (www.gep.com)

1 PO contracts with a minimum of three procurement processes, over US$1 million in Annualized Contract Value (ACV),
and a minimum contract term of three years. Typically, managed spend is greater than US$50 million.

research.everestgrp.com 2

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What is Procurement Outsourcing (PO)?

PO refers to the transfer of ownership of some, or all, procurement processes
or functions to a service provider. The scope of PO is typically defined across
two dimensions:

1. The process scope for PO covers the end-to-end, Source-to-Pay (S2P)
process that comprises Source-to-Contract (S2C) process and transactional
Procure-to-Pay (P2P) process as illustrated in Exhibit 1.

EXHIBIT 1 Procurement pyramid (non-core spend)

PO process scope

S2P strategy

1. Spend data mgmt.
Source: Everest Group ing
rc
2. Strategic sourcing

So (S
u
So

ur 2P
ce
3. Vendor management

-to )
-P
4. Demand management

a
ay

y
2 P -P
(P e-to

5. Day-to-day purchasing
)
r
cu

6. Performance management
o
Pr

7. Accounts payable

8. Procurement systems

2. The second dimension of PO is the category scope. This includes the
various spend categories such as, IT/telecom, marketing and sales, facilities,
office supplies, travel, logistics, contract labor, and maintenance, repair and
overhaul (MRO).

Beyond the process and category scope, a PO relationship is also defined by
the geographic scope and the value of procurement spend, that the service
provider will be responsible for managing, on behalf of the client.


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PO Adoption and Value Proposition

The cost base for PO is fundamentally different and significantly larger than
most other BPO segments, as PO impacts the procurement spend in addition to
the operational costs that are addressed by most BPO segments. Everest Group
estimates that a PO engagement spanning the entire S2P process can address
a cost base that could represent 5-15 percent of an organization’s overall
revenues. This is significantly larger than the operational costs addressed by
most other BPO segments (typically less than 1 percent of the overall revenues).
As a result, the potential bottom-line impact that PO can create is higher.
Everest Group’s benchmarking of PO contracts reveals that, on an average,
organizations that outsourced procurement realized 5-10 percent savings on
their outsourced procurement spend. Most of the PO engagements are at a
minimum self funded with a potential of high ROI’s in the initial years of the
engagement. This translates into a rapid pay-back period of around 1 to 2
years. However, the value in PO is predominantly driven by unit price reduction,
demand management, and supplier/price compliance. These are complex
value creation levers and require all stakeholders across the buyer and service
provider to work collaboratively.

The large value potential, coupled with a complex road to value realization,
has been the key reason for procurement to lag behind some of the other BPO
market segments such as Finance and Accounting Outsourcing (FAO) in terms
of adoption. However, after witnessing vacillating adoption for over a decade,
the PO market is finally coming of age with a steadily increasing adoption in
the last few years. Years 2010-2011 were the best ever years for PO with 50 or
more new contract signings in each year (Exhibit 2). The multi-process PO
market has reached a critical mass of over 300 contracts and service providers
are managing over US$190 billion for their clients.

EXHIBIT 2 Snapshot of new multi-process PO contracts over time
Number of new contracts

Snapshot of new multi-process 57
50
PO contracts over time 45
39 41
35

Source: Everest Group
18 16

7 8

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

As the PO market matures and more buyers consider PO as a viable model to
optimize their procurement spend, the following top ten practices distill the best
practices based on buyer and service provider experiences that should be
considered, in order to realize the significant value that PO promises.


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Top Ten Best Practices in PO

Following are the most important best practices in PO to ensure that the
significant value proposition offered by PO can be realized in practice:

1. Focus on the end-to-end S2P process

PO contracts have typically been either focused on a few activities within
operational P2P or within sourcing and category management (S2C). Fewer PO
contracts take an end-to-end S2P approach. However, the synergies between
these two core procurement processes are significant. P2P-focused contracts
deliver operational efficiency while S2C-focused contracts are able to deliver
unit-price reduction. However, the lack of integration between upstream and
downstream processes more often than not results in significant savings
leakage. For example, non-compliance in the P2P process erodes the value
generated in the S2C process (Exhibit 3).

EXHIBIT 3 Value erosion in a procurement organization
Percentage
Spend baseline
Value erosion in PO
Savings profile (actual) Realized value
Indexed annualized

Source: Everest Group Value erosion
spend

Savings profile (potential)

Year 1 Life of contract (years) Year 5

2. Involve the CFO in addition to the CPO

In order to ensure the targeted savings are fully realized, there must be a tight
linkage between sourcing and finance teams to ensure that contracted savings
get driven to the bottom line by adjusting budgets. Without this close
partnership, sourcing savings are not fully realized, as budget holders most
often spend these savings and consume their full budgets, rather than finance
selectively reinvesting these savings where they can have the greatest impact on
shareholder returns.

Additionally, FAO and PO have a clear overlap around the Accounts Payable
(AP) function (Exhibit 4). PO is heavily dependent on efficiency and compliance
in the AP process in order to derive savings. Significant value created in a PO
engagement can be eroded by maverick spend with non preferred suppliers,
duplicate payments, and poor working capital management. Hence, it is critical
to have finance involved in the PO initiative right from the beginning, along
with sourcing and procurement, in order to ensure smooth hand-offs across the
two functions.


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EXHIBIT 4 Finance & Accounting Procurement of non-core spend

Overlap between FAO and PO
F&A S2P
around AP
strategy strategy
Internal audit Spend data mgmt.
Budget/forecasting
Capital budgeting Strategic sourcing
Treasury & risk management Vendor management
Management reporting & analysis
Regulatory reporting & compliance Demand management
Fixed assets Day-to-day purchasing
Payroll
General accounting Performance management
Accounts receivable Accounts
Tax payable Procurement systems

CFO level involvement can often help accelerate and increase savings,
particularly within areas of the business where procurement has not traditionally
been heavily involved, such as marketing and legal functions. CFOs can be
particularly influential here in brokering these partnerships and ensuring that the
domain expertise of the service provider is fully leveraged so that all high spend
areas are well managed and supported by procurement. Lastly, additional
benefits to finance from active involvement with procurement include improved
information and data, as finance is dependent on inputs from procurement.
More streamlined and integrated processes and data can help reduce the
processing time and effort of the finance function that can lead to savings from
AP headcount reduction.

3. Classify spend as core versus non-core and not just direct versus
indirect

There are multiple nomenclatures to classify procurement spend. The most
common has been the differentiation of procurement spend into direct versus
indirect spend, with the premise that PO typically applies to indirect spend,
while direct spend is strategic and hence needs to be managed internally.
However, with maturity of the PO market, and the need to drive bottom-line
impact in a difficult economic scenario, PO is encroaching on traditional direct
spend areas through P2P outsourcing, tail-spend management and specific
categories such as packaging, bundled services, and MRO. Also, while the
classification of direct verus indirect spend makes sense in a manufacturing set-
up, it has less relevance to service-oriented sectors such as telecom, hospitality,
and financial services.

In the current scenario, where service-oriented sectors are also leading
adopters of PO, it makes more sense to classify spend as core versus non-core
rather than direct versus indirect. All spend that can be outsourced, including
all indirect categories and non-core direct categories such as MRO, can be
classified as non-core spend (Exhibit 5).


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EXHIBIT 5 Prevalence of third-
Source-to-pay cycle  party outsourcing
Low prevalence of
PO category scope Sourcing and vendor
 third-party outsourcing
Procure-to-pay
performance management


Direct
Core
spend  
spend
Non-core
direct
spend  
Indirect
spend
Non-core
spend  

4. Build a long-term vision but adopt a phased approach to manage
risk

As discussed earlier, the PO value proposition is fairly complex, and hence
buyers need to take a phased approach to manage risk. However, it is equally
important to have a long-term vision and not focus on short-term benefits that
can erode with time or lead to severely limited options in the future, when the
client has a clear need to expand the PO scope. It is fine to start the
engagement with just parts of the P2P or S2C function or with certain
categories, in order to build trust and create a comfortable working relationship
between the buyer and service provider. However, the buyers need to have a
long-term vision of how to develop a scalable model for the entire S2P cycle
covering all non-core categories. Buyers need to have a strategic vision on
centralization, adoption of sourcing models, technology and process
transformation, and organizational changes to create an integrated and
streamlined S2P cycle.

5. The three value drivers for PO are spend reduction, compliance,
and operational efficiency – in that order

Unit price reduction drives the largest quantum of value in a PO engagement,
followed by spend compliance and operational efficiency (Exhibit 6). Unit price
reduction which includes savings derived from the S2C process through
competitive bidding, global sourcing, contract negotiation, supplier
consolidation, demand management, and SKU rationalization accounts for 40-
60 percent of savings in PO. However, an aspect that most buyers fail to grasp
is the importance of spend compliance. Compliance drives another 30-50
percent of realized savings. A strong governance structure with equal
participation from the buyer and service provider needs to be put in place to
promote compliance and prevent savings leakage through maverick spending,
budgetary and demand issues, and vendor non-compliance. Operational


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efficiency savings are driven by more standardized and rationalized processes
accounting for reduced time and effort leading to savings through headcount
rationalization and labor arbitrage and operational benefits like reduced
duplicate payments, early payment discount (EPD) capture, and working capital
improvements.

EXHIBIT 6 Value levers for driving realized PO savings
Percentage
100
Value levers for driving realized 10
PO savings

End-to-end S2P
30-50
40-60


Spend-unit Compliance Operating Total
reduction efficiency

6. Build a win-win partnership by providing the service provider
some skin-in-the-game

There are multiple pricing models at play in PO. While managed service fee
(MSF) is the predominant model in PO, gainsharing has also been gaining
traction. While stand-alone gainsharing contracts are rare, hybrid pricing
models involving a combination of gainsharing with managed service fee are
being utilized, as illustrated in Exhibit 7, to create the right combination of risk
and reward for the service provider. A purely managed services fee contract
does not incent the service provider to deliver additional savings, while a pure
gainsharing contract shifts the risk entirely to the service provider, thereby
increasing their reluctance to make upfront investments in delivering savings.
The combination of managed service fee and gainsharing can ensure that the
service provider costs are covered by the managed service fee, while the
gainsharing component can reward the service provider for achieving results.

EXHIBIT 7 Distribution of pricing models in PO contracts
Number of contracts

Distribution of pricing models in 100% = 290

PO
Only managed
36% service fee
Hybrid pricing 46%


3%
15% Only gainsharing
Only FTE-based

The buyer also needs to play a supportive role in PO engagements that have a
gainsharing component. Buyers need to be wary of succumbing to the practice
of not cooperating with the service provider in the scenario where they believe


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that a large gainsharing fee would have to be paid to the service provider due
to significant savings being achieved. In the longterm such practices will prove
detrimental due to the loss of trust between the buyer and the service provider
and ultimately reduce the overall savings impact that can be achieved.

7. Define the contract to drive the right behavior from all
stakeholders

While there is an increasing awareness of performance metrics and SLAs in PO,
there still exist gaps in selecting the right metrics based on the processes being
monitored. Ideally, the buyer should opt for outcome- / output-based SLAs,
such as vendor rationalization, unit price reduction, EPD captured, and working
capital improvement.

There is a need to take a balanced scorecard approach focusing on a few key
outcome- / output-based parameters for each process rather than focusing on
a laundry list of input-based parameters that do not really measure the actual
benefits from the engagement. Having too many metrics not only diverts the
effort involved in measurement and reporting, but also promotes non-
productive behavior to ensure compliance with metrics that may not necessarily
drive value for the buyer. For example, metrics focused strictly on cost savings
may disincentivize service providers from contributing fully to categories, where
prices are clearly rising, such as in healthcare insurance. Service providers
could help the client avoid significant price hikes (cost avoidance) but if metrics
are focused only on unit cost reduction then these valuable efforts are not duly
rewarded. Some clients may focus heavily on metrics that are easily measured
such as turn-around time. However, unless speed is an absolute priority for the
firm, it may be far more valuable to take an additional week or two to achieve
exceptional sourcing results in a complex project than to quickly wrap-up the
deal to meet an artificial deadline.

As part of the contract, buyers and service providers need to create a clear
responsibility matrix to attribute factors leading to savings to ensure that there is
no confusion later, as to what portion of the benefits-accrued needs to be
attributed to buyer-owned programs versus service provider-owned programs.

8. Measure realized savings and not just contracted savings

There are multiple definitions of savings in a PO contract, based on the process
stage at which the savings are calculated.

 Identified savings. Savings potential based on an analysis of the existing
spend base leveraging service provider’s benchmarks, industry best-
practices, market intelligence, and category experience. However, the
service provider is not responsible for actually delivering these savings and
the client is not obligated to select these suppliers that provide the lowest
identified rates.


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 Contracted savings. Savings measured after the strategic sourcing initiative
as the price differential between new or renegotiated contracts and the old
contracts over the volume of the category purchased. This method is easy to
measure and an important metric to indicate procurement value in the
sourcing process. However contracted savings is not very accurate and
sufficient by itself to measure the true value delivered to the client, as actual
purchases may not always be as per contracts, and there are many sources
of savings leakage.

 Realized savings. Beyond the spend analysis and strategic sourcing, the
service provider is held accountable for actually realizing the savings by
ensuring compliance during the P2P process, analyzing the spend profile
with contracted suppliers and monitoring the contracted unit prices.

Realized savings is the most holistic approach to measure true savings
achieved. However, this requires investment in technology and process
innovation to be able to track and measure the realized savings accurately. In a
manual process the task of calculating accurate realized savings can be
extremely time-and-effort intensive. There exists a time-lag of up to 12 months
between measuring contracted savings and realized savings. Hence it is
important that the buyer and service provider take this into account while
creating the payment schedule. The realized savings may also get eroded
entirely, based on buyer business decisions outside the control of the service
provider. Also the PO engagement would require inclusion of the entire S2P
cycle in order to hold the service provider accountable for realized savings. As
a result, the buyer and service provider need to take a practical and balanced
approach by using a mix of contracted and realized savings in measuring
performance.

9. Domain expertise is the key but also leverage global sourcing and
technology effectively

It is well known that category or domain expertise is a key value driver in PO,
and it is important to select service providers based on their domain expertise
with respect to the buyer’s categories and processes being considered as part
of the PO engagement.

However, an often ignored element is the role of global sourcing and
technology in successful PO engagements.

While it is true that the level of global sourcing in PO is limited compared to
other BPO segments such as FAO, there is still significant value to be derived
from leveraging a strong global sourcing model. There are various elements in
the S2C function, such as spend analysis, and RFP analysis in strategic
sourcing, and demand management analytics, which can be driven from low-
cost offshore locations. Low Cost Country Sourcing (LCCS) offers strong unit
price reduction capability for certain spend categories. Most of the P2P


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processes can be completely delivered from offshore locations to reduce the
overall cost of operations.

Buyers typically under-invest in their procurement technology especially around
indirect / non-core spend. Many of the best practices that we have already
discussed around global sourcing, leveraging gainsharing, measuring realized
savings, using outcome- / output-based metrics, and increased compliance
require a strong technology support. This is an area where the buyer can utilize
add-on tools and technology platforms offered by the service provider to
achieve value, without making significant upfront capital investments.

Today’s cloud-based eProcurement tools combined with the service and support
synergies provided by the service provider make the value proposition for
investing in these tools far more attractive now than just a few years ago when
heavy training and implementation efforts made them more cost prohibitive.

10. Success is a function of change management effectiveness

In a recently concluded study by Everest Group, focus on change management
was identified in the top three most important management practices to achieve
best-in-class performance in BPO engagements with procurement in-scope. 77
percent of best-in-class BPO engagements were able to successfully implement
change management plans compared to 34 percent of normal BPO
engagements with procurement in-scope (Exhibit 8).

EXHIBIT 8 Able to successfully execute change
management plans
Number of respondents
Ability to successfully execute
100% = 16 12
change management plans
Disagree 6%
17%

Neutral 50%

83%

Agree 44%

Normal Best-in-class

Ultimately, the implementation of a successful PO engagement comes down to
the buyer’s and service provider’s capability in change management. This
requires strong cooperation between the stakeholders and support from the
buyer’s top leadership to ensure that the complex value proposition of PO can
be realized.


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The main change management challenges (and thus skills required) are:
 Communicating the strategic aims and specific changes of the PO project
 Training all affected stakeholders in the new processes and working
environment
 Up-skilling procurement teams to provide more strategic support to their
clients now, that non-core activities are not on their plate (just taking work
off their plate does not mean that strategic work will follow)
 Persuading non-cooperative client business units of the benefits of the PO
program to encourage adoption and avoid value leakage
 Enforcing new procurement policies and processes aimed at compliance
(often within a non-mandate culture)

Service providers require skilled change management and communication
practitioners who can assess the business readiness for change, anticipate
areas of concern, and build change management plans that are carefully
integrated with the overall implementation program such that stakeholders are
engaged, involved, and encouraged to participate at key steps along the
journey. A typical S2P PO assignment that introduces new best practices in the
sourcing, PO processing, and vendor management processes will require
strong engagement with hundreds or thousands of stakeholders who are
engaged in some degree to these processes. Without careful engagement the
risks of both value leakage and, even worse, service disruption are significant.

Conclusion

The ten best practices listed below are what we believe to be the most
important in delivering value in a PO engagement.
1. Focus on the end-to-end S2P process
2. Involve the CFO in addition to the CPO
3. Classify spend as core versus non-core and not just direct versus indirect
4. Build a long-term vision but adopt a phased approach to manage risk
5. The three value drivers for PO are spend reduction, compliance, and
operational efficiency – in that order
6. Build a win-win partnership by providing the service provider some skin-in-
the-game
7. Define the contract to drive the right behavior from all stakeholders
8. Measure realized savings and not just contracted savings
9. Domain expertise is the key but also leverage global sourcing and
technology effectively
10. Success is a function of change management effectiveness

Beyond these, there are several generic BPO practices that would also apply to
PO. However, PO with its unique value proposition among BPO segments
requires buyers to focus on these PO-specific practices to drive value and
achieve the significant benefits that PO engagements have to offer.


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About Everest Group

Everest Group is an advisor to business leaders on next generation global
services with a worldwide reputation for helping Global 1000 firms dramatically
improve their performance by optimizing their back- and middle-office business
services. With a fact-based approach driving outcomes, Everest Group counsels
organizations with complex challenges related to the use and delivery of global
services in their pursuits to balance short-term needs with long-term goals.
Through its practical consulting, original research and industry resource
services, Everest Group helps clients maximize value from delivery strategies,
talent and sourcing models, technologies and management approaches.
Established in 1991, Everest Group serves users of global services, providers of
services, country organizations, and private equity firms, in six continents across
all industry categories. For more information, please visit www.everestgrp.com
and research.everestgrp.com.

About GEP

New Jersey-based GEP is a leading provider of procurement consulting,
procurement outsourcing and procurement technology solutions, dedicated to
realizing significant savings from procurement operations for its clients. Named
a category leader in procurement outsourcing by the Black Book of
Outsourcing and to the Supply & Demand Chain Executive 100 for six
consecutive years, GEP is also ranked as one of the Fastest Growing
Technology Companies in Deloitte's Technology Fast 50. The company employs
more than 800 people with offices and operations in North and South America,
Europe and Asia. To learn more, please visit www.gep.com.

For more information about Everest Group, please contact:
+1-214-451-3110
info@everestgrp.com


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