2012 research report:top 10 best practices in procurement outsourcing

r e s e a r c h . e v e r e s t g r p . c o m Copyright © 2012, Everest Global, Inc. All rights reserved.

2012

Top 10 Best Practices in ProcurementOutsourcing (PO)

AN EVEREST GROUP REPORT

EGR-2012-1-R-0677

http://research.everestgrp.com

TOP 10 BEST PRACTICES IN PROCUREmENT OUTSOURCING (PO)

r e s e a r c h . e v e r e s t g r p . c o m 2

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.

EGR-2012-1-R-0677

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.

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




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.

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.

EGR-2012-1-R-0677

PO process scope

E X H I B I T 1

Source: Everest Group

Procurement pyramid (non-core spend)

S2P strategy

1. Spend data mgmt.

2. Strategic sourcing

3. Vendor management

4. Demand management

5. Day-to-day purchasing

6. Performance management

7. Accounts payable

8. Procurement systems

Pro

cure

-to-

Pay

(P2P

)

Sou

rcin

g

Source-to-P

ay

(S2P

)




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.

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.

EGR-2012-1-R-0677

Snapshot of new multi-process

PO contracts over time

E X H I B I T 2


Snapshot of new multi-process PO contracts over time

Number of new contracts

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

7 8

1816

3941

35

45

50

57




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).

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.

EGR-2012-1-R-0677

Value erosion in PO

E X H I B I T 3


Value erosion in a procurement organization

Percentage

Ind

ex

ed

an

nu

alize

d

sp

en

d

Spend baseline

Savings profile (potential)

Year 1 Year 5Life of contract (years)

Savings profile (actual) Realized value

Value erosion



EGR-2012-1-R-0677


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).

Overlap between FAO and PO

around AP

E X H I B I T 4


Procurement of non-core spend

S2P

strategy

Spend data mgmt.

Strategic sourcing

Vendor management

Demand management

Day-to-day purchasing

Performance management

Procurement systems

F&A

strategy

Finance & Accounting

Internal audit

Budget/forecasting

Capital budgeting

Treasury & risk management

Management reporting & analysis

Regulatory reporting & compliance

Fixed assets

Payroll

General accounting

Accounts receivable

Tax

Accounts

payable




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

EGR-2012-1-R-0677

PO category scope

E X H I B I T 5


Direct

spend

Core

spend

Non-core

direct

spend

Non-core

spendIndirect

spend

Sourcing and vendor

performance managementProcure-to-pay

Source-to-pay cycle

Prevalence of third-

party outsourcing

Low prevalence of

third-party outsourcing




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.

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.

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

EGR-2012-1-R-0677

Value levers for driving realized

PO savings

E X H I B I T 6


Value levers for driving realized PO savings

Percentage

Spend-unit

reduction

Compliance Operating

efficiency

Total

40-60

30-50

10

100

En

d-t

o-e

nd

S2

P

Distribution of pricing models in

PO

E X H I B I T 7


Distribution of pricing models in PO contracts

Number of contracts

46%

36%

15%

3%

100% = 290

Only managed

service fee

Only gainsharing

Only FTE-based

Hybrid pricing




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.

EGR-2012-1-R-0677



r e s e a r c h . e v e r e s t g r p . c o m 1 0

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

EGR-2012-1-R-0677




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).

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.

EGR-2012-1-R-0677

Ability to successfully execute

change management plans

E X H I B I T 8


Able to successfully execute change

management plans

Number of respondents

100% = 16 12

83%

44%

50%

17%6%Disagree

Neutral

Agree

Normal Best-in-class




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.

EGR-2012-1-R-0677




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.

EGR-2012-1-R-0677

For more information about Everest Group, please contact:

+1-214-451-3110

[email protected]



2012 research report:top 10 best practices in procurement outsourcing

Business