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April 2013 Tackling Trouble Areas

The Procurement Conflict

Weighing the importance of cost savings through outsourcing against the value a good or service provides.

April 05, 2013
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I can’t remember when a client didn’t want saving from their outsourcing event.

Sometimes, it was the primary — or, even the only — reason for outsourcing.

But, is the purchasing process keeping up with the evolution of emerging buying strategies?

A broad view of outsourcing commercial cleaning highlights a six trillion dollar international industry.

And, regardless of the target for outsourcing, there is an emerging trend recognizing that saving, at any cost, is a problem.

This is a maturing of the outsourcing model; an evolution that places value on the company-wide mission beyond silo savings.

Even within the department or business unit, managers are demanding quality, performance, innovation and support of company strategic goals as an integrated benefit from the outsourcing event.

The outsourcing question has grown from a discussion solely about cost savings to the idea of how outsourcing can support my performance goals and the strategic vision of a company for growth.

In short, market leaders have come to realize that the purpose of outsourcing is no longer a one-dimensional benefit; it’s no longer about reacting to external or internal drivers for savings, but embracing it to create a stronger competitive advantage, build improved customer satisfaction and make everyone in the outsourcing process look like a company hero.

Much of this won’t happen when the primary focus of outsourcing is about getting the lowest price that can be beaten out of contractors.

It’s About Savings And A Whole Lot More

“It’s more than just picking the most competitive bid among prospective suppliers,” says Kate Vitasek, a faculty member at the University of Tennessee's Center for Executive Education.

She bases her thinking on the work of Oliver E. Williamson, an American economist and Nobel Prize winner who pioneered a theory of transaction costs.

Williamson suggests that the best outsourcing approach for any company depends on, among other things, a business model that creates performance-based relationships and, ultimately, “vested outsourcing.”

Vitasek and Williamson are focused on the outcome of a sourcing arrangement, not just the up-front price.

Precise measurements are essential for closely tracking performance, with an eye toward ensuring quality and customer satisfaction.

“With value-based sourcing, the buyer and seller have a vested interest in each other’s success,” notes Vitasek.

This model was further advocated jointly by the University of Tennessee, the Sourcing Interest Group, International Association for Contract and Commercial Management and the Center for Outsourcing Research & Education.

They found that, the more critical products and services are, the better off one will be using a performance-based or vested outsourcing model.

David Horn of LCH.Clearnet Group Ltd., a multinational asset clearing house, suggests that focusing on spend alone is also a high-risk strategy.

“It may well be an important one, but it does need to work alongside a fuller risk assessment, asserts Horn. “It may not be a large dollar contract that has the biggest impact on a company’s success and competiveness; it may not be the largest of relationships that offer the biggest opportunities for innovation and gaining a competitive advantage.”

From a historical perspective, the idea of risk management has a fairly long track record.

For example, the Kraljic Portfolio Purchasing Model was created by Peter Kraljic, and it first appeared in the Harvard Business Review in 1983.

Despite its age, it’s an interesting and useful model for reducing risk and lowering costs by taking advantage of the scale of purchasing power.

In this way, procurement moves from being a transactional activity to a strategic activity.

Kraljic declares that, “Purchasing must become supply management.”

Kraljic’s model involves four steps:

  1. Purchase classification
  2. Market analysis
  3. Strategic positioning
  4. Action planning.

To clarify his model, Kraljic offer a two-be-two matrix to highlight the connection between profit impact and supply risk — or, savings and failure.  

He insists that purchasing should always be part of the broader corporate strategic, tactical and operational success strategies.

As a result, he notes that it’s important for purchasers to know how to evaluate risk and overall success by having a structured and insightful approach to the measurement of the product or service obtained through procurement.

Including industry experts becomes essential to achieve high performance and low risk.

The Portfolio Purchasing Model is one way for buyers to understand where the risk and profit or savings consequences might be found in the procurement strategy. 

Effectively Controlling The Risk

Other purchasing professionals also assess risk by searching for the most likely single point of failure (SPOF).

The SPOFconcept is described as a part of any system that, if it fails, will inhibit the entire system from delivering the results needed.

They are the greatest risk in any system that can only succeed because of an unfailing reliability of expected results.

By specifying the performance results advocated by Williamson,Kraljic, Vitasek and others, the purchasing process is likely to deliver a higher performance impact on profits and savings, while moving from a SPOFto a control of the risk factors inherent from the procurement strategy.

In the balance between savings and value, the procurement model is the decisive factor.

Saving the highest amount possible may inhibit the company’s ability to deliver its products or services — something neither party wants.

A procurement focus on the overall value of the relationship to the company’s success is the more attractive alternative.

With this thinking, if operations are compromised by a procurement savings strategy, the single point of failure is procurement.

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