Originally posted on on the e-Sourcing Forum [WayBackMachine] on Sunday, 20 August 2006

Established Procurement Service Providers focused on sourcing are usually market leaders that have a number of inherent advantages which include a larger supply base, higher levels of expertise in niche categories, and the ability to aggregate spend on a larger scale. In addition, they can often tap more economical labor sources in regional markets and implement new sourcing processes and technologies more efficiently.

A PSP reduces the headcount you need to perform certain manual and tactical processes or to manage certain indirect or non-strategic categories that are not a core competence, freeing up your purchasing team to spend a much greater percentage of their time on strategic activities and strategic categories and generate a larger return on your investment in them.

What should you do to prepare?

Managed properly, a relationship with a PSP is very beneficial. However, before you enter into such a relationship, you need to prepare for success.

The very first thing you need to do, even before you make the decision on whether or not to outsource part of your procurement function, is to gather data on the current state of your procurement practice. Do a spend analysis by category and location to determine high-volume vs. low-volume categories. Work with product development to determine strategic vs. non-strategic commodities. Understand your transaction volumes and associated processing times. Document your processes and average sourcing times by category. Determine what currently falls under procurement, what does not, and what should.

The next step is to analyze this data and determine direct and indirect savings opportunities by outsourcing low-volume or non-strategic categories, transaction management, and process execution. Procurement outsourcing only makes sense if considerable year-on-year savings opportunities exist, especially since the greatest savings will not be realized until a year or two into the relationship. Furthermore, a good relationship is driven by a Service Level Agreement (SLA) that specifies mutually agreed upon targets and goals, and incentives for the PSP exceeding those targets goals, and reasonable values for those targets and goals cannot be set unless you have a basic understanding of your current spend and internal performance.

Once you have finished your analysis, you need to decide what will actually be outsourced, what the scope of the arrangement will be, how the responsibilities will be split, and how the relationship will be managed. A governance council will need to be established to maintain control over what is being outsourced and monitor performance and compliance. The council will be key to aligning stakeholders and insuring a single cohesive message is always delivered to the PSP.

A single senior executive needs to take responsibility, coordinate the deal to the point of closure, and oversee the initial implementation. The executive is also responsible for making your employees aware of the plans, overseeing the creation of the transition approach and timing, and explaining the benefits to the procurement function and the organization as a whole.

What should be in the SLA you mentioned?

One of the keys to success, the SLA must define a formal governance and oversight structure, risk-and-gain sharing policies, staffing parameters, operating specifics, and response times. It should be based on key metrics, and measurements against these metrics should be taken and communicated regularly. It should include incentives for exceeding targets and penalties for sub-par performance. It must allow for bilateral transfer of methods, processes, and knowledge and encourage continuous process improvement.

And in conclusion?

Once the SLA is nailed down, the specifics of the relationship need to be addressed. It should be a multi-year agreement, I would recommend at least two or three, with proper incentives, a well defined governance model, appropriate categories and risk management processes, and methodologies for the transfer of best practices. It should also identify and account for any important or relevant legal issues up front to prevent issues down the road.

Remember that the most significant benefits often do not materialize until the second or third year of the relationship, when it has matured to a smooth, natural process and that it takes time to collect enough data to not only measure performance and results, but improvement.

Make sure to not only link the agreement to explicit benefit targets, and continuous, step-change performance improvements, but to include rewards if the service provider exceeds those targets. Incentives drive everyone, partners included.

Then, when the contract is in place, measure performance regularly, insure issues are escalated when appropriate, and confirm that spend visibility is available to your users. Transfer best practices on a regular basis and work together for continuous improvement.

The measurements should include, but not be limited to, Savings Targets, Process Compliance, Supplier Compliance, Supply Base Consolidation, On Time Delivery, Transaction Accuracy, (PSP) Staff Retention, and Quality of Service.

For more information on procurement outsourcing, see the “Procurement Outsourcing: A Brief Introduction” wiki-paper over on the e-Sourcing Wiki [WayBackMachine].