Category Archives: Outsourcing

Lost Value in Outsourcing

Recently we ran a piece on Hidden Costs in Outsourcing which described many of the costs and overpayments you could be making when outsourcing a function in an effort to reduce costs and increase efficiency, even if the outsourcing contract results in reduced costs and increased efficiency. And while SI believes in win-win agreements, they should be above board with each party only taking its agreed upon share of the pie.

But even if the outsourcer only bills what it agrees to and doesn’t markup rates, charge you for shelfware, pass through unauthorized expenses, or hike the commissions, that doesn’t mean they are delivering all the value they are promised. This happens regularly with “full service” management or technology consulting firms, and the client never knows. But due to his unique position, the doctor knows, and having figured it out, refuses to participate in any project that denies a client organization of the full value they deserve. But this doesn’t prevent it from happening — there’s always someone else who will help the consultancy continue the practice.

What are we talking about?

The simple fact that no single management or technology consultancy, no matter how big, is an expert in every process or system you need, despite what they claim.

And the doctor knows you’re saying, we know this, so we chose the consultancy that makes it a practice to bring in experts when it is weak in an area to get us the information we need when we need it. But do they? Specifically, do they bring in true experts? Do they get the right information? Is it appropriate to your situation?

Some firms do NOT bring in true experts. Why? They have no expertise on staff, and use a model to find experts that is not congruent with what it takes to attract experts. For example, some firms are employing the “network” or “network search” model where they build a “network” of experts they can tap into for help. But this network usually consists of freelancers who self-register and/or who are invited based on automated LinkedIn profile searches. Are these people experts? Some are, but unless they are semi-retired folk looking to keep busy, probably not. Most of the people in these networks are unemployed / self-employed and in need of work. Most experts are too busy to even think about registering on another expert or social network, and will not be there. And experts such as the doctor will not engage with this type of model. The last thing the doctor wants to do is provide an hour of advisory to a Big 6 only to have it turn around, take the information completely out of context, and tell its client to consider vendor X or product Y because the doctor recommended it.

Secondly, some firms do not contract the experts for enough time to get the information they need to truly have an advanced understanding from the market. For example, many of these firms will engage experts for as little as an hour or two and expect to get deep expertise on a market and technology and, at the end of it, understand what vendors to focus on or what technologies to dive into. Then, believing they know where to focus, they will have their interns do research on the specific vendors or technologies and produce deep reports. But interns don’t understand the intricacies that help differentiate similar vendors or similar technologies and can easily fall for marketing hyperbole and overlook deep capability.

Thirdly, as they are not experts, they will not understand the intricacies of your situation, what specifically they should be looking for, and what questions they should be asking the expert, should they actually get one. So whatever they do will be of limited value from the get go.

If a company is engaging a consulting firm for help, the amount situation-specific consulting needed from an expert is significantly more than a few hours. And if all your management consultancy is doing is engaging the expert for as few hours as they think they can get away with, and then assigning a junior consultant to go and do the market research, you’re not getting the value you deserve.

Hidden Costs in Outsourcing

A strategy used by many Sourcing and Procurement organizations to get quick wins is to outsource tactical Procurement operations and/or Category Management to BPOs or expert (niche) consultancies. This can be very successful if the BPO is reasonably efficient in processing compared to the organization or if the expert (niche) consultancy has considerable expertise and can quickly find a lot of savings the organization never could. But that doesn’t mean that you are getting the best value. These organizations are trying to maximize their profit, and if you’re happy with the value you are getting, why should they try to optimize their costs?

Before we continue, let me be specific here — we are NOT attacking the hourly rate for their (top) talent. Good category managers are worth their weight in platinum, and you should expect to pay top dollar for them. But you should also receive top value in exchange, not mid-level value and definitely not mediocre value. But that’s what you could be getting if you are not evaluating these services as closely as you would be evaluating your strategic direct material buys.

And, before we continue, let’s make it clear that while we are focussed on Supply Management, these hidden costs could be found in any outsourcing arrangement — marketing support, legal support, engineering support, etc. So what are the hidden costs?

  • Rate Markup this can take many forms, including A rates for B staff or onshore rates for offshore staff; you could be paying 200/hour for the expert, but a relatively inexperienced mentee could be doing most of the work, or you could be told you are being supported on-shore when really 90% of the work is being offshored to low-cost locales in Eastern Europe
  • Temporary Labour if the provider falls behind, they might hire temporary labour and bill you for it; this is okay if you ask them to, but if they do it without your permission for a fixed-cost task, this is definitely NOT ok
  • Shelfware/Bloatware where you are being billed for software not being used or you are being billed for a suite license when the organization is only using one module
  • Pass-through Expenses some organizations will try to pass through any and all expenses they think they can, even if they require explicit pre-approval or the contract says they are the responsibility of the outsourced company
  • (Hiked) Commissions some organizations will charge-back a percentage of savings, a value fee for a successful value-add negotiation, a percentage of a recovery, etc. this is usually okay as this is usually part of an agreement, but there are usually restrictions — minimum value, maximum percentage, and so on; sometimes an organization will charge commissions beyond what they are allowed to
  • Taxes some organizations will charge taxes based on their locale, taxes you may not be technically required to pay — double check the tax lines carefully

And these common overcharges could be just the tip of the iceberg. So be sure to be as cognizant about sourcing your services relationship as you are about sourcing your strategic products and services.

Provider Damnation 70: Outsourced Providers

Dear outsourced service provider, you didn’t think that Carriers and 3PLs were going to get all the attention did you? You can cause your clients just as many headaches as these providers, if not more. In fact, you can also cause them cold sweats, fever, panic attacks, and even heart attacks if you play your cards right (and very, very, wrong for the client).

Outsourced Serviced Providers, especially those that are experts in what they do, can be a boon to an organization trying to get some quick savings to hit some (overly) aggressive (and stupid) savings targets set by the C-Suite (that doesn’t realize Procurement should be about maximizing value, not maximizing short term savings). This is especially true if the Procurement Service Provider (PSP) outsourced to is a GPO (Group Purchasing Organization) that already has contracts for goods and services in a number of categories required by the organization at rates lower than the organization is paying now, as any categories the organization can switch over result in instant savings. It’s also true if the provider is an invoice and payment processing provider that is fully automated and can accomplish the same task as the organization at half of the price (because 2 workers can do the work of 10 and the platform subscription is only the annual cost of 3 worker’s salaries) and free up valuable resources in the organization to focus on strategic value identification activities and not tactical processing.

But these benefits come at a cost.

Handing over a category means losing control on that category.

GPOs are going to select providers that please the majority of their customers, where majority really means the financial majority. So, if the GPO has a few heavyweight Global 3000 clients that account for a significant amount of its annual revenue, guess which clients get the greatest say and the contracts they want? (Hint: Not you!)

Handing over a contract means limited control over a slew of categories.

A GPO is only going to take a contract if it can make money. Since it typically charges a small fee per transaction, it knows it needs a lot of transactions to make money. As a result, it is going to demand a set of categories that mean a minimum annual spend, and the organization is going to lose a lot of control on those categories for the length of the contract.

Handing over processing hands over control … and control over realized savings.

You are dependent on the provider to do an m-way match and detect over billings, duplicate billings, and failure to account for return credits and volume-based discounts and rebates. If they just get the invoice and pay it blindly, and the invoice for a multi-million category is still at last years prices, you could lose hundreds of thousands of dollars.

Handing over processing hands over knowledge.

Knowledge of tactical procurement processing operations, best practices, and the best and worst suppliers from a Procurement perspective is now in the hands of the provider. As tactical processors are displaced and leave, and more and more focus is put on other Supply Management activities, the organization becomes more and more dependent on the provider for even simple tasks. This makes it incredibly hard to pull the function back in house if it ever wants to, or to even switch to another provider in the future. It’s like giving the supplier Power of Attorney. Not a good thing.

Handing over sourcing is giving them the keys to the castle.

Losing control over tactical processing is bad enough, but losing control over sourcing of a set of indirect categories makes you ultimately dependent on the provider. As the great Angus and Malcolm Young said twenty-five years ago, the service provider, she got you by the …

Procurement Outsourcing is On the Rise

But is it the dawn of a transformational era?

Everest Global just released it’s Annual Report on Procurement Outsourcing, which it called the dawn of a transformational era, where it found that the procurement outsourcing market is growing at a rapid pace (12% year-over-year in 2014) but that it is in a state of flux with record new deal signings intertwined with high end-of-year terminations (26%), indicative of service provider switching (or, sometimes, the pulling of the function back in-house because not all outsourcing decisions outsourced the right functions). (However, 2 providers, Accenture and IBM, still command over half of the Annualized Contract Value and the next two largest providers, Xchanging and GEP, command about 17% of the ACV, which means that two thirds of the market is dominated by four providers.)

This, and other findings discussed below, was based on Everest Group’s database of over 1,100 Procurement Outsourcing contracts (each worth over 1M with managed spend typically in the 50M+ range), its database of operational capabilities of roughly 20 Procurement Outsourcing providers, and ongoing surveys and interactions.

There were seven key messages in this report, including the rapid 12% year-over-year growth, but the three we are going to focus on are:

  • The value proposition is transitioning from a cost-focussed model to a cost+value model, where strategic drivers such as market intelligence, supplier relationship management, and operational excellence are gaining more importance
  • The scope of contracts is expanding to a more end-to-end approach
  • The role of technology is growing, with increased adoption of end-to-end platform-based offerings

Advancement of the Value Proposition

In the beginning, outsourcing was mainly focussed on economics (cost reduction):

  • procure goods and services at the best prices
  • optimize activities to be cost efficient

More recently, outsourcing has been focussed on efficiency (cost avoidance):

  • spend consolidation to drive further impacts (with volume pricing)
  • satisfaction of complex demands
  • quality as well as price (to reduce warranty/return costs and protect the brand)

But now outsourcing is starting to focus on value generation:

  • the outsourcer is trying to become a strategic partner and not just a cost centre
  • the outsourcer is trying to define and drive business outcomes that impact overall growth
  • the outsourcer is trying to predict market trends to help organizations adapt to, and take advantage of, macroeconomic shifts early

How? Outsourcing is becoming more interested in identifying innovative suppliers, tracking and enforcing compliance and risk management, and gathering and harnessing the power of market intelligence.

Increasing Contract Scope

While many outsourcing contracts start out as Source-to-Contract (S2C), where the outsourcer helps the organization identify savings in indirect, non-strategic, or even strategic categories where the organization just does not have the volume, many are transitioning to Source-to-Pay (S2P) contracts where the provider also takes over the back-office invoice management and accounts payable function. Similarly, those contracts that started out as (P2P), because the organization thought its first priority was freeing up resources for strategic sourcing, are transitioning to S2P as well because these organizations realize that a third party can source those categories that it does not have expertise in better than the organization can.

More Prominent Technology

“Cloud”, Big Data, Digitization, and Consumerization is reshaping the Procurement Outsourcing marketplace as organizations demand more from their outsourcing providers and outsourcing providers look for an edge over their peers. With the proliferation of S2P SaaS solution offerings on the marketplace, outsourcing providers can not only offer S2P services but also enterprise S2P platform deployments where the customer organization not only gets platform access, but the ability to use the platform for their sourcing projects as well.

These are promising findings. Given that most Procurement departments are under-staffed and that no Procurement department can be an expert in every category and every technology, it’s good that there are maturing outsource providers that can add value to the organization and not just drain dollars.

And the other findings, which can be found in Everest Global’s just released Annual Report on Procurement Outsourcing, the dawn of a transformational era, are promising as well. It’s worth checking out.

Geopolitical Damnation #31: China and the New Silk Road

China is arguably, and simultaneously, the world’s oldest culture and the world’s newest mega-economy and super-power. Not only does China have the 2nd largest GDP in the world, but it is one of only 4 countries that are net international creditors (the other three being Norway, Luxumbourg, and Switzerland). In comparison, the US, with the largest GDP (of slightly less than 18 Trillion), has an external debt that is roughly 18 Trillion. (In other words, it’s debt now exceeds its annual GDP!)

It’s also the world’s most populous country with 1.35 Billion people and the second largest country by land area. It has the world’s third longest river, 14,500 kilometers (or 9,000 miles) of coast lines, approximately 130 ports open to foreign ships, over 11,000 kilometers (or 6,800 miles) of rail, and over 180 commercial airports. It’s rail network and ships transport a significant percentage of the world’s global trade and traffic is still increasing annually.

China is no longer the emerging economy of the 80s and 90s that you outsourced to and imported from — now it is the emergent economy that is outsourcing to Brazil (to serve the North American Market, consider Foxconn) and Africa (to serve the European market). And, for most multi-nationals, it’s their newest, and most promising (and potentially most profitable) market. China already has over 220 billionaires, and this number increases annually. (The US has 442.)

And as a result, China is turning the traditional sourcing world topsy-turvy — especially now that the New Silk Road (China’s Grand Strategy has been operational for eight weeks. (Source: UNZ) As described in the UNZ article, and on SI last fall (in What Impact Will The New Silk Road Have on Global Trade?, for e.g.), this 13,000 km railroad that crosses China from East to West and then Kazakhstan, Russia, Belarus, Poland, Germany, France, and finally Spain enables trade across most of Eurasia. And when the high-speed rail is complete, transport from China to Europe will take even less time than it does now. And China, which is home to 7 of the world’s top 10 container ports and which serves up air cargo that represents more than one-third of global trade value (even though only 1% by weight), will control even more of global trade then it does now! While also being your biggest customer.

You can’t deal with China in the old way anymore. Gone are the days when they were the low cost provider that needed your business. Gone are the days when you could fall back on Mexico. And gone are the days when you never needed to worry about the China market. Now they are a lower cost provider, due to their increases in efficiency (just like Japan increased in efficiency after WWII), but they don’t need your business. They have money and they have the world to sell you. Because Mexico was almost abandoned for China, there are few factories left that can produce modern electronics and none that can produce the volume to equal a Foxconn. And with most markets stagnant, China is one of your few opportunities for growth. Moreover, the supplier you are negotiating with to produce your cell phones for Engineering might be the same supplier your sales team is negotiating with to buy IT’s new mobile factory management software suite.

In other words, when China is across the table, they are not a vendor or supplier that can be beaten down with old-school hard-ball negotiation (even if they historically put melamine in the milk, lead in the paint, and who knows what in the pet food) — they are a partner, and equal, and must be approached as such. Even if you never sell to them, you might sell to one of their partners, and they talk just like we do. This doesn’t mean that you shouldn’t be determined in your negotiations — as you should always fight for the best deal — but be fair, realistic, and base your demands on fact and should-cost models, not empty threats or baseless demands for unreasonable cost reductions.

China is about to become your upstream as well as your downstream supply chain. You have to abandon your old view of the world, accept this reality, and start preparing for it. It doesn’t have to be the damnation that causes your undoing. It can be your salvation. Your choice.