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What Procurement Areas Should Be Outsourced
Few companies have the skills to effectively manage procurement across all spending categories. Smart enterprises should examine their procure-ment strategies to identify the underperforming processes and categories that could benefit from outsourced procurement solutions.
As a result, underperforming procurement operations and underleveraged spending are causing enterprises to leave billions of dollars on the table. In response, many companies are now considering outsourcing underperforming procurement processes and spend categories to procurement service providers (PSPs). How can an enterprise determine which procurement activities to outsource?
To evaluate what areas of an enterprise's procurement should be outsourced, Aberdeen Group recommends using two key matrices. One matrix should evaluate the strategic value and spend "control" of the purchase category. The other matrix should assess whether an enterprise has the human intelligence and infrastructure necessary to manage a particular category of spending.
The relative strategic value of a spend category is largely determined by the impact it has on the successful manufacture, delivery, and differentiation of a product or service. The strategic value of a spending category is further defined by the uniqueness and availability of that good or service in the marketplace.
For example, Intel's Pentium 4 microprocessor has a high strategic value for a PC manufacturer because the speed of a Pentium chip is highly competitive in the market. However, dynamic random-access memory (DRAM), a potentially large portion of spending, may have lower strategic value for the manufacturer because it is currently in surplus.
But do not take that to mean that any product of lesser strategic value should be outsourced. In the above example, the PC manufacturer may still consider outsourcing procurement of both the Intel chip and DRAM if the outsourcer has a better relationship and can arrange better terms with the supplier.
Most companies have developed methods for managing most strategic purchases. Therefore, it is unlikely that these companies would wholly outsource strategic procurement activities. However, many companies are augmenting internal competencies with infrastructure and services provided by outside service providers. In these scenarios, the outsourcers provide supply market intelligence, sourcing strategy, vendor qualification, or online "market-making" capabilities.
Spend control is determined by examining the total spend of a particular category
and how well that spend is "leveraged" across the enterprise. A company's ability to leverage spend is determined by how much of total enterprise spending in one category is done under contract and how many suppliers are used to satisfy that category. When spending is done without a contract and many suppliers are used to satisfy the need, an enterprise is usually showing signs of poor spend control.
Enterprises must evaluate their expertise and their capacity to manage a particular category of spending. One way this can be done is by categorizing spending and reviewing how the internal resources are dedicated to each category. Enterprises can then balance the amount of resources against the total company wide spending for that category.
Additionally, companies should examine the procedures in place to renew contracts
for each category of spend and how often these contracts have to be renewed. They should also examine the sourcing practices used for consistency and sophistication (e.g., if category managers are using "three-bids-and-a-cloud-of-dust" tactics to renew contracts, additional expertise is required).
The value of existing procurement infrastructure can be measured by understanding the ratio between the costs of an item and the transaction costs associated with the purchase of that item. For example, capital equipment - such as manufacturing equipment - typically has high-dollar value, but relatively low transaction costs when compared against the total cost of the product. On the other hand, low-dollar, high volume purchases, such as indirect goods, have high transaction costs relative to the value of goods purchased.
High transaction cost ratios make the procurement of indirect goods ideal candidates for automation as well as outsourcing. Enterprises that have adopted e-procurement have been able to reduce prices paid, improve contract compliance, and improve process cycles and costs for indirect goods purchased.
It is important to note that outsourcing can be used to extend the value of stalled technology investments. In fact, several early adopters of procurement automation technologies have reported that PSP's have delivered requisite sourcing, supplier enablement, and process extension capabilities to improve the returns of their initial technology investments.
Smart enterprises should examine their procurement strategies to identify the underperforming processes and categories that could benefit from outsourced procurement solutions. Enterprises using PSPs have been able to streamline their procurement organization, resulting in very recognizable benefits. Chief benefits that enterprises have derived from outsourcing procurement include reducing costs, improving processes and expertise, and enhancing their focus on core competencies.
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