From Potential to Actual: Capturing Sourcing Savings
By Randy Watson and Suman Sarkar -- Purchasing, 4/1/2008 12:23:00 PM
The power of strategic sourcing cannot be denied. For some companies, reducing costs on goods and services purchased a mere 10 percent has proven to be equivalent to a 25 percent increase in revenue in terms of influencing overall profits. But as powerful a tool as sourcing has proven to be, much of its anticipated benefits are being left on the table in many cases. While companies are sourcing their spend in an effective manner and developing strategic relationships with their supply base, not all of the anticipated savings agreed to in contracts are flowing down to the bottom line, which puts the credibility of the entire procurement organization at stake.
Analyses that we have conducted for our clients show that less than half of their contracted sourcing savings are being captured in the bottom line. Money is being lost due to gaps between the terms of purchasing contracts and the ways in which internal user groups actually make their purchases.
In most cases, failure to comply with master contracts is not a behavioral issue so much as a procedural challenge. The root cause is often found in the company’s purchasing processes and stakeholder alignment strategies. With the segregation between day-to-day buying responsibility and strategic sourcing, end-user functions — HR, marketing, construction, etc. — have become responsible for actually buying goods and services from corporate contracts. Thus, it is critical to get them aligned upfront with the sourcing process.
Once a sourcing effort is complete and stakeholders align with the sourcing decision, action needs to be taken to develop a straightforward process for users to buy under the terms of corporate contracts. End users rarely understand such contracts, so asking them to buy through a corporate contract with no help will result in far more frustration than compliance. To drive compliance, and thereby maximize the percentage of spend that meets the terms of corporate contracts, procurement needs to employ new user-friendly tools and techniques like catalogs to improve the purchasing abilities of others within the organization, as well as spend analytic software to monitor rogue purchasing activity.
The Compliance Challenge
When leadership encounters compliance issues, it typically assumes that it is facing a behavioral problem and issues an aggressive mandate. While this “rule by fear” can bring short-term benefits, it is not the long-term solution for improving compliance. Without a clear understanding of a problem’s root cause, mandates prove to be all push and no pull.
Our experience with end users at a range of different companies showed that most of them made every effort to buy from the corporate contracts. In most cases, they simply did not have a clear understanding of their terms and how to implement them no matter how much time they dedicated to trying to order through master agreements. Thus, for urgent requests — and in today’s just-in-time business environment all requests are urgent — end users typically prefer to work directly with suppliers to avoid the delays they have come to expect via the corporate procurement process.
For a large outsourcing services client, we discovered that the organization actually had hundreds of different contracts across the business with one particular hardware supplier — and that these contracts were frequently used in lieu of the global master contract. Further examination revealed that in addition to all of these contracts, the company also had contracts with the supplier’s distributors. Each contract specified different prices, and our client was actually buying more goods and services through these unfavorable contracts than through the master service agreement. Hence, the savings promised by the master service contract could not reach the bottom line until the rogue spend was eliminated.
Too often, little effort is put into teaching non-procurement personnel how to buy under the new contract terms after a sourcing effort. Simplifying the buying process requires clear thinking around and through component, product and service specifications as well as the requisition process itself.
End users tend to devote excessive time to selecting the “right” solution for their requirements, which requires sifting through the many choices available in the marketplace. Standardizing in advance which items and services may be purchased allows end users to more easily select the item at the negotiated price. While one high-tech company that we worked with was buying hundreds of different servers across the organization, most of its spend was concentrated on a relative handful of base builds. Standardizing the builds not only reduced the end user ordering time, but also allowed the company to leverage an additional 5 percent cost improvement from suppliers by pooling the spend.
Most companies employ highly complex ordering processes that require users to submit requisitions and wait for authorization before the order is processed. At one telecommunications company, requisitions typically went through nine approvals and moved through three different IT systems before the purchasing function actually processed orders, leading to a situation in which the average order took 60 days to process. Too often, a company’s ordering process assumes that the same process and system suffices for the ordering of all products and services, which results in a complex, confusing and time-consuming “one size fits none” ordering process. In this situation, end users seek any avenue to speed up the requisition process, which usually means steering clear of the corporate process all together.
Employing Catalog and Spend Analytic Tools to Manage Compliance
Leading companies have discovered that the most effective way to manage compliance around purchasing policies is to develop an online purchasing catalog system that allows employees to requisition products and services under terms from the master contract. This catalog can be reinforced by a process to monitor and quickly address rogue spend through spend-analysis tools. Figure 1 provides an overview of how one company has managed compliance through a combination of catalogs and spend analytic tools with data feeds to and from suppliers.
At most companies, an online catalog that contains the items that may be purchased from approved suppliers is developed for the corporate intranet or a secure external website. This catalog approach allows the company to offer a finite number of items per category to reduce complexity, but requires that the company have supplier agreements in place and update the catalog on a continuous basis as contract terms evolve. Catalogs enable faster downstream processes, adding fluidity to the approval process and reducing errors, as price checks against the corporate contracts are already reflected in the catalog.
The other side of compliance is to ensure that suppliers are adhering to the contracts. Spend-analytic tools ensure that suppliers are in compliance with agreed-to terms and specifications and help identify rogue spend. While it is acknowledged that not all spend can flow through a catalog, it is still important to ensure maximum value from suppliers — even on spend that is not part of the current catalog. A host of tools that vary by specific application are available to monitor spend in real time. For example, a spend analysis tool for software may be focused on software license management to ensure that a company does not buy excess licenses. A spend analysis tool for telecommunications may focus on verifying that suppliers are billing per contract terms. Figure 2 overviews some category-specific challenges and potential approaches to addressing rogue spend.
Tailoring the Catalog Solution
Though implementing catalogs may sound simple, the effort required to develop them makes it clear that they need to be approached strategically. Unfortunately, many companies have been using them to address spend categories that are relatively insignificant in terms of their overall addressable spend — for instance, by developing a catalog for office supplies while more substantial direct categories continue to demonstrate spend leakage. To make the best use of catalogs, a company needs to answer several questions.
Which items should be cataloged? Items or services that are standardized and have agreed-upon prices must be included in catalogs. Non-standard items that are either custom-made or made-to-order need to be handled through an exception process. Items or services for which there are no negotiated pricing mechanisms should also likely go through an exception-buy process. Because exception buys involve manual transaction processing and a lengthier ordering process, they should only be used on a very selective basis.
Should the company or its suppliers host the catalogs? While a number of catalog solutions are available in the market, no clear consensus has emerged regarding whether the company should manage catalogs in-house or strive for a supplier-managed solution. While internally hosted catalogs provide better data control, they also add cost and effort. Conversely, relying on a supplier-maintained site reduces cost and effort but also reduces control over the data. Trade-off analyses need to be performed, but controlling the data may be key when a company wants to standardize items and minimize user confusion. In our view, a company should host the catalog for all direct and high-spend categories to maximize benefits from compliance.
Who should manage the catalogs? Populating a catalog is a major undertaking, and keeping it updated on an ongoing basis requires dedicated resources. It typically makes best sense for a company to own the price and item review prior to publishing the data, while outsourcing the actual data population and maintenance. The decision will in part depend on the company’s ability to get suppliers to comply with its catalog requirements. If suppliers are willing to support catalog requirements, then the outsourcing requirements may be minimal. Overall, the cost of managing catalogs is negligible compared to the benefits they bring — in our experience, these costs represent less than 2 percent of the total compliance benefits that they drive.
Where to Start?
Catalog implementation involves reducing complexity, deciding on the suppliers to be included in the catalogs, developing a rollout approach and engaging suppliers in the effort. In our experience, a four-step approach to catalog development — outlined in Figure 3 and detailed below — helps achieve powerful results.
Step 1: Standardize Catalog Offerings — Because many suppliers offer a host of product options, a company needs to decide which options it requires in order to minimize complexity. For example, we recently conducted an analysis of network equipment at an outsourcing services provider that showed that it purchased some 6,000 different routers over a one-year period. On the surface, this proliferation appeared to be due to the wide range of customers supported by the company. However, a deeper examination revealed that approximately 90 percent of the spend encompassed less than 5 percent of the total router makes and models. But because standard configurations were not defined on a corporate level, buyers were ordering a wide range of models where only a relative handful was required. Each make and model in the system adds complexity along a number of dimensions, including inventory tracking, maintenance and network management. Once a product has been reduced to a manageable number of variants, it can be more easily included in a catalog — and the newly pooled spend used to negotiate improved terms.
Step 2: Segment Supplier Base — Catalogs can provide a powerful impetus to rationalize the supplier base, but in general only strategic and long-term suppliers should be included in catalogs. Companies make a significant investment entering, linking to and maintaining each supplier’s data included in the catalog, so unless a supplier is strategic the effort to include it likely will not pay off. Most suppliers recognize the significance of catalogs and typically offer competitive pricing to ensure a place in them. In cases where key suppliers are not yet identified, a supplier segmentation exercise can be used to segment the supply base into strategic, preferred and tactical suppliers.
Step 3: Develop a Rollout and Communications Approach — Catalogs can be rolled out through operational teams or an incubator team. Essentially, this involves making a choice between disrupting some day-to-day business in order to get operational teams fully trained on catalogs, or taking an incubator approach that poses less risk to daily business. The incubator approach often involves significant training time at a later date for operational teams and requires the establishment of a temporary catalog startup team.
Step 4: Implement and Involve Suppliers — Suppliers play a critical role in making catalogs work by providing data at regular intervals, validating pricing agreements and providing automated linkage to ensure data transfer with their customers. Supplier cooperation is a key to catalog implementation. Where a supplier is not ready to support catalog requirements, involvement of a third-party service provider to enable and maintain catalogs is another option.
Obtaining Catalog Benefits
Catalog development requires substantial upfront work in terms of gathering and cleansing supplier data, ensuring price validity and synchronizing supplier ordering systems with the company’s procurement system. Additionally, ongoing maintenance efforts are required to ensure that the data remains current. However, once catalogs are populated they streamline the entire procurement process.
For example, one outsourcing firm we worked with reduced its purchase order processing time from 30 days to less than a single day after implementing a catalog system that simplified the requisition and approval processes and linking the budget system with the procurement system. Now, only a small percentage of the company’s orders are made outside of the catalog system, thereby greatly reducing the number of manual interventions required — the percentage of the company’s purchase orders requiring manual intervention dropped from 90 percent to less than 5 percent, as shown in Figure 4.
Some companies are creating sales catalogs that link with buy-side catalogs, thus making it simpler for their own customers to place orders. In such a system, once a sales order is placed an order is triggered automatically to suppliers if the items are not already in stock. The effort of cataloging items improves customer satisfaction, as customers gain the ability to seamlessly place orders, track orders and receive items quickly.
Capturing the Contracted Savings
Procurement faces a challenge posed by the need to simplify purchasing through catalogs so that all employees can leverage the corporate contracts that procurement so painstakingly negotiated and maximize the realization of these favorable terms. Given the typical level of savings foregone due to poor compliance, the return on investment from cataloging is well worth the effort.
Identifying Non-Compliance Root Causes
A pharmaceutical company found that millions of dollars in potential savings were being lost due to a 55 percent compliance rate on indirect spend despite the procurement organization’s attempts to encourage the use of corporate contracts. While the company’s hundreds of business units and decentralized management made for a difficult compliance environment, an analysis was undertaken to identify additional reasons for such low compliance. The assessment revealed that the lack of corporate and business unit executive ownership of and involvement with the processes and infrequent spend and compliance reporting lie at the root of the problem. Only by addressing these areas could the company hope to approach 100 percent compliance with the corporate contracts negotiated through the sourcing process.
Using Catalogs to Extend Procurement’s Reach Within the Organization
Traditionally, the human resources function at a high-tech company had been granted a substantial budget for events, and the procurement organization was kept outside of its purchasing process. When procurement was at last asked to source the HR spend, it began the effort by launching an intranet site that made it easier for HR personnel to do their purchasing. As the catalog usage increased, procurement was able to build an understanding of HR’s spend and negotiate favorable deals with a few of the companies used for the HR events. The strategy worked — instead of forcing debate and testing executive allegiances through a “turf war,” procurement came to influence HR’s buying decisions simply by making it easier to make purchases.
Working With Contractors to Reduce Material Costs Through Catalogs
The procurement function at a retailer that was purchasing construction materials for new stores used catalogs to achieve cost reductions for key materials. However, contracting directly with material suppliers resulted in confusion at the construction sites because contractors did not know when to expect materials, resulting in frequent delays and cost overruns. The company then instituted a policy that required general contractors to order material through a new catalog that directly linked to the vendor’s ordering system. Doing so provided the general contractor with schedule control while putting the company’s preferential pricing agreements to use, ultimately saving millions of dollars while simplifying the process through which general contractors ordered materials
Figure 1 – Compliance Management through Catalog
Figure 2 – Spend Analytic Tools
Figure 3 — Catalog Development Approach
Figure 4 – Benefits from Catalog
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