Global myths of procurement outsourcing: Myth 1 - ROI comes from cost reductions
Oct 30, 2012 1:07:00 PM
Following on from my introductory post in the Global myths of procurement outsourcing series, this post dives into the first myth - that ROI from procurement outsourcing comes from reducing the cost of running the function.
Procurement outsourcing is a greatly misunderstood area of outsourcing - as this series aims to highlight. Whilst this is partly to do with misconceptions around procurement, there are also issues created by the word 'outsourcing'.
The trouble is, when people hear 'procurement outsourcing', their immediate impression of it is led by their experiences in HR, IT and Finance outsourcing where a large part of savings comes from the cost arbitrage (mostly people) from moving costs from a high cost area to a lower cost area.
Procurement outsourcing is quite different. It's about running the function in a way that is not replicable or affordable internally. It's very similar to how companies bring in specialists to augment highly skilled resources in areas such as legal, audit, and IT. They do it because its too costly and impractical to maintain all that is needed in-house. And you get a better result with the experts.
The ROI from procurement outsourcing comes from two areas:
- In the first few years, there will be a one off shift in the cost base, generating very large savings that, as long as they are effectively captured, go straight to the bottom line. We have uplifted organizations net margins by 5-10% - so its very material. Think about the impact this will have on your business when the CFO can deliver additional margin without asking Sales to mine their clients for another sales dollar.
- Over the long term, the value proposition is not just about savings. Instead, it moves to achieving value for money, and stopping the cost base from deteriorating to where it was before. This is a paradigm shift that business leaders need to make.
The point here is that once you have the cost base well managed, you dont then turn off the management of it. In the same way that you dont remove the HR function once its performance is high. Instead, the function becomes more sophisticated. More mature. Of course, incremental savings are always generated, due to factors such as changing demands, innovation, etc. But now on-going value is added in intangible areas such as reduced risk in the supply chain, future proofing, supporting the business achieve its objectives, improved customer service, assisting stakeholders in achieving their objectives, streamlining processes, etc (read this blog for further discussion on this subject).
The right way to view procurement outsourcing is to view it in the same way as outsourcing specialized areas such as legal (note: not legal process), or creative areas, where you need specialized skill sets. And where it is more pragmatic to leverage expertise versus having it in-house. By outsourcing, you get specialists in each of the areas you need and for the timeframe in which you need them. You get constantly fresh ideas and benefit from their scale and expertise. Not to mention you get to hear what else is going on in the space, as outsourcers work for many other companies.
In short, the ROI from procurement outsourcing is large, and is driven by the way the model works. And it also enables you to receive a far better service than an in-house team is able to offer.