Outsourcing Procurement funded on a shared savings basis

Outsourced purchasing services.gifThe services offered by Outsourced Purchasing Service Providers, and their subsequent fees, warrant the scrutiny of a competent Purchasing Manager before an organisation contracts itself to a savings proposition, Wally Johnson, Chairperson of Purchasing Index (PI) UK, tells SmartProcurement.

“In these increasingly difficult recessionary times, growing numbers of cash strapped public and private sector CEOs and CFOs, with sometimes questionable procurement aptitude, are being courted directly or indirectly by Outsourced Purchasing Service Providers (OPSPs) with promises of budget-balancing purchasing savings for the prospective clients’ increasing expenditure on goods and services. The proposition, for those prepared to take on the OPSPs’ services on a contingent reward basis, is based on the OPSP’s promise that “it won’t cost you anything, even after paying us you will have more cash to spend than before you signed up for the service!” The OPSP’s service funding proposition (that it will require only marginal fixed cost recovery arrangements, if any, and that its real reward will be the circa 25% share of the savings it will deliver over the next 12 months) merits a little more attention from a competent in-house Purchasing Manager, if, that is, that Purchasing in that organisation ever gets to see the details of the arrangement before the CEO/CFO has contractually committed the organisation to the OPSPs’ supposedly generous proposition.

Typical OPSPs’ propositions for this kind of service will include some/most of the following features:

1. Savings will be delivered over the immediate future (a 12-month period), taking effect from the completion of an OPSP managed ‘sourcing exercise’ on the client’s behalf in the form of a new 12-month framework covering the agreed spend categories. The OPSP’s offer to the prospective client will quote the items to be covered by the framework and the quantities to be purchased. These will be the items that the client had purchased over the preceding 12 months from its then current suppliers.

2. The OPSP then submits what its deem to be the most favourable offer received in response to its invitation to tender (!), NB: not all do this, for the client’s approval of the proposed new sourcing arrangement and the prices quoted therein. This is accompanied by the OPSP’s own analysis of the savings it will deliver over the agreed 12-month period and its proposed commencement date.

3. The OPSPs’ proposed savings will most probably have been calculated solely on the basis of the before and after prices of the products covered by its sourcing exercise multiplied by the quantities purchased from the supplier over the preceding 12 months. Upon the client’s formal acceptance of the OPSP’s new sourcing / pricing proposition, an invoice for 25% of the calculated savings will immediately be submitted to the client’s sponsoring officer.

Walter Johnson.jpgNB. "It is not unusual for the arrangement between the OPSP and the client to also include provision for additional fixed cost elements related to matters such as the number and types of spend categories covered by the service and the employment of specialist OPSP Analytical Services staff. This can take the OPSP’s 25% share up to and above 30% of the savings it will claim to have delivered."

"Common shortcomings of the Shared Savings Funded OPSPs’ offerings include, but are not limited to, the following practices:

1. During the proposition stage, the methodologies employed to measure savings usually do not include any provision for measuring the client’s then current prices against prices of other comparable organisations purchasing the same items under the same or similar circumstances. The before and after prices are the important factors in the new sourcing arrangement. The majority of the OPSP’s reward is based solely on the better prices it will offer compared with those the client was previously paying. PI is a long-established price benchmarking service provider, and has never encountered an OPSP sourcing arrangement that makes provision for prices it has negotiated on its client’s behalf keeping in-step with possibly falling market prices over the 12 months that follow.

2. In the kind of arrangement being discussed, OPSPs are in many instances engaged in processes that carry a significant possibility of a conflict of interest (OPSPs’ rewards are directly linked to the savings generated by their own measurement methodologies at a moment in time. In many of the outsourcing situations PI has encountered, this kind of arrangement could be described as a licence for the OPSP to print money – which many of them have done!)

3. An OPSP’s demands for an upfront payment of 25% of the savings to be delivered over the following 12 months is often out of line with the promises it made when it was selling its services to the prospective client’s CEO or CFO. Upfront payments for future savings deliveries can inter alia have a material impact on the client’s cashflow, given that the client could be paying prospectively for what the OPSP is at this stage only promising to deliver over the next 12 months. It would not be unreasonable for the client to insist that it not pay anything to the OPSP until the savings have been delivered.

4. Assumptions that the client will be buying the same shopping basket of requirements over the next 12 months that they purchased over the previous 12 months will be, for many spend categories, manifest nonsense. Vendor distributors often adopt selling price strategies that are typically based on

A. a modest number of core listed (frequently used) items at low prices; with
B. the rest being taken from a catalogue covering more than 20,000 over-priced items, a large discount from which still does not result in low prices. A discount of 50% can still leave you paying more then ten times Value-For-Money prices! This kind of pricing strategy gives suppliers opportunities to redress the initial loss leading prices that they had to offer for the core listed items.

To Sum Up

"Little information is available in the public domain about what happens at the client level at the end of a 12-month shared risk and reward OPSP arrangement, aside from the common OPSP practice of moving on to other spend categories for the client.

Given that CEOs and departmental heads at the business unit level are often the biggest ‘big spenders’ in an organisation, what does their usual practice of short-circuiting the Purchasing Department in matters such as this tell you about the organisation’s control over ‘the big spenders’?

Variations of the OPSP business model outlined in this discussion are currently being adopted in growing numbers across the UK public sector. A likely light on the horizon is the public and private sector top management’s growing interest in possible answers to the question “what is a procurement saving?”

For more information on dealing with Outsourced Purchasing Service Providers, send an email to wally@pricetrak.com

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