A Case for Offshoring Procurement Outsourcing?
By Katrina Menzigian -- Supply Chain Management Review, 9/1/2008
Most internal procurement functions remain underinvested and in order to achieve desirable levels of spend-savings companies actually need to make up-front investments in resources and capabilities for the function. In some cases these investments may be funded by re-investing portions of the savings from the early stages of the procurement outsourcing (PO) engagement to fund that extra investment. However, the end result is the same—internal function costs go up in the short-term.
This can be alarming for a client, as increased up-front investment runs counter-intuitive to the outsourcing initiative aimed at reducing costs, and thus stops potential buyers in their tracks. By selectively introducing offshoring into the PO engagement, the supplier can be more cost effective in delivering the savings. In short, you might get a bigger bang for your investment buck through offshoring.
However, our research indicates that the adoption of global sourcing in PO has been low. When compared to its close cousin, finance and accounting outsourcing, PO is way behind in the use of offshore resources.
But adoption of global sourcing in PO is changing. The degree of offshoring is rising, and contracts signed in the last 2 years have nearly 40 percent of the work done in nearshore/offshore locations as compared to just 14 percent historically. We believe that the trick to get the PO market to truly move into an accelerated cycle will be to combine expertise and arbitrage—to bring skills and knowledge to a client at a price well below what they could achieve themselves. We are seeing combinations of labor arbitrage and expertise now being used very effectively in related knowledge process outsourcing, and there is no reason why PO cannot benefit from it.
The current market trends that are facilitating increased global sourcing include:
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innovation in PO technology (internet-based vendor search, eRFX, collaborative meeting tools, analytics)
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improved offshore-skills (as the offshore labor pool gains significant exposure to foreign markets)
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increased buyer acceptance of the global sourcing concept (especially among mature buyers).
“What” and “How” of Global Sourcing in PO
We analyzed the offshorability of key activities in the Source-to-Pay (S2P) process and found offshorability of PO processes is much higher than would be evident by current levels of offshore adoption of around 25 percent. There is significant scope of offshoring in the Procure-to-Pay (P2P) space, analytics, and in hosting/maintenance of procurement systems.
There are certain activities, such as negotiations and vendor relationship management, where significant barriers, both physical and knowledge-based, prevent large-scale offshore operations. However, we believe that significantly more tasks can be performed by most suppliers and buyers of PO services to date. What is required is better education of internal supplier teams and the clients, detailed process definition to create visibility into roles and responsibility, mentoring and training programs of resources, and tool and process standardization.
The current delivery model, which is primarily on-site/on-shore, will need to evolve to a globally-leveraged delivery model. We believe the market is evolving to a three-tier delivery structure: 1) on-site, 2) in-region and 3) off-site.
Strategic sourcing and relationship oriented work would typically reside onsite at customer locations in order to work with clients and vendors. Given that over 75 percent of PO contracts are signed in the US and UK, these countries remain key on-site centers. Continental Europe is also witnessing increasing levels of PO activity and will have on-site presence.
Activities like tactical sourcing will be more and more based at in-region centers. The in-region centers are typically less costly than on-site locations but the key driver is centralization and access to the local market and not purely labor arbitrage. Eastern Europe and Latin America are now fast-emerging as in-region destinations for EMEA and US buyers respectively.
Operations, analytics and help desk support will be provided by off-site centers. Also, as tactical requirements stabilize and knowledge transfer matures, even tactical sourcing work can migrate off-site so that suppliers can continue to provide a high level of service in connection with year-on-year productivity and operational cost reductions.
Expanding Choices of PO suppliers
As depicted in Exhibit 1, the PO supplier landscape consists of four sets of players. Historically, the PO market has been extremely concentrated with the top five players commanding nearly 85 percent of the market share. However, the entry of offshore-centric and PO specialists is changing the competitive landscape.
Offshore-centric players like Infosys BPO and Genpact are making the necessary investments (in terms of people and technology) that are required to make an impact in this market. Infosys BPO recently announced a technology alliance with SAP in the Procure-to-Pay (P2P) space. Genpact has also formally launched its partnership with ICG Commerce—the combined entity offers strong capabilities in both the sourcing and P2P processes. Most offshore-centric players are established finance and accounting outsourcing firms with significant offshore capability, and are trying to expand their portfolios by looking at opportunities that can be linked to their existing capabilities.
We expect the supplier ecosystem to transform, and supplier positions to converge with time. We expect P2P focused players to start offering sourcing focused services along with P2P. Similarly, sourcing focused players who want to participate in the full-service market will establish offshore centers—either on their own or by partnering with other more established offshore players. As a result, trends of global sourcing in PO would also a be key determinant of future merger and acquistion activity, as more and more PO players would try to cover their delivery holes through acquisitions. This is good news for potential buyers of PO services as their options are now expanding.
Conclusion
Global sourcing is playing a key role in enhancing the value proposition of PO. In order to increase buyer adoption, suppliers will need to take a fresh look at the rapidly transforming PO ecosystem, and incorporate requisite changes to their existing delivery models. Buyers, in turn, will need to open their existing models to a new and fresh viewpoint on how procurement processes can be managed and delivered. We expect this metamorphosis of the PO ecosystem to signal further market maturity. While global sourcing would never be the key value driver in PO, it may eventually help markets take off through better management of operational procurement costs.
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