To outsource or not to outsource?

Supply Management, May 10, 2007 by Cooper, Anna

That is the question. And Anna Cooper has taken a long, in-depth look at it. Here she summarises her findings

Procurement outsourcing is a controversial subject. Raise it among purchasing professionals and stand back.

The benefits are well known. Improved return on investment through better use of resources, a focus on core competence and greater economies of scale.

But many remain unconvinced. They highlight the potential drawbacks, including a conflict of interest and loss of control Some also fear core competence may vanish as activities previously performed internally are delegated to an external agent

Procurement outsourcing is a relatively new area with limited academic research, which is why I chose it for my recent MSc thesis. Here I will share some of my findings.

So what is procurement outsourcing? I suspect "procurement" needs no explanation here, so let's examine the word "outsourcing". We use it a lot but do we understand it? It can include either designated tasks or an entire function being carried out by another firm. It is the transfer of some, or all, of an organisation's procurement activity to a third party.

Other definitions discuss value-adding activities and may incorporate an international angle - but be careful not to confuse "outsourcing" with "offshoring" (which concentrates on moving labour elsewhere).

TRENDS

As there was little information on procurement outsourcing, I've looked at the two terms separately to try to draw conclusions. Outsourcing is broad, spanning many industries, yet it does not appear very deep. It is driven mainly by cost-reduction targets. Even where the rationale for outsourcing explicitly references the modern "core competency" theory, the outsourced part may still focus on costs and savings made, with little evidence of strategic intent or focus. For example, short-term gains can be made through labour arbitrage, but doing the same thing with cheaper workers may not provide long-term benefits. Because moving work abroad only offers a short-term gain, a one-off hit that can be copied by competitors and will not provide savings year after year. For that, you need to improve your procurement continually and stay one step ahead of the competitors. A major rewrite of competition rules is required to make it difficult for competitors to imitate and ensuring benefits are sustainable.

And, as for procurement, it has evolved from a buying function to one whose ultimate goal is to design the most efficient and effective value chain with the buying strategy absorbed into the overall business plan.

PROCUREMENT OUTSOURCING MODEL

After analysing outsourcing and procurement theory in depth, I developed a model to illustrate current best practice. This, I hope, will demonstrate the concept of procurement outsourcing (see diagram over page).

The axes represent the progress of Outsourcing' (from tactical to strategic) and 'procurement' (from immaturity to maturity), and may help you to see where your organisation sits.

The four sets of circumstances this matrix describes are: a company with a 'basic proposition', 'access to expertise', 'focus on core competences', and a 'no role' situation, where an organisation with procurement maturity wishes to outsource strategically. Let's take the four in turn.

1) BASIC PROPOSITION

This quadrant describes a traditional, cost-focused department outsourcing procurement tactically. In this context the role for procurement outsourcing is a basic one: to reduce internal transaction costs and external costs of goods and services.

If an organisation's internal purchasing function is primarily traditional and administrative, and if the company does not believe it requires strategic input from procurement, outsourcing it may be the logical outcome.

The value proposition may include: savings in staff time and operating costs, improved purchasing leverage, and increased visibility and control of spend, all of which will contribute to tactical cost reduction.

2) ACCESS TO EXPERTISE

The access to expertise quarter describes a traditional, cost-focused procurement department which wishes to outsource purchasing for reasons over and above the basic proposition of cost. Drivers might include all those outlined in the basic proposition, although an additional strategic outsource impetus will also be evident.

This customised procurement outsourcing offering may have greater impact on the firm's outcomes than the basic proposition. For example, it may enable strategic outsourcing with less impact on cost and time than organic internal development through recruitment.

As it could be argued that purchasing can only advance by investing in skilled people, a valid role for a provider would be giving an alternative and accelerated route to skills. This area of the matrix also demonstrates access to improved process, information systems and technology.

This option is best if you need to catch up quickly with competitors but it's not so good in the long-term. It's better to grow organically and have the expertise internally if procurement is essential to the business.