Penny wise, pound foolish

Penny wise, pound foolish

Deployment of procure-to-pay (P2P) tools renders clarity in a firm’s procurement process, spend structure and supports fact based decisions and actions. A non-differential approach to third party spend however has serious drawbacks that impact the firms bottom line what in comes to management sourced services contracts. Organizations engaged in driving procurement optimization through automation need to know that P2P solutions do not provide the one-size-fits-all solution that they are hoping for. In fact, such an approach can result in significant value loss from more complex sourced services arrangements.


 

The growing use of procurement tools

A recent trend to optimize procurement efforts aimed to respond to the need to reduce the cost and improve control over third party spend, is the deployment of Procure-To-Pay tooling. This approach has yielded several advantages: amongst them are driving price discipline in the supply base, ensuring consistent sourcing processes to stop or reduce maverick spending. There are however serious and often unnoticed drawbacks inherent in this approach. The approach is based on two unjust assumptions, which results in “Penny Wise, Pound Foolish” behavior. The first assumption is that the supplier base is homogenous. The second, that there is no difference between the type of purchases. By placing smaller and simpler to manage commodity arrangements (the ‘Pennies’) in the same bucket as the larger and complex services arrangements (the ‘Pounds’), procurement optimizations  may deliver savings in the buying stage but a significant part of these savings is lost in the post-signature operational stage.

 

What do organizations buy today?

Research by Forrester shows that on average across industries, services represent 58% of the aggregate procurement spend. It also shows several industries above the average with an even higher representation of services in their procurement mix. This includes Insurance, Financial Services, Professional Services, Healthcare, Telecommunications and Retail. These percentages range from 74% to 98%. The services sourced by organizations clearly vary in scale, type and complexity. While services are generally more complex to manage than goods because of their complex and dynamic nature, and therefor involve higher buyer uncertainty, within services there are some categories that require even higher levels of effort to manage complexity. This includes IT Services, Facility Management, Professional Services, Construction and Infrastructure and Telecommunications.

 

Why are service more difficult to manage?

Services are fundamentally different and more complex to management than commodity products due to the following reasons:

  • Delivery and consumption of services take place simultaniously making in notoriously difficult to define a clear cut “receipt of services”;
  • Service delivery models are mostly complex with mult-layered service levels; KPI’s and obligations bound together with various cross service and cross organizational interdependencies;

Additionally, the fact that 80-90% of the services spend is usually concentrated with 10-20% of suppliers raises the complexity of managing services suppliers even higher. It is therefor imperative that for any procurement management strategy to be effective, it will need to address the specific requirements of these large and complex services suppliers. Given the high stakes, it is clear that strategic relationships are a strategic asset that demand on-going senior management attention commensurate to their importance. Ignoring the value of properly managing these relationships is tantamount to corporate negligence. Research by organizations like IACCM, KPMG and PWC, shows consistantly that ineffective governance of sourced services causes up to 48% of the expected contract value can be lost. In addition to the above value leakage, the cost of managing complex services contracts effectively is significant; typically 3 – 7% of the annual contract value. Some firms even report governance spending of over 15%. Driving this ongoing cost down through automation should be a key consideration in a firm’s sourcing technology strategy (TRAC can brings this cost down by as much as 25%).

 

P2P tools do not address the management of services effectively

P2P tools were primarily designed to handle the procurement of larger volumes of goods. These tools may be adequate for the broader supplier base, but are not designed or equipped to manage strategic services providers. The reason for this is simple. Their fundamental design objective is to impose a standard pre-signature discipline for all suppliers and by definition (a) that cannot be varied to accommodate the special needs of services providers and (b) does not offer deep-enough sourcing governance functionality during the post-signature phase to manage services engagements effectively. We say that P2P tools are typically designed for high volume – low value contracts as opposed to low volume – high value contracts.

The table below illustrates the specific areas where P2P tools need to be supplemented with a specialized governance tool to cater to strategic services suppliers. We have seen enterprises that try to force fit overlay the P2P solution onto services procurement and management processes quickly witness these shortcomings. As a result, these processes are excluded from the P2P solution and adopt a combination of significant manual effort and isolated technologies such as stand alone spreadsheets that are error prone and difficult to maintain. This increases the cost of governance and renders value leakage in services contracts, effectively neutralizing the savings generated in the supply chain of goods. It is therefor not surprising that a recent study by the IACCM found that 85% of firms is not happy with the tools – including spreadsheets – they use for contract management.

 

Contract Governance Area Required supplement
Business alignment
  • Contract alignment to business objectives and services
  • Customer satisfaction
Contract authoring
  • Contract alignment to business objectives and services
  • Customer satisfaction
Contract management
  • Hierarchical contract repository
  • Contract change management
Supplier management
  • Obligation tracking / compliance
  • Governance process performance
Invoice validation
  • Complex pricing structures (ARC/RCC)
  • Invoice prediction and scenario planning
Relationship management
  • Governance structure
  • Meeting management
  • Issues, actions, decisions and dispute management
Risk and issue management
  • Engagement and delivery risk management
  • Regulatory and policy compliance
Dispute management
  • Positions of the parties
  • Dispute settlement

 

Which tool should be prioritized?

Given today’s services procurement landscape, an integrated combination of a P2P system with a specialist sourcing governance tool like TRAC is the optimal way to address the divergent needs of both supplier types i.e. getting control over all suppliers at a basic level and ensuring value retention for the strategic service providers.

One of the most common – and costly – traps large enterprises fall into is the myth that they need to first instill basic procurement hygiene before they can address the management of strategic suppliers. The strategic service providers with complex and dynamic contracts, account for a large percentage of the spend and this is where the majority of the value leakage tends to occur. The more complex and dynamic the arrangement, the higher the percentage of value at risk. Given the high stakes, complex service arrangements are strategic assets that demand on-going governance with senior management investment and attention commensurate with their importance. For organizations to realize the full value of sourced services, post-signature governance is must, not a nice to have. It must be a top priority to realize business value. You can unknowingly ignore, underestimate or neglect the challenges inherent to sourced services engagements .. .. but they will not ignore you, as many organizations have already experienced.

For large enterprises this means that if they continue on the typical path of fixing the larger supply base first, it may take them several years to circle back to their strategic service providers, by which time most of the anticipated value in those strategic engagements will have already been lost. Both need to be addressed in parallel. In fact, for the industries with a high percentage of sourced services, it is advisable to deploy the governance of sourced services ahead of procurement optimizations for the general supply base.

 

TRAC is the ideal solution to manage sourced services

TRAC is our unique cloud-based sourcing governance solution that allows you to have full visibility and control of your complex and dynamic sourced services and supplier relationships. It is specifically designed to manage the post-signature phase of strategic services arrangements that tend to be complex in nature and contain hundreds of embedded obligations. It supports all critical governance processes and offers a ‘single source of truth’ for both the client and the service provider. Tactical supply arrangements, by contrast, have a much lower obligation density and rarely require this level of attention.

TRAC offers unmatched service provider governance capability during the post-signature phase (see Figure 5) by integrating the key supplier governance disciplines of contract, performance, financial, risk & issue, meeting and dispute management on a single platform. P2P tools, on the other hand, are designed to manage the bidding and procurement of non-complex products (typically commodities), and the subsequent spend analysis and management for those products and focus primarily on the pre-signature phase. Given today’s services procurement landscape, an integrated combination of a P2P system with a specialist sourcing governance tool like TRAC is the optimal way to address the divergent needs of both supplier types i.e. getting control over all suppliers at a basic level and ensuring value retention for the strategic service providers.

 

Please contact us if you are interested in reading the full white paper on this topic or if your are interested in learning more about we can help you to optimize your sourced services governance. We are more than happy to assist you.

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