Why it Pays to Focus on Outcomes Rather than Transactions in Procuring Supply Chain Services

• Get updates on trade, Customs and regulatory changes
• Stay informed on trade compliance seminars,
  workshops and industry events

x

Canadian Transportation and Logistics Jan 31, 2012

Vested outsourcing (VO) will be ready for prime time when the purchasing mindset switches to achieving mutually desired outcomes from simply buying the right things. Kate Vitasek, author, consultant and University of Tennessee professor, shares that prediction with supply chain professionals at every opportunity.

Procurement and outsourcing practitioners' top priority has always been to get a better price whatever it takes. That approach leads to a shell game in which buyers hide their real revenues and suppliers rarely expose their real costs.

But such a power and information imbalance results in a tense zero-sum game in which buyers invariably win and sellers lose. Vitasek explains that there is a cost to such "muscularity" because the buyers cannot win all the time and since suppliers never forget, they constantly look for ways to get even.

Buyers conduct tough negotiations to score short-term savings at the expense of sellers. In its place, she proposes finding innovative ways of creating and sharing greater value for both sides by collaborating to solve real problems. "Try to make the pie bigger not just reduce the cost of each slice," she says.

Such a mind-changing approach opens the door to win/win opportunities. That was the result of the 2007, US$185 million outsourcing deal between Microsoft and Accenture One. The software giant's goal was to modernize its global back office - procure-to-pay - operations involving the 92 countries where it did business.

Ultimately Microsoft reaped US$30 million in savings thanks to reducing the number of business application systems to 40 from 140, administration hours by 23%t and contract costs by an initial 20% rising to 35% by the end of contract.

Accenture came out ahead as well. Although contract revenue fell, its profit margin more than doubled. In other words, despite taking in less money, it kept more of it. Most important after two years, the original seven-year contract was extended for a further five years indicating both sides were happy with the deal.

Logistics consultant Jim Eckler, claims to see similar deals starting to emerge in Canada's 3PL market space. They contain two common qualifications. "One is a significant portion of the contract is at risk," he says. "Second, the performance outcomes are based on achieving specific business results including reducing inventory levels and related costs.

"Few existing 3PL contracts include such terms, let alone performance metrics."

From her research, Vitasek concludes that buyers must make the first move and leave money on the table. Their first impulse should be to hold out an olive branch not a baseball bat during negotiations. That helps build trust with sellers while increasing transparency and focusing more attention on solving real problems. In her view, where there is no trust or transparency there is no cooperation or collaboration. The last two traits are crucial for win/win negotiations.

Such an approach helps unbundle price and value. That will happen when buyers adopt a long-term strategy of encouraging suppliers to become value-added partners and abandon the short-term tactic of driving down prices.  In Eckler's mind, the separation of outsourcing from the procurement function will speed up that change. For example, Eckler points to Procter & Gamble's (P&G's) outsourcing centre of excellence.

As a result, it will be easier for buyers and sellers to sit down on "the same side of the table" to establish mutual-advantage or shared-value objectives and work together rather than argue over prices.

Buyers must also understand sellers' key financial concern. "It's not about increasing revenue," says Vitasek, "It's about preserving margin."  In many outsourcing contracts, it's all about cost per transaction in which suppliers must fulfill work outlines in the contract - so much for each pick or pack etc.

Such a check-list approach leads to perverse incentives. She cites the example of a 3PL storing a client's huge supply of five-year old calendars for which it earned a monthly fee. There were no incentives for it to develop innovative, value-added options. That requires developing process improvements not just blindly carrying out contract terms. Vitasek states that according to lean principles, 90% of business activities do not add value.

"Sellers should be asking clients 'Why?' not 'How?'" she says.

Problem solving requires time, resources and smarts. To get suppliers onside and facilitate the shift in risk taking, Vitasek suggests introducing 90-day payment terms. Developing innovations create working capital concerns. Longer periods give service providers more time to develop and test new ways of doing things.    Such extensions also enable both sides to understand the rhythm of each other's businesses.

Shorter time slots such as 30 days result in only pure commodity service changes. "Extending the contract period helps drive innovation by encouraging service providers to invest in your business," she says.

In fact, Vitasek believes that the logical result of such partnership deals is to make them permanent. "Both sides need to restructure agreements and increase incentives and sign larger deals to include transition costs to becoming life-time suppliers," she says.

Such arrangements ease pressures on suppliers and increase trust since they become less concerned about getting paid. As well, they do not have to worry about business development and marketing costs or the hassles and risks related to attracting new clients.

And if buyers can find suppliers that can do the job why do they need to change?

Sharing greater risks in outsourcing contracts tends to attract larger, often global buyers. Another case study that Vitasek cites is the 2003 contract between Procter & Gamble and Jones Lang LaSalle. It involves14 million square feet of real estate at 165 sites in 60 countries, including 50 North America non-manufacturing locations.

The agreement covers three distinct areas: facility management, project management and strategic occupancy services. Facility management services include such things as building operation, security, mail delivery, and dining and car fleet operations. Jones Lang LaSalle also oversees a US$70 million annual capital project budget.  In the contract's first year, real estate operations spending came in $1 million under budget.

However, Eckler contends that small- and medium-sized firms are better suited for VO-type contracts. "Large organizations take time to make up their minds because they must get support from more executives and departments," he says. "But smaller organizations can make decisions faster because they are more entrepreneurial and have fewer people involved."

Read Full Article on Canadian Transportation and Logistics »