At times of enormous disruption to global supply chains, it’s easy for procurement only to think about direct spend. But it’s just as critical to ensure value is delivered in outsourced service contracts.
“Today’s health and economic crisis, as a result of coronavirus, means that typical approaches to cost management will need careful consideration as business’ key focus has to be staying in business” Lorna Brown, Former CPO, Global Financial Services
We live in an ever-changing world, where what had been predicted as a prosperous year for a business could turn into a fight for survival thanks to something that it has no control over. As the world pulls together to combat COVID-19, businesses face the challenge of reduced revenue forcing them to tighten their belts and search for further savings.
In times of crisis, most organisations will fall into the same pattern and focus their cost reduction effort on direct spend categories. After all, your first thought in a crisis or risk management situation is more likely to be ensuring the stability of your production supply chain, rather than identifying the cost savings you can secure from the organisations delivering your HR or IT Support services.
But why is this the case? Organisations may consider their direct categories as more business critical, or believe that they can release greater value from them with closer management of their global supply chain. For an increasing number of organisations, however, outsourced services form the core of their business. And by focusing on the right cost levers, review of these service contracts could deliver just as much in terms of savings as direct spend.
Pulling on the Cost Levers
Structuring a contract for the procurement of services is can appear to be a different beast to one for the procurement of goods. Many procurement professionals will go their entire careers without creating a single RFQ, tender or contract for an outsourced service.
The reality is, however, that there isn’t a great deal of difference beyond what is delivered by the supplier. Procurement still needs to know that suppliers are able to meet an organisation’s requirements. A robust contract needs to be put in place to ensure that services are delivered efficiently and effectively.
And when it comes to cost levers, there’s no need to start with a blank sheet of paper when proven procurement strategies will still fit the bill. Everest Group, a consulting and research company with an established history in the outsourced services space, has conducted extensive research on this topic. Amy Fong, Vice President in Everest Group’s strategic outsourcing and vendor management practice, is clear that this research has highlighted five key cost levers for procurement to use right away when it comes to their outsourced services: “we see a lot of common themes where buyers can do a better job.”
1. Pay the Right Price
Former CPO in Global Financial Services, Lorna Brown, believes that organisations need to be “a bit curious and engage with the supplier to understand how they are delivering the services.” This will allow for a greater understanding of how the service is built up, but also what is driving the costs, and consequently the price in the market.
Services in high demand, but with a lower supply where there are fewer people capable of providing a quality service will cost organisations a premium. In the IT services market, this premium has been charged for everything from basic digital skills all the way up to large-scale, highly complex data analytics over the years. The availability of labour with these skills is the key cost driver. With each ebb in the requirement for these skills, rates for outsourced services will come down.
Being clear about how the cost of labour has influenced your price is a great way to pull this particular cost lever.
2. Understanding Total Cost
Procurement’s consideration of cost needs to go beyond the ticket price that is paid. There are other factors to take into account such as quality of support and adherence to Service Level Agreements (SLAs). It’s all about Total Cost of Ownership.
Got a great price for your basic service agreement? Great! But did you discuss and agree a price for ongoing support? Or agree how many people are assigned to your contract? Or how much you are paying for secure data storage? It’s critical to understand the whole picture beyond the basic price.
If you are just looking to drive savings on the bottom line price by whittling down your supplier’s margin, they will look to move or hide costs elsewhere. No matter how good a deal you think you have at the outset, if you aren’t tracking TCO you’re probably losing any savings you may have initially achieved and leaving this cost lever un-pulled.
3. Find the Right Deal Structure
One of the key decisions an organisation will have to make regarding its services is which model or structure their deal is going to take. In outsourcing of services, a fully Managed Service can be very attractive to an organisation with day-to-day operation provided by an external specialist, with the business free to focus time and effort elsewhere.
However, organisations using a Managed Service have to accept the fact that they will hand over a level of control, which in turn raises their risk. Procurement still needs to understand what’s happening throughout the outsourced service provider’s supply chain.
Organisations may also choose to use on-demand outsourcing, where they pay for support based on the number of times it is used, or a ‘Break/Fix’ service where it pays for just the work that is done. There is no right or wrong answer as this will differ from organisation to organisation. What’s important is picking the right option.
When it comes to cost savings, innovation is a key part of the puzzle that cannot be missed. And when it comes to pulling the innovation cost lever for outsourcing services, the focus should be on “Big I” Innovation (i.e. digital transformation), rather than “Little i” innovation (i.e. continuous improvement activities).
As with the other cost levers we have shown, innovation that is being looked at in other areas of the business can just as easily be applied to outsourcing too. Consider all the current industry favourites such as Robotic Process Automation (RPA), AI and Machine Learning – these can have an impact on costs.
However, despite the fact that there is increasing importance placed on innovation in outsourcing, many organisations are still missing the mark. There’s a lot that can be achieved from deploying this cost lever in the right way at the right time.
5. Financial Engineering
Cost lever number 5 takes the modernisation and digital transformation found in the innovation space one step further: when it comes to the concept of innovation not just about the business scoping out activities for different areas of its categories, but more about how it modernises the entire solution.
It’s important to use financial engineering to have the impact on profit that is required as the initial outlay or investment across the board will be significantly higher than a service that doesn’t include these types of outcomes. Organisations may choose to look at alternative sources of finance, assess potential Joint Ventures or Managed Services with flexible margins (in line with traditional Financial Engineering). Using this cost lever is about getting creative and perhaps walking the path less travelled for success.
Pull the Levers with Care
The 5 cost levers for outsourced services represent an individual and collective strategy for cost savings in the outsourced services space. Pulling one alone would be effective, and using all of them in some way could deliver also deliver great results.
To find out more about these cost levers, and to access expert advice on how to use them, register for the Everest Group sponsored webinar 5 cost levers to pull right now with your outsourced services, to be broadcast on Thursday May 7th 2020 at 2:30pm GMT. To find out all the information you need, including how to sign up, visit the Procurious website or click here.