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Strategic Sourcing - By Paul McMinn

Corporate downsizing has taken a toll in many organizations, especially in areas such as procurement, regarded historically as a cost center. With continued economic uncertainty and instability, companies are continually looking for ways to add to growth and contain costs to sustain growth.

By Paul McMinn | March 04, 2014

Getting the Best Value for Your Procurement Dollars

My computer sounded the familiar Outlook calendar alarm for an upcoming web conference call that was scheduled for the next hour, and I glanced again at the agenda and attendees with my notes in the margin from a week ago when I'd printed the meeting invitation. For a pre-RFP orientation call for an indirect procurement category such as lab supplies and equipment, my eyes followed down the list of participants of this global company; I saw it was represented by procurement directors from the various divisions and a steering committee comprised of the North American director (whose share of the global spend was greatest) and two team members from finance and accounts payable in addition to the project lead category manager. Under this list of client attendees, I penciled in "lab manager" with a circle and question mark. I knew there was a mix of quality control functions as well as research and development, which are typical. However, for a company this size, with a lab consumables, equipment, and reagent spend close to $10 million a year, the lack of representation from the user community was eclipsed only by the information introduced during the call that the category manager for office supplies had just been assigned to the team and had no experience with lab supplies.

Many would have found this surprising as recently as ten years ago, but in the current economic climate this is a pattern that has become all too familiar. Corporate downsizing has taken a toll in many organizations, especially in areas such as procurement, regarded historically as a cost center. With continued economic uncertainty and instability, companies are continually looking for ways to add to growth and contain costs to sustain growth. While indirect spend can require as much as 20 to 40 percent of an organization's revenue, for a typical pharmaceutical or life science company it is about 25 percent of total revenue, making the savings opportunity for cost containment in this area potentially significant.

The challenges in deriving savings are often part of the organizational culture because many indirect spend categories are managed at the departmental level (e.g., lab supplies managed by R&D in the pharma sector) versus a procurement function reporting up through finance. Finance may not have the degree of control for directing spend in a life science company, and conversely, a lab manager's budget and concerns may often be lost in a top-down finance-driven culture. Add to this mix the natural complexities of the lab supply category as a component of indirect spend that is often highly fragmented across business units with disparate terms and conditions and a lack of current market intelligence,given that the buying organization is focused on the contractual agreements only every three to five years. It's not uncommon for the next contract renewal to have a totally different team in place, with some institutional knowledge lost through attrition, reorganization, or downsizing, which all work against the buying organization's competitive posture.

Procurian, an Accenture company, refers to this as "information asymmetry" when describing the lack of uniform market intelligence for each category class. The days when procurement had deep domain experience in each category sector are largely gone, as it is no longer economically feasible to maintain that level of expertise indefinitely, and as organizations lose much of this unique knowledge base in procurement, the gap can be filled in a variety of ways for many organizations.

Outsourcing

While many of us are familiar with outsourcing as a concept, perhaps it impacts us only in small ways, such as IT support for a software product or any number of service provider call centers where support roles have been outsourced to contract firms. When it comes to procurement functions and support for the lab professional, many organizations have not made that leap, although there is a strong service segment of organizations expanding to provide those services as an outgrowth of business process outsourcing (BPO). In today's market, there has not been much movement within the lab and research community to outsource this function, with the notable exception of third-party vendors, also referred to as "tail spend." For indirect segments such as core lab supplies and equipment that are often integral to product development and QC processes, many companies would benefit by looking internally to fill those roles on a project basis and designating not only a functional resource in procurement but also a technical resource. The technical person understands the products and their applications for QC and research and can provide the crossfunctional team support needed not only to fill the shortfalls in the knowledge base but also to provide ongoing program support to identify savings opportunities that need to be validated and implemented at the user level. Let's take a look at that process today, with a view toward identifying potential roles and contributions by the lab manager in a matrix structure.

The current state

At a fundamental level, both lab managers and procurement professionals want to ensure that they are getting the best value for their procurement dollars and approach this process through a Request for Proposal, or "RFP," process. Capital equipment (more than $5,000) is typically excluded, as this is often addressed through a bid process. Traditionally, procurement may survey its lab managers for their top spend items, or, if their systems can provide the data, an annual market basket of goods or a "hot list" may be derived based on the Pareto principle. The hot list typically has fixed pricing for some period of time, which provides some degree of cost control, and a separate discount schedule is added to address "spot buys" with a discount from a price list. Items purchased from "all other" lab supply vendors may fall into the third-party or tail spend domain. Because the buying organization has no concentration of spend in this category, the leverage is limited and spend is optimized for the best terms and conditions offered. This current state is typically comprised of either a primary supplier or distributor for the lab category, a secondary supplier who may be defined, or a combination of both, including regional suppliers that have either unique product offerings or a specialty supplier such as of fine chemicals or biologicals. These buyer-supplier relationships may be formalized with contractual agreements for three to five years or may simply represent price offers with no commitment from either party. Primary contracts or agreements typically have some form of supplier inducement for the buyer to reach an agreed-upon spend threshold or a "loyalty" premium for renewing or agreeing to an extension of an agreement, which will vary depending on the volume of spend.

The challenges

While the market basket is a key indicator of competitive performance, many organizations lean on it heavily in their award decision process, when, in fact, the Pareto principle falls significantly short of the 80/20 rule, with a natural break in unit spend volume around 55 percent or less for lab supply spend. Coupled with the fact that the delta from competing suppliers on a weighted market basket analysis is typically less than 3 percent and often less than 1.5 percent, we begin to see the limitation of the Pareto analysis in this spend segment highlighted by the lack of market information and widening market intelligence gaps between suppliers and buyers today. Given the fact that the 55 percent market basket analysis is typically inconclusive, the next question is how the remaining 45 percent of the category spend is evaluated. Because the cost of change is most certainly more than 3 percent, it falls to the supplier to clearly demonstrate the value provided in other areas that tend to be more subjective from a buyer's perspective. Projected financial savings that meet CFO guidelines typically fall short due to inability to adequately quantify the savings and to the resource constraints by procurement, finance, and the lab user community they serve to track and drive programs and initiatives successfully to reduce costs. In the scenario above, most organizations may include a supplier scorecard for quality issues and an end-user survey of the incumbent supplier with a list of corrective actions, even a comparison of terms and conditions and payment terms, but most buying organizations would not make a change based on this limited analysis. AT Kearney did a survey in 2010 of procurement organizations and found that "less than half include compliance management metrics such as spend integrity or accuracy and supplier commitments, scorecards, and reviews. This data, of course, helps the realization and sustainability of identified benefits and also informs future supplier selection and negotiations."

The path forward

Ed Cross of Xchanging Procurement Services and Peter Smith of Spend Matters have identified what they call a third "key foundational stone" that adds to the strategic sourcing and category management function with a program and delivery discipline in tracking these proposed initiatives and the actual deliverables of savings programs in conjunction with supplier resources. Given the complexity of the lab category and the importance of user participation and adoption of these programs, the lab manager is best positioned from a skill set perspective to lead this effort in a matrix role as a bridge from the R&D/QC/production environment to the procurement and finance function as a business manager to drive the success of viable savings initiatives that today don't occur for lack of resource allocation. At a minimum, lab managers should take an active role in representation or participation in these steering committees and teams. Doing so would ensure that their interests are represented and they have a working knowledge of the key business and market drivers that affect the value they receive from these agreements and their impact on the financial health of their organizations. The lab market will continue to consolidate, and the question you should ask as a lab manager is how your cost center and organization will be impacted. What pilot programs can you envision or take advantage of in the marketplace that could potentially enhance your department's performance or productivity or provide cost reductions or efficiencies? Many global lab supply agreements are being implemented by buying organizations with director-level resources aligned with the user community where skills such as project management and Six Sigma certification will be the desired tools in your scientific bag. It's the new normal in lab procurement, and the watchword is value.

References

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