This week’s Wiki-Wednesday article, ‘Shape Demand… For Services’, looks at the challenges procurement organizations face as they work to address internal demand for services. As an increasing number of non-core functions are handled by third parties, it is important to consider the management of this spend as the outsourced category model it is.
Before selecting the appropriate method for reducing demand, procurement must discern the driving business reason behind the need to reduce consumption. Having a focused approach to reducing demand allows procurement to target the right demand drivers and buyer behavior and make the most effective changes. Is the goal long or short-term savings, or an issue of total cost to meet a contracted objective?
If the goal is short-term savings through demand reduction, procurement will need to find a way to work with the contracts already in place. By properly communicating the cost to purchase a service to the departments buying off the contract, and measuring and reporting on usage, procurement should be able to increase visibility and hold buyers to the demand levels they really need. If the method for making use of outsourced services conceals the cost to the department or organization (whether deliberately or not) buyers may unintentionally cost the organization more through demand that is higher than necessary because they are not fully informed.
Longer-term savings goals may require restructuring or renegotiation of existing contracts. Contingent labor is often sourced and charged using a ‘cost plus’ price structure. Each outsourced resource is paid a competitive hourly wage and the provider is compensated on a percentage of that salary. Any pricing negotiation with the provider should focus on the markup percentage rather than the hourly wage to prevent unqualified resources from being put on staff. That being said, the hourly wage is driven by the skills requirements defined by the buying organization, like materials pricing is driven by specifications. Revising the skills expectations for each role to accurately meet the needs of the organization may allow the hourly wage and the effective markup to be reduced.
In the scenario where an outsourced provider is (or should be) focused on the total cost of meeting a corporate objective, it may be the role of the provider to manage demand. Setting up an appropriate compensation structure in the contract makes all the difference. In the book Vested Outsourcing, consultant and author Kate Vitasek describes the ‘Activity Trap’, a common outsourcing pitfall that is caused when suppliers are compensated based on transactions rather than goals. If a transaction is non-productive but results in the provider being compensated, that provider has no natural incentive to avoid performing it. If compensation is based on goals being met, the provider is incented to maximize their efficiency – the less hours required to meet the goal, the higher their profit.
It is important to look at services contracts much like material contracts – and manage demand the same way. Although the unit of measure is an hour or a resource instead of a box or a dozen, the behavior that drives the demand, consumption, and spending is the same. Keeping the focus on that behavior rather than the delivery model will allow procurement to leverage the skills they use to reduce spend in materials categories.