We invite all procurement, P2P, and supply management practitioners to participate in my upcoming CPO-focused research study (to be called “CPO Rising 2015: What’s Next for Procurement?“) by clicking the link and taking this survey. Respondents get a chance to participate in the industry’s definitive study and they also get the final report. If you enjoy our work and/or have a few minutes to spare this week, please consider it.
And now, back to our regularly scheduled programming….
On this season of CPO Serial, I interviewed the Chief Procurement Officer (CPO) at a large US-based manufacturer about his experience with a company-wide outsourcing initiative and how he and his procurement leadership team and the entire organization approached outsourcing. Readers can find the first seven episodes here and get caught up on what has become an insightful and instructive real world case study focused on outsourcing the procurement function.
In our last episode, the CPO discovered a mistake of huge proportions in the 11th hour (21 months into the project): with updated estimates that better reflected reality, the initial procurement outsourcing project was projected to have negative net present value. Based upon that calculation, the company would have been better off if it did not outsource the procurement function. In today’s episode, we learn what the CPO and the transition team tried to do to make the BPO business case work, plus we hear about the last-minute push by the CPO and his team to consider an alternative outsourcing model.
CPO Serial: Episode 8 – Hail Mary
Andrew Bartolini: So let’s get back to to the negative NPV (net present value). The new transition team lead didn’t seem phased in any way by the new business case numbers. Does the negative NPV decision or discussion move beyond this new person? Do you go back to the executive team?
Chief Procurement Officer: Well, first, we tried to make the business case work. The message was, “Well, the business case has to be positive.” And I was like, “Yeah, and I’d like to sing like Bono, too, but it’s not going to happen.” [laughs] So then we started a series of odd exercises to try to make this a positive NPV. We needed to increase the savings and to do so, we needed to disregard our typical savings guidelines, which are that we don’t carry over savings into a new year because that’s the way the company manages it financially. For example, our current policy says that if you save a dollar today and you’re going to save a dollar again next year, you don’t get credit for the second year savings because there is a new cost basis. So, we don’t carry over savings, nor do we carry over prevention. Now, you can say that that’s short sighted, many organizations carry over prevention for three years, and so on. Well, we don’t do that. And most of the company runs on a year-to-year account basis. So, then the answer came back, “Well, for this project to work, you have to carry over. The NPV rules permit that you can carry over the NPV for three years.” Well that immediately and totally changes the financial picture. Of course, we never got that benefit in tracking our own numbers so we are no longer comparing apples to apples.
Now, for the category management outsourcing and support piece, we had to frame it more as a “what else can we do to make the transactional outsourcing piece viable?” By the way, a standard NPV can run as long as 10 years. So, we took the our business case and extended it from five years to 10 years. I really didn’t agree with the approach because we had signed a contract with the BPO for five years, and we could not reasonably assume that we’d get the same terms, conditions, and pricing for the next five years. But we really helped the business case out because when we doubled the length of the analysis period, we could amortize the transition costs across a much longer time period.
AB: Right, I mean correct. This seems all kinds of wrong to me
CPO: So, all of the transition costs and payments to the old BPO and the new BPO were spread out over ten years instead of five and as a result, the business case moved from a negative return to a $2.7 million positive for the transactional outsourcing.
AB: Okay, but again, it’s no longer apples to apples, right? With some financial massaging, you just “put lipstick on the pig” that this deal has become.
CPO: Yeah, so it came out to a $2.7 million positive return for the transactional piece over a ten-year period…. and in my opinion, that’s peanuts given the transition, the pain, and frankly, everything that we went through and would need to go through in the future. I mean, even to get to this paltry figure, we had to massage the savings numbers using an entirely different set of savings tracking rule and we also made some very poor assumptions as to the contract renewal in five years. This is when I started to lobby to keep the transaction group captive and not outsource it. In other words, I proposed that we would outsource the category management augmentation piece of it which had a positive yield but would keep our buyers group within the company and pull them out of procurement and move them to a shared service center.
AB: How did it go?
CPO: So, we ultimately made a formal request – based largely on the $2.7 million NPV and the substantial benefits from the category management augmentation piece – to adopt a different outsourcing model, one that was more of a strategic sourcing augmentation. It would have included support for category management, billing, contracting, etc. – which was the piece of work that the BPO’s subcontractor was going to support. So we went to the committee that was managing this, and asked for permission to quantify the business case for keeping the group captive, and that was summarily denied.
AB: Okay, of course, there’s the headcount reduction number that the executive team has already committed to. They wanted that number.
CPO: Right, they wanted that number and so did our CEO. So, now, the contract is finalized and the BPO provider has given us everything we need. The business case is finalized. There’s a positive NPV – it’s negative for the transactional procurement work, but overall we can get to a $10 million plus NPV for a ten-year period. Again, we had questions about whether or not we had the right assumptions in the 10-year analysis, but never mind, it’s a ten-year NPV and it was “positive” [CPO uses air quotes]. Since, the transactional outsourcing portion of it was still not lucrative for us, we go back and ask for permission one final time to retain the staff and operations – Our “Hail Mary.” It was an awkward few days because the BPO executives were onsite to sign the final contract after a frenetic couple of days where we negotiated the final handover and transition costs, as well as payment timing. So we come to an agreement with the BPO provider and our Chief Operations Officer came down to sign the contract and we’re just sitting there hoping to hear from the CEO about whether or not he’ll consider retaining the transactional procurement team/operation. Anyway, the answer comes back, and it’s a “no.” We were disappointed but not surprised. We needed to suck it up, and that’s what we did. We signed the contract and started implementation.
As you have read, outsourcing procurement and AP had caused much pain and frustration for the CPO and team. And, even though they had to massage the numbers to make the business case work, there was no going back. They would have to make it work, at any cost.
Next time on CPO Serial: The contract has been signed. Now, the organization and the BPO provider prepare to implement the plan. Surely nothing else could go wrong….. or, could it?
RELATED ARTICLES
CPO Serial: Procurement Outsourcing (Episode 7) – Our Dilbert Moment
CPO Serial: Procurement Outsourcing (Episode 6) – The Rubber Hits the Road
CPO Serial: Procurement Outsourcing (Episode 5) – Vendor Selection
CPO Serial: Procurement Outsourcing (Episode 4) – The RFP
CPO Serial: Procurement Outsourcing (Episode 3) – The Counterproposal
CPO Serial: Procurement Outsourcing (Episode 2) – A Business Case is Made
CPO Serial: Procurement Outsourcing (Episode I) – It Begins
