How To Affect Cost Reductions By Converting Non-Traditional Purchases Into

Author(s):

Janet L. Sickinger, MA, MBA, CCA
Janet L. Sickinger, MA, MBA, CCA, 3M, St. Paul, MN 55133-3327, 612/737-3073.

80th Annual International Conference Proceedings - 1995 - Anaheim, California

Services Contracts

ABSTRACT.
Purchasing organizations traditionally have been recognized as being "champions" when it comes to reducing overall product costs. Such innovative activities as supplier teaming practices, value engineering, JIT ordering, the supply Chain Management process, inventory reduction practices, strategic contracting, the installation of automated and "paperless" purchasing systems, EDI, risk management, supplier performance measurement systems, and continuous supplier improvement programs, have contributed to economizing the expenditures for goods. The operative word here is "goods".

The majority of purchasing organizations in today's companies have been chartered with the responsibility for the procurement of "tangible" items such as hardgoods, softgoods, capital equipment, MRO and any other item that can be seen and felt. Yet, as we study the expense ledgers of today's companies, we notice a shift in the level of the dollars spent for "tangible" goods versus the "intangibles". Much of this shift is a result of the recent changes in world economies which have generated fierce competition and the need for significant product price reductions. Industry has been achieving these product price reductions by reducing its operating expenses and downsizing its labor force. Many of the activities that had previously been performed by the company's workforce prior to downsizing are now outsourced. The data is showing that in the manufacturing industry alone, average annual expenditures for the procurement of intangibles may represent as much as thirty percent of total company expenditures (excluding payroll for employees).

In non-manufacturing industries, this number would be higher. Therefore, if a Fortune 200 company spends approximately $9 billion annually for the procurement of goods (tangibles) and services (intangibles), approximately thirty percent (or $3 billion) of those expenditures may be an untouched, area of opportunity for the Purchasing organization to "add value". Several purchasing organizations in Fortune 500 companies have begun plowing this fertile area of opportunity and have found that on an average, they have been able to save their companies ten to twenty percent of the overall expenditures for services. Using the figures above for our Fortune 200 company, we see an opportunity of potentially saving $300 million to $600 million. This paper will discuss the strategies and techniques, to identify the areas of opportunity, management of the political, cultural, and process changes, development of the attendant tools, and technical skills necessary to affect significant cost reductions.

THE AREA OF OPPORTUNITY.
The first step that a purchaser should take in identifying the "areas of opportunity" would be to review the company's ledger accounts for expenditures. A listing of total expenditures for goods and services should be extrapolated and divided into two categories: 1.) Traditional Purchases, and 2.) Non-Traditional Purchases. Traditional Purchases are those expenditures for goods and services that had been traditionally procured by the Purchasing organization. Conversely, Non-Traditional Purchases are those goods and services that have been traditionally procured by some organization or individual other than the Purchasing organization. we at 3M, prepared such a list, and discovered that approximately one third of the total expenditures were for Non-Traditional purchases and about ninety-plus percent of that Non-Traditional amount was made up of expenditures for services. We felt that we were onto something big. We benchmarked our results with other companies and found the results to be quite similar.

Historically, major services needed by a company have been performed by the employees of that company: printing and publishing services, engineering drafting services, sales and marketing services, cafeteria, janitorial, lawn and maintenance services. Other areas of needed services that were small, non-recurring and sporadic were procured from outside suppliers. The individuals typically responsible for procuring these services were secretaries, engineers or other company employees not formerly trained in procurement practices. Since these areas of expenditures did not represent a significant portion of the company's overall expenditures at that time, they did not merit much attention or scrutiny.

However, times have changed. The mid-80's brought about worldwide economical changes, which in turn, generated fierce competition towards the price reduction of products. Companies responded by improving productivity and quality by reducing operating and labor costs through downsizing. The reduction of operating and labor costs were achieved by procuring the same labor and other services from the outside at a much reduced price. Therefore, employees lost through attrition and layoff programs were replaced with contract workers and consultants. Other major services performed internally by the company such as manufacturing, marketing, engineering design/drafting, janitorial, groundskeeping, maintenance, security, mailroom, accounts payable, and even PURCHASING are now being outsourced! With the tremendous advances in automating and streamlining purchasing activities through EDI, procurement cards, on-line releasing systems for requesters, and so on, many top company officials now see purchasing as a routine, tactical service that may be outsourced. Hence, it is critical that Purchasing organizations recognize, market and optimize their core competencies which will produce value-added, strategic contributions in the way they "invest" (not just spend) the company's money. We submit that the largest untouched area of opportunity today for many Purchasing organizations is in the procurement of services. Warning though, even though it is fertile ground, it's a laden mine field full of political and cultural bombs.

REMOVAL OF ROADBLOCKS.
After we identified and segregated Traditional versus Non-Traditional expenditures, we had to identify and segregate the expenditures for services out of the Non-Traditional category. The list in figure 1. (below) identifies the top twenty two categories of Services typically not procured by a purchasing organization.

  1. Building Repair/Construction
  2. Consulting
  3. Office Equipment Maintenance
  4. Insurance
  5. Computer/Telecom Maintenance
  6. Transportation
  7. Waste Treatment/Disposal
  8. Air Travel
  9. Groundskeeping Service
  10. Hotel Rooms
  11. Production Equip. Maintenance
  12. Product Testing Services
  13. Outside Material Processing
  14. Uniform Rental/Laundry
  15. Car/Truck Rentals
  16. Programming/Software
  17. Vehicle Maintenance
  18. Food Service
  19. Temp. Personnel
  20. Utilities
  21. Plant Security
  22. Legal & Accounting Services

The reader will quickly realize that some of the categories listed in Figure 1. represent significant dollar levels. As such, the individual or organizations traditionally responsible for administering those categories will not want anyone else encroaching on their area of responsibility or obtaining control. With these types of situations, the Purchasing Organization may offer not to take over total control and responsibility of the procurement process, but only contribute ITS AREAS OF CORE COMPETENCIES. Such competencies may be providing overall company policies/practices guidelines regarding ethics towards supplier selection and day-to-day interactions. Other procurement competency contributions would be reducing risk by setting-up and negotiating proper service contract types, reducing costs through the competitive bid process, and implementing supplier performance measurement/corrective action systems.

STRATEGY.
The next step is to total the annual expenditures, and assign a priority to each category in Figure 1. This may be done by assigning the higher priorities to the highest dollar categories or to the friendliest most accessible area to penetrate-or both. The most important step is to get that first "success story". For example, applying the simplest of purchasing techniques, such as competitive bidding, negotiation, reduction of the supplier base and application of favorable prompt payment discount terms will result in an "easy" 10%-15% in reductions. Our first success story was just that. One internal group was under pressure to reduce cost and do more with less. They were responsible for obtaining temporary clerical help for internal organizations. They had been obtaining these personnel from approximately eleven outside Temporary Help Agencies. We let the Agencies know that we would be awarding 4 contracts to the best overall value proposal. One of the contracts awarded was to a company classified as a Small Disadvantaged Business (SDB). The prices went down, but more importantly, the agencies were now to be responsible for much of the administrative and reporting work previously done by our administrator. Needless to say, the Administrator was much happier having to deal with 4 agencies rather than the 11 that they had previously. That project resulted in a quick half million dollars in cost reductions.

Perhaps the most critical element of the plan is to staff this special "strike force" with the most strategically skilled negotiators. These people will become the key marketers of the process, and as such, must represent the very best professionals that Purchasing has to offer. Several authors of Purchasing textbooks assert that one of the areas that commercial purchasing areas can learn from Governmental purchasing is the area of service purchasing. Some of the strongest talent in our Services Contracting group had past experience in Governmental purchasing.

Cross functional teams should be organized with representatives from all the internal functional areas affected by the performance of the service. The formation of cross functional teams ensures "buy-in" from the organization that may feel its territory is being invaded by Purchasing. For it will be these members (under the facilitation of Purchasing) that are paramount in developing the process, evaluation/measurement approaches, the statement of work, and ultimately, the contract formation that will govern.

It is important for the Purchasing organization to have an on-going marketing campaign of these "success stories". Therefore a formal "marketing plan" should be developed and championed by the Vice President of Purchasing and consistently report the results to the highest management levels of the corporation.

TECHNIQUES AND ATTENDANT TOOLS.
Purchasers of services generally find the process paper-laden. In addition to tailored statements of work, service purchases will require written Request For Proposals (RFPS) built around those statements of work. Tailored statements of work must be accompanied by tailored schedules, deliverables lists (both data deliverables as well as project reviews, training, and reports) and special contract terms and conditions. It is important to note that purchases of goods are protected under purchase order terms and conditions as well as the Uniform Commercial Code (UCC). Service agreements on the other hand, are governed under the Common Law of Contracting, and as such, have no such added protection. Therefore, it is critical that the contractual agreement be carefully constructed to "fit" the risk and nature of the services to be procured. "One size fits all" agreements do not always work here! It is easy to see that this increase in administrative and human produced detail will cause individuals to query whether or not value is being added. However, after those first few "success stories" start coming in, it will be evident that the careful strategic work up front pays off in the end.

Proposals received from bidders are only as good as the Request for Proposal (RFP) developed by the purchasing cross functional team. The company, lead by purchasing, must take a firm stand and "drive" the process, its requirements, content, direction and proposal evaluation/measurement criteria, rather than letting the supplier drive the requirements and results.

As a minimum, the RFP must be constructed to elicit the following information from the bidders:

  1. A total Responsiveness and understanding of the technical and statement of work requirements.
  2. Demonstration of an acceptable system of management and provision of a suitable management plan.
  3. Proves excellence of any proposed concept, practice, approach, process, design or solution.
  4. Evidence of applicable company experience and past performances.
  5. Quality key personnel to be assigned to the project.
  6. Commitment of corporate/company resources and their dedication to the program.
  7. Proof of financial responsibility.
  8. Suitability of the price proposed for the performance that will be rendered.

The use of the Supplier's contract must be avoided at all costs. It is the buyer's right and responsibility to design and offer the contract terms and conditions that the business transactions will be governed under. This is where purchasing experience and expertise is critical. Contract types for goods are often firm fixed price (FFP), lump sum, or fixed price line items. The indefiniteness of service requirements promotes circumstances where: indefinite quantity/indefinite delivery, requirements-type, time and material (T&M), level-of-effort (LOE), and labor rate contract-types are necessary and appropriate. Service contracting situations may, in fact, require combination or composite "hybrid" contract types with the more firmly defined line items set up as FFP line items and the less clearly defined services falling under "cost reimbursable" line items.

Service purchases (other than construction) are often awarded on other than lowest price. Most service contracts will consider the proposed approach and experience of at least equal or higher importance as the low price. Architectural and Engineering (A&E) firms are, in fact, selected based strictly on technical qualifications and a contract is awarded based upon negotiation of a fair and reasonable price with the best technically qualified firm.

There are many publications and workshops that will assist the purchaser in the disciplines of developing RFPS, constructing proper contract terms and conditions, designing and analyzing statements of work, schedules and deliverables lists. The April through October 1994 issues of the NAPM Insights magazine contained the following articles on services contracting: "A Statement Of Work Primer", "Leasing Property-What You Should Know", "Contracting For Temporary Employees", "Contracting For Medical Services", "Three Steps To Purchasing Travel Services", "The Media Buy", and "Minimizing Loss In Insuranceland".

CONCLUSION.
Opportunity awaits the purchaser through the identification and conversion of a company's non-traditional purchases into "traditional" service contracts. This untouched territory in most companies is laden with opportunity for cost reductions. Through the effective use of tried and proven purchasing and contracting techniques, the purchasing organization may lend tremendous value-added activities to the functional areas of the company requiring the procurement of services.

REFERENCES

Graw, LeRoy H., C.P.M., C.P.C.M., "Service Contracting? Let's Not Get Personal Here!" A Collection Of Presentations From The 76th Annual International Purchasing Conference (May 5-8, 1991): 304-308.

Rowe, Kenneth M., "How To Purchase Services" NAPM Seminar (April 14-15, 1994).

Zemansky, Stanley D., C.P.M., CPCM, CPPO, "Contracting Professional Services" A Collection Of Presentations From The 76th Annual International Purchasing Conference (May 5-8, 1991): 48-53.


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