In the second in a three part series, Alan Gleeson explores what sourcing optimization is and explains some reasons for its growing popularity? Read Part 1 here - Sourcing Optimization - A Definition.
The Building Blocks for Sourcing Optimization
Ensuring demand is broken down into small granular lots is a key element in the market-informed sourcing component. There are a number of immediate benefits.Firstly, it encourages participation from a broader supplier base. SMEs can now participate, safe in the knowledge they can be competitive (perhaps with a niche good/by virtue of a geographic base or by taking advantage of capacity constraints i.e. an ability to bid on more lots than they can serve by capping their exposure through the stipulation of ‘capacity constraints’).Secondly, the approach used is ‘sealed bid’ so suppliers have to submit considered ‘best offer’ bids and have no visibility of other participants bids. This approach reduces ‘emotional bidding’ as well as making it more difficult for suppliers to collude.Thirdly, suppliers can bundle and package lots together as they see fit, offering tiered conditional discounts which ratchet up as more business is won. (Suppliers can just pick the attractive lots, and align these with existing business to drive utilization rates).Finally, as mentioned in the previous post, the [private sector] buyer can also add business constraints giving them finer control of the outcome.In effect, the approach lets all parties play to their strengths without discriminating against any one group. SMEs can identify parcels of work they can competitively serve, and larger businesses can bundle and package lots together that reflect their economies of scale (sharing savings in return via offering tiered discounts). Similarly, larger players are also forced to ‘sharpen their pencils’ as they’ll recognize the new approach helps drive competitive tension on the supply side.
Some Context: Why is sourcing optimization emerging only now?
Within the worlds of sourcing and procurement there has been a historical tendency to favour a sole supplier approach in many categories. At first blush the arguments appear compelling; a small number of suppliers ensure easy contract management, and aggregating demand helps drive economies of scale amongst larger suppliers.There are also a number of obvious winners under this approach i.e. the time pressed procurement manager (who has to manage a single contract) and the large supplier (who will typically exercise their market power) which will likely lead to opportunism and rent extraction over time.But what of the procuring body or buyer? Is a sole supplier relationship likely to lead to the best outcome for them? Will aggregation on the demand side automatically lead to savings due to economies of scale?It is becoming increasingly obvious; the above argument is a lot more nuanced. By simplifying their contracting, firms can capitalise on economies of scale, but they can duly fall victim to monopolies and oligopolies (especially when they are selecting from a shallower supplier pool). As Peter Smith remarked in his recent post:“How about the whole belief system around the benefits of aggregation and scale in contracts and negotiation? The view that I’ll always get a better deal if I put all my spend together? (Remember, the UK’s National Audit Office has failed to find any evidence that large buyers got better prices than smaller when they’ve sought such evidence in their reviews of government procurement). Where is the hard evidence of the benefits of aggregation?”In many respects, Stephen Allott Cabinet Office’s “Crown Commercial Representative” for Small Business, hit the nail on the head when he declared ‘aggregating demand is sensible but it shouldn’t necessarily lead to aggregation of supply’.With sourcing optimization, the approach looks to leverage buyer strength (and aggregation is a positive element), however, by disaggregating then into small lots/ line items etc the market can then offer a richer set of bids, enabling the buyer to evaluate the various permutations for the best combination.There is also increasing evidence of contracts in both the public and private sector where supplier power is to the fore with the ‘tail wagging the dog’ as it were.While clearly there are some categories, where ‘split awards’ are simply not practical, in most spend categories, sole supplier arrangements do not lead to optimal outcomes. Unsurprisingly, a growing number of people feel there is growing evidence of market abuse by ‘monopolists and oligopolists’:
1. Cabinet Office minister Francis Maude plans to standardise on open formats to cut costs on Office suite and break ‘oligopoly’ of IT suppliers. The Guardian
Of course there are numerous examples of market abuses from the private sector also, although these are not likely to see the light of day for obvious reasons.However, what appears eminently sensible i.e. disaggregate demand and encourage competition from a wider supply base, goes against the ethos espoused by those in the ‘sole supplier’ camp. The counter arguments will range from economic ones (it will cost more) to practical ones (who is going to manage the 10 small SMEs?) but it is increasingly apparent neither argument will stand up to scrutiny.Other reasons why sourcing optimization has not enjoyed mass adoption yet include:
The tide may finally be turning though. Increasing numbers of buyers recognize the need to ensure competitive tension exists amongst suppliers, and sourcing optimization is increasingly viewed as one means by which to achieve this. Given the approach is one which can help buyers elicit savings without squeezing suppliers the appeal is obvious. Finally, in recent years the transition has begun away from costly complex enterprise solutions to software as a service/managed service approaches meaning the benefits of sourcing optimization is now available to a much wider audience. This article originally appeared in Spend Matters UK.