Service sector business currently accounts for about two-thirds of the U.S. Gross Domestic Product, and about 8% of economic growth. A recent CAPS Center for Strategic Supply Research study found that purchased services averaged 39% of total purchasing spending. However, about 69% of the supply chain management professionals surveyed indicated that purchasing services is more difficult than purchasing goods.
In light of the increasing trend towards outsourcing business processes and the likelihood of moving these business processes to offshore locations, it is prudent for organizations to focus on improving the means for obtaining these services. First, there are a number of barriers to address if service purchasing is to be improved.
- Lack of resources focused on services -- The CAPS survey mentioned above found that the average buyer of direct material is responsible for 36 active suppliers. The average buyer of direct services is responsible for about 105 active suppliers. These buyers are responsible for approximately the same level of total spending. The dilution of the services buyers' time makes it difficult for the buyers to be proactive with their suppliers.
- Lack of Information Technology support -- Services buyers are less likely to be supported by technology and information systems, and often have to use software provided by the service suppliers for making services purchases and tracking services spending and supplier performance.
- Knowing when to outsource -- Overdependence on service providers because of reliance on supplier-specific assets, such as ordering and information systems, decreases the power that the buyer has over the supplier. This opens the door for opportunistic supplier behavior.
- Understanding of cost drivers and structures -- There is limited understanding of the cost drivers and underlying cost structures of the services supplied. Part of the problem with this lack of understanding is that it can create misaligned incentives, as the buyer might think that the supplier wants higher volume when the supplier really desires more certainty in its volume.
- Lack of a holistic view of services spending -- In the CAPS study, less than 60% of services spending flows through formal systems and processes. The spending on services is fragmented across many functions and locations, and often flows through decentralized structures. In addition, it frequently involves non-standard services unlike the more refined processes for purchasing goods.
- Growing supply base -- In the CAPS study, 58% reported an increase in the number of offshore services suppliers, while only 4% reported a decrease. The supply base is growing larger, and the suppliers now are more difficult to manage with differing cultural nuances.
These barriers are critical because services spending is growing as a percentage of total spending as firms outsource more activities, such as back-office operations, that used to be performed entirely in-house. In addition, because services has not been managed as closely, services now presents a greater opportunity for potential cost savings than does the purchase of materials and components. The latter areas of spending have been closely scrutinized by most firms over the past decade or more so that the low-hanging fruit has already been harvested.
Address Your Weaknesses
In light of the potential positive contribution of improved management of purchasing spending to the bottom line, we are providing a number of ideas for organizations to address the weaknesses in their services purchasing practices. These suggestions include:
- Understand the magnitude of the services purchasing spending. Without an understanding of the total spending, it is difficult to assess the potential for savings and difficult to make a business case for pursuing services-purchasing improvement.
- Segment the purchasing spending based on value and risk. This will allow you to set priorities, and allocate time so as to reduce the risk while maximizing potential rewards.
- Allocate appropriate resources relative to economic return to the area of services supply management. If there is a big opportunity, it is sensible to dedicate more resources.
- Increase the professionalism of the services purchasing area. A professionally trained service buyer can help control both overbuying and overspending. Services supply managers should have either focused college degrees or additional training on buying, negotiations, cost management, and the particular type of services that they are buying.
- Measure effectiveness and ensure proper business controls. This can help reduce risk and improve compliance to Sarbanes Oxley. What gets measured gets done.
- Put the best people in services supply management. This will help to increase the level of accountability for services spending. In addition, this is where the greatest area of opportunity lies for most organizations. Materials and components supplier management and spending is already largely under control.
Even though the purchasing of services is growing in importance and magnitude, the resources to manage it are not. Because of the current state of services purchasing, it appears that there are untapped opportunities for organizations to improve their services purchasing in terms of both cost and value by dedicating more, and perhaps different, resources to services purchasing.
Some companies realize the importance of involving supply management in the purchase of services, and that supply management involvement in services may not mirror their involvement in the purchase of direct materials. For example, Bank of America (BofA) has put effort into developing an understanding of its total services spending. It reports that Supply Management is involved in 100% of its service purchases and views supply management as performing an essential, value-added service. It has increased the resources dedicated to and the professionalism of services supply management through training and hiring people with skills in purchasing goods, or specific backgrounds in the services being purchased. The supply management personnel, in turn, train the users of the services to better measure and manage the service providers.
Thus, BofA is better matching resources with the opportunities it perceives and improving services spending visibility, control, and measurement. Yet, much of the responsibility is placed in the hands of the "users" of services rather than having supply management take control. The user involvement is appropriate in this case because the users specify the needs and are most aware of whether the service supplier is performing to expectations.
Dedicating skilled resources to establishing new systems for better managing the purchase of services could result in a tremendous return on investment and improvement in value of services for the dollars spent. Developing an outstanding capability to purchase, and manage the purchase of, services could truly be the next frontier for improved supply chain and organizational performance.
Wendy L. Tate is an assistant professor at the University of Tennessee in the Department of Marketing and Logistics. Lisa M. Ellram is the Allen Professor of Business and Chair of the Department of Management at Colorado State University. Corey Billington is professor of operations management and procurement at IMD, and was formerly vice president of supply chain services at Hewlett-Packard where he managed procurement and central engineering.
Copyright ©2007, by the Regents of the University of California. Reprinted from the California Management Review, Vol.49, No. 4. By permission of The Regents. All rights reserved. This article is for personal viewing only by individuals accessing this site. It is not to be copied, reproduced, or otherwise disseminated without written permission from the California Management Review. By viewing this document, you hereby agree to these terms. For permission or reprints,contact: [email protected].
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