Understanding the Costs of Convenience: A managed service is not the same as a managed cost
Since 2008, multiple recessionary periods have brought cost-cutting pressures to the corporate world, and procurement and expense management departments have been a primary target for budget reductions when times have gotten tight. Today, the vast majority of even the healthiest businesses have not restored these departments’ resources to pre-Great Recession levels.
As a result, today’s procurement and category management professional is often asked to manage a workload that would have been divided among three team members in 2007.
It’s not surprising, then, that convenience and ease of expense management have become leading criteria in deciding how to contract for—and continuously manage—indirect expenses.
As convenience has grown in priority, various outsourced-management organizations have accordingly grown in popularity. Many of these enterprises—Group Purchasing Organizations (GPOs), Integrated Facilities Management providers (IFMs), and brokers, to name a few—make their money (in whole or in part) as a percentage of the dollars being spent on the programs they “manage.”
Let’s park there for a moment because it’s a critical point to understand when it comes to these relationships.
As a general rule, your GPO, IFM, and broker partners make more money when you spend more money.
If your costs go up, they get a raise.
It is for this reason that the quotation marks surround the above use of the term “manage.” Let’s be crystal clear about what you can expect from these “cost-plus” organizations:
- A GPO will manage your contracting for a good or service, typically through a network of preferred suppliers, likely placing you in an agreement with competitive unit costs.
- An IFM will manage the performance of various contracts, processes, and services required to keep your facilities running.
- A broker will manage the process of contracting with a supplier (or, often, cobbling together a network of suppliers) to provide a particular service.
But here’s what none of them can be expected to do: manage costs.
When I hear a procurement pro tell me that a certain indirect service category is “managed” by a GPO, IFM or broker, I immediately think (based on decades of experience and a vast universe of data points), “they’re spending 20-50% above optimal.”
The reason for this reaction, of course, is that while the provision of a service may be “managed,” the actual expenses being incurred in these relationships almost never are.
In this context, I like to reference Merriam-Webster’s definition of the term:
1: to handle or direct with a degree of skill: such as
a: to exercise executive, administrative, and supervisory direction of
b: to treat with care
c: to make and keep compliant
I’ll give the best GPOs, IFMs, and brokers partial credit for 1a and 1b (though your mileage may vary). On 1c, though, these convenience-based strategies fall flat. They simply don’t attempt to solve your cost problems. And why would they? It would run contrary to their interests:
In all of these cost-plus arrangements, the best client is the one who spends as much as possible while remaining a client.
The model plays right into the hands of indirect suppliers which had already spent much of the last decade-plus developing a range of strategies designed to increase customer spending after contracts take effect. They had already noted their customers’ increasing leanness and had realized that one of the chief vulnerabilities created by this state was an inability to truly and effectively manage costs on a continuous, month-to-month basis.
The result has been a major contribution to a widespread phenomenon we’re seeing at an increasingly alarming rate, especially among Fortune 500-sized accounts: “Good Contract, Bad Deal.”
The outsourced-management provider puts in place a negotiated deal with at least reasonably competitive unit costs, and the customer sees the unit costs and feels good about the deal they’ll be getting. These unit costs, however, are merely numbers on a document—they are unit costs, but they are not actual costs. They’re designed to promote an outcome, but of course, they are not, in and of themselves, outcomes.
The document, with its attractive unit costs, gets signed and then resides in a file folder. The document doesn’t have brains, it doesn’t conduct audits, it doesn’t know when overcharging has occurred, it doesn’t know when new products and services not contemplated in the agreement have been added, and it doesn't know when inventories listed on invoices don’t match inventories actually circulating in an account.
Of course, the leaned-out procurement department doesn’t have the resources to do these things, either—that’s why they chose the convenient route to begin with.
And so…is the GPO, IFM or broker partner actually performing all of these essential expense management tasks? Why on earth would they?
If any of these organizations actually catches and corrects some form of over-spending, it will be taking money out of its own pocket.
And so, these activities simply don’t tend to happen in these sorts of arrangements.
And unfortunately, with indirect suppliers’ strategies for increasing customer spending now so well-honed, this deficit in business expense management activities all but assures overspending in the 20-50% range.
The indisputable fact is that the critical discipline missing from traditional GPO, IFM, and broker-“managed” arrangements—continuous, vigilant expense management—is the very discipline most necessary to defend your bottom line in 2022.
It’s understandable that an overburdened and understaffed procurement team would need to prioritize convenience in some of its decision-making, and the universe of traditional GPO, IFM, and brokers has smartly capitalized on this need.
Customers and prospective customers of these organizations should be well aware that the incentives in these relationships are aligned to reward spending increases—not decreases—over time.