Investing in Procurement — How to "Play" the Sector Beyond Ariba (Part 2: Internet Capital Group)

Click here to read Part 1 in this series.

For those interested in investing in the procurement marketplace today, one of the most curious stealth plays is Internet Capital Group (NASDAQ: ICGE), which, as of last summer, held 81% of ICG Commerce's outstanding stock. I see ICG Commerce as one of the more differentiated procurement BPO providers in the market, capable of bringing material value to clients through process and expertise, not just labor cost advantages, especially across complex indirect categories (and more mundane ones). More important, however, investors can (and should) look at the parent company as the closest way to play the procurement BPO market today, as the ICGE recommendation is as much a bet on the macro procurement climate as it is an individual company recommendation. Unlike other firms, where procurement BPO is a drop in the overall outsourcing bucket (e.g., IBM, Accenture, Infosys, Genpact, Wipro), for ICG Commerce, focusing on spend management results is the organization's singular goal.

ICG Commerce is not small -- but not large, like other general purposing outsourcing and BPO shops, where massive multi-tower deals often run into the eight or even nine figures over multiple years. According to an earnings release from earlier this year, in the first quarter 2011, ICG Commerce reported $29.1 million of revenue, which represented "an increase of 27% over the comparable 2010 period." For the period, "EBITDA increased to $5.2 million." While I won't get into analyzing ICG's quarterly results or examining them through a financial lens, it's quite clear that the company is growing and on solid financial footing. There are multiple reasons for this.

One, obviously, is differentiated capabilities, including significant category depth and the ability to deliver more holistic procurement BPO solutions for complex categories like marketing/agency spend, legal and accounting services, areas where other firms may lack a similar proven end-to-end footprint and set of processes and tools (e.g., some focus more on cross-company spend aggregation for categories, which is not always the slam dunk it might sound). But perhaps on a more basic and non-comparative level, the most important thing about ICG Commerce -- and specifically, its parent, ICG Capital -- from an investment standpoint is that the solution/BPO provider competes in a market that is beginning to look quite interesting, with solid growth and an uptick in smaller initial relationships that are likely to lead into larger engagements down the road. Moreover, the market for outsourced procurement services is continuing to bifurcate, with a range of new offerings, from market intelligence services to enabling hosted software that can complement SAP, Oracle, Ariba and other systems.

On the demand side of the equation, buyers (mostly CEOs, CFOs and occasionally senior procurement leaders) are becoming smarter about the need to put a different focus on procurement BPO than other process outsourcing areas. This is helping some organizations overcome the previous fear/legacy of procurement BPO engagements coming up short (one of the first large engagements in the financial services industry was a giant flop).

One of the biggest market dangers to ICG Commerce (and ICGE), if viewed from an investment standpoint, is the potential for high profile, big-scale blunders among larger firms in the procurement BPO market. Spend Matters is currently tracking one such BPO engagement not going as planned (the engagement does not involve ICG Commerce). If it goes public, it's likely to prove embarrassing not just for the provider in question, but could potentially taint the broader procurement BPO market by means of association. Perhaps this is one reason ICG Commerce is careful to describe what they do as "procurement solutions" rather than BPO.

Still, regardless of what you call it, the solutions or BPO market in question generally remains healthy and growing. And from a sourcing and material cost reduction standpoint, it's a market where deep domain, category and process expertise will always trump models predicted on labor cost arbitrage or automation plays alone. For this reason, Internet Capital Group, from an investment standpoint, remains a potentially good proxy for both broader market procurement solutions market growth but also the adoption of targeted services and outsourcing by procurement customers that are increasingly more tailored than ever before. Moreover, given ICG's focus on enabling services and solutions rather than software, it is an intriguing (and risk reducing) portfolio complement to Ariba, which focuses specifically on applications and supplier/buyer connectivity, having shed its services assets in a carve-out where Accenture bought a division that now competes against ICG Commerce directly.

Disclosures: ICG Commerce is a Spend Matters sponsor. Over fifty other providers have engaged Spend Matters and our affiliates in recent years, including a range of direct ICG Commerce BPO and management consulting competitors/substitutes. See our "Disclosures" section for a partial list. Jason Busch, the author of this post, is not an investor in Internet Capital Group, Ariba, SciQuest or any other solution vendors in the procurement marketplace because of his role covering the solutions market.

Jason Busch

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