Spend Matters welcomes a guest post from David Clevenger, Vice President of Corporate United.
In reading Mr. Woodcock’s piece on GPOs (What Group Purchasing Organizations Can Do For Private Equity Firms), I couldn’t help but feel that I was being lured into a trap. Despite my wariness, I find myself compelled to respond, if for no other reason than to offer a different perspective on the original post.
The article begins by demonstrating some confusion regarding private equity firms; “alleging” that these firms make money by buying companies, gutting them, and re-selling them at a profit. Separate to whether or not PE firms have (in this case) been confused with hedge fund firms, one fundamental point was missed: private equity firms need to make their investments more valuable. In fact, the majority of private equity funds operate in industry sectors where they have some element of expertise, make long-term commitments, and profit from the improvements enjoyed through their investment and the application of their management strategies.
These firms represent some of the most impressive and powerful companies in the world. The top 10 U.S.-based PE firms alone manage funds well in excess of $300 billion. These organizations (e.g., TPG Capital, Goldman Sachs, The Carlyle Group, KKR, et al) reached these heights by employing the best management strategies available to make their portfolios more profitable and to deliver value to their investors.
In some cases, as noted in the post, these strategies include operational efficiencies and the implementation of a lean approach that might ultimately lead to reductions in force. In an increasing number of cases it also includes the adoption of a group purchasing strategy; and in discussing this point the author offers a number of misleading observations.
Private equity firms are not employing the services of their own or external GPOs because they don’t understand the full value of this approach, they are doing it because they understand it clearly. They have also found that the employment of the traditional procurement strategies alone is not enabling the kinds of change they hope to achieve within their investment portfolios.
In fairness to the author of the original piece, let me offer him an out. It seems as though Mr. Woodcock is confusing the leveraged buying concept that has existed in commodity markets for more than 100 years with the role of the modern group purchasing organization. While leverage continues to play an important and powerful role in the updated version of aggregated buying, the piece price savings achieved through utilizing a GPO are merely the beginning of a broad and comprehensive value proposition that delivers strong and sustainable results across categories.
The piece argues to the contrary by compiling a list of six quantitative and six qualitative factors that contribute to value creation. The assessment of almost all of them in the context of a group purchasing organization is categorically incorrect.
Quantitative (Unit Cost, Cost Avoidance, Process Improvement, Compliance, Value Add, and Buy Less)
The author notes that the GPO model will only deliver results against unit cost improvements, and none of the other factors. This, politely said, is a gross misstatement.
Yes, as I mentioned above, leveraging a GPO can enable piece price savings, and that alone makes it attractive. With that said, the model also delivers strongly against all five of the other factors listed among the “Six Routes to Savings,” which is precisely why the model is seeing such strong adoption within and outside the private equity community.
Cost avoidance, which is defined in the original post as “avoiding contractually obligated price increases,” is an area strongly addressed by GPOs. Cost avoidance more accurately refers to the ability to avoid increases in cost due to changes in market dynamic, scope creep, process or part failure, or movement in indices. If something is contractually obligated, then you’re going to pay it. With that said, the strength of a GPO typically results in more effective contracting strategies that enable these types of obligations to be avoided altogether, which goes unmentioned in the original article.
Process improvement and value add are two important factors in long-term value enhancement. Internal procurement departments, particularly those focused on indirect spend, frequently lack the resources and subject matter expertise to drive these improvements. In addition to having best-in-class sourcing capabilities, group purchasing organizations are largely focused on supplier management and supplier development; which Mr. Woodcock goes as far to note in his article (“Also, through a GPO, supplier management is essentially outsourced, reducing internal resource requirements.”). These activities result in working with suppliers and buyers to identify continuous improvement opportunities and process improvements that drive ongoing and sustainable value. This is an area where the group participating in the GPO is leveraging more than volume; they are leveraging knowledgeable and active resources.
In his article, the author defines “compliance” as adherence to preferred suppliers. While this definition is partially correct, it fails to tell the real story of compliance. Adherence to a preferred supplier is important, but just as critical is the adherence to the contractually negotiated items and services. Adherence to a supplier alone leaves open the door for scope and price creep. Group purchasing organizations manage to this level of detail for their members, increasing savings and optimizing the leverage they provide.
Buying less is a great way to save money; perhaps the CFO’s personal favorite. Successful demand management strategies are not developed by procurement in a vacuum. Instead, functional spend owners working with their supply partners to better understand the needs of their end users and create approaches that satisfy their requirements while reducing the need to for excess usage. GPOs serve to facilitate these discussions by providing real benchmarks across their membership to establish achievable metrics so that their members can achieve and sustain strong results, instead of just enjoying the short-lived success of a paper-clip culture.
Qualitative (Complexity, Customization, Control, Comprehensiveness, Coverage, and Commercials)
In covering the “Six C’s of Sourcing” the author falsely characterizes the role of GPOs by positioning them in an antiquated context.
- Complexity: The author classifies “consortium buying” as best suited to “commoditized categories.” Firstly and as previously noted herein, the days of traditional consortium buys have long since passed. The approach employed by today’s group purchasing organization is applicable across spend categories. The GPO for whom I work offers more than 30 category offerings, only about a half dozen of which are traditional commodity spend areas. The approach, well applied, works exceptionally well. This dynamic is true not only of my GPO, but our competitors as well.
- Customization: The author states that GPO models will struggle to cater to unique contract requirements, which is false. GPOs operate within a flexible framework that allow participants to enjoy the value of the various types of leverage offered while retaining the ability to create unique contract terms that address their specific needs.
- Control: The original post accuses GPOs of holding members hostage. It’s strong language; but also inaccurate. In truth, participating members are not obligated to utilize GPOs holistically, they leverage the model based on their unique needs in the areas in which the most value can be driven.
- Comprehensiveness: The author got right in his original piece. The GPO model is not focused on covering the 150-200 different areas of indirect spend. Instead, the model is focused on driving exceptional value on a set of large, strategic categories that can have a meaningful impact on participants’ bottom line. In essence, it is consistent with the strategy of an internal procurement department, which also does not have the resources or knowledge to adequately pursue every area of indirect spend. Instead, they apply the 80/20 rule in seeking to make an impact. The utilization of a GPO enables those internal procurement departments to do more.
- Coverage: The author states; “Most GPOs operate regionally with only loose global alliances, while the current industry direction is to leverage volume by implementing standardized global suppliers.” Most GPOs, certainly those being utilized by private equity firms, utilize globally capable suppliers where they exist. The major challenge as it relates to indirect spend is that not all supplier communities are globally capable (yet), and no procurement or GPO effort has changed that.
- Commercials: The author states that “GPOs are generally compensated through rebates from suppliers, but the customer generally can’t see the amount.” Again, this is not the case. GPOs are, in many cases, operated on administrative fees that are incorporated into the pricing offered to members. This is also reflected in members’ pricing and transparent to participants.
In closing, I would encourage any reader to take with a generous grain of salt a perspective on GPOs and private equity firms from someone whose knowledge on both subjects appears to be limited. His fear that encouragement to use a great solution has turned into a mandate to use a great solution is exactly what every procurement professional hopes their organizations will do when they adopt a best of breed strategy.
If this is, in fact, an attempt to promote private equity’s use of traditional outsourced sourcing and procurement options instead of maximizing their use of GPOs, the author may have been better suited to speak to the attributes of the former rather than offering half-truths and untruths about the latter.
The truth is that smart, progressive organizations like large private equity companies and savvy procurement professionals across all sizes of companies utilize the best approaches at their disposal, and group purchasing organizations clearly rank as one of them.