We should stop overpaying for digital procurement solutions

Spend Matters welcomes this group guest article from leaders in the procurement space discussing why we overpay in procurement. We welcome this post from Edmund Zagorin, CEO of Bid Ops; Gregor Stühler, CEO of Scoutbee; Joe Fox, CEO of Vroozi; Shaz Khan, CSO of Vroozi; Suja Katarya, CEO of Procure Analytics; and Dr. Elouise Epstein, Digital Futurist and VP, Kearney.

As procurement professionals and startup founders, we know all too well how challenging it can be to source, negotiate and award contracts for digital solutions. The struggle is real. Because we have sat on both sides of the table, we have seen hundreds of these technology deals and we’re writing this blog post to address an uncomfortable truth: procurement teams are overpaying for digital solutions.

It doesn’t have to be this way. But the key to win-win technology partnerships and deploying “best of breed” procurement transformations is understanding the true drivers behind digital solution pricing. That’s why we wrote this blog post: to shine a light.

The goal of this post is to reveal the secrets behind digital solution pricing (especially subscription pricing), secrets that can help your procurement team strategize, specify, source, qualify and execute on a “best of breed” digital procurement roadmap.

But to understand how we got here, we first need to be mindful of the recent history of digital procurement — from 2000 to 2020 — and why most of these technology deals across the Fortune 1,000 have ended up overpriced and under-delivered in the first place.

Defining the problem: “Painful transformations” have become self-fulfilling prophecies

To understand why there is such variation in pricing, scope and time-to-deployment for digital procurement solutions, it helps to know a few things about how the infrastructure for cloud-based software drives the unit pricing on a solution’s Order Form.

In the old days, “enterprise software” in procurement required an almost irreversible level of commitment to a single technology vendor (typically the same vendor that also provided the enterprise resource planning — ERP — system). As companies got bigger, the vendor selection cycles got longer, and the number of necessary approvals skyrocketed.

This “scope creep” was driven by valid IT concerns regarding the underlying mainframe (pre-cloud) application technology. Customers were forced to install these pre-cloud solutions on their own machines, spend months or even years on painful integrations, and ensure that any solution was adequately maintained and supported. Before the cloud, this was the only option for “digital” transformation. Thus, the vendor selection process for a digital procurement system could last months or even years. This was because each solution was seen as bedrock infrastructure, built to last for decades.

The problem with this pre-cloud approach to technology vendor selection is clear to anyone familiar with Lean or Six Sigma: adding steps to any process increases the risk that the process will fail. More steps lead to more approvals. More approvals lead to higher costs. Higher costs lead to approvals, more stakeholders, more scope. You get the idea. This is a classic project management doom spiral: business units end up paying a tremendous premium for their own inefficient vendor selection cycles.

The result is that procurement teams have come to associate “digital” with pain.

To compensate for this pain, procurement teams demand customization, adding more scope to the already-dizzying vendor selection process and further compounding the doom spiral. The result is that technology innovation cycles in procurement have become so long that by the time a solution is deployed it is often already obsolete (by at least a decade). This is why today’s “best of breed” enterprise SaaS offers a truly revolutionary opportunity for enterprise procurement teams to deliver a better outcome.

The Window of Opportunity: Connected procurement apps and the rise of “best of breed” that is (temporarily) quite affordable

The fundamental concept of “best of breed” digital solutions is that you can buy software as a service, instead of a product. (This is concept is sometimes written as “Software-as-a-Service,” or SaaS). In other words, instead of making a decade-long commitment to a single vendor’s installed application on a physical machine, procurement teams can buy multiple simple plug-and-play solutions hosted and connected on a secure cloud server. “Best of breed” solutions have narrower scopes, fewer features, higher rates of adoption and drive tangible business impact.

The clear benefit of fewer features in multiple distinct-yet-connected solutions is user-friendly interfaces. “User-friendly” isn’t just an empty buzzword. It refers to interfaces built using user-centric design principles, including rapid prototyping, professional user testing and continuous “agile” improvements. (The next time a technology provider says their solution is “user-friendly” or “agile”, follow up with basic validation questions like: “How many user tests were performed during the prototyping phase of your interface? Answer: Five users tested per distinct feature is a best practice, or “What is the ratio between user-centric designers and engineers staffing your development team?” Answer: One to four is a best practice staffing ratio between designers and engineers).

“User-friendly” isn’t something that happens by itself. User-friendly interfaces are the result of robust investments of time and capital focused on mapping and supporting each user persona’s goals within an interface. This is why “best of breed” technology development requires a disciplined focus. It is also nearly impossible to achieve a user-centric design if there are too many user personas. If everything is important, then nothing is important. If there are too many optima, then no one can optimize.

“Best of breed” solutions therefore cannot, by definition, do everything. The best ones only perform a few tasks but perform them exceptionally well. By focusing on a specific set of related tasks around a core user persona, “best of breed” solutions enable small startups to deliver measurably better digital products than larger vendors — and at a fraction of the cost. It’s a dynamic that benefits startups and startup customers.

However, enterprise procurement teams today are still selecting digital solutions like they did in the era before cloud-based web applications existed. Our technology sourcing processes are still built to select vendors, not solutions, and to negotiate contracts for installed applications, not cloud-based microservices. This misalignment is the reason why procurement teams are overpaying for digital solutions. And this is a problem that every procurement team, now armed with the truth, can solve today.

The drivers behind digital solution pricing: Why SaaS changed everything

If you have ever requested a proposal from a digital solution provider, you have probably noticed that there are typically pricing “tiers.” The most popular units of value in cloud-based SaaS software pricing are:

  • Number of users
  • Number of projects
  • Number of credits for future utilization
  • Number of API calls (for developer-focused solutions)

However, just because these are the units of value doesn’t mean that they are the drivers of the cost for the digital solution provider. This is what makes “best of breed” digital solutions uniquely different from services or materials (e.g. different from buying machines and mainframes). If we buy an hour of a consultant’s time, we know there is a limit to how much savings we can negotiate because our provider must pay their employee’s hourly wage. In other words, the agency’s ability to discount is constrained by their underlying costs (and, of course, their need to earn a profit margin).

Similarly, if we buy a brick or a nail or a doorknob (or ten million doorknobs), we know there is a cost to produce and deliver the doorknob in a manner that meets our technical and operational requirements. What is crazy is that this cost-driven pricing is simply not true of cloud-based SaaS due to the exponentially declining cost of compute power.

For example, it does not cost a start-up substantially less to deliver a solution with two users than it does a solution with 20 users, and it costs startups only a few dollars more for 200 or 2,000 users. The reason that customers with 2,000 users pay more for digital solution is that they are getting more value. This understanding of pricing is completely different from a margin-constrained approach, such as service hours or physical goods.

This is one reason why technology start-ups are typically backed by venture capitalists: “best of breed” digital solutions enable attractive business models for investors. Enterprise SaaS typically offers excellent margins (usually well over 90%) and the recurring revenue business model helps analysts to forecast predictable revenue from annual customer subscriptions. So, you may be wondering: how can procurement teams use this insight into digital SaaS software pricing to negotiate win-win deals for “best of breed” technology (and stop overpaying for digital procurement solutions)?

The secret for better savings: Solution cost is a function of sales cycle length

The key is understanding the two biggest drivers behind digital solution pricing: 1) the cost of the sale, known in the SaaS industry as CAC (Cost of Customer Acquisition) and 2) the number of years the company has been in business. Companies with earlier products and faster cycles can offer better pricing across the board.

Thus, it should be obvious why most procurement teams today are overpaying for digital transformation deals — every step, every meeting, every approval, every stakeholder adds cost to the technology provider’s CAC, which per software industry norms, must increase the pricing to the customer. Longer cycles result in higher pricing, higher pricing requires more approvals, more approvals result in longer selection cycles.

As procurement professionals, we are trained to protect our business from overspending through controls. Paradoxically, these same controls will end up massively increasing the price for SaaS software, where technology sales teams are forced to pass the cost associated with a lengthy sales cycle back onto the customer.

The impact of bottlenecks and delays on SaaS solution pricing in procurement are dramatic. Recently, a procurement colleague came to one of us with a solution deal from a cloud-based procure-to-pay (P2P) provider that was signed three years ago. The total cost of the solution? $1.5 million. A different customer showed the same agreement from the same provider for the exact same scope of work. The total cost of the exact same? $150,000. That’s an order of magnitude different — for the exact same solution.

What made the difference? The answer is simple: one sales cycle took less than 180 days to close, the other one lasted over two years of perpetual consultative selling. By imposing higher cost of sale on the solution provider, the second procurement team virtually guaranteed their business would end up overpaying. And, surprisingly, this is actually a rational outcome — the P2P provider didn’t per se overcharge the second customer. On the contrary, this CAC-driven pricing is not only common for digital solutions but has a strong foundation in market principles. Outside of engineering staff, the highest labor cost of most digital solution providers is the sales team.

Simply put, if procurement teams want to secure improved business value from our digital solution cycles, then we should rethink our process around technology selection to optimize for fewer stakeholders, fewer approvals and well-defined business outcomes. Efficient processes will result in better value deals for SaaS every time.

We should hold firm on the “best of breed” maxim: a solution’s well-defined clarity of focus and investment in user-centric design are the key to digital procurement success.

Procurement’s future is increasingly looking like it will resemble an “ecosystem of connected apps” from multiple providers than a solution from a single technology vendor. Like apps on an iPhone or tabs in our browser, “best of breed” is the most likely evolutionary path for digital procurement in our modern era of cloud-based solutions.

Conclusion

As procurement professionals and startup founders, we know that win-win relationships between digital solution providers and procurement teams are possible. We have seen it and we’ve lived it, from both sides of the table. But they will not happen without mutual intention. In order to unlock these benefits, we must work towards fundamental change.

So let’s start today by leveraging the procurement profession’s greatest superpower: creating a process for selecting a supplier for a defined business need. After all, this is precisely the area where we are arguably best equipped to deliver results for other business functions. Why not apply these same core principles to the task of procuring digital procurement solutions?

The “best of breed” approach to digital transformation creates a revolutionary opportunity, but only if we have these much-needed updates to our technology selection process. Together we can transform the current lose-lose cycle of overpaying for obsolete technology into a win-win of great pricing for “best of breed” digital solutions.

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Voices (2)

  1. Michael Shaw:

    Clearly some organizations are still evaluation software solutions the way they did on-premise software 30 years ago and in general I am a fan of Best of Breed Solutions but to suggest that using a a more efficient (less time consuming evaluation) would create lower CAC and therefore lower pricing for software solutions is an erroneous assumption.

    While the process that many organizations use for evaluating procurement solutions may need some rethinking, the length of time a procurement organization takes to evaluate alternative solutions should not have any bearing on the price negotiated.

    I believe what is being suggested is if software solution providers can keep customer acquisition costs down they can pass that savings on to the customer. There is no direct correlation here, however this insight could be an effective negotiating point for procurement professionals who are able to more expeditious decisions.

    There are more effective ways to get better deals than restructuring the evaluation process.

    Procurement practitioners feel free to contact me to discuss more on this topic .

  2. Gary Hare:

    All – excellent post. The explanation of how CAC impacts pricing should be an eye-opener to prospective SaaS solution buyers.

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