Procurement Outsourcing – Which Payment Model Should You Use? (Part 1)

Through our "Hot topic" month considering procurement outsourcing, we have looked at some of the reasons organisations outsource and the different elements of the overall procurement process that might be considered for outsourcing. Before we hit the end the month, let's take a look at the money. Because one major decision for organisations contemplating or implementing procurement outsourcing is the commercial and payment model they wish to use with their outsourced service provider.

Get this wrong, and there is every chance you will end up with an unhappy client, an unhappy provider, or both. There are many options, but here are some of the most commonly used.

Fixed fee - the provider and client agree a specification for what will be delivered, whether that is particular categories to be managed by the provider, research services or whatever. That fixed fee is then negotiated between the parties, in all probability based on a detailed look at the level of staffing and other resources used by the service provider to deliver, plus some margin to cover overheads and profit.

A transaction or activity based fee - particularly if the outsourcing is heavily transaction-based (around the P2P cycle rather than the strategic sourcing or CatMan process), then some or all of the fee might be based on a cost per transaction. That could include onboarding suppliers, processing a purchase order or handling an invoice and payment.

Share of savings - for an outsourcing that is largely based around managing certain categories, or conceivably managing a project or programme, then the provider might be rewarded by a share of the savings they can generate. The variables here are usually around the percentage split, how long the provider gets rewarded for (is it just savings in the year of doing the deal, or for longer), and issues around identified versus implemented savings - more on that in part 2.

Performance based fee - there is a certain degree of overlap with the last heading, but here we are thinking about a broader performance related payment mechanism. That might include an element of targeted savings, but could also include other factors, such as internal customer satisfaction with the procurement service, perhaps even supplier satisfaction, targets on process times and transactional efficiencies, and meeting corporate social responsibility or other non-cost objectives.

Of course, some or all of these can be combined. In fact, for major procurement outsourcing initiatives, it is unusual to find a contractual mechanism that is totally based on just one - although we do occasionally see something that is very heavily "share of savings" based. But more often, there might be an element of fixed fee, plus some targets that will link to a certain amount of additional performance payment (or penalty), and the "savings" element may be an important part of that performance fee.

So what are the positives and negatives of these options? And what should anyone contemplating a procurement outsource, large or small, consider in terms of the payment and reward structure? We'll give some answers at least to that in part 2 on Monday.

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