What Group Purchasing Organizations Can Do For Private Equity Firms

Private Equity (PE) firms allegedly make money by buying companies and restructuring and decreasing workforces to sell them shortly thereafter at a profit. In reality, increased competition has made this model less common. PE firms are holding companies longer and becoming more active in adding value through operational improvements.

Meanwhile, procurement organizations are focused on delivering value to the business – whether that is cost savings, reduced risk or higher quality – through increasing the amount of spend under the management of procurement professionals. So, where do the paths of procurement and PE intersect?

The answer is that “operational improvements” include the indirect cost base, which PE now views as a previously-untapped source of value. Their strategy is leveraging volume. The biggest PE firms own portfolios of companies that, collectively, would rival the world’s largest companies in spend terms.

Today, most PE firms have Group Purchasing Organizations (GPOs) partnerships and encourage their portfolio companies to use pre-negotiated rates through GPOs. There are advantages to using a GPO, particularly in smaller organizations, which can piggyback on contracts with volume-based rates. Also, through a GPO, supplier management is essentially outsourced, reducing internal resource requirements.

Alas, there is a catch, and it is when “encourage” becomes “mandate” and when this strategy becomes the sole strategy, as it lacks the benefits that a best-in-class sourcing and procurement function can provide. Let’s look at what GPOs accomplish from quantitative and qualitative standpoints.

Quantitative – there are more ways to deliver value than simple cost savings and these are identified as the “Six Routes to Savings”:

1. Unit cost: Paying a lower price
2. Cost avoidance: Avoiding contractually obligated price increases
3. Process improvement: Re-engineering an internal process to reduce consumption and to avoid cost
4. Compliance: Increasing compliance to existing preferred suppliers in order to maximize savings
5. Value add: Maintaining price paid for product/service while increasing quality
6. Buy less: Reducing volume consumed

The GPO will only deliver the first of these, yet best-in-class sourcing and procurement functions are much more than like-for-like cost reduction and can deliver far more value.

Qualitative – the “Six Cs of Sourcing” covers areas beyond cost-out, or the total price of acquisition, where the GPO model alone is less than ideal and where a good sourcing and procurement solution will deliver bigger benefits.

1. Complexity: Consortium buying is best suited to commoditized categories, but there are many categories where this “one-size-fits-all” approach doesn’t work – facilities services, professional services, FTL/LTL freight, etc.
2. Customization: Every organization has different requirements and the GPO model will struggle to cater. A good sourcing and procurement solution customizes supplier contracts according to requirements.
3. Control – GPO buying holds you hostage to other consortium members. You may want to do one thing but if everyone else wants to do another, you lose control.
4. Comprehensiveness: Successful sourcing and procurement functions address all spend types – strategic suppliers, one-off capital expenditure projects, tail-end suppliers and ad hoc purchases – a GPO is only really able to help with rate on strategic spend.
5. Coverage: Most GPOs operate regionally with only loose global alliances, while the current industry direction is to leverage volume by implementing standardized global suppliers.
6. Commercials: GPOs are generally compensated through rebates from suppliers, but the customer generally can’t see the amount.

A GPO can deliver quick wins to smaller organizations by leveraging volume. GPO is a good solution to what amounts to a small piece of the puzzle when looking at the full source-to-pay lifecycle. However, a single procurement organization can be as good everywhere as a GPO is in the volume arena, and provide far more overall value. There’s really no substitute for a well-run strategic sourcing event, backed up by a properly managed procurement function, which can deliver tremendous value to the organization year after year.

From: Spend Matters