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Group purchasing

Collective action

Group purchasing organisations promise cost savings and process efficiencies. But if they are to grow, they need to overcome some formidable obstacles

 

Spring 2008

 

by Nick Martindale

 

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Back in the 1990s a number of group purchasing organisations (GPOs) sprung up in the US. The concept was both simple and alluring: organisations would pool their buying requirements to obtain sizeable discounts from suppliers, resulting in cost savings and taking the burden of managing suppliers in certain categories away from the procurement function. Examples included the e-marketplace-based automotive and aerospace industry consortiums Covisint and Exostar.

 

But, hampered by mistrust and divisions among participating companies, the premise on which these organisations existed failed. Collaborative buying was dealt a hefty blow from which it has yet to fully recover.

 

“If you look back now you’d say ‘did we really think that these competitors would work well together?’,” says David Clevenger, a vice-president of Corporate United. “The majority of them have either gone away completely or changed dramatically from the original vision. A lot of organisations invested tens of millions of dollars only to see them fail.”

 

Corporate United is an example of the more restrictive type of GPO that exists today. Formed in 1997 and based in the US, it focuses on indirect spend across all industries. The organisation now has 120 members – up from 36 in 2003 – of which around 50 are Fortune 1,000 companies, says Clevenger. The average member is a $4 billion company with 13,000 employees. Participating companies pay a one-off, upfront fee of $50,000 and can pick and choose the categories in which they participate.

 

“Part of our challenge has been just to educate people about the fact that this is different,” says Clevenger. “We’ve always been an independent organisation so our member companies don’t have any ownership. Beyond that, the fact that we’ve always focused on being horizontal and representing companies across industry sectors has allowed us to maintain an environment where we don’t have the competitive issues. People can share best practice across industries without having to give up any form of advantage in the marketplace.”

 

The main attraction in joining such organisations is usually the cost savings that can result from pooling volume. US-based office supplies retailer OfficeMax has been a Corporate United customer for three years (see case study, below). Jim Borg, its senior director of strategic sourcing, readily admits that cost was the company’s main motivation. “It was cost savings while expending very little resource on our part,” he says. “Our internal resources can be put to looking at items and categories that directly impact our business.”

 

But as well as direct cost savings, Clevenger argues that members can gain as much from networking opportunities and shared knowledge, which he claims can save organisations money on consulting fees and time spent researching initiatives on their own.

Corporate United is not the only example of a GPO that has developed a prosperous niche. Some industries such as healthcare – where participants are distinguished more on quality of service than any other factor – also lend themselves to such initiatives. For example, in the US, VHA focuses on community-owned, not-for-profit health centres, whereas University HealthSystem Consortium (UHC) targets academic medical centres and affiliated hospitals.

 

Provista, meanwhile, has concentrated on non-members of these organisations for the past 30 years. The group recently expanded into other non-commercial areas such as higher education and the prison service and Eldon Petersen, company president, believes the concept is gradually taking off again. “The group purchasing play could fit many other markets and industries,” he says. “It’s going to be slow in some and quicker in others, but it’s going to begin to take effect.”

 

In 2006 another US healthcare purchasing organisation, HealthTrust, which boasts almost 2,000 members and $10 billion of purchasing power, set up CoreTrust, a spin-off that targets large companies and private equity investors with revenues of over $500 million. It commenced national operations across the US in 2007, promising access to savings in 30 indirect categories in return for a three-year commitment.

 

Consultancy AT Kearney offers clients a similar service through its LSN brand, although it sees itself performing a different role to Corporate United by providing buyers with a forum in which to discuss their requirements, which can then be put out to market. This differs to vendor-based consortium models, claims Joseph Raudabaugh, president of AT Kearney Procurement Solutions, which tend to offer members a limited number of standard contracts. As such, LSN levies an ongoing subscription fee rather than a one-off membership charge.

 

Other examples of group purchasing can be found as part of wider industry initiatives such as the oneworld airline alliance, or among large Asian conglomerates such as LG Group and Samsung, which started collective buying across their various businesses via e-marketplaces and later opened up their services to other companies.

 

The group purchasing model can also be found in the UK. NHS Supply Chain, for example, is a joint venture between the logistics giant DHL and the US healthcare GPO Novation – owned by Provista, VHA and UHC – which has taken over some of the categories of spend for Britain’s national health service.

 

There have also been a number of initiatives in other areas of the public sector. At a national level, OGC buying.solutions negotiates framework agreements for civil government, for example, while other bodies, such as Scotland Excel, operate at a regional level.

 

Slow progress

 

Yet for all these current initiatives – restricted as they are by scope, geography and, in some cases, sector – overall take-up of group purchasing remains low. A recent study by AT Kearney into the future of non-product-related sourcing found that shared procurement organisations ranked sixth out of seven possible scenarios that could be used in the next two to four years. Only 5 per cent of CPOs thought this was a “probable” development for their organisation, with 15 per cent thinking it “somewhat probable” and 80 per cent seeing it as “not at all probable”.

 

Paul Bestford is senior director, strategic sourcing, at pharmaceutical and healthcare products company Wyeth. He explored the idea of group purchasing when the company chose to outsource its transactional procurement in January 2007, but rejected it as he didn’t feel there was anything around that offered sufficient value at that time. And while he doesn’t rule out joining such initiatives in the future, he admits to concerns over introducing more complexity into the supply chain and the practical implications of getting a group of buyers to agree on product specifications.

 

“There is huge complexity in aligning non-production specifications internally, let alone with other companies,” he points out. “There’s a big opportunity cost associated with the resource effort required to resolve that complexity.”

 

There is also the risk of upsetting internal stakeholders who have traditionally enjoyed a free hand when it comes to supplier selection, as Raudabaugh explains. “The real challenge if I’m a category manager is that I’m not sure I want to go and convince my internal stakeholders that we’re switching and now they have to work with a third party. They either lack the self-confidence or the stature to effect it in their organisation or they don’t want to go to the effort.”

 

These divisions can be even more marked in the public sector, according to Ray Searles, director of procurement at the UK-based North West Collaborative Procurement Hub, which represents 52 NHS trusts, including hospitals and ambulance services. He describes how individual members even compete to “beat the hub” in their own dealings with suppliers.

 

“Building trust in our delivery is difficult,” he says. “When organisations such as ours are set up [the hub was formed three years ago] they essentially take responsibility away from the local procurement team. The benefits in terms of time and in taking to the market a much bigger spend are obvious, but that doesn’t stop people pushing against it when they feel their authority is threatened.”

 

Other companies worry about losing control over decisions about supplier selection and contract negotiation, even if this is confined to indirect categories. “When it’s provided by a third party, it’s outsourcing by another name,” says Rob Woodstock, head of procurement consulting, UK and Ireland, at Accenture. Even Corporate United’s Clevenger accepts that his organisation has become “something of a hybrid outsourced solution”, which he admits is “a departure from the original vision”.

 

Yet in most cases, the service-level agreement remains between the buyer and supplier and companies can usually opt out of certain categories. “We still control the agreement,” says OfficeMax’s Borg. “We’ve still got the ability to bring equipment on or not, depending on our needs. I don’t think there’s any loss of control; it’s just having a consultant doing the groundwork and bringing the results to you.”

 

Cultural differences

 

But this concern over going at least part way down the outsourcing route perhaps explains why the more successful group purchasing initiatives have tended to be in the US, suggests Khalid Khan, a senior associate at consultancy Booz Allen Hamilton. He believes US purchasing departments tend to be more open to the concept of bringing in third parties to run aspects of their procurement operations. A tendency towards smaller, local suppliers and introducing unique customer-specific demands also gets in the way of establishing European GPOs. “The US is still a very homogenised market, even in indirect spend,” he says.

 

How appealing such initiatives are for suppliers is also open to question. Wyeth’s Bestford points out that suppliers will only benefit if the products or services in question are very similar or identical, and in supply chains where fixed costs are “proportionally significant”. “This is generally less evident in the service-based categories that make up a large proportion of our portfolio,” he says.

 

But AT Kearney’s Raudabaugh claims LSN has no problem in attracting suppliers to take part. “They’re lining up a three to five-year commitment with anything from 10 to 25 clients at any time,” he says. “So for them it’s about efficiency because they get the volume lock-up and term length, and they get closure on multiple accounts at any one time, so the support costs are lower too.”

 

Despite all these obstacles, there remains a degree of interest in the idea of group purchasing. So could another reason why it has not taken off to any great extent in Europe simply be down to the lack of a Corporate United-style organisation? Over the past four years, Ulrich Piepel, CPO of German utility company RWE, has developed an informal network of peers at non-competitive companies that combines spend on certain non-core categories such as IT services, office supplies, cleaning and security.

 

Piepel is an opponent of procurement outsourcing, because he believes the function is a strategic weapon that supports the business and brings innovation and high value to the RWE Group. But he would be tempted to use the services of an external third party to secure further group purchasing discounts “if there were companies that could do it for low-volume product groups more professionally than us and there would be benefits for RWE”.

 

Outsourced provision

 

When Thomson, a global provider of video technology, systems and services, looked to address the issue of indirect spend in 2000, it decided the outsourcing model wasn’t mature enough at that time to justify handing over control to an external provider. Driven by a desire to increase market knowledge in non-core categories such as office supplies, IT, corporate travel and consulting; to develop global sourcing initiatives; and to obtain savings through combining spend, Thomson joined forces with chemicals business Rhodia, Schneider Electric and steel manufacturer Arcelor to form KeyMRO.

 

Four years later, KeyMRO was sold to IBM and it now operates as an outsourced provider to Thomson. David Chambeaud, its chief sourcing officer, says this arrangement continues to deliver both cost and process efficiencies. “If we were taking on these commodities today, we would need to increase our purchasing resources and may lose all the benefits built up through the years of experiencing outsourcing,” he says.

 

But while the theory behind group purchasing is solid, the further it diverges from the basic premise of simply pooling volume, the harder it is to see it taking off to any great extent. Understandably, companies will continue to be wary of such organisations after the experiences of the 1990s and may simply feel they have higher priorities than shaving a few per cent off their indirect costs.

 

According to Accenture’s Woodstock, the procurement world is just not ready for such shared processes and external collaboration, however attractive it sounds in theory. “Procurement as a profession still has quite a long way to go,” he says.

 

“We’re still at a point in time – both on consortia buying and outsourcing – where companies have got room to improve internally and are probably quite rightly focused on that before turning their attentions to the next wave of savings.”  

 


CASE STUDY:

Tidy savings

 

When US-based office supplies, furniture and computer equipment retailer OfficeMax found itself under pressure to cut costs three years ago, it turned to group purchasing as a means of maintaining its spending power on non-core products and services.

 

It now uses Corporate United to purchase services in four categories – employee relocation services, photocopiers, temporary labour and water – which Jim Borg, OfficeMax’s senior director of strategic sourcing, estimates has saved “several hundreds of thousands of dollars”.

 

He says: “In strategic sourcing, we have three category managers and eight people in total in the whole department, including the administration people. We couldn’t do this if we weren’t using outside services.”

 

The biggest obstacle was overcoming opposition from internal business units that had previously been responsible for buying those kinds of products and services.

 

“We had to explain that they would be part of the process of choosing the vendor and of making sure that the vendor would be compatible with our own system,” says Borg. “But it’s pretty hard to rebuff the savings that you get. In some cases we get the same vendor that we had been using but at a lesser cost.”

 

Once internal stakeholders have gained more trust in the concept of group purchasing, Borg hopes to extend the range of categories the company sources through this route. For example, he is pushing Corporate United to include wooden pallets in its portfolio, as this currently represents a big expense for OfficeMax.

 


Nick Martindale (nick.martindale@cpoagenda.com) is deputy editor of CPO Agenda

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