4.2 Sourcing, Purchasing and Contracts

The primary objective of sourcing is excellent business and user satisfaction, combined with a low total cost of ownership. To succeed in attaining these goals, sourcing must achieve, maintain and utilise a strong negotiating position towards the suppliers.

Sourcing and purchasing are traditionally quite challenging functions as the tasks they both take care of conflict:

  • Be flexible enough to accommodate large sourcing projects that require comprehensive sourcing processes and fast procurement sprints that are needed for agile development initiatives
  • Be strong enough to enforce company policies and regulations (security, architecture, legal, etc.) throughout the vendor network, while at the same time listening and learning what new vendors have to offer
  • Manage the supplier ecosystem and contracts lifecycle to implement necessary controls and additionally, sponsor creative cooperation and new innovations.

Sourcing and purchasing must evolve to manage all of the above considerations, as well as providing:

  • A sourcing strategy to indicate the right sourcing approach and preferred partners for value streams and service domains. In the case of developing a new product, solution or service, there might be a need to go to the market and use sourcing team’s expertise. On the other hand, using existing vendors for smaller improvements and changes, a direct purchase process can be used instead
  • A sourcing process that will support gate-based development initiatives by requesting and contracting products, solutions or services from the market with the best possible business, at the reasonable price and within the expected timeline
  • A purchase-to-pay process enabling to order, contract and deliver quick and efficient services from existing vendors within the existing frame agreement, enabling speed and agility in incremental development initiatives
  • A holistic vendor and contract management capability that implements the sourcing strategy and enables direct purchasing. By monitoring existing contracts, preparing contract renewals and providing analytics on costs and service quality, the company sourcing position is constantly updated.

 

Sourcing strategy

Sourcing strategy describes service and vendor categories and lists the preferred vendors. It also sets objectives for creative ecosystems, consolidation of synergies and mitigation of vendor lock-in situations.

The key objectives of the sourcing strategy are to:

  • Identify service categories and define the primary service strategy to provide services internally, source from only one vendor (single source), or to source from multiple vendors
  • Build innovative and competitive ecosystems to create business value
  • Maintain a good negotiation position by avoiding vendor lock-in situations and having alternative sourcing options
  • Introduce cost targets and key commercial terms for agreements and related implementation plans.

When setting the sourcing strategy, it is essential to consider:

  • Business drivers to define what the company wants to achieve: low cost, fast time to market, exclusivity and innovations. By defining some high-level guiding principles, the priorities can be understood and agreed
  • Market dynamics to define how many suppliers are available, why the suppliers want to engage, if there are any regulatory issues and what the rising and declining ecosystems are.

 

Figure 4.2.1 The ecosystem

 

Sequential RFP sourcing process

The starting point of the sourcing process is a business need originating from strategic planning, business capability planning, service planning or concept design. When evaluating the feasibility of the sourcing request, one must consider the alternatives between extending the relationship with the existing service provider(s) or to initiate a Request for Proposal (RFP) process with a larger list of service provider candidates. In the public sector, the latter alternative is often the only choice available to treat all potential service providers equally even if extending the existing frame agreement provides shortest time to market, higher business value and cost synergies.

Traditionally, companies use a toll-gate sourcing process to deliver RFP process. This is a comprehensive process that involves multiple suppliers and the result usually gives the best commercial terms. These processes can take quite some time and usually fit well when going in parallel with other planning and preparation activities.

 

Figure 4.2.2 Sequential RFP process

 

In some cases, a certain service provider could provide a shortcut to higher business benefits and therefore, a single source initiative might be a good alternative. Single sourcing is similar to the RFP process but with a single candidate only. Single sourcing requires clearly predefined business targets and if not met, the opportunity will be opened for other candidates as well through a normal RFP process. Successfully implemented single sourcing can save costs and maximise business benefits. It is applied typically in diligent cases requiring high confidentiality. Single sourcing should still fulfil all documentation or process requirements to ensure complete transparency and traceability.

 

Incremental sourcing process

Digitalisation sets another requirement for sourcing: learn fast and scale fast, which means in practice that there is no time nor reason for a time-consuming RFP process. Usually the process starts by having some ideation and prototyping sessions with your ecosystem partners ending up with something that cannot be defined properly beforehand and which requires specific ecosystem parties to be involved. In these cases, the sourcing parameters are almost opposite compared to parameters in a traditional RFP process. The incremental sourcing process allows a way to proceed with the sourcing process without compromising an innovative approach to development.

Incremental sourcing process consists of following steps:

  • Signing a trial agreement/LOI (Letter of Intent) to agree commercial frame, business model and Intellectual Property Rights (IPR). A more comprehensive set of standard terms and conditions are typically attached as an appendix to simplify the future negotiations
  • Executing a trial where the idea, concept and solution is tested and verified to secure that both meet the business and technical requirements. Preferably some real user testing with Minimum Viable Product (MVP) will also be done under trial
  • Negotiating and signing a full commercial agreement in parallel or subsequent to the trial.

However, it is worth noting that the commercial terms in the incremental sourcing process can be less favourable than in a full sourcing process. In addition, incremental sourcing should not compromise proper documentation. For example, requirement handling or awarding a supplier without proper evaluation that can be audited.

 

Purchase-to-pay process

Purchase-to-pay or operational procurement is generally understood as part of sourcing that involves the actual buying of products and services. In simplified terms, a purchase is as simple as a work order within an already agreed commercial framework. Procurement and contract management usually ensures that the commercial framework relates to the price and scope and the possible sanctions in case the agreed terms are not fulfilled.

All purchases made under the framework agreement are managed by individual contracts (e.g. work order or purchase orders). Monitoring and control of the agreements are essential for two purposes:

  • Securing the suppliers adherence to the contract as the monitoring covers the volume, price changes and quality control
  • Securing internal control that only authorised purchases go through, ensuring that this process and the purchases are in line with the sourcing strategy and budgets. It also ensures that costs are allocated properly internally.

In many cases, the procurement and contract management work with Managed Service Providers (MSP) who operate as a broker with standardised contracts end terms.

A modern procurement and contract management capability is as automated as possible (e.g. systems integration) in order to:

  • Speed up the purchasing process
  • Allow spotting deviations in data
  • Use advanced data analytics
  • Follow price development
  • Observe how suppliers from two different framework agreements are performing compared to each other.

 

Vendor and contract management

Service management together with sourcing are responsible for developing and managing successful vendor relationships by adopting a clearly defined and structured governance model with regular meetings. On top of the existing services, the governance model also addresses the emerging opportunities brought forth by service development and potential new solutions.

Sourcing maintains a list of the company’s vendors and identifies the key vendors amongst them. Categorisation of vendors is essential to manage them all in a holistic manner. Vendors can be categorised based on their criticality or classified based on the individual vendor’s impact and value to the business, e.g. primary, complementary, or utility vendors.

The classification can be used further to form a proper governance model for the vendors. The classification also gives guidance on how to set up an adequate level of collaboration and performance management for each vendor. This limits the time and effort used in vendor meetings and enables focusing on the vendor relationships producing the most value. A good practice to engage vendors and vendor candidates in a meaningful dialogue is to host an annual or biannual vendor interaction session, where business technology management and vendor ecosystem share future outlook and development roadmaps and identify opportunities for alignment, additional business value and joint development initiatives.

Sourcing also maintains a contract repository containing all contracts including electronic versions with attachments as well as location references for the originals. A good practice is to write a contract summary document containing key information of the contract. Such key information also includes deviations to standard terms and conditions, validity period, contact persons and contract value.

Sourcing is responsible for the timely initiation and execution of contract revisions. It informs the service managers and service portfolio steering about expir­ing contracts. These, in turn, may authorise sourcing to renew contracts and/or initiate tendering. Service management ensures that vendor cooperation runs according to the agreed governance model on strategic, tactical and operational levels. Vendor management should focus on strategic and tactical levels and reduce the need for operational management by using IT Service Management Systems with real-time service information.

Apart from the sourcing lead, vendor management roles mostly belong to development and services disciplines depending on the phase and scope of the vendor cooperation. For example, a service manager responsible for the most critical service provider will also own the service contract and the vendor relationship as well as taking care of the cooperation on the tactical level.