Economic Development

Buy By Data

States that can apply "strategic sourcing" to their purchasing operations stand to save millions of dollars.
by | January 2006
 

Pennsylvania procurement officials like to lay out a familiar scenario: Imagine you're hosting a family picnic, and you need ketchup. A lot of it. Would you drive all over town, darting into convenience stores to buy enough small packets of ketchup to feed the family? No, you'd go to the supermarket, where you can buy one big bottle for a much better price.

That's common sense, but it's also a purchasing strategy that has eluded state and local governments for years. Now, some public procurement officers are realizing they can save significant amounts of money simply by monitoring state expenditures and selectively targeting vendors to get the best possible price.

The concept is known as "strategic sourcing," and many states now see it as a means of saving money through smarter purchasing. A private- sector practice for decades, strategic sourcing was largely absent from state procurement practices even a few years ago. Delaware was the first state to implement the method in 2002; a handful of other states, including Illinois, New Mexico, Virginia and Rhode Island, followed in 2003. Today, 24 states are either practicing some form of strategic sourcing or are in the process of implementing it.

Shifting to a strategic sourcing approach involves some challenges. It relies on more centralized controls and much more thorough data- collection. And it raises the specter of getting too cozy with a limited number of vendors. But as more states adopt the approach--and as they experience dramatic savings--they are finding ways to overcome the barriers. As a result, strategic sourcing is very quickly becoming the gold standard in state procurement.

FIXING THE SHOPPING GENE

The broad concept of strategic sourcing is incredibly simple: States can save money by paying close attention to purchasing practices-- who's buying what from whom and how much of it. Pinning down a more specific definition is slightly more difficult. There are as many variations of strategic sourcing as there are arenas in which it's utilized. The 2004 California Performance Review, which urged the adoption of strategic sourcing in California, called the concept "a rigorous, systematic process by which the organization analyzes its expenditures, evaluates both internal and external influences, and determines the appropriate supplier relationships necessary to support overall organizational goals."

If that is too dense an explanation, there's the ultra-simple one procurement officials in Pennsylvania use: smart buying.

Regardless of its variations, strategic sourcing is predicated on two broad concepts: analyzing expenditures and leveraging a state's collective buying power to obtain the lowest possible price for goods or services. Purchasing itself doesn't necessarily have to be centralized, but it's essential to have a central overseer to gather data from disparate agencies, use that information to negotiate with vendors and then steer agency buyers to the carefully negotiated state contracts. Purchasing officials who use the system say they are able to avoid the issue of favoritism for one vendor over another since all contracts are driven by purchasing data collected from the state agencies.

Strategic sourcing has borne substantial savings in almost every state that has implemented it. Pennsylvania can lay claim to being one of the bigger success stories. When Governor Ed Rendell took office in 2003, he faced a budget deficit of around $1.5 billion, a formidable shortfall for any state. Rendell looked to strategic sourcing as a salve for many of Pennsylvania's financial problems. "I knew we could do it," he says. "I had read during the campaign about private industry doing such sourcing, and I thought it was something we could get into easily."

Rendell says he inherited "some woeful contracts with private vendors." The state had 25 separate cell phone contracts--five with the same company and at five different rates. Purchasers were buying personal computers from 15 different companies. That made for some obvious opportunities for strategic sourcing. "We hadn't used our leverage as purchasing power for anything," Rendell says.

Three years into its strategic sourcing efforts, Pennsylvania can boast at least $140 million in savings. It went from maintaining 17 warehouses to running only four--for an immediate savings of $4.5 million. As more contracts are put in place, the state expects its strategic-sourcing savings to total more than $200 million a year.

DEVELOPING THE BASE

One of Pennsylvania's biggest initial challenges came from suppliers who were concerned with one of the central tenets of strategic sourcing: Consolidating contracts means reducing the number of vendors that do business with the government. That can be a tough sell, says state General Services Director James Creedon. For instance, two years ago, Pennsylvania bought its office supplies from 1,800 separate vendors; now, a single vendor supplies all state agencies. Creedon acknowledges there were discussions about the trade-off and the economic impact of purchasing from fewer suppliers. Ultimately, he won the day by arguing that purchasing didn't have "a mandate from the voters to spend more money and buy more from more vendors. We had a mandate to reduce spending." A corollary of that point is that while states have an interest in supporting small businesses, they shouldn't do it through procurement. "You have to separate the notion of creating a favorable business environment in your state from the way you buy your goods and services," says Frank Kane, a spokesman for General Services. "Create an environment that's good for growing businesses, but don't try to subsidize those businesses through procurement."

The best way to combat vendors' concerns, Creedon says, is through information. In the case of the 1,800 office-supply contractors, 68 percent of those vendors received less than $1,000 a year from state contracts--hardly an amount worth the trade-off on higher prices for the state. Concrete information such as this allows procurement officials to show more explicitly what's best for the state, which can alleviate concerns about suppliers.

But getting that data--compiling accurate, comprehensive information about how a state is spending its money--is the single biggest roadblock states face when moving toward strategic sourcing. "You have to streamline your procurement and aggregate your data," says Ellen Phillips, the deputy state purchasing agent for Massachusetts and the president of the National Association of State Procurement Officials. "The most common obstacle is identifying what savings you're actually going to get through strategic sourcing." States frequently aren't initially equipped to identify those savings. The mere collection of current spending data can often prove incredibly difficult.

That was certainly the case in California, where strategic sourcing was adopted in 2004 to help address that state's crippling budget shortfalls. State officials were exuberant about the method's potential--and forecast $96 million in savings in the first year alone.

But when they began their analysis, they found the purchasing information in almost hopeless disarray. Shoddy bookkeeping in several agencies thwarted the effort to aggregate and examine statewide data. Purchasing officials had hoped to complete the data analysis in a couple of months; it dragged on for more than six. There was no consolidated data center. "The state was spending $4 billion to $6 billion a year," says California's general services director, Ron Joseph. "But we didn't really know how we were spending it or exactly what we were spending it on."

As an initial strategic sourcing effort stalled, the state was forced to revise its predictions on savings. Last May, the Department of General Services announced the new estimate: a mere $5 million for the first year. "We got off the ground quite a bit more slowly than we had hoped," says Joseph. "But we still saw the potential."

The good news for California is that the revised first-year prediction turned out to be too low. California ended up saving $11.3 million in fiscal year 2005. Since then, the effort has begun to yield substantial results. The state now anticipates $170 million in savings from the strategic sourcing contracts negotiated so far. That's certainly a healthy start, but some officials there are still unsure about the ultimate potential of strategic sourcing to save much more than that.

BUILDING A FOUNDATION

The issue of collecting purchasing information is also vexing procurement officials in Minnesota as they shift to strategic sourcing. Despite an electronic trail from official purchasing cards used by agency buyers, purchasing information was not sufficient to determine what was being spent on what.

But even as the state trains a closer eye on its procurement data, it is discovering another problem, something Director of Administration Kent Allin dubs "maverick spending"--non-contract purchasing where procurement employees in various agencies are not making use of the state-negotiated prices that are available to them. Reining in that practice is essential for the state to get a handle on its expenditures. The bottom line, Allin says, is that strategic sourcing cannot be successful without comprehensive purchasing information. "You need the foundation in data," he says.

And that may not be all you need. Strategic sourcing, California's Joseph says, "is more than saying, 'Okay, we're going to buy a lot. Give us a good price.'" Bundling purchases is just the starting point. "If you're going to do this at its fullest level," he says, "you need a very good understanding of yourself as a consumer. You need to know the marketplace very well. Strategic sourcing is a very simple concept that's very difficult and complex to implement."

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