What is group purchasing and how does it work? (part2)

Meeting place for people and finances. CFO CAFE.

In the first part of this article, we talked about the benefits of group purchasing and how to choose categories and pool partners. Let’s now look into how such purchases are organized.

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Group purchasing participants

Group Purchasing Organization is a company that specializes in certain categories. Group Purchasing Organizations can be:

o  Vertical – they serve a specific sector, for example, clinics and hospitals. Companies working in healthcare industry, such as Intalere and Insight, may be an example of Vertical Organizations.

o  Horizontal – they serve companies of different industries and focus on indirect (non-operations) categories: office supplies, courier services, travel arrangements, vehicles fleet management, IT, mobile communications, etc.

Client (also known as a Partner company) is a pool member company, end customer of goods and services.

Pool is a group of client companies that want to take advantage of group purchasing format. They contact a Group Purchasing Organization to lead the process.

Account manager is an employee of a client, a key contact person for a Group Purchasing Organization, who helps to establish contact with existing suppliers and stakeholders within the company, assesses results, and resolves disputes.

Project manager is a Group Purchasing Organization employee who leads the project, interacts with suppliers, holds a tender, develops a contract, and introduces new commercial conditions.

 

There are 2 models of group purchasing.

Option 1:

  1. A Group Purchasing Organization concludes a separate service contract with each client (pool participant).
  2. GPO analyzes and standardizes the client’s need for a purchased category, holds a tender based on combined requirements of pool participants, and agrees upon the outcome with each client. Then it Coordinates implementation of the sourcing deliverables.
  3. A client provides GPO with an access to the necessary data and makes key decisions: approves the vendor, coordinates and implements deliverables, keeps track of the project progress.
  4. GPO gets remuneration from a client, consisting of a fixed part and/or result-based remuneration. Suppliers do not pay remuneration.

A project consists of three phases:

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Phase Scope Timeline
Diagnostics
  • Data collection and analysis
  • Making specifications
  • Market analysis
  • Potential assessment
  • Vendor selection strategy
1-2 months
Realization
  • Preparing and conducting negotiations and tenders
  • Collection and analysis of quotations
  • Drafting recommendations and agreeing them with a client
  • Signing a contract
1-2 months
Implementation and Support
  • Communications
  • Preparing procedures, instructions and orders
  • Changing a process
  • Transition to new commercial terms
1-2 months

A client starts to get savings from group purchasing upon completion of the third phase of the project.

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Estimated savings

Savings from group purchasing are calculated using the formula:

 Savings1 = (Old price – New price) х Planned purchase volume for a period*

Reducing consumption (for example, deactivation of non-used sms-services and subscriptions) is also recognized as savings and calculated using the formula:

 Savings2 =  Old prices х Planned purchase volume for a period *

*As a rule, the period is understood as time interval of 1 or 2 years.

Option 2:

  1. GPO in certain categories chooses suppliers with the best commercial conditions and enters into frame contracts.
  2. A client compares their terms with the supplier’s conditions and, if required, can join a pool without holding a tender.
  3. A client signs a contract with a pool provider and starts picking volumes.
  4. GPO gets remuneration from the supplier. Typically, this is a percentage of the turnover with the customers attracted by GPO.

 

What model shall I choose?

Each of the models has its pros and cons.

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  Option 1 Option 2
  • GPO is not affiliated with suppliers, operates strictly to the benefit of the pool.
  • Maximum consideration is given to requirements of every member of the pool.
  • In addition to the main supplier, a client can get a backup supplier.
  • You don’t have to change suppliers
  • A client does not pay remuneration to GPO, works directly with a supplier.
  • A client quickly gets savings by joining current pool conditions.
  • Small companies can get the same conditions as large players
  • Longer time from a project’s start to actual savings.
  • Sometimes it is difficult for clients to explain their management that they need to pay remuneration to GPO.
  • Remuneration paid by a supplier to GPO is included in the cost of goods and services for a client.
  • Generally, there is no backup supplier.
  • A client joins the pool on current conditions, with fewer “customization” options.
  • Conflict of interests is possible: GPO gets remuneration only from a supplier. The supplier can influence GPO to the detriment of clients.
  • Generally, the current supplier has to be replaced with a new one which is not always convenient.

 

 

For large companies (with aggregate purchases of more than 500 million Rubles per year), we recommend the first option.

Where do I start?

  1. Select a Group Purchasing Organization, draw up a service contract and a non-disclosure agreement (NDA) with them. Pay attention to the following aspects:
    • experience in group purchasing with indirect categories;
    • methodology for project implementation, IT tools, templates available;
    • the method of calculating savings should be stated in a contract.
  2. Choose one pilot purchase category.
  3. GPO collects a pool of clients.
  4. Start a project simultaneously with all the others.

Success factors

  1. Commitment of the management of a client company (CEO and CFO) to the project. Otherwise, there is a high probability that initiators and suppliers will simply not let it be realized. In creating Agrega, for example, the decision was made by the shareholders of BAT and AB InBev. Thus, they managed to create a global structure of indirect purchases for both companies.
  2. Presence of a strong account manager at the client company. The person must be result-oriented and have influence within the company in order to defend pool conditions and introduce new commercial terms.
  3. Timely approval of decisions within the project. One of our projects dragged on for almost a year because of long approvals within one of the companies; as a result, the client got savings much later.
  4. Similarity in corporate cultures of pool members. For example, in the case of Agrega, it was difficult to find a compromise between BAT and AB InBev, since Inbev was focused on the cost effective and simplest solution, and the initiators in BAT wanted the best one. Often, as a result of a tender, the companies remained with their suppliers and conditions.
  5. Comparability of purchase volumes among pool participants creates an atmosphere of cooperation. If purchase volumes are significantly different, it is likely that the largest participant in a pool will start to dictate terms and conditions to the smaller clients.
  6. Maximum possible standardization of specifications. The unification of specifications by at least 50 % makes it easier to obtain favorable terms from suppliers.

Still have questions?

E-mail us or read FAQs:

Categories of what size can be considered for group purchasing?

We at PrECA conduct group purchases for companies whose expenditures are between 5 and 20 million Rubles per year on average. But we’ve seen some cases with categories of 50-70 million Rubles per year; for them, the same principles apply as those for larger categories.

Will my commercial terms be available to other pool members?

Companies may disclose information to each other only by mutual consent. A Group Purchasing Organization has access to business information of each participant, but does not disclose it to other pool members. In view of this, a non-disclosure agreement (NDA) is concluded. Besides, in case of a disclosure, GPO risks its reputation.

I’m confused. Who does a client conclude a contract with?

If you are a large company (aggregate purchases amounting to more than 500 million Rubles per year), then the first model will suit you. In this case, you conclude a service contract with Group Purchasing Organization. When a supplier is selected, you (with the support of GPO) conclude a supply contract with the vendor of goods or services.

Important: a Group Purchasing Organization is not an agent in a transaction and you cannot require them to become an agent. GPO is a partner who outsources procurement processes for a certain category, arranges interaction between pool participants, makes analysis and optimization. If they become an intermediary, then their costs and risks will greatly increase, which means, it will also be costly and inefficient for you. In addition, to become a supplier of office goods, for instance, you need entirely different competencies.

What savings can be expected? How to make sure that savings from a project will not be “eaten” by remuneration for GPO services?

The amount of savings depends on many factors, the maturity level of purchases, the amount of costs, how often and how well projects in this category are realized. As a rule, savings amount to 5 – 25 % of current annual costs.

Ask a Group Purchasing Organization for a preliminary estimate, it is free and will provide you a guide to savings. Let’s say, you get an overvaluation at this stage. Then at “diagnostics” stage, you will get a more accurate assessment of the potential for cost reduction. If you can see that the forecast savings do not cover the costs of GPO services, then you can exit the project. But you will need to pay for diagnostics.

It’s worth remembering that saving on procurement costs is not the only benefit that a participant in group purchases gets. GPO provides clients with a legally reliable contract and tender documentation (for audit, taxation, etc.), an optimized stock list and tariffs, reduction in the number of suppliers and terms of delivery/provision of services, improvement of supplier’s services, benchmarking, checking the efficiency of an ongoing process, working capital reduction, etc. Besides, you do not spend your employees’ resources on holding tenders, signing contracts, following up contracts, and managing suppliers.

What if someone exits a pool? Does the supplier change prices?

It is possible, because a supplier counts on a larger volume, and if a key customer leaves, they may need to review the conditions for the remaining pool members.

On the other hand, in collective purchasing there is no group contract, there is a collective tender, which results in a pattern of unified commercial conditions. Then the deliverables are fixed in contracts between the supplier and each client. These contracts contain no reference to volumes of other clients.

If a partner with a large share in the total volume drops out of the pool, GPO chooses another comparable participant and negotiates with the supplier not to change conditions _ usually it works, because the supplier is interested in keeping the other participants.

Is there any commitment to pick volumes?

There is no such a commitment, a supplier gets the forecasted volumes, as GPO warns about it in advance. In this case, when a decision has been made based on the tender results, commercial conditions must be fulfilled according to the contract and tender results, as in the case of normal sourcing. The client’s exit from a pool and further cooperation with an ex-supplier under worse conditions is also a violation of agreements.

Is there any way to customize specifications? Or one size fits all? And what if someone from a pool gets lower quality?

If necessary, of course, you can customize. But a project of group purchases is carried out in standard categories (for example, stationery), where the need to customize is minimal.

Savings and standardization should not jeopardize quality, a Group Purchasing Organization looks for alternatives that suit everyone. If a customer is not satisfied with the proposed specification, they can keep the previous one. For a supplier, purchase volumes in terms of money play a more important role than the number of items purchased.

We have global frame contracts on exclusive terms, which a Group Purchasing Organization will not be able to get.

It is necessary to make a comparison. Our experience shows that global contracts for Russia almost always lose to local solutions. Local consolidation gives more benefits, since a supplier is local and makes an offer taking into account the conditions in Russia. In a global contract, you get averaged values that may be profitable throughout the company, but this is not the best solution for its Russian business unit. Besides, many global suppliers are not present in Russia, therefore they need to subcontract local providers. This makes their services even more expensive. In any case, you do not have to switch to another supplier, if you think it is unprofitable.

I would like to participate, but I’m not sure that the project will bring any benefit. After all, we are a large company and we hold tenders ourselves.

Ask a Group Purchasing Organization to compare your actual conditions with the conditions that can be obtained within a pool. They will make a rapid test and evaluate the project potential. If there is no potential, then they themselves will not be interested, because they won’t earn money with it.

I still don’t understand why we can’t get such conditions ourselves. After all, we have our own procurement department and we hold tenders ourselves. What is it a Group Purchasing Organization does that we can’t?

Involving a Group Purchasing Organization does not replace a procurement department and does not discredit its efficiency, but adds to it. Of course, you can implement a project on your own. But this requires internal expertise, which is difficult to obtain when a company, in addition to direct purchases, has more than 70 indirect categories, and resources are limited.

Participation in group purchasing helps to achieve more than one can do independently. Within a pool, group dynamics, volumes, competencies, and developments are used. The more suppliers are involved, the higher the competition is. Even if you are a large company, with a larger volume you will get more favorable terms. For example, in a pool of 6,000 SIM-cards, the operator’s tariffs can be much better than those of a company with 3,000 SIM-cards.

In indirect purchases, this is important, because even for large companies, each category alone is of a relatively small volume.

You save resources and can assign them to higher priority projects. When there are such categories as raw materials, packaging, transportation, and marketing, spending your own experts’ time on office supplies is not very efficient.

Group Purchasing Organizations specialize in indirect categories. For each category they have specific IT tools, templates, and methodologies. Analytics are used much more. For example, in terms of mobile communications, uploads and details for 12 months are analyzed using a special script. Procurement departments confine themselves to getting tariffs, whereas a Group Purchasing Organization selects tariffs and options, taking into account the volumes and particular characteristics of each subscriber’s consumption, recommends changes in mobile communications policies, monitors the level of services, disables unnecessary options and services. After implementation, it ensures that billing prices correspond to the tariffs, and unnecessary services are not forced on to subscribers. When a provider introduces new tariffs or products that improve services or reduce costs, a Group Purchasing Organization suggests using them. All of this is much more than just holding a tender for an existing need.

A Group Purchasing Organization is more motivated, as their remuneration depends on the results achieved for a client. There is no such driver in any procurement department. But procurement departments can use this tool to achieve their goals.

And aren’t there any risks?

There are risks. Here are just some of them:

  • A wrong Group Purchasing Organization was chosen, with no experience of consolidation and category expertise, and they failed.
  • Corporate cultures of companies in a pool were too different, and the pool collapsed.
  • Timing of a project was delayed, and you needed your result right away, you had to do everything yourselves.
  • You counted on saving a certain amount, but in the end it turned out much less.
  • A project was not supported by management who had it stopped.
  • A category was not covered by earlier purchases, initiators are highly influential so they blocked the project.
  • An account manager was very busy and couldn’t dedicate their time to the project, as a result, a Group Purchasing Organization worked without their support, and initiators or suppliers blocked the project.

Risks can be mitigated by negotiating the terms from the very beginning, determining scenarios and further actions.

And is it legal at all? What if competition authorities sue us?

For competition authorities (Federal Antimonopoly Service in Russia) to make a claim for violating the antimonopoly law, the market share controlled by a pool has to reach 30 %. In indirect categories, this is impossible, even if all FMCG companies and banks are pooled together, because categories are purchased by all companies and the customer market is too fragmented. For example, there are only 4 federal mobile providers, but the number of legal entities that use mobile communications amounts to dozens of thousands, which is almost all companies in Russia.

And why should suppliers participate in group purchasing? What is the benefit for them?

Suppliers are interested because:

  1. They get a lot of money from a single tender. It is easier for them to “sell” this deal inside their own company, to get favorable terms for a client, and bonuses for themselves.
  2. They facilitate work by standardizing technical and commercial conditions and optimizing their product range within a pool. In addition, they can obtain extra discounts from a manufacturer, ordering a smaller number of items in larger quantities.
  3. They save on logistics, because goods can be delivered to several locations in one go. In case of Internet services, for example, you can divide the cost of cabling and installing telecom equipment between several clients. For instance, technical support engineers can go to provide repair and maintenance of printers in one shopping mall, covering several stores there at once.
  4. Costs for operational support are also decreasing, since you can support a group of clients following the same procedure. For example, one service manager is responsible for supporting all SIM-cards within a pool under the same rules, SLA and tariffs.
  5. A supplier’s marketing and sales costs decrease, as they bid for one tender instead of 5-7.

If you are interested in group purchases, e-mail us, we’ll be happy to answer your questions and help you initiate your project.

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