Why should SOW suppliers pay a program fee?
A fair question. But the wrong one to ask when trying to justify a supplier-funded SOW program.
First – define what a program is
A contingent labor program is a coordinated management model that provides governance and operational support for the exchange (i.e. buying and selling) of temporary labor services within a client organization. So, when the program scope is expanded to include statement of work, that simply means the exchange (or market) for SOW-based services at the client organization is being similarly managed by the program.
Next – acknowledge what a program is not
The establishment of a program does not in and of itself create the market. To be clear: program is not the same as market. In fact, the genesis of the market for buying and selling services was established a long time ago when the client organization made the very first buy from a third party service provider. More than likely the contingent labor program (i.e. MSP, VMS, internal coordination, policies, etc) wasn’t even a glimmer in the eyes of the organization executive team that early in the company history.
The better question to ask
Just because there is no formal, organized or mature management function to provide governance and operational support to the exchange of SOW-based services does not mean that the market does not exist. And similar to the loud, crashing sound the fallen tree most assuredly makes in the forest, the market for services that no one is really managing surely comes at a cost.
So here’s the better question to ask when considering the case for a supplier-funded SOW program or program expansion into SOW:
Who currently pays for and has been paying for the unmanaged market of SOW-based services?
The costs of the unmanaged market
You won’t find them in a single line item of any budget or in any GL expense report. Why? Because un-managed also means un-visible spend and vendor data, and un-controlled invoices and payments, and un-centralized processes, making the costs to support the market un-likely to be identified and estimable. Nonetheless the cost impacts are real and a solid case can be made. Consider a sampling of common impacts in un- and under-managed markets for SOW-based services:
- Manual processes to submit, approve and pay invoices can run as high as $20 per invoice
- Procurement cycle times can delay projects for weeks driving acquisition costs (for the buyer) and new business development costs (for the supplier) materially higher as a percentage of total project costs
- Sole sourced engagements tend to come with 25-50% price premiums; and that does not even include the costs associated with excessive SOW amendments and original SOW budget over-runs
- Contract, regulatory, wrong vendor risks are higher when the processes to source and develop and execute contracts is disparate, manual and uncontrolled
- Lack of visibility into spend and vendor data not only handicaps commercial term negotiations but exposes the organization to misclassification and wrong vendor risks.
Future cost savings or current costs?
For those who have developed the business case for initiating a new spend management program, or even expanding an existing one, the list above probably looks familiar. Most of us, though, tend to think about these examples (and plenty others too numerous to list here) as the cost savings to be achieved by putting program management in place vs the current costs being incurred by the un- or under-managed market for SOW-based services.
Aren’t they the same thing?
Purists will argue the difference between cost cutting and cost take outs, etc., of course, but for now let’s just keep it simple and straight forward:
Future SOW market-related cost savings to be achieved by the implementation of a program management solution are equal to some factor of the current waste in sourcing, contracting and payments processes plus the current over payments to third party service providers; or
Savings = process efficiencies + improved pricing
Approach supplier funding from the correct perspective
The title of this article was chosen because that is a question I get from clients and partners quite frequently. They ask it sincerely, not knowing what the value proposition of a supplier-funded program is for the SOW supplier and being understandably concerned about supplier rejection to the new program, thus leading to program failure. To a procurement manager or organization that has not been confronted with this kind of business problem opportunity before, it is a logical response to have.
My suggestion is that the funding conversation between buyer and seller not be entered into with the mistaken belief that both parties are currently at a point of equilibrium regarding the pending costs and services of the new program management being considered. Acknowledging this fair playing field fallacy favors the SOW supplier side of the negotiation because it ignores the reality of the current state:
The current costs of the unmanaged market for SOW-based services are borne by the client company, not by the supplier(s).
How to leverage this perspective
In an unmanaged SOW-based services market the external service provider has already baked into their fee structure a healthy allocation for new business development (i.e. their cost to get new business: sales team, marketing, RFP responses, contract negotiations, holding named resources on the bench until project start, etc). They do this, in part at least, to account for the very real risks of encountering the same unmanaged market challenges that are motivating the client to put program management in place: inefficient processes, waste, long cycle times, delayed project starts, etc.
Here’s another good question to ask
If the client organization fixes these market problems by putting a well functioning program in place to manage it, doesn’t it make sense for the supplier to at least share in that cost?
Wouldn’t participating in a program that eliminates waste and reduces procurement cycle times benefit suppliers as well? Yes. Isn’t this a fair argument for them to at least reduce the NBD allocation they have built into their fee structure? Yes. Experience tells us most professional service firms have NBD allocations that are 3-5X that of the program fees they are being asked to pay.
The counter argument
When I walk through this reasoning with some clients they react by saying something like the following:
“But we have already negotiated their pricing or rates pretty hard. We can’t ask them to take on a 2% program fee, they’ll just add it on to current pricing and we will end up paying for the program any way.”
My initial response to this kind of resistance is to softly reject the near perfect transparency the stakeholder is effectively claiming he or she has into this supplier’s pricing and the position of that pricing relative to the pricing within their company’s micro market for that particular type of spend or practice area. Remember, this client’s SOW-based services market is currently un- or under-managed, which is why they are pursuing the program solution in the first place. The probing into the validity of this claim goes something like this:
- If you have not been fully managing this spend or vendor category, how do you know? How do you know there is not room for the supplier to absorb the fee?
- What kind of benchmarks have you been using to validate that the supplier’s pricing is completely aligned with market expectations?
- What was the last price increase the supplier notified you of? Do you track and validate each increase?
- Do you have a rate card reconciliation dating back to the last time you negotiated these rates? Does it go back more than 3 years? And if they increased rates during that time did you validate the reasons they gave you for the increases?
- What is your supplier’s current margin? What is their overhead allocation? How do these compare to the other suppliers in the same spend space at your company?
- For fixed fee or deliverables-based pricing how have you validated or benchmarked that pricing to ensure it was priced exactly as it was supposed to be priced?
- Has your supplier(s) provided you with a breakdown accounting for all segments of the rates they are charging you? How about for the fixed fee engagements? Are their fixed fees at a premium or a discount to a comparable time & materials arrangement?
In order for a client to make a credible claim that their current supplier pricing is so tightly managed and thus cannot withstand the addition (absorption) of a 1-3% program fee, a great deal of existing and historic transparency and pricing structure familiarity is required. In most cases, however, that is not the reality of the current state for a company looking to initially establish SOW program capabilities.
In the rare case such familiarity and transparency do exist, and where the supplier pricing is so tight that they would indeed have to add the fee on top of current pricing, then I would still advocate the supplier-funded model as a viable alternative to a buyer-funded program for the following two reasons:
- Tacking the fee on to each individual engagement is a good way to allocate program utilization costs fairly across the client organization; and
- The supplier-funded model is an SOW program expansion path forward that does not require Procurement to cut a check (often a very real obstacle).
In the end, having the supplier-funded SOW program conversation with some clients is tough because often the resistance they have to the supplier paying the program fee is not pricing related at all; rather it is relationship based. Clients, including procurement, vendor and category managers, often don’t want to ‘rock the boat’ – aka risk the wrath of business unit executives who the suppliers are sure to complain to when the program fee topic is broached.