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Tech Industry

More bang for the IT buck

Corporate buyers of IT goods haven't had it so good in a long time but researchers at McKinsey say that many companies may still be paying more than they should for technology products and services. Is yours among them?

Corporate buyers of IT goods haven't had it so good in a long time. Technology vendors, feeling the pinch after two years of sluggish sales, are discounting their products--sometimes heavily--to book new revenues. In many companies, managers are crowing about the price breaks they have won from technology sellers, particularly on purchases of hardware products.

But companies may still be paying more than they should for IT goods such as software, telecommunications services--and hardware. The price breaks won so far are just the tip of the iceberg; many companies could actually strike better deals, particularly on terms and conditions that over time will add costs to technology contracts.

Furthermore, many companies still buy more IT than they need, primarily because they have an inaccurate picture of their requirements. Vendors, happy to take advantage of this lack of clear thinking, pocket the excess.

Reversing the tide can save a bundle. During the 1990s, as technology became more essential to running a business, companies spent more and more on IT goods; IT purchasing accounted for 4.11 percent of corporate operating expenses in 2001.

Reversing the tide can save a bundle.

Although companies in many sectors have capped further growth during the past 18 months, the cost remains quite sizable. Purchases of IT goods typically account for 50 percent of total IT expenditures--or up to 70 percent when the cost of systems integrators and other service providers hired to help install systems is factored in.

Companies can save 10 percent to 20 percent or more on what they currently spend for many IT goods by more rigorously managing how much they buy, how they bargain for it and how they handle their purchases. But to wrest these dollars from vendors, companies must make IT procurement a capability, not just an exercise in cutting deals. Many large companies have already developed sophisticated capabilities for getting the most from their direct-goods suppliers. They can now bring comparable discipline to the way they buy and manage IT.

Our analysis of good and bad IT-procurement practices in many industries suggests that companies must take a two-pronged approach to developing top-flight IT-purchasing capabilities. First, they should act quickly to take advantage of the tail end of the buyers' market by reopening existing contracts with selected vendors to demand extra price breaks and to strike better deals on terms and conditions. To prepare for this hard bargaining, IT departments and the businesses they support must work together to become smarter about precisely what is needed, which suppliers to buy it from and what the best deals look like.

Gains won today, however, will go straight to the vendors tomorrow if these renegotiations are treated just as one-off projects. The second half of our approach, then, is to look to the longer term. Companies must put in place the processes, organizational structures and support systems to ensure that they will continue to buy only what they need, on the most advantageous terms, across all categories of IT spending.

The complex world of tech buying
Just as technology has become more important, it has become harder to make effective IT-purchasing decisions. The technology and the business requirements it supports are more complex, and buyers must struggle to develop a specialized understanding of both. Globalization too has augmented the problem: When, for example, does a company benefit from consolidated sourcing on a global basis, and when is it better to source piecemeal from a number of national vendors?

Despite these changes, companies generally haven't altered their approach to IT purchasing: The IT manager for software, hardware or telecommunications generally plays the role of IT purchaser. This seems to make sense; after all, picking the right technology requires a deep understanding of products and the probable evolution of technology. But assessing the technology a company has and needs poses a far broader organizational challenge.

In large part, the problem is that IT-purchasing activities are typically fragmented. The IT organization and IT managers in business units may independently make contracts with the same vendors or buy similar products from different ones, each unaware of what the other is doing. That kind of buying inevitably leads to overbuying.

What is more, data on purchasing are often spread out across many sources throughout an organization. Pulling together information on how much money is spent on any IT category--PCs, for instance--or even on purchases from a particular vendor, can be a nightmare.

The broader issues that drive IT-procurement costs--such as managing demand from business units, policing standards and tracking assets--get overlooked if cutting deals is the main consideration. Moreover, companies rarely have clear IT-procurement processes that stretch across whole enterprises. Coordinating these processes helps pull together all the pieces of the puzzle, such as defining ways to assess user demand for new IT goods, developing a companywide view of preferred vendors and conducting sophisticated financial analyses of ways to construct purchase contracts. In the void, IT buyers have fewer opportunities to use their data, skills and clout to negotiate better deals.

Vendors, by contrast, have been doing their homework. They collect and analyze data about buying patterns and noodle new ways to design contracts. They create more complex product offers. They have well-defined selling processes they continually improve. Their sales reps can count on a host of support functions. So while vendors are giving price breaks today, they are positioning themselves to get the money back tomorrow.

Hardware server manufacturers, for instance, are teaming up with enterprise software providers to develop bundled offers-software configured for and packaged with specific machines-at what appear to be attractive prices. But down the road, this approach will make it more difficult for customers to switch hardware as well as software and thus will give the vendors leverage in negotiations.

Similarly, for customers with multiyear contracts that have yet to expire, telecom providers are offering lower prices, acknowledging that they have dropped, in return for two- to three-year contract extensions. This arrangement may not be a good deal for customers: Vendors offer current rates in exchange for long-term extensions, thus locking in the buyers. Instead of accepting such offers, buyers should negotiate assertively by making credible threats to replace these vendors when contracts expire.

The growing imbalance at the negotiating table between sellers and buyers will be exacerbated if, as we expect, the technology industry consolidates. Fewer and bigger vendors will have greater bargaining power and the resources to further improve their selling skills. Solving any of these IT-procurement challenges will save money today. Solving several of them will ensure constant savings over the long haul. The downturn in IT buying will end soon, and vendors will then be significantly less willing to cut deals that don't excite them. If buyers want to have contracts on their own terms, they need to make changes right away.

In large part, the problem is that IT-purchasing activities are typically fragmented.

Getting a better deal
By taking a broader approach to defining IT procurement, some companies already save tens of millions of dollars annually, beyond any price breaks they achieve by pitting hungry vendors against one another. Besides focusing on how to get good prices from vendors, smart companies address the problems endemic to the fragmented approach to IT procurement-assessing demand for technologies, sourcing and managing vendors, and compliance with contract terms. No company has put in place all pieces of the puzzle to complete this broader approach, but many have reaped big savings by improving selected areas.

Building a world-class IT-procurement capability may take time, but companies can implement some of its elements in a matter of weeks or months and get an immediate payback. They should start by reopening negotiations with selected vendors to cut better deals--and use this activity to judge their IT needs more precisely. The use of near-term opportunities to lay the groundwork for more complex organizational and process improvements in purchasing can benefit even companies that are good at handling most aspects of IT procurement.

How do you identify which contracts to open and what to demand? The answer lies in viewing IT procurement integrally, in focusing on the total cost of owning an IT product, and in collecting and using the right data to make purchasing decisions and manage the goods. That way, instead of thinking exclusively about prices, managers can ask tough questions about the forces that drive IT-purchasing costs--such as what technology does the company need as opposed to what it has?

Typically, contracts that are ripe for change offer the biggest opportunities to cut the overall cost of items such as PCs. Beyond their price, a company might tally how many kinds of PCs it has and the associated charges for maintenance, parts, peripherals, and so on.

To assess the scope for improving the efficiency of IT procurement, a few innovative companies have assembled joint business-IT teams including technology specialists, procurement managers and managers from business units or functions who know what the business needs. All of the company's IT goods are scanned for signs that spending could be trimmed.

Does one unit buy PCs configured with more expensive features than another unit? Do businesses buy PCs from different vendors? Are vendors longtime incumbents? When did the company last talk with their competitors? What is its total spending, by vendor, for PCs and peripherals? Seeking answers to a few broad questions like these helps the team create an initial list of potential opportunities.

The harder work is accumulating the solid information needed to make critical decisions. The teams we have observed must often pull together information from disparate sources. Data on spending may come from accounts payable. Contract information (expiry dates, key terms and conditions and price escalators) comes from across the enterprise and from contracts, and is collected in one place. Information on assets (the number of software licenses the company owns and who owns them, the location of all PCs and hardware lease schedules) must be tracked. The teams also collect technical and business data on vendors.

With this information, teams have a specific and detailed view of costs--and opportunities. A team at a large financial company discovered that over 40 percent of its IT consultants had worked there for more than three years. The team estimated that the company could save 30 percent of its total spending on consultants if it owned, rather than contracted for, the services of its long-term consultants who have generic skills. Similarly, a team at a large insurance company discovered that although in theory it had negotiated competitive wireless rates, the actual rates were very high, because many employees were significantly under- or overusing the minutes it had bought.

Managers can also use information to look more objectively at the full price of fragmented IT spending. One company saw clearly what it cost to have 15 variations on PCs, from maintenance and software-development expenses that were four times those of comparable companies using more standardized PCs to higher bills for packaged software and hardware peripherals. The company also recognized that it would have to be more careful in assessing the return on investment of its purchases; if it had questioned in advance the benefits of having so many different PCs, it would probably have made different buying decisions.

We have found that some companies, even those with good IT-purchasing practices, don't understand their vendors' markets.

Collecting better information about vendors is another vital piece of the IT-procurement puzzle. We have found that some companies, even those with good IT-purchasing practices, don't understand their vendors' markets. Yet insight into them is critical for choosing the right vendor for a product and for conducting successful negotiations to buy it.

A mine of information on vendors can fuel a good IT-sourcing strategy. For any product, companies should select the vendor that makes sense and identify what it will consider important in the negotiations. Armed with better information and a sharper sense of what is possible with individual vendors, IT-procurement managers can reopen negotiations. The initial gambit involves inducing the vendor back to the table, often with a mix of carefully aligned incentives, such as term extensions, the purchase of new products and promises to let the vendor use the company as a marketable "reference" client.

We have seen a number of companies chalk up substantial savings after preparing carefully to renegotiate contracts. One engineering company, on the verge of signing a $40 million telecom voice- and data-services contract with a vendor that offered a 10 percent price break, decided instead to call time-out. Meanwhile, it collected more data on its usage and spending, and put a lot of energy into building a sourcing strategy. The result: The company adopted a "dual-sourcing" approach--having two vendors provide different parts of the service--saving an additional 25 percent.

That is phase one. With the renegotiations completed, companies must establish new contract policies and processes. After renegotiating a $30 million purchase of PCs and peripherals, for example, one telecom company changed its internal system for ordering PCs so that it rigorously enforced compliance with the new contract and managed the number of PCs it purchased. Higher-level managers must now authorize purchases of PCs that don't comply; monthly PC purchases are posted on the company intranet; and business units receive scores for compliance with standard purchases, which increased to 90 percent, from 60 percent, over six months. Furthermore, the ratio of PCs to employees dropped to 1.2, from 1.44, over nine months. The company saved $4 million by making fewer and more standardized purchases.

Building for the long term
Reopening negotiations can reduce IT-procurement costs today, but the gains can be locked in only by institutionalizing the change. Having seen what good teams at companies on the leading edge of procurement can achieve, we estimate that a business can cut its spending on IT goods by 3 percent to 7 percent a year if it makes its team permanent.

Moreover, even the most vigorous effort to collect data on IT spending leaves a company with little more than a snapshot in time; unless it is continually refreshed, it has no value. Sourcing strategies too must be refreshed. The team's activities need to be turned into practices, procedures and processes. In other words, companies must integrate activities that were fragmented and organized vertically--by technology category.

One bank has already found all this to be true the hard way. Armed with better information and smarter sourcing strategies, it secured deals that cut its IT-goods spending by 15 percent. But it failed to create a replicable process despite hiring an experienced lead negotiator to bargain with vendors. Lacking a process that could be plugged in each time a contract arose, the negotiator couldn't manage the pipeline of contracts effectively and had to reinvent the wheel time and again.

The blueprint for a comprehensive IT-procurement organization is still being drawn. But some key elements of the way companies should organize it, define its processes, and develop its supporting infrastructure are already becoming clear.

Nearly every company we have observed building an IT-procurement organization is hiring procurement professionals to lead it and to negotiate with vendors. These purchasing managers have the skills to convert data into insights for making deals, to manage vendor relationships, and to monitor contracts. IT employees may have a role in providing technical information and in assessing vendors, but not in negotiations.

One hotly debated question is how to design the unit. Should purchasing decisions for all categories be centralized (and, if so, in IT or in global purchasing?) or decentralized to the business units? We think the answer is a hybrid of both, because this approach makes the smartest use of the resources of the corporate center and the business units to manage hundreds of technology contracts.

In a hybrid model, a decision about purchasing IT goods is made centrally or locally depending on its "natural owner." Commodity IT goods, such as PCs or printers, can be standardized and thus require little input from business users; the central IT-procurement unit can direct the process of purchasing these products. But more strategic IT goods, such as mainframe software or customized enterprise software, require heavy user input. Business users take the lead in these purchases, with strong assistance from IT procurement.

It is critically important for companies to standardize IT-procurement processes--by defining roles and responsibilities, codifying procedures and building templates for functions such as vendor management--so that they can be replicated for every contract. But the key processes to get right, and to integrate tightly, define the core of IT procurement: sourcing, order to payment, managing the performance of vendors and the compliance of users, and developing and managing vendors.

Over the longer term, data collected to manage vendors and users can guide continual improvement initiatives by providing information, say, on how long it took a certain vendor to fix a problem or whether costs in the second year of a contract were reduced as promised, and if so by how much. Closely tracking vendors and users helps IT-purchasing managers see where problems crop up and guarantees that costs will constantly fall.

Investment in an IT-procurement support system isn't a silver bullet--it is a tool--and companies must beware of the tendency to focus more on building the tool than on its purpose, for they don't have a clear view of what procurement should do and often confuse tools with capabilities. To build infrastructure, companies must understand how to tap existing systems for the data that IT-purchasing managers need and how to invent other systems--for instance, to support newly codified IT-procurement processes, performance metrics and reports.

The task isn't an easy one. Because IT-purchasing data must be pulled from many different systems within a company, the data are rarely defined or measured consistently across them. Establishing common definitions and metrics for these systems is the first order of business. A number of them may need to be integrated into an IT-procurement support system. Companies may also have to integrate new tools into the mix, including electronic requests-for-proposal and auction systems or market analysis and target-cost-cutting applications. Smart companies phase in the introduction of these new tools.

During the past 30 years, companies have dramatically improved the way they source and manage direct materials. Now that IT has become critical to the way companies do business--and accounts for a sizable proportion of their operational spending--they also need to make systematic improvements in the way they buy IT.

For more insight, go to the McKinsey Quarterly Web site.

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