Putting a price tag on an international procurement office (IPO)

Third in a series

Arvid Pedersen -- Purchasing, 10/7/2004

Quantifying the Value of an IPO

During the evaluation and decision process of opening an International Procurement Office (IPO), predicting the anticipated cost savings and associated costs of the IPO can be difficult. Initiating the evaluation process with a clearly defined mission and scope as discussed in the first article of this series is a logical first start, but clearly additional information is required to create an accurate projection of both IPO savings and operating costs.

In addition, there are various schemes for funding the IPO, from corporate budgeted overhead costs, charging a shared services assessment, or applying a user fee that is added on to all divisional purchases of materials or products managed by the IPO. The user fee can be a percentage of total costs based on the previous year's dollar value, or as an IPO service fee expressed as a percentage of each requisition or order.

Naturally, the objective of an IPO is to reduce overall material purchase price. But cost reductions need to be evaluated on a landed cost basis. Landed costs must consider at a minimum: freight, customs duties, extraordinary supplier management costs, freight expedites, and currency hedging costs or exposures. Typical results have shown that the costs of creating the IPO will be paid back several times over in material cost savings by the second or third year of operation. But consideration must also be given to the greater quality control, scheduling, and expediting activity that will be facilitated by regional supply management staff, providing additional savings and justification for the IPO investment.

In order to conduct a fair cost evaluation, expected operating costs must be tallied. Depending on the country of choice there can be considerable hidden costs. Companies must conduct their own due diligence on the cost factors as described in the second article of this series; however I strongly recommend meeting with the American Chamber of Commerce (AmCham) in the potential IPO location cities to survey members on their experiences. Chamber members will have the latest details on office costs and risks and are generally very willing to share their wealth of experience with noncompeting companies. As long as the company plans to join the organization once the IPO is opened, most Chamber directors will provide local intelligence services on initial fact-finding missions.

As with any international venture, there are always greater risks (and potential rewards) when conducting business across international borders. Companies must plan on varying cost/risk/performance fluctuations and swings over the life of an IPO, so assigning risk factors to each major evaluation criteria will lead to a superior decision process. Careful consideration must be given to: exchange rate fluctuations, transportation costs, transportation leadtimes, customs duties, local labor rate inflation, raw materials availability, employee retention factors and political stability.

Quantifying the value added of an IPO can be a difficult task as there are quite often many unknowns in the initial planning phase. It is recommended to maintain the IPO budget and cost reduction plan as a living document during the planning phase to reflect current business environments and findings. It is also advised to determine early on in the process how the IPO will be funded throughout the life of the organization.

The fourth article on this subject will appear in a future issue of PURCHASING.