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Challenges of purchasing centralization - empirical evidence from public procurement

By Katri Karjalainen (Helsinki School of Economics)
Supervisor: Dr. Erik van Raaij

Abstract

Centralization of purchasing activities is an escalating trend for both public and private organizations. Organizations are attempting to capture the economies of scale in purchasing prices and process costs by replacing individual purchases done throughout the organization with corporate-wide framework agreements. These benefits are achieved by the formalization of purchasing processes and channels, e.g. e-procurement, and the reduction in supplier base, developed by the central purchasing unit. But these changes may challenge the other employees used to handling purchases more informally at a local level as well as limit participation of smaller suppliers. To facilitate a scientific treatment of these challenges of centralization, this thesis has three objectives: 1) To examine how organizations can estimate and quantify the cost effects of purchasing centralization, 2) To study what kind of consequences the development of centralized purchasing and the phenomena associated with it have for the suppliers, specifically for the involvement of small and medium-sized enterprises as suppliers and 3) To conceptually and empirically analyze the forms and reasons of non-compliant purchasing behavior i.e. maverick buying and what types of measures can be used to reduce such behavior.

The thesis consists of four papers which look at the challenges of centralization primarily through the eyes of actors facing the change process, while also addressing the inherent problems of the procurement function as reflected in principal-agent theory. In the first paper of the thesis, “Value of centralization”, the cost effects of centralization on purchasing prices and tendering process costs are estimated. The estimation of process costs is done by surveying the time spent on the tendering process both for the decentralized operating model and the centralized operating model in the Finnish government and estimating the costs of those times. The second type of cost effect, price difference, is estimated by comparing the central framework agreement prices to market prices. The savings potential in both process costs and purchasing prices show that the number of units centralizing their purchasing process and the purchasing volume being pooled do not need to be very high before economies of scale becoming evident.

The second paper, “The involvement of small- and medium-sized enterprises in public procurement: Impact of resource perceptions, electronic systems and enterprise size” investigates what kind of an impact the phenomena related to centralization, i.e. increased use and consolidation of e-systems in procurement and more formalized and burdensome tendering processes, have on SME involvement in public procurement. The results of hypothesis testing using data from a survey conducted among SMEs show that perceived lack of resources especially in legal expertise and administration is associated with low SME involvement in public procurement. By analyzing suppliers to municipalities and state organizations separately, it is also found that lack of electronic systems in order processing and invoicing is related with low involvement of SMEs especially in state procurement, but not in municipal procurement, which is far behind in its centralization efforts.

In the third paper, “Non-compliant work behaviour in purchasing: an exploration of reasons behind maverick buying”, a systematic literature review is used to identify different forms of maverick buying, ranging from unintentional maverick buying to straightforward sabotage. These different forms and reasons are then validated and enriched through a series of in-depth interviews with purchasing professionals. These results are significant as the mere introduction of centralized contracts will not bring the expected benefits of centralization; contract compliance is crucial to achieve these. Only by being able to identify the forms of and the reasons behind maverick buying are organizations able to attack the problem.

The last paper, “Maverick buying as an agency problem”, extends the investigation of maverick buying as an agency problem in which the principal is the purchasing department negotiating the contracts for use by the whole organization. The ordering and operative buying is then delegated to the agents i.e. various individuals in the organization. In this research paper hypotheses on maverick buying as an agency problem of ‘hidden action’ are proposed and tested with survey data from the Finnish Government. Empirical testing shows that maverick buying is related to the two conditions of agency problems: information asymmetry and goal incongruence. Based on the results, traditional governance mechanisms of principal-agent theory are efficient in reducing non-compliant behavior, while governance mechanisms to reduce honest incompetence are efficient in reducing the conditions of the agency problem, specifically information asymmetry.

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22 May 2009