Businesses compete in the real world with core competency. The core competency can be, for instance, excellence in design and low cost manufacturing. The purpose of businesses is to satisfy customers. Businesses, with its number of functions and process flows, have to add value to the product in order to satisfy customers. The satisfaction of customers is attained by providing value for money experience.

The value addition in each stage of the process flow is dependent on the cost of that particular process and the perceived value addition. If the cost exceeds the perceived value or the perceived value is not significant, businesses have to look at that process. Outsourcing is one of the ways to solve a business problem. It is a process by which a process flow is given to the third party, thereby utilizing the resources for any other value added activity.

The value addition in purchasing depends upon the criticality of the items purchased. In the Bill of Materials, usually 80% of the items are recurring and non-critical. The remaining 20% of the items are critical because of their high cost-low volume nature, which means large inventories are not necessary. In industries such as automobiles, where early stage supplier involvement is necessary for design and modular manufacturing, outsourcing of purchasing will not make sense.

Outsourcing saves cost by eliminating costs of purchasing such as processing and labor costs. This is possible for the third parties because their core competency is in purchasing and they excel at it. Some of the outsourced activities are proposal management, contract management. Proposal management includes preparing proposals, bids and qualifying bidders by inviting bids for projects. Contract management helps manage third parties who provide non-critical items such as office supplies, prepare contracts and negotiations.

Outsourcing works well in private as well as government enterprises. Most of the service providers have consulting services and purchasing services. Their fee structure is based on flat management transaction fees and/or retainer fees plus profit sharing on the savings accrued.