9781932159493 chapter 13 strategic sourcing your most important tool

Straight to the Bottom Line: An Executive's Roadmap to World Class Supply Management

by Robert A. Rudzki, Douglas A. Smock, Mike Katzorke and Shelley Stewart, Jr. J. Ross Publishing. (c) 2006. Copying Prohibited.

Reprinted for Joseph Bacarro, Accenture

[email protected]

Reprinted with permission as a subscription benefit of Skillport, http://skillport.books24x7.com/

All rights reserved. Reproduction and/or distribution in whole or in part in electronic,paper or other forms without written permission is prohibited.

http://skillport.books24x7.com/

Chapter 13: Strategic Sourcing—Your Most Important Tool

Overview

In the upcoming chapter on supplier relationships (Chapter 14), we note that the word "partnership" is often used casually in the business world when the speakers often means different things.

The term "strategic sourcing" can sometimes fall into the same trap. Simply adding a few bells and whistles to conventional purchasing, and then slapping the word "strategic" onto the process or the department name, is not the same thing as adopting the process that the authors have used in their careers to generate significant improvements in corporate financial performance.

What is strategic sourcing? It is a fact-based, rigorous process that involves substantial internal data gathering and evaluation, and extensive external data gathering and interactions, in order to select the most appropriate strategy and negotiations approach and ultimately select the right supplier. Strategic sourcing transforms conventional purchasing into a strategic process involving all appropriate stakeholders in a company and which can add significant value by reducing total costs relating to purchased goods and services. In a recent further evolution of strategic sourcing, the concept has expanded beyond adding value to a company's earnings to include adding value in other factors affecting return on assets or return on invested capital, such as improvement in payment terms and inventory programs.

To put strategic sourcing into perspective, it is one of three critically important elements in modern procurement (see Figure 13.1).

Figure 13.1: Three interrelated elements of modern procurement.

On a daily basis, there is a need for accurate and efficient transactional execution (often now referred to as just "purchasing"). Here, the focus is on easy and cost-efficient order placement (with suppliers that have been selected by strategic sourcing), order follow-through and expediting (if needed), order receiving, and order payment. In the state-of-the-art company, the end user (not a purchasing professional) places an order into a system that is populated with approved suppliers and approved materials/prices using master agreements or contracts, and that system communicates directly through electronic media with the approved supplier. As opposed to traditional purchasing, in which the end user communicates his or her needs to someone in purchasing (by phone, fax, e-mail) and then that purchasing person communicates with the supplier, state-of-the-art purchasing involves the direct involvement of the end user and minimizes the nonvalue-added involvement of purchasing.

On an ongoing basis, there is supplier management, which involves the continuous and active supervision of the supply


Reprinted for OET7P/664429, Accenture J. Ross Publishing, Rudzki, Smock, Katzorke, Stewart (c) 2006, Copying Prohibited

/ 8

base. This includes evaluating supplier performance against criteria agreed to during the negotiations phase of the sourcing process, discussing opportunities for mutual process improvement, and resolving conflicts. Some of these ongoing activities are tactical in nature; others are strategic.

On a periodic basis, there is strategic sourcing. Intensive strategic sourcing efforts often occur every three to five years for a specific spend category, with active monitoring of the supply market in between those sourcing events. The distinction between the complementary functions of purchasing (the tactical and operational elements) and strategic sourcing can be described along three dimensions:

n The primary mission/objective: Purchasing is typically focused on the tactical day-to-day execution of orders, receipts, and supplier on-time delivery to meet the daily production demand and as a result is heavily transaction oriented. Classical purchasing textbooks talk about the goal of purchasing being the "three rights — the right parts, at the right time, at the right price." The primary objective of strategic sourcing is to become a competitive differentiator for the business. This is accomplished by employing a multistage process to understand supply markets, understand internal needs, identify qualified suppliers interested in your business, structure the right type of relationship, negotiate, and implement. Furthermore, strategic sourcing involves leveraging the corporate spend and partnering with a small, preferred supplier base, which is capable of achieving continuous (year-over-year) improvement in cost, quality, delivery, technology, and service.

n The planning horizon: Planning horizon for the purchasing function is 1 day to 12 to 28 weeks into the future (depending on the longest lead time in a company's supply base). Strategic sourcing activities are focused on long-term continuous improvement activities, but must also deliver near-term financial results. As a result, strategic sourcing planning horizons begin two to three months from today and can extend as far as five years or more in the future.

n Organization structures and individual competencies: As one might expect based on the differing objectives and planning horizons, the organization structures and competencies are near polar opposites of each other. The purchasing organization and its professionals need to be expert "firefighters" with extremely fast reaction times. Purchasing individuals must withstand tremendous "real-time" pressure and cannot become bored or intolerant of very intensive and repetitive daily transactional activities. The strategic sourcing process and activities must be organized cross-functionally to be successful with engineers, manufacturing and quality personnel, commodity managers, and financial analysts. These professionals must be competent in planning, project management, financial analysis, negotiation, and cross-functional operations.

In any organization, resources typically are pulled toward and consumed by the tactical activities. This is a natural outcome when you consider that failing to perform the tactical and transactional activities on a day-in, day-out basis can trigger immediate problems for an enterprise. The dilemma is that the greatest value add comes from the strategic activities. The

challenge, then, is how to redirect and reallocate resources to strategic activities. [1]

Companies with significant experience and success in strategic sourcing often establish separate, dedicated resources or subteams for the tactical activities and the strategic activities. This makes sense because the objectives are different, the processes employed are different, and the skill sets are often very different. The tactical and strategic personnel can be viewed as subteams of an overall effort that is focused on achieving significant, breakthrough results, with ongoing and active supply management and utilizing efficient processes.

[1]Robert A. Rudzki, "Leading Strategic Change," Supply Chain Management Review, January/February 2001.

Strategic Sourcing: The Process

There are different variations of the strategic sourcing process. The shortest version the authors have seen is a five-phase process. A.T. Kearney's classic seven-phase process (shown in Figure 13.2 and which is the basis for the strategic sourcing description provided in this chapter) is well known among chief procurement officers; there are other variations that have more than seven phases. For the interested reader who wants to do a deep dive on the subject of strategic sourcing, there are entire books and seminars on the subject. What we provide in this chapter is a description suitable for the executive-level audience to understand the process, its rigor, and its potential.



/ 8

Figure 13.2: Classic strategic sourcing. (Source—A.T. Kearney, Inc.)

Regardless of the number of phases in the individual design, the basic components and steps in true strategic sourcing are the same. Doing it well requires a meaningful investment in personnel and skills.

First, there is a need to define and profile the sourcing group. A sourcing group is defined as a group of purchased items that are likely to be sourced from the same subset of suppliers. Examples of sourcing groups are safety equipment and supplies (which is served by many manufacturers but a unique subset of major distributors within the supplier world), personal computers (again, served by a unique subset of manufacturers within the supplier world), and truck transportation (served by a variety of service providers serving various segments, such as flatbed, enclosed box, refrigerated, and tank). Obviously, within each sourcing group there may be many specific items, but the commonality we are looking for is that the group of items or services in a sourcing group is available from a distinct subset of suppliers. Other terminology is often used. Some companies refer to these groups as "categories" and to their supervision as category management.

Profiling the sourcing group involves both internal data and external (supply market) data. The internal profiling is greatly aided by having the ability to analyze your spending detail. "Spend analysis" tools, described in Chapter 7, can be powerful aids to speed up the sourcing process, and provide the facts necessary for analysis, and to present the size of opportunity to suppliers that will be participating in the sourcing process. In addition to historical and projected volume data for the sourcing group, critical data include specifications, delivery requirements, technical support, and systems interactions (especially for direct materials involved in the production process). Delineating between "wants" and "needs" is also very important. More than one sourcing effort has been greatly aided by shortening the list of specifications to include only true "needs," thereby enabling more suppliers to qualify for participation.

External profiling of the sourcing group involves understanding the supply market, both currently and prospectively. Even historical studies of how markets can respond to various events and pressures can be extremely revealing in forecasting the future. Plastic resin markets, for example, react consistently to changes in gross domestic product, auto sales, or housing starts and swings in oil or natural gas prices (depending on basic chemical type). Preorders surge and inventories bulge in advance of expectations that resin prices really will rise. If you can develop forecasts for any of those events, you can develop a strategic sourcing plan for plastic resins that indicates contract versus spot buying approaches, which will save huge sums on purchase price and inventory costs. Very few buyers take adequate advantage of opportunities in spot resins markets.

Knowing today's market price (market intelligence) is not the same thing as fundamentally understanding the supply market (market knowledge). In fact, a comprehensive supply market assessment will involve assessing each component of Professor Michael Porter's "Five Forces" framework: suppliers, buyers, substitutes, new entrants, and internal market competition.

Furthermore, understanding the supply market involves determining whether the market is a global market, a regional market (e.g., North America), a national market, or a local market. Properly assessing the geographic scope of the markets, and whether or not the suppliers are capable of serving your needs on a global, regional, or national basis, is critical for designing an effective sourcing strategy.

Let's follow an example through the seven steps of the strategic sourcing process. Safety equipment and supplies are manufactured by a wide range of manufacturers, but the majority of the volume goes to the marketplace via a well-defined group of major distributors with extensive product and service ranges as well as a national or global presence. (All of the "Five Forces" are at work in this marketplace, with post-September 11 awareness driving demand in many areas of this supply category.)

Second, there is a need to determine the likely sourcing approach, based on the sourcing group profile. This step often involves "positioning" the sourcing group in a 2 × 2 matrix, similar to Figure 13.3. The internal assessment from the prior step is noted on the "impact on business" axis, and the external assessment is noted on the "supply market complexity" axis. The value in positioning a sourcing group in this fashion is that it suggests appropriate sourcing strategies and can guide the data gathering in the next few steps.



/ 8

Figure 13.3: Assessment to determine the right sourcing approach. (Source—A.T. Kearney, Inc.)

For example, sourcing groups that fall into the "strategic" category are high-value groups where the supply market is difficult (i.e., the supplier has the negotiating advantage due to the supply market characteristics). In that quadrant, it is often best to focus on a strategic relationship or partnership approach, which can often involve long-term agreements, shared cost and quality targets, leveraging the supplier's expertise, and optimizing the operational and administrative processes between the supplier and customer.

Those that fall into the "bottleneck" category are also in difficult supply markets, but are lower value sourcing groups. Since these sourcing groups often do not have the visibility, due to smaller size, they have the potential to become problems for your business unless you devote time and effort to careful supplier selection and relationship structuring.

On the left side of the matrix, sourcing groups that fall into the "leverage" category are high-value groups where the supply market is very much in favor of the buyer. This is the classic opportunity to utilize your buying clout and the supply market to the advantage of your competitive sourcing effort.

Those sourcing groups that fall into the "noncritical" category are also easier supply markets that call for a competitive supplier selection process, but due to their smaller size also deserve attention to simplification and automation, including use of procurement cards with the selected suppliers.

It is important to note that this is a preliminary assessment of the appropriate sourcing approach. Further insights that develop as the sourcing process proceeds, including results from the request for proposal (RFP), will refine the approach.

Safety equipment and supplies is relatively low value, highly leverageable, and somewhat critical due to the sensitivity of properly protecting employees; it requires the supplier to have product application expertise to aid in specifying, substituting, and standardizing products to achieve lowest cost while assuring a high level of safety and personal protection.

Third, the focus is on generating a portfolio of qualified and interested suppliers. This starts with all current and past suppliers in that sourcing group, adds likely alternative suppliers, and also searches for nontraditional suppliers that might have the ability to grow into a qualified supplier role. Extensive database research, along with benchmarking with other companies, can help to identify all potentially relevant candidates.

Turning the list of potential suppliers into a shorter list of prescreened and prequalified suppliers requires two things: a carefully thought-out inventory of evaluation criteria and a good fact base regarding each potential supplier. It is at this stage that the sourcing effort often utilizes a request for information (RFI), which, if structured properly to ask the right questions, can not only be a powerful tool for understanding the strengths and weaknesses of each supplier, but also



/ 8

provide additional insight into the supply market.

Following the safety equipment and supplies example, high on the list of RFI considerations might be number of manufacturers represented, application services and training offered, and proximity of distributor locations to sites requiring service. After the sourcing team uses the criteria to screen the initial list of suppliers, there is a shorter list of prescreened potential suppliers to approach with the selected implementation path (step four). There may also be additional insight to confirm the preliminary assessment in step two, or to revisit that assessment as part of step four.

Fourth, the appropriate implementation path is selected. The appropriate path for approaching and selecting suppliers is determined by the position of the sourcing group in the 2 × 2 matrix, plus what has been learned so far in the first three steps of the sourcing process. As a general comment, the left-hand side of the matrix represents sourcing groups where the supply market favors a competitive supplier selection process. In other words, it is more of a buyer's market. Specific implementation path options include volume leverage (consolidating the number of suppliers), expanding supplier options (by developing new supplier alternatives), and aggressive negotiations that take advantage of the supply market's weakness.

The safety equipment and supplies spend category is clearly positioned on the left-hand side of the matrix, which favors a competitive supplier selection process. However, developing a longer term supplier/customer partnership will be necessary in order to capture and implement additional cost reduction opportunities in areas such as substitution, standardization, and new product development.

The right-hand side of the matrix represents sourcing groups where a competitive selection process might be inadvisable or even impossible, due to the more complex supply market situation plus the potentially critical importance of those categories to a business. In those sourcing groups, the effort might best be devoted to initiating a collaborative effort with the supplier, based on themes such as product specification improvement, joint process improvement, and — more fundamentally — a supplier/customer partnership. (For a more comprehensive discussion of supplier partnerships, see the next chapter.)

Fifth, there is a need to develop and execute a well-thought-out negotiations strategy. This involves, among other things, crafting an RFP to be sent to all prequalified suppliers, analyzing the RFP responses, and constructing and executing a negotiations strategy in accordance with best practices (see the section on negotiations in Chapter 17). The authors cannot stress enough that if the negotiations phase is allowed to proceed in an informal manner, a significant loss of potential value can occur.

Using the safety equipment and supplies example, it may be beneficial to segment the RFP by major usage categories such as breathing apparatus, face protection, hand protection, foot protection, etc. to determine relative buying power in each segment. Comparative information of this type can provide valuable insight for the development of negotiations strategies. In addition, this technique of revealing strengths in specific areas of a broad category of supply provides an opportunity to "identify the best fits" for unique requirements.

Sixth is operational integration. Once the negotiations are complete, the focus turns to transitioning to the new supplier or transitioning to a new business relationship with a retained incumbent. In the case of introducing a new supplier, this process often involves a testing period as part of a planned ramp-up. The testing should involve not only the purchased product or service but also the requisite administrative, operational, logistical, systems, and quality processes important to you as the customer.

Including key stakeholders as participants throughout the sourcing process can provide significant benefits, including ownership and buy-in at this stage of the process.

During this phase, the hand-off occurs between the original sourcing team and the ongoing implementation team and user community. The authors have found it very useful to include in the final report card of the sourcing team the success of the transition to implementation. That way, you avoid a sourcing team "throwing the contract over the wall" into the laps of unprepared users.

Seventh and finally, there is value in continuously benchmarking the supply markets in order to monitor changes in the supply market, be aware of evolution of the product or service, and ultimately be in a position to make an informed decision about updating the sourcing group strategy or the suppliers selected as part of that strategy. With regard to the chosen supplier, this can mean such things as the establishment and monitoring of agreed-to ongoing key performance metrics, timely updates regarding new products, and general market knowledge information that may be critical for demand planning.

The point here is that strategic sourcing is not a one-time event. It is a periodic event, with the periodicity a function of



/ 8

internal considerations and supply market developments. Without an explicit process to monitor the supply market, the timing of the "re-sourcing" decision might be left to accident or happenstance — and that would not be conducive to achieving the best financial results.

Strategic Sourcing: Determining the Priorities for "Waves"

Companies that have embarked on strategic sourcing often talk about their experiences in terms of the "waves" of sourcing teams. The first wave is composed of those sourcing categories that were determined to be the best spend categories to kick off the sourcing effort, the second wave is the "next best" spend categories, etc. What is best practice for selecting the categories for each wave?

The classic approach is to perform a high-level assessment of two factors for each potential sourcing category: the opportunity for reduction in total costs and the ease or difficulty in negotiating and implementing a new agreement. The opportunity assessment is greatly facilitated by having a comprehensive discussion and review of the market factors affecting that category. Depending on the quality of your team's pre-existing understanding of these market factors, it may require external research, including analyst or industry reports and input from parties that have previously studied that sourcing category (including consultants). The assessment of ease of negotiations and implementation is heavily dependent on the current supply market, the current contract, and internal issues and constraints that are important to your company. Those internal issues and constraints can include such factors as operational issues, systems issues, and even the willingness to consider a change of suppliers.

The results of this high-level assessment are then plotted on a diagram, similar to Figure 13.4. The top right-hand corner of the diagram, comprised of higher opportunity, easier implementation categories, becomes Wave One. The number of categories selected for Wave One will depend heavily on how many professional resources are available to staff the efforts. Note that the sourcing categories shown in Figure 13.4 are for illustrative purposes only and may have no relevance to the correct assessment of those categories for your company at any point in the future.

Figure 13.4: Planning a comprehensive sourcing program with "waves."

Depending on company culture and eagerness to change, it is not unusual for companies to select a small number of sourcing categories (perhaps four to six) to "seed" the effort in Wave One and prove that strategic sourcing works within their business culture. After initial successes with some easier, high-opportunity categories, an increasing executive commitment is made to the subsequent waves.

A few companies, either because of financial stress or because their culture is amenable to embracing significant change, proceed on a "tidal wave" basis. In that approach, the objective is to achieve monumental change in a shorter period of time, and a significant resource commitment is made from the very beginning. This resource commitment is often



/ 8

comprised of a cross-functional pool of high-potential employees from the procurement organization, operations, finance and accounting, R&D, and marketing who are plucked from their normal duties for a two- to three-year assignment to a "core team" that will drive the strategic sourcing process. Sometimes that core team is aided by outside consulting resources from one of the experienced procurement consulting firms.

Co-author Rudzki compiled data from six years of strategic sourcing experience at Bethlehem Steel in the mid to late 1990s. Those data reflected a fairly linear relationship between the amount of strategic resources dedicated to strategic sourcing and the resultant new annual cost reductions achieved. The data revealed a hard-dollar return of approximately $1 million per employee per year one year after the resource commitment was in place.

The decision to start slowly with a small first wave or start big with a tidal wave is heavily dependent on a company's culture, the commitment of the executives in the company to embrace change, and the leadership of the procurement organization. As important as the start of the process is, it is equally important to ensure that it becomes embedded in your business as a core business process.

Strategic Sourcing: Key Success Factors

There are a few absolutely critical success factors for strategic sourcing. First, strategic sourcing must be part of an overall, coordinated transformation plan as described throughout this book and as illustrated in Chapter 9. With that organizational support and context, strategic sourcing has a stronger chance to succeed as an initiative and has excellent prospects of becoming an embedded business process that serves your business well into the future. Without that support and context, strategic sourcing is likely to face an uphill battle.

Strategic sourcing must also have access to cross-functional talent and resources, either through ad hoc team members borrowed from key departments and locations or, even better, through the assignment of high-potential employees to a core team role lasting two to three years. This latter idea has served companies well in terms of both strengthening the sourcing process and providing valuable developmental experiences to employees viewed as having significant upward potential in their careers.

Another key success factor in strategic sourcing is avoiding the captive mind-set. When you self-constrain your consideration of alternatives, you have a captive mind-set. A practical way to avoid the captive mind-set is to construct teams that are composed of personnel who understand the reasons why something has been done a certain way in the past, plus personnel who have no such historical perspective but are simply focused on applying the sourcing process to a "new area" in order to achieve breakthrough results. The probing questions asked by the "naive" team members often create highly productive working sessions.

The authors cannot say enough about the importance of stakeholder involvement throughout the sourcing process. In fact, one of the key success factors is identifying early in the sourcing process who the key stakeholders are, inviting them to play one or more roles in the sourcing effort, and regularly communicating with them as the sourcing effort proceeds. The final role of the stakeholder is often "signing off" on the negotiated results (and the calculation of benefits) and commissioning the implementation phase.

Beyond the role of stakeholders with specific sourcing teams, the executive officers of the company can assist by asking for periodic report-outs by the teams. In particularly challenging situations, the authors have found it to be very powerful for each executive officer to assume the role of executive sponsor of one or more sourcing efforts.

Another key success factor is recognizing that the conclusion of the sourcing effort may be that leverage and competitive bidding is not the right approach to supplier selection. A supplier relationship/partnership approach may be more appropriate.

Finally, the authors suggest selecting the sourcing team composition with an eye toward who may be necessary for the implementation phase. Why is that important? The ultimate benefit of strategic sourcing comes from effective implementation. Sometimes you are lucky, and the supplier and materials specifications are unchanged and only the commercial terms change. That's a relatively easy implementation. However, you must be prepared for the possibility that all key elements will change: supplier, specifications of what is being purchased and delivered, commercial terms, and operational integration. Since that is a possibility with every sourcing effort, the authors strongly suggest selecting team members for the sourcing phase with an eye toward which personnel will be crucial to successful implementation.



/ 8

9781932159493 chapter 13 strategic sourcing your most important tool

Documents