Strategic Sourcing Initiatives: Procurement Strategies for Purchasing Profit
Strategic Sourcing Initiatives: Procurement Strategies for Purchasing Profit
Strategic sourcing is an important area in business, especially for supply chain managers. With the advent of enterprise information systems (EIS) like SAP, more data is available for analysis than ever. In addition to tried and true strategies like demand forecasting, companies are engaging in new tactics to maximize profit margins and minimize costs associated with the sourcing/procurement process.
Moving Away from Functional Structure: The Category Sourcing (CS) Strategy
Category sourcing, often abbreviated to CS, is the notion of forming discrete groups of related products and managing these products together through the sourcing process. A great demonstration is to visit Amazon.com and browse through the “categories” – home and garden, electronics, books, etc. Each category has subcategories, and each subcategory in turn has even more specific subcategories, and so on and so forth.
In a business context, category sourcing allows a corporation to separate responsibilities for sourcing and procurement for separate product lines. This often occurs in the case of a large company like PepsiCo that has a wide variety of products (soft drinks like Pepsi, juices like Tropicana, snacks like Doritos, etc). It makes sense to manage sourcing separately for products that are very different and require special processing.
Implementing a category sourcing process occurs with the following steps:
- Make categories (groups)
- Select the sourcing strategy
- Select suppliers
- Purchasing & Negotiation
In the first step, making categories, the team in charge of the CS implementation must determine which suppliers operate in which categories, and what their relative strengths are (to determine what sort of leverage they can exert during the negotiation phase). In the second step, selecting the sourcing strategy, the purchasing team must decide how exactly procurement is going to occur – on a regular basis, when needed, etc. After these two steps, the team can select suppliers and proceed to the purchasing and negotiation steps.
In 1983, Peter Kraljic described a matrix that can be used to describe items obtained through the procurement process. The x-axis describes expenditure – the cost of the items – and the y-axis describes sourcing risk, or how hard replacing a supplier for a certain product might be.
Items in the lower left quadrant of the Kraljic matrix are viewed as routine – for example, office supplies like staples and paperweights. They’re inexpensive and nice to have around, but the business will not collapse in their absence.
Items in the top left quadrant of the Kraljic matrix are bottleneck items. They’re often inexpensive, but a lack of availability could severely impact operations. For example, a specific replacement part for a production machine might only cost $37, but if it isn’t available, the whole machine is inoperable.
Items in the lower right quadrant of the Kraljic matrix are leverage items. These items are expensive, but a lack of availability will not cripple the business. This is one of the best places for sourcing teams to focus if they want to save money.
Finally, items in the top right quadrant of the Kraljic matrix are critical items that are not only expensive, but also very important to the business operations. It is in the best interests of a business to carefully monitor the status of these items in inventory, and to develop good relationships with multiple suppliers. In most cases, multiple performance indicators would be used to track the status of these items.
Supplier Relationship Management: A Tactical Sourcing Strategy
Supplier relationship management (SRM) is the practice of managing relationships with suppliers. (Hopefully, that definition was fairly obvious.) The aim of SRM is to produce a business to business (B2B) relationship between supplier and customer that is mutually beneficial.
SRM is a relatively new approach in business practice, and it has been helped along tremendously by the development of integrated CRM/SRM components in enterprise information systems. Like all aspects of supply chain management, SRM is most effective if managed in tandem – collaboration with the supplier is an inherently necessary part of SRM.
SRM can be handled in several ways. In the case of a small contract (or a relationship between small companies), the bowtie model is often used. In the bowtie model, there is only a single point of contact, and the “relationship” between the two companies is managed by two people. This approach can be beneficial due to the ease of management (only one person in charge) but also has downsides: if the two people don’t get along, the relationship can be rocky. If one of them leaves, a lot of important knowledge may be lost.
Thus, most larger companies utilize an alternative model known as the interdependent model. In this model, teams from both businesses collaborate to let each other know what is feasible and what they’d like to do moving forward.
Benefits of SRM
SRM provides the following benefits.
- Promotes collaborative solutions and innovation
- Improves supply chain visibility
- Reduces redundancies in the supply chain (reduced costs for both parties)
- Breaks down functional silos
- Long term gains for both supplier and customer
Procurement Management: Tools for Managers to Effectively and Strategically Manage Sourcing
There are two primary tools used by supply chain managers to effectively manage sourcing: negotiation and cost management.
Negotiation is broadly defined as “the process of giving and receiving concessions.” In the context of sourcing and supply chain management, negotiation occurs between the team responsible for purchasing/procurement (customer side) and the team responsible for sales (supplier side).
After determining if negotiation is necessary, there are three stages of the actual negotiation:
In planning, the teams determine their objectives going into the negotiation. This helps each side determine what issues are most critical to them (cost, lead time, customer service, etc) and which issues aren’t quite so important (issues that can be given as concessions).
Execution is obviously the most important step of negotiating. Considerations include location of and timeframe of negotiation. Generally, managers should keep these principles in mind during negotiations:
- Find an agreement zone (a solution agreeable to both parties)
- Don’t be argumentative/belligerent
- Utilize fact, not opinion
- Trade concessions – don’t give them away. “I do something for you, you do something for me.”
- Pay attention to the negotiation tactics utilized by the other side.
Once negotiations are complete, the deal should be closed and both parties should deliver on their agreements.
The other important tool is cost management, a sourcing tool utilizing variable-fixed cost theory that is more extensively discussed here.
Strategic cost management focuses on several areas, first of which is reducing non-value added (NVA) expenditures. Value-added activities are defined as those that directly add value to the business. NVA activities don’t add value, and include excess inventory, long cycle times, quality defects, and down time.
Another cost management strategy is Total Cost of Ownership (TCO), which analyzes the lowest “real all-in” costs as opposed to just price. Two scenarios will clarify the difference.
- Imagine that Supplier A sells specialized bolts for $1.00 apiece. Supplier A has a 10% defect rate, and defective bolts cannot be used. Supplier B sells the same bolts for $1.05 apiece, but their defect rate is so low that it’s essentially zero. Who should you buy from? (Answer: Given that only 90% of bolts from Supplier A work, each working bolt costs $1.11, which is six cents more than bolts from Supplier B. So you should purchase bolts from supplier B.)
- Imagine that you’re buying a car to use for the next five years. Car A is only $15,000, but is a gas guzzler that will require $5,000 of fuel a year. Car B is more expensive, at $25,000, but only requires $2,000 of fuel per year. Which car should you buy? (Answer: total cost of Car A is $15,000 + 5 X $5,000 = $40,000. Total cost of Car B is $25,000 + 5 X $2,000, so you should buy Car B. Please note that this scenario assumes no cost of capital.)
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