8
Strategic Sourcing
Purchasing should be concerned with the strategic planning aspects of procurement process
—Ben Lapner”
Chapter Objectives
To understand:
- Role of procurement in supply chain
- Prevailing procurement practices
- Strategic procurement process
- Strategic sourcing vs. traditional sourcing
- Success factors in strategic sourcing
Framework of Strategic Procurement Process
Strategic sourcing is a process aimed at obtaining maximum advantage on cost, technology, process and quality by leveraging the company's buying power. Strategic sourcing is one of the key methods that purchasing departments are using to lower costs and improve quality. Strategic sourcing recognizes that people, including innovative suppliers, are a valuable part of an organization and focuses on reducing waste or non-value-added costs. It is a disciplined, systematic process for reducing the total costs of externally purchased materials, products and services while maintaining or improving levels of quality, service and technology. Strategic sourcing studies are tedious and time-consuming initiatives.
Strategic Sourcing at Speed Auto2
Speed Auto (SA)—a leading two-wheeler manufacturer—has a large supplier base with a high level of technical knowledge in their respective areas. SA decided to involve the suppliers in the manufacturing process and increase R&D capability. SA wants their suppliers to be more integrated in the product development process in their supply chain. They mapped out the product development process at SA to determine at which point each supplier is inducted into the process and identify where in the supplier should be included.
After process mapping, a list of select suppliers were invited to the SA headquarters to introduce the concept and find out which supplier would best fit in SA product development process. The suppliers were from various industries such as forging, electrical, tyres, glass, plastics, spark plug, fuel injection pump, stamping, metal pressing, aluminium, steel, castings, gears, rubber, etc. The executives of SA explained to the suppliers that the company is shifting from its internally focused process to suppliers’ focused process to become more involved in its product development. To emphasize the point, suppliers were given a full walk through of the production plant and were given a brief on manufacturing process. While most of the suppliers made materials that went into two-wheelers, not all of them were fully aware of the actual process at SA. During the plant visit, some suppliers provided valuable feedback and process improvement ideas. SA also prepared a list of 15 specific challenges and it wanted the suppliers’ input on the same. Suppliers were advised to study the challenges and submit their solutions to SA at the earliest. SA got hundreds of ideas from suppliers on the above 15 areas. The ideas ranged from materials management to product development to cost reduction. Some were directly focused on addressing the challenges.
Suppliers appointed specific people to focus on the SA challenges. SA's procurement department fixed up facilitators to coordinate with the suppliers. SA has taken care of providing access to suppliers on certain proprietary information through legal contracts. For SA, this strategic sourcing project served to bring the procurement and the technology organizations closer. SA found that suppliers were thrilled with the openness of SA to share their new technologies in development. With the great benefits from the above strategic sourcing move, SA continued supplier's involvement in innovation process in future.
INTRODUCTION
Today the procurement function of most of the high-technology companies covers interaction with important business processes that goes into planning, sourcing, making and delivering a final product. Since material cost accounts for over 50–70 per cent of the total cost of production of product, efficient functioning of material management has received greater attention. Hence, the sourcing has been identified as one of the thrust areas for improvement in most of the manufacturing companies.
Strategic procurement exists whenever an organization seeks to acquire a project, a service, a product, or a commodity that has high value significance or importance to it. The need to procure a strategic project or service gives rise to a challenging business exercise. Such exercises should be approached with seriousness and well-structured processes.
The process used for strategic procurement is designed to ensure that the organization's needs, issues and risks are effectively managed. For achieving this, the best qualified supplier is selected for the purpose. Strategic procurement often gives rise to strategic relationships. A strategic relationship may exist either within an organization or between organizations. They exist even when a product, service or commodity is being supplied that has significant potential to damage the organization in some form if the supply is delayed, not affected or increases in cost.
Strategic sourcing is a process which starts with the thorough analysis of the input material. The analysis covers the volumes the firm buys, economies in purchasing, marketplace of the products and usage pattern. The relationship with suppliers is highly integrated in strategic procurement as compared to traditional buying process.
In the strategic procurement process, more focus is given on the products which are purchased in large quantities. These products justify the time and expense, which the buying company would spend on the study of the product and the industry to further develop a long-term relationship with the supplier. The research would be based on how the key suppliers operate, their business practices, and where the money is added to the final cost of the product. The buyer will work with the supplier to redesign processes and lower production costs to maximize on margins that suppliers make.
Dell–Leveraging Supplier Expertise for Green Packaging Solution
Dell when decided to make its packaging more environmentally friendly, decided to get out-of-the-box packaging solutions. Dell collaborated with packaging suppliers to get the reach of the desired goal.
Dell wanted to reduce the size of its boxes. The aim was to use more green materials in packaging to make it recyclable. Dell wanted a packaging material other than hardwoods and softwoods, which takes a long time to grow.
Dell invited suppliers for brainstorming sessions on new ideas on packaging problem. One of those suppliers was Unisource Global Solutions. The material that Unisource suggested for use in Dell's packaging was bamboo. Being a member of the grass family, bamboo grows back much faster than hardwoods, making it more environmentally friendly. The process of turning bamboo into pulp is mechanical and uses fewer chemicals than paper pulp. The green feature is that bamboo has a smaller carbon footprint as compared to other materials. So from an environmental perspective, bamboo was a final choice for Dell. Unisource provided samples of the materials it would use and suggested supply sources for the raw bamboo. The cost analysis showed bamboo would reduce Dell's packaging costs and the idea moved from the research phase to the production phase. Today, Dell is shipping Inspiron Mini 10 and 10v Netbook with product cushions made of bamboo. According to Dell, this type of project is only possible by adopting strategic sourcing approach. This approach builds a trust with suppliers and makes them feel like they are able to suggest new ideas and solutions at any time. In addition, Dell's packaging suppliers do business in different industries, Dell introduced some best practices from beyond the computer market.
Source: David Hannon, Dell leverages supplier expertise for Green packaging solution by Purchasing, 14/1/2010
In the strategic sourcing approach, the buyer after knowing the market and costs of production at supplier end will set the target price and go backward. The buyer further studies the manufacturing plant and process at supplier's end and suggests improvements to reduce the cost of the product. The buyer's engineer helps the supplier rearrange the production layout to make it more efficient. The collaboration with vendor helps in improving buyer/seller communication, planning lead time, engineering and customer service. The supplier collaboration sometimes leads to significant improvements in quality of the product. The buyer–supplier collaborative efforts gives many benefits such as reduction in inventory levels, speed to market, large cost savings and reduction in product development costs. However, with the strategic sourcing approach, companies reduce the suppliers base, but the supplier need to have commitment to continuous improvement, cost consciousness, customer orientation, employee involvement, flexibility in operation, and financial stability.
PURCHASING ORIENTATIONS
Invariably in the industry there are three orientations observed to procurement. The first one is buying orientation which exhibits discreet transaction. This means that buyer–seller relationship does not exist after the transaction is over. The second one is the procurement orientation wherein the buyer assures the relationship, provided the supplies are as per buyer's requirements (specifications). The supplier has to upgrade his product and process quality as per the requirements of the buyer. There is no technical or financial help to the seller from the buyer's side. The third one is the supply chain orientation, wherein the buyer considers the supplier's supply chain as an extension of his supply chain. The supply chain orientation exhibits strategic sourcing process.
For improving the procurement, companies can go in for innovative methods in sourcing. Many firms build cross-functional teams and purchasing personnel as part of its team building exercise. His involvement is right from product design to commercializing the product. This is contrary to what was practiced earlier wherein purchase people were not involved in product design process and were simply asked to buy the materials after the product design is complete. Today even suppliers are involved in product designing at buyer's end. The suppliers are experts in their field and hence, they bring along with them a large knowledge base to design product that would otherwise be absent. This helps in preventing poor product designs and also manufacturing errors. In many companies, the cross-functional teams include personnel from purchasing, manufacturing, engineering, and sales and marketing.
Procurement is the development of a true partnership between a company and a supplier of value. The arrangement is usually long-term, single-source in nature, and addresses not only the buying of parts, products, or services, but also product design and supplier capacity. Partnering agreements allow mutual exchange of confidential information, proprietary restrictions, non-disclosure, non-competitive, certification of processes, routine audits, delivery performance, quality performance, as well as the transfer of control of a process or product.
The relationship between partners is unlike the traditional adversarial relationship between buyer and seller, where the buyer pits one supplier against another frequently during the year, focusing entirely on unit cost. Under these conditions exists a mutual distrust between parties that is counter-productive to both. For the buying company, there generally exists an unleveraged multiple supply base that results in competitive cost disadvantage. For the seller, he is continually negotiating price reductions at a disadvantage, kept in the dark, expected to ‘jump through hoops’ in an instance, and generally kept subservient to the buyer.
In a strategic procurement agreement, both companies view each other as equal partners, assisting each other with training, technical support, and developing complete trust. The buyer involves the supplier in the new product design from the beginning and thus allows the supplier to bring its expertise to the table. The cost savings of the product or process innovations are shared between the buyer and the supplier.
Within the buyer's company, procurement is elevated to the strategic level and included in the long-term planning process. Strategic objectives such as part number reduction, supply base reduction and new strategic agreements are assigned to the senior procurement officer and the procurement group for achievement. The idea is to leverage the procurement for a competitive advantage.
The biggest single issue in strategic procurement is trust and reliability on a group of single suppliers. In such cases, each supplier/partner should have adequate capacity and should be equipped to recover quickly from a sizeable catastrophic event (fire, storm, flood, etc), minimizing the risk and exposure of losses to the buyer.
STRATEGIC SOURCING
Today many companies have started realizing the importance of strategic sourcing as it is a source of cost leadership leading to competitive advantage. Many companies have now switched to E-procurement and further to strategic sourcing.
The strategic sourcing can be defined as an eftort on the part ot buyers to caretully evaluate and to form long-lasting relationships with suppliers. The relationship between buyers and suppliers is beneficial to both and has an impact on their attitude. In the strategic sourcing initiatives (Exhibit 8.1), buyers consider their suppliers as partners instead of commodity providers and this change in attitude has a positive impact on the success of both the buyer and supplier.
Exhibit 8.1 Traditional vs Strategic Sourcing
| Traditional Sourcing | Strategic Sourcing |
|---|---|
| Transactional buying | Knowledge-based buying |
| Negotiation-based buying | Integrated procurement |
| Objective avoid stock-outs | Life-time cost approach |
| Commercial and follow-up skills | Leverage volume buy |
| Individualistic style | Cross-functional approach |
| Emphasis on lowering price | Emphasis on value creation |
| Discreet buying behaviour | Collaborative working style |
| Authoritative approach | Interpersonal and coaching skills |
| Discreet contract | Life-time contracting |
In the manufacturing firm, there is a large spent on purchasing raw materials, parts and components. The purchases are to an extent of 75 per cent of the company's budget to create finished products and services. The flow of input materials has to be continuous without delays to run a company's production cycle without stoppage.
Hence, companies go for strategic sourcing initiatives to build a stable relationship with key suppliers to ensure that they have a steady supply of quality materials without frequent price hikes. By finalizing a proper purchasing arrangement, the buyer can secure a lower price on those items because the vendor is assured for buying those materials continuously for a longer time.
The supplier selection process should be based on certain parameters. The suppliers should be chosen based on their experience, reputation, price, quality and reliability. The contract terms between buyer and seller should be mutually beneficial. This will help in strengthening the relationships between them.
To cut cycle time, the buyer and seller can use software solutions in procurement process. If a company is interested in strategic sourcing, using e-sourcing software and changing the traditional way of purchasing can enhance the procurement process.
In today's competitive business scenario, the market decides the price of the product and hence the profit of any organization depends on controlling the cost of operations. In most of the manufacturing organizations, 60 to 70 per cent of the budget is spent on the procurement function. Hence, there is a significant opportunity in improving the bottom line through strategic sourcing. Thus ‘strategic sourcing’ is a comprehensive process designed to pursue all avenues of creating value by leveraging a company's buying power with select suppliers, conducting best price evaluations, sourcing globally and conducting company/supplier joint process improvements.
The strategy is to shift the company's focus from the current ‘transaction’-oriented independent buying of goods and services to a ‘product’-oriented strategic approach. The strategic sourcing approach is designed to:
- Reduce total cost of acquisition of inputs
- Overview supply market and internal requirements
- Enhance bottom line
- Create value
Many organizations have executed successful strategic sourcing programmes with significant results. Strategic sourcing provides guidelines to handle key sourcing decisions as follows:
- Outsourcing
- Low cost country sourcing
- Accelerated sourcing
- Collaborative sourcing
For high value procurement opportunities, a company should identify the highest impact cost reduction opportunities. They must understand what they buy and from whom they buy it. With strategic sourcing approach the buying organization can avail the following benefits:
- Increased customer leverage
- Increase in buying power
- Rationalization in product specifications
- Better financial controls
- Improved contract compliance
KEY FACTORS LEADING TO SUCCESS
Strategic sourcing is an important activity, the success of which is dependent on the following factors:
- Commitment from top management.
- Involvement in terms of money and manpower.
- Empowering the sourcing teams.
- Structured procedures and practices.
- Continuous monitoring of sourcing process.
- Use of IT and communication technology.
- Rationalization and development of suppliers.
Organizations spend large percentage of the cost of goods in purchasing. This makes purchasing am important area to focus to gain competitiveness. This fact has been realized by some of the progressive companies in India along with its counterparts in the Western world. Tata Steel, HUL and Maruti are a few amongst them.
In today's context, an organization's success could well be tied to the ability of its suppliers to be collaborative in new product development, responsive to a change in demand and achieve improvements in product design and manufacturing efficiency. Supplier collaboration can reduce the need for large inventories. It can quickly introduce goods and services to accommodate new product designs as well as changes in existing ones. Thus strategic sourcing process focuses on the following:
- Knowledge-based buying
- Systems development for world–class purchasing organization
- Value creating relationships with suppliers
In the strategic sourcing process, spend analysis is at the front. It identifies, consolidate and standardize information from a wide range of data sources. With the help of spend analysis, firms can create ‘commodity matrix’ as shown in Figure 8.1. It is a methodology for placing commodities in four quadrants. It shows expenditure on two dimensions: Complexity of the product and Saving potential of the product. Analysing these dimensions of the product/service reveals the commodities that are to be considered for strategic sourcing study.
Core items are those that directly impact the company's throughput. The value of these items is high and so is the complexity of the product. These items are generally manufactured by medium to large companies; the thrust is on developing alliances.
Company's throughput is not affected by the commodity items, but they play an important role in reducing the downtime of the plant and machinery. These items are less complex and saving the potential of these items is also less compared to the core items. These items are typically bought throughout the company under various applications (wide variety) and their demand too fluctuates. Hence, the challenge lies in consolidation and standardization of these items (cement, electrical and mechanical spares).
General items, like commodity items, do not impact the throughput of the company but they facilitate the creation of a working environment. These items are also bought throughout an organization. But unlike commodity items they are less standardized. So, the challenge lies in consolidating company-wide buy so as to maximize the volume. Examples are personal computer peripherals and other office supplies.
Critical items are important from the safety, health and ergonomics point of view of employees. The complexities of these items are high. The requirement is critical items with the right specification.
Strategic sourcing is a proven approach to understand and deliver significant cost reduction and building a sustained value-creating relationship with the suppliers. The fundamental objective of any organization is lowering the cost of goods manufactured. This can be achieved through reduction in prices of purchased products and services and reduction in their specific consumption. Strategic sourcing does exactly the same by addressing the total cost.
Supply chain organization has an active role in improving the bottom line of the company by taking advantage of its systematic influence upon the three types of costs categories, that is, material cost, working capital cost and overhead cost. The first two are linked to procurement policies and methodologies. To achieve competitive edge, firms need to look into two aspects. The first one is the sourcing effectiveness, which covers strategic relationship management, spent aggregation, supplier consideration and category expertise. The second one is procurement efficiency, which encompasses process and policy, automation, centralization, consolidation and outsourcing.
Supply chain management concept eliminates functional silos by accepting the whole supply chain as a ‘single entity’. All functions along the chain share the common objective of ‘supply’ and are involved in strategic decision-making. The emphasis is on integration rather than on interfaces between the different functions. The supply chain becomes responsible for total inventories in the supply pipe line and also for satisfying customer needs and expectations while meeting all agreed customer service parameters and company targets.
MAJOR TRENDS IN PROCUREMENT
The important trends observed in procurement practices across the various industries are as follows:
- Focus on global sourcing.
- Compressing supply chain cycle.
- Eliminating middlemen.
- Green procurement to address environmental issues.
- Real-time value added partnerships.
- Emphasis on outsourcing to focus on core competencies.
Today companies are using advanced supply management techniques such as collaborative cost reduction, end-to-end integration, tiered sourcing and design-to-cost. These techniques generate nearly twice the rate of savings on their procurement of direct and indirect materials and services than companies solely relying on traditional sourcing methods. To capture cost savings through traditional sourcing strategies, procurement needs to drive other operational benefits such as improved working capital or increased quality of products and services.
In addition, companies are doing more in-depth analyses of comparative risks (in offshoring) of various low cost countries (socio-political, environmental and skill sets) as opposed to a rush to a particular low cost country. They are engaged in development of domestic value-added partners. In a nutshell, the following market trends are currently impacting the way procurement is done:
- Increased multi-sourcing.
- Greater significance to governance.
- Continued rise of global sourcing.
- Consolidation in supplier market.
- Emphasis on value creation.
However, the manta is to keep track of current suppliers, evaluate their pricing and keep competition high while going for global sourcing.
SUMMARY
Strategic sourcing redefines the traditional approach to buying and using materials and services. Strategic procurement is the development of a true partnership between a company and a supplier of strategic value. The arrangement is usually long-term single-source in nature. It addresses not only the buying of parts, products, or services, but product design and supplier capacity. Partnering agreements allow the exchange of confidential information, proprietary restrictions, non-disclosure, non-compete, certification of processes, routine audits, delivery performance, quality performance, as well as the transfer of control of a process or product between buyer and seller.
The relationship between partners is unlike the traditional adversarial relationship between buyer and seller, where the buyer pits one supplier against another focusing on unit cost. Under these conditions exists a mutual distrust between parties that is not productive to both. For the buying company, there exists multiple supply bases that results in a competitive cost disadvantage. For the seller, the buyer is continually negotiating price reductions, which is a disadvantage.
In a strategic procurement agreement both companies view each other as equal partners, assisting each other with training, technical support and developing complete trust. The buying company involves the supplier right from the new product design cycle, allowing the supplier to bring its expertise to the table. The cost savings, in general, are mutually shared for product or process innovations.
Within the buying company, procurement is elevated to the strategic level and included in the long-term planning process. Strategic objectives such as part number reduction, supply base reduction and new strategic agreements are assigned to the procurement group for achievement. The idea is to leverage the procurement talent and assets for a competitive advantage of the organization.
The strategic procurement is an operational strategy that, if implemented properly, will provide a new dimension to competing: quickly introducing new customized high-quality products and delivering them with unprecedented lead times, swift decisions, and manufacturing products with high velocity.
REVIEW QUESTIONS
- Discuss the various purchasing orientation in various organizations.
- Explain the strategic procurement process with its benefits and its limitations on the organizations to practice it.
- How does strategic sourcing differ from traditional purchasing process? Explain.
- What are the key factors leading to the success in strategic sourcing process?
- Discuss the latest trends in procurement process with their implication.
INTERNET EXERCISES
- Visit http://www.purchasingpractice.com/services/sourcing-mgt/ to learn about strategic sourcing. Purchasing Practice was founded by ‘Unique Consultancy Services’ and they have developed tools that deliver dramatic results in the area of procurement.
- http://www.eNotes.com, is a comprehensive online educational resource which is used daily by thousands of students, teachers, professors and researchers. E-notes provide innovative services and online learning environment. Visit http://www.enotes.com to study further on strategic sourcing.
VIDEO LINKS
- Strategic Procurement, http://www.logisticsbureau.com.au/video-supply-chain-logistics.html
- Global Sourcing, http://www.logisticsbureau.com.au/video-supply-chain-logistics.html
PROJECT ASSIGNMENT
- Select a leading firm manufacturing steel (Tata Steels) or consumer durables (LG) or electrical equipments (ABB) and study it strategic procurement process, procedures and policies.