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The "Balanced Purchasing" Model: Research Findings

Author(s):

Timothy M. Laseter
Timothy M. Laseter, Vice President, Booz Allen & Hamilton, Inc., New York, NY 10178, (212) 697-1900.
Chris Shephard
Chris Shephard, Principal, Booz Allen & Hamilton, Inc., Cleveland, OH 40114, (216) 696-1900.

83rd Annual International Conference Proceedings - 1998 

Abstract. Booz Allen & Hamilton, through research and client work, has identified an emerging model for finding the right balance between cooperative relationships and a commitment to competitive pricing. The model, which we have dubbed "Balanced Purchasing", moves beyond the religion of "trust" that is so popular today-without reverting to an adversarial approach. Unfortunately, Balanced Purchasing is difficult to achieve-far more so than any of the one-dimensional approaches also shown in Exhibit I.

Exhibit I: Purchasing Approaches (not available in text version)

Organizational Capabilities. Achieving Balanced Purchasing (the upper right quadrant of the matrix) requires a broad, organization-wide perspective on purchasing. Leading practitioners demonstrate that the key to Balanced Purchasing is not a set of purchasing skills, but a broader set of six organizational capabilities. As indicated in Exhibit II, Booz Allen's field research has demonstrated that some capabilities appear universally applicable in any industry, while others are only critical for certain companies or industries. In fact, no single company has fully developed all six capabilities: the very best performer in one of the capabilities may be only average in another.

Exhibit II
Organizational Capabilities for Balanced Purchasing

UNIVERSAL CAPABILITIES

  • Modeling Total Cost
  • Creating Sourcing Strategies
  • Building and Sustaining Relationships

DIFFERENTIAL CAPABILITIES

  • Integrating the Supply Chain
  • Leveraging Suppliers in Innovation
  • Evolving a Global Supply Base

The first three capabilities are the core processes for defining and developing the supply base and, as such, are universally applicable to any type of company. The first, "Modeling Total Cost" provides the underpinnings for the entire purchasing process. "Creating Sourcing Strategies" drives the critical shift from a tactical purchasing perspective to a strategic one. "Building and Sustaining Supplier Relationships" focuses on the cooperative dimension of the Balanced Purchasing model.

The second three capabilities highlight different ways to leverage the supply base for competitive advantage. Most companies, however, tend to focus on one of these three at most-only the largest and most sophisticated can afford to build superior capabilities in all three areas. "Integrating the Supply Chain"-ensures rapid delivery of goods and services with minimal waste and has received the most attention over the past decade. However, many companies-particularly those producing highly engineered products are now focusing on "Leveraging Suppliers in Innovation." Finally, as companies increasingly compete in a global marketplace, they are "Evolving a Global Supply Base" to support their worldwide needs.

This paper covers the research findings on the three "universal capabilities".

Modeling Total Cost. Our research, sponsored by Strategy & Business, found that 25 percent of companies surveyed have no cost models. Moreover, of those companies that did build models, many elements of the "total cost of ownership" where not included-or even tracked systematically. Furthermore, two-thirds of the respondents were not confident that the cost information provided by suppliers gave more than a "general sense" of the true costs.

Firsthand experience from working with many companies paints a more bleak picture. Only the most sophisticated companies truly understand the total cost of materials with an adequate level of rigor. In fact, most companies don't understand their own costs let alone their suppliers'. The poor tracking of internal acquisition costs shown in Exhibit III bears this out.

Exhibit III: Modeling Cost: Elements of Total Cost Tracked by Supplier
(graphic not available in text version of this paper)

The most accurate and robust cost models follow five key principles:

  1. Capture cost drivers not just cost elements
  2. Build commodity-specific models to highlight the key drivers
  3. Consider the impact of total cost of ownership
  4. Start simple and add complexity only as needed
  5. Triangulate around data to improve accuracy and confidence

Creating Sourcing Strategies. Most companies develop some form of sourcing strategies and/or commodity business plans. But the degree of organization-wide involvement, the level of analytic rigor and thoroughness of documentation vary widely across companies. In fact, few companies create sourcing strategies as well as they would like. From our survey of a wide range of companies, this capability had the greatest "development gap" between the average "criticality" rating and average "competency" rating.

As is true of most tools and techniques-particularly ones that include the word "strategy"-the output of the process is useful, but the process itself can provide the greatest value. When commodity plans are done well, multi-functional teams are forced to step back and make a rigorous examination of the current supply base and take a long-term view of purchasing-related decisions. Most important, effective sourcing strategy development builds cross-functional buy-in to the priorities for each commodity and supplier.

Our research found that on average about two-thirds of a company's outside purchases are managed by the purchasing function. Even leading companies seldom exceed 90 percent. Formal sourcing strategies cover only about 60 percent of the spend managed by purchasing-so that on average only around 40 percent of the total outside purchases are covered by formal sourcing strategies. (See Exhibit IV).

Exhibit IV: (Not available in text version of this paper)

Effective sourcing strategies are created by applying seven principles:

  1. View supply base rationalization as a result not the objective
  2. Use multi-functional teams
  3. Coordinate across regions and business units where necessary
  4. Conduct rigorous global research
  5. Examine total acquisition cost
  6. Segment the spend for focus and to break compromises
  7. Quantify the benefits

Building and Sustaining Supplier Relations. Surveyed companies rank this organizational capability as the most critical of the six because it sets the tone for long-term cooperation. Setting improvement targets, structuring incentives, and investing in supplier development all play a role in finding the right balance. An overly soft approach without aggressive targets leads to stagnation in the supply base as well as "trust-based partnerships" that don't deliver results. Targets that appear unreasonable or indicate a lack of concern for supplier profitability can leave suppliers in a "Darwinian rivalry".

According to our survey most companies-having rationalized their supply bases-claim strategic relationships with about a fourth of their suppliers. But the degree of implementation of the tactics for building and sustaining relationship remains quite low.

In structuring and negotiating a relationship with suppliers, companies most often use supplier self-audits and industry indexed pricing as standard practices. Direct equity investment, productivity clauses and full-time, on-site support are never used by a significant number of companies.

To sustain tighter relationships with suppliers, companies choose "softer" techniques to build rapport and satisfaction over time or money-intensive techniques. Companies most often use recognition/awards followed by supplier councils and "supplier satisfaction" tools. On the other hand, on-site development engineers are never used by almost a quarter of the surveyed companies. Customer training is equally rare. (See Exhibit V.)

Exhibit V: Building and Sustaining Supplier Relationships
(graphic not available in text version of this paper.)

Building & sustaining strong supplier relationships requires three things:

  • First, mutual dependency, which occurs when both parties understand that cooperation is necessary for each company to succeed.
  • Second, ambitious common goals to drive both sides to achieve the best they can from the relationship.
  • Third, assessment of the supplier's competency-because an incompetent but well-intentioned supplier is still incompetent.

Conclusion. Balanced Purchasing is far more than a "philosophy," but it does rest on a set of basic principles:

  • Fact-based decision making
  • Long-term, strategic thinking
  • Adaptable solutions-not silver bullets
  • Collaborative value creation-and sharing
  • Pragmatic execution

The challenge isn't understanding the capabilities or the principals. Building the capabilities across an organization is the difficult task. Much like the cooperation/competition matrix, the six organizational capabilities are intuitively appealing and rather straightforward in concept. However, our field research underscores that even the best firms do not feel that they have fully developed all of the capabilities.

Book references:
A book that further elaborates on the Balanced Purchasing model will be published in the Fall of 1998 by Jossey-Bass as part of the Strategy & Business book series.


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