Procurement to Strategic Sourcing: How to Make the Transition

Author(s):

Ralph G. Kauffman, Ph.D., C.P.M.
Ralph G. Kauffman, Ph.D., C.P.M., Assistant Professor, University of Houston-Downtown, Houston, TX 77002, 713-221-8962, www.dt.uh.edu, kauffmanr@dt.uh.edu
Thomas A. Crimi, C.P.M.
Thomas A. Crimi, C.P.M., Supply Chain Team Coordinator, Texaco, Inc., Houston, TX 77402, 713-752-3981, crimita@texaco.com

85th Annual International Conference Proceedings - 2000 

Abstract. Strategic sourcing is defined. A process for making the transformation from transactional procurement to strategic sourcing is presented. Key areas that must be addressed to assure successful transformation are discussed. These include: business strategy identification, alignment of sourcing strategies and business strategies, use of a total cost model, varying degrees of supplier relationships, inclusion of value-added services, and transforming the mindset.

What is "Strategic Sourcing?" "Strategic Sourcing" has been defined as "a periodic event that includes the identification and selection of initial commercial arrangements with a selected supplier that either creates or resets a relationship" (Slaight, 1999). Strategic sourcing consists of identifying those purchased items that are important to the achievement of strategic business objectives and then developing and implementing short and long-range plans for procurement of those items. Another way to define strategic sourcing is to identify what it is not. Strategic sourcing is not the procurement of materials and services on an as needed, day-to-day, ad hoc basis.

How Strategic Sourcing Can Benefit An Organization. Strategic sourcing benefits an organization in several ways. Two primary sources of benefit are: (1) improved ability of the organization to achieve strategic goals due to alignment of purchasing strategies with business strategies and (2) improved contribution from purchasing outcomes resulting from the increased support that purchasing processes and initiatives receive from being aligned with business strategies.

Making the Transition. Making the transition from a traditional procurement environment to strategic sourcing requires an organization to take several steps:

  1. Establish a business case for making the change, including estimation of potential benefits from the transition and expected costs to make the transition.

    This will require:

  2. Identify what are the main strategies of the business. These will determine the business needs of the overall organization.

  3. Identify total spend and divide it into commodities and services that are strategically important and those that are not strategically important. Enterprise Resource Planning (ERP) systems will aid in providing and monitoring needed information and will expose opportunities that can be leveraged across business units - they provide the "big picture" which can enhance longer term thinking.

  4. Obtain initial support of management on the basis of the business case

  5. Create a high-level cross-functional team consisting of representation from all company functions likely to be affected by a change to strategic sourcing. As a team:

  6. Review strategically important commodities and services, determine long-range requirements, potential changes in requirements, customer concerns, technology concerns, and (in the case of international situations) in-country requirements. Pull together divergent interests and identify those that are common. Develop a cost/benefit case for presentation to management

  7. For non-strategic buys, determine procurement methods that will minimize the cost of procurement yet realize acceptable levels of cost, quality, service, delivery, etc.

  8. Identify suppliers that have the capability or potential capability to meet strategic purchasing requirements, "strategic suppliers." Strategic suppliers should be resourceful, best-in-class, full-service suppliers. Coordinate the supplier base across the organization.

  9. Include strategic suppliers on the cross-functional team and business unit sub-teams as necessary.

  10. Develop an overall strategic sourcing plan including implementation steps and ongoing management processes. Assure that the plan is aligned with business unit needs.

  11. Obtain management approval and backing for the strategic sourcing plan.

  12. Implement the plan (this will likely require sub-teams depending on the variety and complexity of the identified strategic commodities and services). Develop a test pilot for implementation in one limited area of the business (make mistakes on a small scale and fine-tune any process changes). Roll out to other units after achieving success in the test pilot.

  13. Monitor implementation and ongoing operation of the plan. Apply continuous process improvement and revise implementation as needed.

What are Your Company's Business Strategies? Strategic sourcing means strategic in terms of an organization's business strategies. One of the first steps in moving to strategic sourcing is the identification of company business strategies. Business strategies may be stated in a variety of ways. Some general strategy statements may include: products and product lines, business or process competency development or application, market development, achievement of market share, narrowness or breadth of market segments served, development or application of business processes, development or application of technology, and make versus buy of products, parts, or materials.

Many organizations have business strategy documents that are updated on an annual or other periodic basis. If a business strategy document does not exist for your organization or if it needs interpretation, consult your management for assistance.

Alignment of Sourcing Strategies and Business Strategies. This is the key to success in strategic sourcing. The best sourcing strategy will not be successful if it is not perceived to be in alignment with the business unit goals of the company. This alignment is often the most important factor in securing management's support of a strategic sourcing program. In presenting any strategic sourcing program to management, it is necessary to show how the program supports achievement of the organization's business strategies. Examples and comments on alignment at two companies are provided by John Stephens and D. Larry Moore in an article in Purchasing Today®, January 1998. Following are some general business strategies and ways in which sourcing strategies support them.

  1. Product and Product Line Strategies - Includes new products, revisions of existing products, elimination of products from existing lines. Purchasing must participate on new product and product review teams to contribute marketplace knowledge and expertise. For new and revised products, purchasing must arrange for timely supply. For products being phased out, purchasing needs to phase out supply arrangements and avoid new long-term supply commitments for short term needs.

  2. Business or Process Competency Application or Development - A business possesses certain competencies in particular areas or processes of business. Strategies may include the application of these to additional business areas. For example, a company that produces packaged goods products for the consumer retail market may have a strategy to purchase additional product lines from other companies or to purchase entire companies in appropriate lines of business. Purchasing's marketplace contacts and expertise is useful in identifying potential acquisition candidates and also in determining the best ways to supply the purchased material and service requirements that acquisitions will bring. Other companies' strategies may be to enter new lines of business, which will require the development of the required competencies to operate such businesses. For new product lines, purchasing competency will also need to be developed. Appropriate training and education strategies will need to be adopted by purchasing as well as by other company functions.

  3. Market Development - The development of new markets for existing products is often a business strategy for many companies. Purchasing can contribute to achievement of goals of such strategies from its marketplace knowledge. Implementation of reduced supply lead times, just-in-time supply, focused factories, and mixed model scheduling are examples of tactics that may be needed to enter new markets and for which new or revised purchasing strategies may be necessary.

  4. Increased Market Share - Often the achievement of increased market share requires products that are more competitive. This strategy may require an additional strategy of being a low cost producer. Purchasing can contribute to lowering the cost and increasing the competitiveness of products by arranging supplies of materials, parts, and components that are more competitive in price, quality, service, lead time, supply flexibility, or supplier response.

  5. Narrowness or Breadth of Market Segments Served - Specialization in a narrow segment of a product market often means depth of product line within the segment of specialization. For example, a company that specializes in distributing electrical supplies will supply a much greater variety of electrical products than will a general distributor who provides only the most popular items but in a large number of product lines. For the specialty company, each product may have a smaller sales volume but collectively they are significant. Purchasing strategies for such an operation require in-depth expertise and knowledge of the buying markets served and of the supplying markets. A business strategy that involves supplying a broad market, on the other hand, requires purchasing to also have a broad market knowledge and less in-depth knowledge about any particular market, either buying or selling.

  6. Development or Application of Business Processes - Business strategies that require new processes or application of existing processes to new or different situations need sources and expertise in the new processes or in their application. Purchasing, through its marketplace knowledge is often in a position to identify other companies who have developed and/or are using similar strategies or applying different strategies to similar situations.

  7. Development or Application of Technology - Business strategies that require development of new technology or new applications of existing technology also require sources of the technology and/or sources of expertise in its application. Purchasing, again through its exposure to the marketplace and the knowledge available there, is often in a position to contribute the identification of potential sources of technology or of sources of expertise in its application.

  8. Make Versus Buy of Products, Materials, or Services - Any business strategy that requires the use of products or services should include consideration of where is the best source of obtaining or producing the requirement. Part of that decision is whether to obtain the item from the marketplace or to produce it internally within the business. Purchasing should always be involved in make versus buy decision processes. Purchasing should contribute much of the information on the "buy" side of such considerations.

Sourcing Strategies to Support Business Strategies. The preceding section identified some general business strategies and some ways in which purchasing strategies can be aligned to support the business strategies. The use of total cost procurement models, appropriate supplier relationships, and seeking value-added services are additional tools that purchasing can use to develop supportive sourcing strategies.

  1. Total cost procurement models. Look at sources as sourcing supply chains rather than individual companies. Abandon the low price sourcing model and use total landed or life cycle cost. Include all costs in the supply chain when comparing sources and source chains. Supply chains must compete with each other as chains and not as individual organizations. Study of alternate supply chains and application of trade-off analysis may identify opportunities to construct new, lower total cost chains from components of existing chains.

  2. Supplier Relationships. Supplier relationships can be looked at as a continuum from individual transactions with no planned continuity between transactions at one end, and a strategic alliance involving cross investment and very long term contracts at the other end.

A useful way to simplify this picture is to look at three possibilities: transactional relationships, collaborative relationships, and alliance relationships. A variation of the concept of ABC analysis can be applied to all purchases to sort them into the three groups for relationship analysis purposes.

"A" items are strategically the most important and may also be the greatest quantity and/or dollar volume items. These should be considered for alliance relationships. Alliances usually imply long term commitment, possibly sharing of cost data, and cross investment.

"B" items are less strategically important and likely less volume or dollar intensive but are still important enough that some continuing relationship with a source supply chain is desirable. These items should be considered for collaborative relationships. Collaborative implies that there is a continuing relationship but not necessarily a long-term commitment, and no sharing of cost data or cross investment.

"C" items are least important strategically and likely the lowest in physical and dollar volume. This does not necessarily mean that all low-value purchases are "C" items. Low value purchases that amount to significant volume over a year may be "B" or even "A" items, depending on how important they are to the business and the overall volume. "C" items may also include purchases that are high in unit cost but are not strategically important or are required only infrequently.

C. Value Added Services. Part of considering sources as chains includes seeking out value added services from the chain wherever possible and economically beneficial. Examples include: inventory stocking, planning, and analysis, on-site, off-site, or a combination; supplier integration to reduce costs and improve efficiencies; project inventory planning; packaging design, manufacture, and recycling; provision of transportation services; transportation integration among suppliers; reduction of lead time through use of electronic communication means such as EDI and Internet.

Strategic Sourcing Methodology. Adopting a strategic sourcing methodology is a "key" in making the transition from a primarily transactional procurement organization to a strategic one. Several highly integrated steps should be followed which involve: collection and analysis of spend data, determination of customer requirements, undertaking of market analysis, development of product and service group strategies, evaluation and profiling of suppliers, selection of suppliers, negotiation of agreements with suppliers, planning of implementation, installation of reporting systems, measurement of results including supplier performance, and management of supplier performance.

Transforming the "Mindset." Unfortunately, some business managers have the viewpoint that purchasing and supply is simply a transactional or, at best, tactical function. To effectively make the transition to strategic sourcing, this mindset must be changed. Purchasing and supply management must be viewed by management as strategic. To change this perception, purchasing must develop and sell value-adding programs and services across and up and down the organization. The total cost model can be used to develop strategic supply alternatives that reduce costs, improve quality, or otherwise support the main strategies of the business. Some examples of value-adding programs include vendor stocking, integrated supply, cycle time reduction, investment recovery, e-commerce, and strategic alliances. Management and business units must see bottom line impact from strategic sourcing initiatives to view purchasing as strategic. Solid, measurable results from supply alternative initiatives can be used to illustrate that the strategic sourcing approach does make significant contributions to achievement of overall business strategies and improves the bottom line.

Purchasing itself also must be transformed with regard to mindset and must learn to think strategically. Two articles that provide suggestions on how to do that are contained in Purchasing Today® in February and March 1998. The February article also includes a chart that can be used to determine where your supply management focus is currently: transactional, tactical, or strategic.

Another element in making the mindset transition is the continuous promotion of purchasing itself as a profession. Stress to management and anyone else that will listen that purchasing professionals are uniquely qualified with skills in cost and price analysis and management, supply chain management, use of ERP resources, and e-commerce. Expose management and internal customers to examples of what is possible through circulation of Purchasing Today® and other articles that contain examples of supply management excellence. Highlight the C.P.M. designation as an identifier that indicates the qualification of a person to competently perform purchasing and supply management responsibilities.

References

Bordon, George G. "Is Your Staff Thinking Strategically?" Purchasing Today, February 1998, 4-5.

Bordon, George G. "Making the Move to Strategic Procurement." Purchasing Today, March 1998, 10-11.

Slaight, Thomas H. "The Future of Purchasing and Supply: Strategic Sourcing," Purchasing Today, October 1999, 43-45.

Stephens, John, and D. Larry Moore, "Purchasing and Strategic Planning: The Link." Purchasing Today, January 1998, 38-39.


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