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The Future of Purchasing and Supply: Strategic Sourcing

Initiative #3: Strategic Sourcing
Take the Initiative: Continuing coverage of the trends shaping the profession

By Thomas H. Slaight, vice president with A.T. Kearney in New York City.
Purchasing Today®, October 1999, page 43.

Just when smart organizations thought they had squeezed the last ounce of savings from their supply bases, enlightened purchasing and supply organizations are saving even more by focusing more on process than function. New-style purchasing departments lead their organizations to join with suppliers to spur innovation, apply joint expertise to product development, and create genuine supply advantage.

In the once mundane world of hard-nosed negotiations aimed at reducing costs, managing supplier relationships, and buying everything from paper clips to private planes, "those buyers down in purchasing" have traditionally been a minor blip on the CEO radar screen. Not any more.

What is Strategic Sourcing?

Strategic sourcing is a supply management tool that delivers significant cost reductions and other benefits. More specifically, it's a periodic event that includes the identification and selection of initial commercial arrangements with a selected supplier that either creates or resets a relationship. That sounds simple enough, but what makes strategic sourcing different from a traditional sourcing activity? After all, "identifying and selecting initial commercial arrangements" can just as easily be accomplished with the old "lowest of three bids" process, right? Not quite. Strategic sourcing requires that organizations divide their spend into categories and then classify the categories based on the importance of that product or service, and on the complexity of the supplier marketplace. From there, the purchasing organization - and the supplier organization - must recognize that various relationships are required. At one end, the least strategic relationships might be based on cost, but at the other end, the most strategic suppliers are chosen for their ability to create new business opportunities or technological advances. Specifically targeting or searching for suppliers in such a formalized manner, to fill this role is what strategic sourcing is all about.

Strategic sourcing is the first rung of the ladder. And once it's combined with strategic supplier management and effective day-to-day purchasing activities, the outcome is true supply advantage. (See the article, "Restructuring for Innovation," in this issue for more on supply advantage.)

Why Focus on Strategic Sourcing?

In the past, purchasing and supply functions have often had a sole mission: Drive costs to the lowest possible price points, then track and report them. Although they still value cost-reduction initiatives, most CEOs believe that purchasing and supply management's role should go beyond cost cutting. In the 1997 CEO Global Business Study by A.T. Kearney, the top priorities for supplier relationships were: cost reduction, quality improvement, access to new resources, and enhanced sales. Furthermore, those leaders who value end-product competitiveness as a primary objective, 86 percent, also valued establishing relationships with leading suppliers (79 percent). In these organizations, purchasing and supply management professionals provide strategic positioning advantage and revenue enhancements.

Go-getters in purchasing and supply management have heard their CEO's message and recognize that strategic sourcing - and the subsequent strategic supplier management - will bring them to center stage as a major part of organization-wide success. The alliances that they create with suppliers spur innovation, identify new product opportunities, bring access to new markets or technology, and provide new intelligence for strategic decisionmaking.

At Cisco Systems, the San Jose, California-based provider of Internet networking materials, strategically selected supplier relationships are a key driver behind its recent remarkable growth. Cisco inaugurated a build-to-order program and rolled out extranets through which suppliers can monitor and fulfill customers' orders. This new cooperative relationship with suppliers, combined with a high percentage of production outsourcing, has done much more than help the company slim down costs. Cisco has quadrupled its output without investment in new plants, and its products now reach the market in one-third the time. The close cooperative efforts yielded yet another reward: Cisco's shareholder value has quadrupled in three years.

So, there are bright spots in terms of strategic sourcing, but it's hardly the norm. Few organizations have managed to become leaders in both sourcing and strategic supplier management. Proactive purchasing and supply management professionals that capitalize on working with suppliers to foster innovation and develop markets are still a rarity. Some organizations are simply not focused on establishing purchasing processes to make the creation of genuine supply advantage the norm rather than the exception.

Failure to make procurement process-oriented rather than transaction-oriented often stems internally from the purchasing organization, rather than from the supply base. Many suppliers stand ready to contribute to their customers' success any way they can to increase their own revenue through better cooperative relationships. Suppliers are a vast, often untapped resource. Purchasing and supply relationships can become a guessing game in which suppliers try to determine how they can add more value. Their customers often fail to provide the answers. In order to change this, in the coming years, the most successful purchasing and supply organizations will project some of their highest objectives on the sourcing process, by choosing their suppliers based on strategic objectives and constantly evaluating current suppliers for the same contributions. What does it take to source strategically?

Getting There

An organization creating supply advantage sorts through its suppliers and determines how their role and their relationship should change. Mindful of its own core competencies, the organization decides which components to maintain or build itself, and which to outsource. It chooses which relationships should be transactional, collaborative, or strategic; which relationships to drop and which to nurture. The result of this strategic sourcing process is a select few supply-advantage alliances in which the members become partners in innovation, leading to marketplace advantage. Let's take a look at some of the joint-operating philosophies that organizations will want to consider in their strategic sourcing efforts.

  • Common purpose. The organization and its suppliers work together to develop complementary strategies and objectives and agree to reach these objectives with a common approach and set of values. The new partners agree on objective performance measures that will ensure proper accountability. The organization then offers rewards and provides incentives contingent upon the suppliers meeting these measures. In many cases, this common purpose is reflected in value-based compensation structures. Traditionally, measurements have been based on cost-saving measures. Imagine if performance measurements were extended to include revenues that resulted from the supplier relationship. For example, did a supplier relationship result in a new business venture that is now making money for the organization?
  • Joint processes. In place of artificial boundaries between the customer and the supplier, processes are designed to flow seamlessly between the two organizations. This includes business processes related to product design and development, as well as to requisitioning, delivery, and invoicing. Technology is a key tool in making this happen effectively. Imagine that suppliers will be selected or retained based on the ability for information to move freely between the organizations. Engineers at General Motors, for example, share new product design information with their suppliers' engineers to speed products to market and guarantee reliability and quality.
  • Effective dialogue. The purchasing organization and its suppliers promote communication by creating opportunities, processes, and well-defined communication points - from strategic discussions on the creation of value to tactical contacts targeted at getting the job done right.
  • Multidimensional relationships. The alliance is not limited to research and development. Rather, purchasing and supply management involves its key suppliers at many levels and in many different business functions - stretching across all areas including finance, marketing, and sales. A unique criteria in the future may be the reciprocity that will be required for the purchasing and supplier organizations. Might it become a criteria that the supplier chosen for its strategic value is also held in the same regard as a customer?

A common purpose, joint processes, effective dialogue, and multidimensional relationships may be the cornerstone of the most strategic relationships, but developing these qualities in a supplier takes time. To set these objectives, the purchasing and supply organization must align with the strategic objectives of the larger organization. Market position - including cost leadership, customer service, and market penetration- drive decisions for purchasing and its suppliers. The chief procurement officer can build a procurement strategy around cost leadership and value-creating supplier partnerships. This strategy addresses:

  • Organization
  • Changing mindset
  • Information sharing
  • Use of information technology, performance measures
  • Supplier management

Strategic, Strategic Sourcing

Many of the initiatives associated with strategic sourcing - dividing spend into categories of critical importance, establishing differing metrics for different levels of suppliers - are in place at some leading organizations. So, what is on the horizon for this aspect of the purchasing and supply field?

Let's start with the well-known quadrant that divides suppliers into four categories, based on amount of spend and criticality of the product or service. Typically, the most important buys with the most complex suppliers fall into the "strategic" quadrant. Now imagine that box divided into even more specific categories. There will be some strategic suppliers with whom relationships are formed, based on their ability to refine existing processes for cost reduction and cost saving objectives. Process improvements and integrated relationships that add value are stressed. But, there will be other strategic suppliers with whom the objectives are something different entirely. They will be chosen based on their ability to create joint ventures with the purchasing organization, resulting in a whole new source of business.

For example, imagine you're choosing a software provider, with whom you'll be establishing a strategic relationship. But you're not only looking at the provider to develop customized solutions that you know will bring value to your organization. You enter into the relationship with the full intention that at some point, your organization and the supplier organization will take that new product or service - developed through team effort - to market together, providing both organizations with a whole new source of revenue. A supplier chosen for that purpose was certainly sourced strategically.

Identifying suppliers who can take on partnership or alliance responsibilities is daunting. Those who sign up the right partners, however, are setting up the potential for sharing enormous dividends. Workable relationships involve a willingness to share risks and build new business models with partners. When a purchasing and supply organization attempts breakthrough innovation for marketplace advantage, it is critical for partners to share common goals. Prospects for successful change are as dependent on the lead organization as on its supplier partners. New collaborative partnerships are partnerships of equals. Supplier partners that fail to move the innovation curve will ultimately be replaced with partners who do.

Beyond strategic sourcing, those who are willing to move away from traditional operating modes soon learn an important lesson: Building relationships inside and outside the organization is an ongoing process.

"We do everything by the book in terms of sourcing, but we are still focused on the old procurement world," groaned one procurement professional recently. "We still lack the skills to trust our suppliers and to build the kind of relationship where there is give-and-take and where new ideas flow." For the organization that can create supply advantage - that can build the necessary relationships and get ideas flowing - the rewards will include competitive advantage as well as the opportunity to see competitors like this one only in its rearview mirror.

Initiative #3: Strategic Sourcing

"Box page 44"

The 1998 study, "The Future of Purchasing and Supply: A Five- and Ten-Year Forecast," by NAPM, the Center for Advanced Purchasing Studies, A.T. Kearney, Arizona State University, and Michigan State University, details 18 initiatives that will shape the purchasing and supply management function in coming years. Each month, Purchasing Today® provides commentary on an aspect of the study. Initiative #3, Strategic Sourcing, says that:

  • In the future, it will be critical that purchasing and supply organizations tightly integrate with suppliers.
  • Supplier assessment and evaluation will become more detailed and precise.
  • Although many organizations are striving to simplify and standardize, they will have to customize their supplier metrics to each supplier's performance.
  • Over the next 10 years, there will be an intellectual fight over designing metrics that are very specific for particular chains that take advantage of them.
  • There is no strong trend occurring to reduce complexity and standardize as much as possible by applying one metric throughout a supply chain.

Are You Prepared? Ask Yourself the Following Questions.

"Box page 45"

Strategic sourcing is cited in "The Future of Purchasing and Supply: A Five- and Ten-Year Forecast" has a trend facing purchasing and supply professionals. Is your organization already engaged in such activities? If not, is the framework in place to start these processes? Here are just a few questions you can ask to determine whether the climate is right for strategic sourcing efforts.

  • How many of your strategic suppliers meet regularly with the top executives of your organization, including the CEO or heads of other divisions? At least a small handful should be doing that. In order for your strategic sourcing efforts to go to the next level, single contacts within your organization are not enough. Suppliers need to be regularly exposed to the top levels.
  • When your organization is evaluating entry into a new market or new line of business, is purchasing and supply management brought into the discussion? As the best link into the supplier community, purchasing and supply needs to be involved if suppliers are to be involved at the strategic level.
  • When your organization's strategic setting group comes to an impasse based on cost targets or threshold issues, are purchasing and suppliers brought into discussions for solutions?
  • When the supplier community has a new technology to be introduced, do they seek out your guidance for promotion within your organization? This is different from a supplier approaching purchasing to sell them on an idea, but rather teaming with them, showing a high level of trust. Purchasing and supply is not just the vehicle to communicate the message, but rather an ally in forming new business relationships.