If you were told that you could drive a 5 to 10 percent increase in your company's shareholder value, would you be interested? Of course you would.
For years, leading procurement organizations have implemented rigorous strategic sourcing programs to coordinate purchasing across divisions and regions, renegotiate and reduce pricing, streamline supplier networks, develop new suppliers, and establish a more strategic focus within purchasing organizations. The results have been significant cost savings for the company, which translates into improved shareholder value. And because 80 percent of a company's total materials and services spend is comprised of 20 to 30 percent of the categories purchased, it is common for these programs to target the larger-spend categories. A Fortune 500 company that applies a global strategic sourcing program across 80 percent of its $5 billion corporate spend to achieve a conservative 7 percent savings can realize about $280 million in bottom-line improvements — not a bad message to take to shareholders.
However, once the major categories have been sourced, corporate interest in the strategic sourcing program often wanes, leaving a big piece — the "tail end" — untouched. Since this typically represents about 20 to 30 percent of a company's total purchases, addressing this portion of spend can generate a great opportunity to maximize savings, improve margins and ultimately increase shareholder value. So, what is preventing purchasing organizations from extending their sourcing programs to the "tail end?"
The Barriers and Benefits
Companies are slow to tackle this problem for a number of reasons, ranging from limited resources to the level of sourcing difficulty. The tail end consists of numerous, dispersed purchasing categories, each with relatively low expenditure levels. To maximize initial savings, sourcing programs naturally hit the higher-spend categories first, where there is more leverage with suppliers and relatively high savings can be achieved. In today's resource-constrained environments, assigning the best resources to core spending categories often leaves the procurement organization strapped when it comes to conducting day-to-day purchasing activity. It becomes quite a challenge to identify and allocate additional "special" talent to enable sourcing of the lower-spend categories, which, individually, may not seem worth the effort.
Another barrier is the uncertainty and associated risk of failure. Many of these smaller spend categories are typically not core to the business or may be highly technical with complicated specifications, making it more difficult to carry out the sourcing process. With these characteristics, savings ranges are more questionable, and it is not possible to guarantee success at a 90 percent — or more — level, which means there must be more of an appetite for risk to gain the reward.
What organizations should recognize is that the tail end of spend can provide considerable savings and should not be overlooked. In fact, some dispersed spend categories that have never been through the sourcing process may produce very high savings relative to more recently sourced categories. For example, consider a large merchandise retailer with over $5 billion in total corporate purchases and a $1 million courier services spend. In this case, due to the relative size, courier is not considered a large, "core" category. However, by employing strategic sourcing strategies, the courier category has the potential to deliver an estimated 8 to12 percent in annual savings, or $80,000 to $120,000 for that category alone. If you extrapolate these savings out to the rest of the tail, assuming that the 8 to12 percent represents an average benefit, the retailer with $5 billion in spend and approximately $1 billion (20 percent) in unaddressed spend can realize a savings opportunity of $80 to $120 million.
How to Capture the Opportunity
To fully leverage investments and maximize savings, companies should extend strategic sourcing programs beyond core categories to the tail end. This calls for a simplified strategic sourcing process that is augmented by the necessary technology to accelerate benefits, capture and increase the total return on investment. To support the simplified process, it is critical to shift resources and allocate some of the organization's top resources to the effort. We recommend that you consider the possibility of pursuing the following two paths.
The first path is to group a number of lower-spend categories and assign a purchasing resource to the bundle. Timelines for completion and sequencing of categories are up to the purchasing professional, however he or she is expected to deliver cost reductions at a predetermined rate over an extended period of time. For example, consider a bundle that includes safety supplies. With clear specifications and an availability of substitutes, the category can be addressed through online catalogs and reputable buying consortiums with pre-negotiated contract pricing in place to aid the sourcing process. As the benefits from the bundle decline, the purchasing staffer dedicates a smaller percentage of his or her time to this effort and transitions the rest of its time to another bundle or other purchasing activities.
The second path is to develop cross-functional teams that focus simultaneously on multiple categories with a strong, fully-committed team leader and several team members dedicating an hour or two each week to the effort. For example, a large pharmaceutical company utilized the small-team approach to address several low-spend categories, including landscaping. A sourcing-experienced professional acted as the main point of contact, managing a number of categories on a part time basis. Each category was supported by an extended team of several people, each focusing on their particular category for a few hours per week. In a workshop fashion, the extended team members reviewed RFXs, provided subject matter expertise and ensured company buy-in for group decisions while maintaining their other daily responsibilities. Using this approach, the landscaping category delivered annual savings of over 15 percent over a period of only two to three months.
Regardless of the path, a simplified strategic sourcing process should be followed. Key initial activities include assessing categories to understand internal purchasing habits and external market issues, followed by determining appropriate sourcing tactics, such as unbundling prices, redistributing volumes or substituting materials. During these first steps, teams will benefit from the breadth of experience across the cross-functional part-time team members. Juggling a number of categories, they can prioritize, share and distribute activities to move fairly quickly through this part of the process. At this stage it is also worth rethinking requirements and benchmarking volumes and pricing against pre-existing consortium rates to leverage volume buying wherever possible. Those categories with identified benefits can be "handed-off" to a consortium to accelerate the sourcing process and to free up resources to focus on other categories.
The Power of Tools
As with sourcing of core categories, the entire process can be accelerated and made more efficient through the integration of widely available e-sourcing tools. In the earlier steps, it is critical to utilize spend aggregators, which help organizations get a handle on baseline spend data and facilitate spend analyses. Later in the process, as teams assess supplier alternatives, execute their sourcing strategies and conduct negotiations, they will benefit from the use of additional electronic tools, such as e-requests for information (e-RFIs), e-requests for proposals (e-RFPs) and Internet auction technology. Making use of e-auctions to facilitate supplier contract negotiations eliminates time-consuming rounds of face-to-face negotiations and, again, frees up resources to move on to the next priority.
If e-sourcing tools are not already in place, it may be difficult to warrant significant investment for the tail. But, there are a number of do-it-yourself e-sourcing tools available today. Once users are properly trained in the use of such tools, they require little external support. Additionally, these tools will prove valuable when utilizing the team approach, as they can be easily adjusted for use across a variety of categories, and users can apply expertise while shifting from one category to the next.
In summary, to capture missed savings, companies should extend strategic sourcing efforts to the smaller, dispersed spend categories, or the "tail end." Big wins in some categories will compensate for dead ends in others, with positive end results. Choosing a "team" or "bundled" approach to tackle these categories, as well as utilizing a simplified strategic sourcing process that is augmented by technology enablers, will ensure success. To further accelerate the process and minimize in-house resource requirements, investigate external consortium-type deals. Pick the path that best suits your environment and resource situation. When determining the right mix of resources, consider previous sourcing experience, leadership and other skills. Overall, you may need a more structured approach up front with less structure as the teams or individuals gain experience. Regardless of the sourcing arrangement, the tail end will yield substantial incremental savings to the bottom line.
CV Ramachandran is vice president, A.T. Kearney, and Theresa Lawless is manager, A.T. Kearney.