Are You Ready to Strategically Source?

Before a company is ready to use any e-procurement or strategic sourcing technology, a lot of in-house analysis and supplier analysis needs to be done. Before you make the e-sourcing leap, find out exactly what kind of house cleaning is involved.

What ever happened to the business in e-business? Unfortunately, e-commerce buzz tends to focus only on the latest technology or tools that improve efficiencies. For example, the buzz surrounding e-procurement tends to imply that online, transactional tools will automatically save a company money simply because they are a form of technology.

The real benefit of e-business for procurement starts with the attention given to sourcing practices as a process: First a company should align its business practices and organizational structure and, once that is accomplished, then it can apply the tools that drive strategic change. It is only after this sequence of actions is followed that companies can impact bottom-line profitability through strategic sourcing.

How can strategic sourcing practices impact business performance? Opportunities for improvement can be found through reductions in cycle time (20 to 50 percent), unit price (5 to 30 percent) and time-to-market cycle (10 to 50 percent), according to various sources including the Aberdeen Group and Gartner Group.

Process, Not Function

Whether your company has grown by acquisition or is managed by independent business units, chances are that you may not have integrated sourcing practices to leverage your buying power across the enterprise. Purchasing the same materials across the enterprise in a decentralized approach, coupled with the lack of integrated, unmanaged systems, makes it difficult for chief financial officers and other senior managers to see where spending is taking place in order that they might take advantage of strategic sourcing practices. In lieu of that, purchasing becomes a function, rather than a process, and employees or departments become too set in their ways to change.

For example, a Company with Business Unit A may be purchasing a certain raw material from the same source as Business Unit B. However, if the enterprise resource planning (ERP) system is set up in a multiple-instance fashion, visibility of those purchasing sources goes away when the financials are rolled up and aggregated in the P&L. The result is the inability of the company to leverage economies of scale across the enterprise to gain price, delivery and other efficiencies.

That's why it's important for senior management to make a conscious decision to improve sourcing practices to enable the alignment of business practices and organizational structure before technology is bought or applied. 

Becoming a world-class sourcing organization is an ongoing, continuous improvement process with a steep learning curve. The four basic steps in this improvement process are: profile purchases and suppliers, define sourcing groups, define suppliers and contracts, and then select appropriate technology requirements or enablers.

 Step 1: Profile Purchases and Suppliers  

This process begins by looking at current, as is practices to identify spending in both the indirect and direct categories. The key variables a company should examine include the number of suppliers; the number of transactions; the volume per transaction; and the type of transaction, like spot, fixed asset or contract labor. Do not underestimate the effort required to consolidate, validate and categorize this data. Depending on the automation of a company's current purchasing systems and accounts payable, this information may reside in paper form in multiple locations and in various formats. 

Next, a company needs to profile its current procurement processes and organizational purchasing practices. When analyzing current process and organizational execution, the following questions need to be resolved: What is the current cycle time and event time within the sourcing process? What are the current controls and approvals required by purchase type? Who manages the supplier contracts, and where does the data reside? Who owns the supplier relationships? It's important to model the entire requisition to reconciliation process to measure cycle time and the frequency of purchase types and exceptions (disconnects).

This is also the time to profile suppliers' capabilities by asking questions like: Do they currently support the use of blanket purchase orders? Do they have agreements in place with other customers to support vendor-managed inventory? What type of electronic transactions are they currently performing or planning to offer with other customers, and when? What type of customer self-service tools, like online order placement and changes, order status, inventory status and billing, do the suppliers offer? Do the suppliers currently bundle transportation cost, or is it a separate line item on the invoice? Do they offer their products or services through third-party distribution and/or online marketplaces?

After understanding a company's current purchasing types, process and behaviors, the next step is to define and apply performance metrics, including: direct spend (COGS), in-direct spend (SG&A), purchase price variance, supplier quality, supplier performance and material acquisition costs. The performance metrics should be put in place to establish a current performance that can be benchmarked against an industry or direct competition to determine where the greatest opportunities for improvement may exist. For instance, if a company's SG&A is 10 percent higher against its industry and/or competition, then opportunity probably exists to reduce indirect expense.

Once the process, spending patterns and performance metrics are understood, senior management must then champion and align the organization to support the effort going forward. This may include how financial performance is measured at the business unit level, how people are compensated and any organizational structure changes. Without strong, clear leadership from senior management, organizational change cannot occur effectively.

Step 2: Define Sourcing Groups

The as is spending data for the indirect and direct categories can subsequently be segmented into a sourcing profile quadrant grid according to four areas:

  •  In the lower left area of the quadrant are routine/transactional purchases, which represent the lowest business impact and supply challenge to the organization.  Examples include indirect purchases, such as office supplies, that typically have no brand or little supplier loyalty.

  •  In the upper left area of the quadrant are leveraged purchases, which represent higher business impact with greater supplier loyalty yet little supply challenge. Examples include personal computers, office furniture and common raw materials.

  •  In the lower right area of the quadrant are the bottleneck purchases, which offer higher supply challenges due to fewer suppliers and unique item specifications but low business impact. Examples include unique raw materials, custom components and specialty-designed parts.

  • The most critical/strategic purchases are found in the upper right area of the quadrant, which are direct raw materials with selected sources that can produce high business impact yet present supply challenges.

This quadrant profile is not a new concept. However, what is new is the next step that organizations take when moving from purchasing as a function to developing a successful sourcing strategy as a process. This process is based on establishing key relationships and contracts with suppliers.

At this point, it's important not to jump ahead to consolidating suppliers or buying new technology before sourcing groups are identified. These groups will fill the gap between a company's as is and to be practices, thus allowing consideration to be given to ways of either exploiting buying power (routine or leverage quadrants) or creating an advantage (bottleneck or strategic quadrants). 

In addition to identifying sourcing groups, the gap also typically requires companies to re-train people to support project management disciplines, internal and external building teams, new processes and the use of new tools. Remember: these people will move from a transactional environment to an analytical role within the organization. The profile for strategic sourcing personnel includes qualities such as excellent interpersonal communication, the ability to facilitate teams, market knowledge, analytical, commercial background, negotiations and computer literacy. This begins by assessing and, in many cases, training sourcing groups in total cost evaluation (not just price), establishing supplier selection criteria, market analysis, and the impact that sourcing groups will have on business and customers. They also need to understand where quality, supplier flexibility and price relate to a company's overall mission. 

Once sourcing groups are identified, they will need to consider three objectives for an effective sourcing strategy for each material or service:

  • Define a strategic vision that supports overall business objectives. Depending on a company's core competency, price may be a small part of the equation compared to quality or responsiveness to its customers.

  • Develop a sourcing strategy for each category based on assessments of its material or service profile that is validated by opportunities and company objectives.

  • Select a strategy that clearly outlines how the materials or service will be managed in the future and the performance targets that are to be achieved.

Basic sourcing strategies that can be applied to certain buying practices to achieve buying power or advantage include volume concentration, best-price evaluation, global sourcing, product-specs improvement, joint-process improvement, and relationship restructuring.

Step 3: Define Suppliers and Contracts

Starting with the highest business impact, a company may first look at how to approach the strategic quadrant. Typically, this sourcing group should be less concerned with volume concentration, best prices and the ability to globally source because these will only negatively impact the supplier relationship. The primary focus should be on improving the process, specifications and collaboration between the two organizations to form a more strategic relationship.

This is also the point at which contracts are realigned to reduce the number of people doing business from the supply side and to initiate the change from a function to a process. This will have two effects on suppliers: Some will lose the company's business. However, others will increase their business opportunity with the company while at the same time reducing their transactional costs of doing business.

Another sourcing area with high business impact is the leveraged quadrant where volume concentration, best prices and global sourcing are the key approaches. For this area, one way an e-procurement portal can cut transaction costs to leverage the buying of these goods across the organization is to negotiate with one supplier. Although the relationship with the supplier is less important, because the goods can be bought from any number of sources, the supplier may drop its prices by 3 to 10 percent, for example, because the buying organization is increasing its per-year spending with them. In addition to more business, the supplier will benefit from reduced cost transactions and better forecasting through automation. Price is one of the issues, but the process and technology add value to back up the discount.

Next, examine how to move items out of the bottleneck quadrant into the leverage or strategic quadrant. This typically involves working with the product development or engineering group within the company on item rationalization to determine other options or re-engineering the product to support more readily available components. Another option may be to purchase a sub-assembly version of multiple components from available suppliers. These techniques require supplier collaboration between product development, engineering and the company's strategic sourcing groups.

The next step in the process is to aggregate suppliers and select the suppliers that can offer better costs, higher quality or greater flexibility. At this point, stronger relationships and multi-year contracts can be developed to enable forecast and product-requirement sharing.

Step 4: Enabling Technology

The last step in the process  the one that many tend to start with  is applying an appropriate technology to the sourcing practice. Technology tools are the best practices for sourcing when organizations have gone through a process improvement and determined the best approaches for each sourcing group. Tools that are best applied to each quadrant are:

  • Collaborative planning, forecasting and replenishment (CPFR)  Due to its complex nature of forecast and inventory sharing, this tool is best applied to strategic suppliers.

  • Request for quote (RFQ)  This tool is best applied to leveraged and strategic purchases when trying to agree on a product's specification, availability and quality. It will set performance measurements, quality, required delivery times and price.

  • Deviation from spec  This is used in conjunction with the RFQ to allow suppliers to submit specification changes that may be within tolerance of required material that have the opportunity to move items from the bottleneck quadrant into strategic or leveraged.

  • Procurement portal  This tool is best applied to leveraged and non-critical quadrant spending to reduce transaction time, aggregate suppliers and increase the visibility of where dollars are going.

  • Reverse auction  This tool is typically used in routine and leveraged purchases where specification, quality or supplier relationships are considered non-critical.

  • Marketplace  This is best used to reduce transaction costs with high-volume routine purchases. Marketplaces enable catalog and content aggregation with many suppliers. 

  • Employee requisition  This is best used to reduce transaction costs while streamlining the requisition process. It reduces transaction costs with high-volume routine purchases.

  • Employee expense  This area may afford opportunity based on the amount of business expense encountered by a company. Typically, this would impact service organizations with a highly mobile service and sales organization.

  • Transportation  Companies can achieve significant cost savings by closely managing inbound and outbound transportation as a strategic sourced service. They can apply technology in the planning, aggregation, status and routing of inbound and outbound transportation.

  • EDI transactions  This has been the traditional means of electronic enablement between trading partners.  Compared to Web-based transactions, this is an expensive option; however, it may be the only option with certain suppliers due to the technology adoption rate within their organization. 

  • Product development management  Building tighter relationships between a company and its strategic suppliers is key to any strategic sourcing program. This can be accomplished by leveraging Internet-based communication and collaboration tools between your external suppliers and internal product development, engineering and strategic sourcing groups. This improves time to market and assists the process of moving items from the bottleneck-sourcing quadrant into the strategic quadrant.  

  •  ACH  EFT  Typically used with the leveraged or strategic categories, since it does not typically impose a transaction fee to the supplier (a bank may charge a transaction fee). This tool provides little reporting capabilities within systems.

  • Purchasing card (P-card)  This enables buyers within an organization to remit payment at the time of purchase. It does come with the overhead of transactional fees  fixed transaction fee + percent of purchase  that is paid by the supplier.  It also provides excellent reporting and control to the issuing company.

During this technology-enabling phase, a company needs to review its current information technology environment to understand where supplier-master, item-master, inventory and fixed-asset data resides. Are the current systems capable of supporting business rule execution of supplier contracts during purchasing execution and accounts payable reconciliation? What electronic transactions currently exist between a company and its current suppliers? What systems can be leveraged, and what needs to be added to enable the e sourcing practices?

Strategic sourcing is a key business process, which leads to better relationships and collaboration with suppliers and improved processes. Ultimately, it impacts the end customer by the ability to pass along price reductions and improve turnarounds. Yet saving money has little to do with e-procurement tools until the organization is aligned to take advantage of them.