For many years, procurement organizations set their sights on cost, specifically cost reduction. They found their mark—and their value--in unearthing ways to reduce expenses related to direct and indirect purchases of goods and services.
But procurement organizations are increasingly eyeing a new sight picture that takes a broader view of their procurement targets. More and more they are zeroing in on a practice called strategic sourcing, which Mukund Acharya, vice president of GEP, a procurement and supply chain consultancy, says is simply a “data- and fact-driven exercise that looks to maximize not just the savings options but the total cost of ownership.”
Bill Huber, managing director of Alsbridge, an independent global sourcing advisory and consulting firm, defines strategic sourcing in more depth, stating: “Strategic sourcing is the effective acquisition of third-party capabilities and supplies in a manner that will provide a material competitive advantage to the firm.”
With strategic sourcing, procurement organizations are aiming at a new way of doing things. “It’s a changing of the guard really,” says Steven Lutzer, founder of Lutzer Global Inc., a retained search firm specializing in strategic sourcing, procurement and supply chain. “Old school procurement is on the way out. If they really want to do strategic sourcing, they have to adopt new methods to succeed.”
This includes knowing the categories of spend within the organization, Lutzer stresses, then clustering and coding that spend to get the biggest bang for the company’s buck. On the direct materials side, it may be purchases for anything from resins to glass to electronics components,. The spend on the indirect side is more decentralized and it might be anything from information technology, business services to facility spend. “One vendor may be selling to six different divisions within your company,” he says. “But if you create meaningful categories of spend across the entire organization, you’re able to cluster the spend and negotiate with vendors in a more effective way.”
The process involves understanding what the needs are and the clusters of spend, developing a spend profile, assessing the supplier base then finding synergies and opportunities, according to Sundar Kamakshisundaram, vice president of Procurement and Business Network Solutions at SAP Ariba, a software and information technology services company. “You try to find opportunities before you execute the sourcing process. That is why it’s strategic,” he says. “It helps you put together a commodity strategy, or category strategy, so that you can develop an optimal contract with a supplier.”
Giving Strategic Sourcing a Shot
However, though strategic sourcing is right on target, not every procurement organization has given it a shot.
Huber reports that one of the largest barriers to strategic sourcing is a misalignment between how the procurement function measures cost savings and how the business measures profit and loss (P&L). “Traditional procurement cost savings is based on a comparative year-over-year or transaction-over-transaction analysis focused on total cost reduction,” he says. “Very few procurement organizations add the value of capability differentiation to their financial calculations, so the primary key performance indicator (KPI) for most procurement organizations is related to its impact against static requirements.”
Furthermore, Huber maintains that “innovation in products or services that improves the business’s speed to market, ability to service customers or attractiveness of its own products tends to be recognized only anecdotally, and not as a quantitative financial measure of procurement performance.” The issue then becomes that “unless innovation is related specifically to reducing the cost of the product being purchased that innovation is going to be undervalued by most procurement analytical models and by the KPIs by which the strategic sourcing organization will be measured.”
The second barrier is capacity, speed and prioritization, adds Huber. “Most sourcing organizations are under-resourced for their aspirations. They aspire to deliver significant value and guidance on every engagement, but the fact is that doing that takes a lot of time and effort, and the best strategic sourcing people are often engaged in multiple important projects simultaneously,” he says.
He recommends procurement operations clear this hurdle by being selective in the projects they take on then hitting them out of the park. “This can be difficult, especially in regulated industries where the mandate to ‘manage all spend’ is a requirement of doing business,” he says. “But this is where the smarter CPOs are figuring out more creative ways to maintain an appropriately managed spend environment without trying to do everything within their own organizations.”
Know What You Don’t Know
“Companies don’t know what they don’t know,” says Acharya.
To accomplish strategic sourcing, companies need to understand fully understand their spend categories. They need to understand the definition of the category, usage patterns, suppliers used, stakeholders involved, total expenditures and volumes, and more.
Unfortunately, most spending occurs somewhere on the back of the system, says Kamakshisundaram, who explains it might be on an enterprise resource planning (ERP) system, an operational system, a travel and expense database, labor tracking software or a spreadsheet. “
Firms such as GEP, SAP Ariba and GT Nexus, a supplier of a cloud-based supply chain management platform, offer technology that aids companies in capturing spend data, which is often fragmented across a company’s disparate data systems. Such business intelligence tools allow companies to extract data from ERP systems, data warehouses, accounts payable software and even spreadsheets, and summarize it in meaningful ways. The tools can cleanse the data and normalize entries to provide a three-dimensional spend ability.
Once data are housed in one place, a company can begin making some strategic sourcing decisions, beginning with setting its scope. Procurement needs to determine if they want to engage in an enterprise-wide initiative or only use strategic sourcing to manage one or two categories of spend.
“Determine which spend categories you’re going after and then create sourcing initiatives on these categories,” Lutzer advises.
It’s essential that procurement organizations understand the fundamental business problems that the company needs to solve to be dominant in their sector, and tailor their sourcing to those goals. “For example, if the company’s strategy is geographic expansion, then sourcing capabilities and priorities need to align with geographic expansion. The point is to define the things that will be most valuable to the company’s success in the next few years, and to prioritize being able to enhance those things through truly ‘strategic sourcing,’” Huber says.
Essentially, Acharya says strategic sourcing takes a broader view of the procurement process. Yes, a company may need a specific component, but before purchasing it from a given supplier, the procurement organization should also be looking at the quality of service the supplier provides, the viability of the supplier, and the total cost in terms of how the supplier is working with the company to improve the quality of the product and keep the cost down.
“Big Data is behind strategic sourcing,” adds Guy Courtin, vice president of Industry & Solution Strategy for GT Nexus. “The amount of information available helps us better understand our suppliers, and it carries all the way through the value chain. We can trace country of origin, viability of a company, find out if there have been complaints about their service and more.
“All of this information can be used to help procurement make better decisions, and it can be leveraged to get better agreements with suppliers,” he adds. For example, procurement might be able to ask a supplier for a better price or level of service based on the data analytics.
Don’t Forget the People
Technology might help the situation but it doesn’t solve the problem.
“Technology is only as good as the people who are using it,” says Courtin. “You have to get employees to buy in to the change.”
Change management isn’t as easy as one thinks. “Though procurement can easily create these strategic sourcing agreements, they usually cannot mandate that different divisions use them,” he says. “You can influence their use, but you cannot force it.”
Stakeholders may be used to working with one particular supplier, which has been their supplier for some time, thus changing to another supplier—even if they are cheaper or better—requires change management. “There will always be tension with stakeholders saying we are different, we are unique, I can’t risk service or my business to get something cheaper,” says Acharya. “You have to understand what their key drivers are, and make sure you have a clear message for them.”
There always is a “what’s in it for me” mentality that must be overcome, agrees Huber, who states that unless “procurement professionals can demonstrate that they really understand the challenges their business partners face, they will never be fully brought into the inner circle of many aspects of the business.” This means they need to know beyond cost what the stakeholders are concerned with. They might be concerned with the vendor’s reliability, their ability to meet their expectations, and more. All of these things must be factored into strategic sourcing decisions.
Procurement operations also need to fully understand the spend categories their stakeholders are concerned with. For example, if the category is marketing spend, they need to know the nuances involved with buying through an agency, they need to understand print media and digital media, and more. “The best way to become a trusted adviser is to understand the spend category or stakeholder spend you are trying to track, then send someone in who knows that category well to do the negotiating,” Lutzer says.
Lutzer recommends creating a stakeholder committee before procurement reaches out to suppliers or develops a request for proposal (RFP). This committee might meet monthly or quarterly, and it should involve senior leadership. “Ask them what vendors they might consider, set up criteria to qualify vendors, and make them part of the team for these sourcing initiatives,” he says. “When procurement goes out on their own and doesn’t get stakeholders involved, they’re not likely to have buy in later on.”
Keep an Eye on KPIs
Courtier recommends asking the following once a strategic sourcing program is in place. “What is the measure of success? What is the measure of improvement? How do we monitor this moving forward?”
Companies can establish KPIs that track their successes when it comes to strategic sourcing. Huber recommends these “KPIs focus on the value add to the company’s businesses, with traditional measures of “realized cost savings,” compliance and spend under management balanced by Net Promoter Scores (nPS) for satisfaction, and financially sophisticated models reflecting net present value (NPV) contributions to strategic/transformational projects, and upstream/downstream efficiencies resulting from procurement’s contribution. Additionally, other KPIs should track cycle time, end user enablement, use of social media, level of automation, etc.”
Lutzer further recommends companies look at compliance to the strategic sourcing agreements. Review regularly how much of the spend your organization is going through your strategic sourcing agreement. “If you spend $100 million on a specific spend category, how much of it is spent using your sourcing agreement,” he asks. “Are you at 80 percent or 30 percent compliance? What can you do to increase compliance?”
Putting strategic sourcing in the procurement organization’s crosshairs can help companies create synergies and develop opportunities that save them money, spurs innovation, builds greater efficiencies and meets a company’s targeted goals.
7 Ways CPOS Plan to Generate Value Next Year
43% - Working to consolidate spend
39% - Increasing the level of supplier collaboration
31% - Helping to restructure existing relationships
30% - Reducing total life cycle ownership costs
29% - Improving specifications
25% - Restructuring the supply base
21% - Reducing transaction costs
--Source: The Deloitte Global CPO Survey 2016