Strategic Sourcing: A Recipe for Strategic Excellence
By Roger L. Ball
For much of the 20th century, the process of
acquiring goods and services was considered as somewhat of a nuisance. However, over the past 10 years, the competitive business environment has shifted from a relatively stable to a dynamic and intensely competitive environment. This new environment has forced businesses to reduce costs, increase productivity, and look for ways to better manage expenses.
In managing expenses, senior executives in organizations have realized that on average, 50 percent or more of an organization’s operating budget results in purchased inputs—or those funds flowing through the purchasing department resulting in purchased goods and services. Therefore, many have concluded that the decisions made by purchasing professionals in spending these funds can largely determine the financial viability of the organization. Indeed, all of these issues serve as a driving force that continues to influence the visibility of purchasing and its role in creating customer value and helping organizations achieve greater strategic success.
At a time when organizations are becoming increasingly aware of the value that an effective procurement process can deliver, leading-edge purchasing departments are collaborating with top-tier suppliers to spur innovation, apply joint expertise to product development, identify new product and market access opportunities, and provide new intelligence for strategic decision-making.
These professionals have heard the message of senior administrators and recognize that strategic sourcing can be a valuable tool in helping the purchasing function move to center stage as a credible contributor within the organization.
What is Strategic Sourcing?
Although strategic sourcing can be defined in a number of ways, a good start to understanding it is to first identify what it is not. Strategic sourcing is not the purchase of materials and services on an as-needed, day-to-day, hand-to-mouth basis. This is largely transactional buying. Instead, strategic buying is the opposite: A systematic process that directs purchasing and supply managers to plan, manage, and develop the supply base in line with the organization’s strategic objectives—and in a manner, that optimizes the contribution of the supply base to the organization. Figure one, page six, provides a comparison of transactional buying and strategic buying.
Some definitions focus on supplier relationships and others focus on the concept of applying long-term business objectives to sourcing decisions—both are valid. The Institute for Supply Management (ISM) defines strategic sourcing in the following manner:
Strategic sourcing is a process driven by an identified goal or need and consists of:
• Evaluating current and potential sourcing opportunities and
• Assessing their value and relevance according to long-term goals and overall business and supply management objectives.
• Formulating and applying actions plans and processes for critical commodities or supply networks.
Ultimately, strategic sourcing is knowing what kind of relationship to develop based on market knowledge, the commodity, and the long-term business objectives. It is a sourcing process whereby organizations choose suppliers in a deliberate, calculated fashion. Selection decisions are determined based on factors such as a supplier’s new product development capabilities and capacity to share information electronically, or the ability for a supplier’s component to differentiate the final product. With strategic sourcing, organizations analyze and decide on suppliers based on the strategic impact of potential suppliers and commodities on the organization or supply chain, instead of simply awarding supply contracts to suppliers with a narrow focus on lowest bid.
Key to strategic sourcing is gaining an understanding regarding the supplier landscape in order to determine the following:
• Who are the suppliers?
• How are they related?
• What is the customer buying?
• Who are they buying from?
• What are the risks?
• How much is spent with each supplier?
• What is the quality of goods purchased?
Julie S. Roberts, in her March 2002 Inside Supply Management
article entitled, “Sourcing Strategically: It’s Your Move,” notes that “commodities should be evaluated in terms of their relation to the organization’s overall objectives. If an item has little bearing on the objectives, it might be handled as a transactional purchase with a transactional supplier relationship. However, if the commodity helps the organization retain a competitive advantage, then the supply manager ought to devote his or her energies to strategically sourcing this commodity.”
What should be done with less critical commodities? In many cases, strategic approaches taken for less than strategic commodities involve identifying suppliers that require minimal day-to-day management. Commodities purchased from these suppliers may be purchased using e-procurement tools and purchase cards, both designed to simply the acquisition process and minimize costs, but also provide acceptable levels of quality, services, etc.
Effectively managing less strategic commodities also plays a key role in the strategic sourcing pro-cess, primarily as a means for allowing additional time and resources to be devoted to “high-impact” purchases.
Why Strategic Sourcing?
The importance of strategic sourcing was highlighted by Michael Eisner, CEO of The Walt Disney Company, at a shareholder’s meeting in Chicago, IL. Mr. Eisner stated, “Another effort underway to optimize our company’s performance is our strategic sourcing initiative, a top-to-bottom review of our purchasing practices. Within five years, we expect to be saving more than $300 million annually from strategic sourcing. Since we’d all rather I talk about movies, let’s put this in terms of movies: $300 million is the equivalent of earning the combined ultimate profits of “The Rock,” “Ransom,” and “The Waterboy” each year and every year.”
Strategic sourcing benefits for an organization include:
1. Improved ability of the organization to achieve strategic goals due to alignment of purchasing strategies with business strategies.
2. Improved contribution from purchasing outcomes resulting from the increased support that purchasing processes and initiatives receive from being aligned with business strategies.
Organizations creating supply advantage will sort through current suppliers and determine how their role and their relationship should change. Mindful of its own core competencies, an organization will decide which services to maintain, and which to outsource. It will decide which relationships should be transactional, collaborative, or strategic, and which relationships to drop and which to nurture. At the end of the day, the result is a few, select supply-advantage alliances in which the members become partners in innovation, leading to optimum efficiency in the source selection process. Figure two, page eight, provides an example of how commodities and supplier relationships are analyzed in strategic sourcing.
Lets examine some over-arching principles of the strategic sourcing process. Regardless of how you establish your strategic sourcing plan, it should be taken in stages and well documented. Without written documentation and tracking, you will likely begin to see the process become stagnated and your desired goals not met. It is important also that the process have bottom line impact—meaning that measurable deliverables are essential. Remember, you can only manage what you can measure. Solid, measurable results from supply alternative initiatives can be used to illustrate that the strategic sourcing approach contributes significantly to the achievement of business objectives and improves the bottom line. The process must also have a time line. Without scheduling tasks, it is easy to let things slide in lieu of the normal day-to-day tasks. The process must be realistic. Setting unattainable goals will only serve to frustrate people, leading to the inevitable phrase, “I told you it wouldn’t work!” The process must not contain every contingency. The resulting “paralysis by analysis” will leave you wondering if you’ll ever get the sourcing effort airborne. Last, and most important, understand that your key stakeholders not only include your customers, but your suppliers too.
Making It Work:
The Seven Step Sourcing Process
At the heart of strategic sourcing is a seven-step process. It can be applied to each of an organization’s spend categories. Like all business pro-cesses, there is no single, right or wrong solution. This article merely outlines one angle used in actual practice. Figure three, above, provides a graphic overview of the seven-step strategic sourcing process.
Step One—Conduct Internal Assessment
In Step One, the team ensures an understanding regarding all details related to the spend category. For example, if the category is wastewater treatment chemicals at a public utility, the team will make sure that it understands the definition of the category, confirm usage information, and know why the types and grades of chemicals are specified. Consumers at operating units are identified; other people with an interest in the commodity are identified. Existing supplier relationships are cataloged and understood, as well as the existing purchasing processes that end-users and suppliers are familiar with because more than likely, there will be changes to existing processes.
Step Two—Conduct Market Assessment
Alternative suppliers, other than incumbents, are identified. Key supplier marketplace dynamics are identified, and supplier and user target cost information is determined. Major supplier cost components are evaluated, and the supplier’s supplier marketplace is analyzed for risks and opportunities.
Step Three—Collect Supplier Information
In Step Three, the sourcing team develops a supplier survey for both incumbent and potential new suppliers. The survey helps to evaluate supplier performance capabilities and cost. The team also verifies spend information with data provided by incumbent suppliers.
Step Four—Develop Sourcing Strategy
Step Four is the development of the sourcing strategy. The combination of the first three steps—the internal assessment, the market assessment, and updated supplier infor-
mation—provides important input to developing a sourcing strategy.
The sourcing strategy for the category will depend on three factors:
1. How competitive is the supplier marketplace?
2. How aligned are your organization’s users on the need versus opportunity to test incumbent relationships?
3. What alternatives to a competitive assessment exist for your organization in this category or closely related categories?
Step Five—Solicit/Evaluate Offers
Step Five involves preparing a Request for Proposal (RFP). This will define the basis for competition to the pre-qualified suppliers. It includes product or service specifications, delivery and service requirements, evaluation criteria, pricing structure, and financial terms and conditions. In addition, a communication plan is executed that will attract maximum supplier interest, ensure that every supplier competes on a “level playing field,” and enable the buying organization to arrive at an optimum selection decision.
Step Six—Negotiate/Select Suppliers
In Step Six, the sourcing team applies its evaluation criteria to the supplier responses. If additional information is needed beyond the RFP response, it is requested. Conduct the negotiation process with a larger set of suppliers, then narrowed to a few finalists. If the sourcing team uses an electronic negotiation tool, more suppliers may be retained in the process longer, providing greater opportunities for success among diversity suppliers. Award scenarios are conducted to compare a series of outcomes in terms of total value or implementation cost differences. User departments are included in the final selection process. Senior executives are briefed on the selection outcome and their approval is obtained. Senior executives are prepared to receive calls from any disappointed suppliers once they understand the rationale.
Step Seven—Implement Recommendations
In Step Seven, the winning supplier(s) are notified and invited to participate, implementing recommendations. Implementation plans vary depending on the degree of supplier switches. For incumbents, there will be a communication plan that will include any changes in specifications, improvements in delivery or service requirements or pricing. The buying organization may have received significant improvements from the process. It’s important that improvements are recognized by the organization and by the supplier.
For new suppliers, a communication plan has to be developed that manages the transition from old to new supplier at every point in the organization’s process that is impacted by the spend category. Receiving docks, using department, finance, and customer service are often impacted by a change, meaning that they will be particularly sensitive to risk during this period. It is particularly important to measure the new supplier closely in the first several weeks of performance. Being able to demonstrate performance equal to or better than the former incumbent to your using organization will be particularly important.
It is also important to capture the intellectual capital that your sourcing team has developed during the seven-step process, for use the next time the category is sourced and to refresh memories should questions arise.
Three important feedback loops in the seven-step process, include:
1. Measure and report.
2. Capture learning.
3. Ensure compliance.
“Measure and report” gauges the benefits from the sourcing exercise through the life of the new arrangement and reports results to using departments and executive groups, addressing familiar comments like, “The word is that they’ve saved a lot in that spend category, but I’ve never seen it.”
“Capture learning” begins with the internal and external assessments in Step One and Step Three and continues to capture information throughout the process. Changes in supplier marketplace dynamics, including new entrants, supplier contracts, and personnel in using departments all need to be captured. Some of the spend analysis and e-sourcing tools available today have such electronic means.
“Ensure compliance” is aimed at the supplier, the using department, and the purchasing department. The supplier must be measured against performance metrics that were agreed upon in the sourcing process. The using department must not solicit new suppliers or alter the performance terms that were agreed on. Purchasing must maintain contact with the supplier on an ongoing basis to build on the relationship.
Where Can You Turn For Additional Help?
There are a number of tools and resources available to assist purchasing professionals in acquiring critical skills needed to be successful in strategic sourcing. These include resources such as:
• References—Textbooks, magazines, and various industry-specific publications.
• People—Peers in the purchasing profession.
• Technology—Internet and Intranet.
• Education—Professional organizations such as the National Institute of Governmental Purchasing (NIGP), the Institute for Supply Management (ISM), and the National Contract Management Association (NCMA).
• Benchmarking—Center for Advanced Purchasing Studies (CAPS) maintains an ongoing database of procurement “best practices.”
Make the Commitment
The seven-step strategic sourcing process will not necessarily work for all commodities. You will find that some will not make it beyond the market assessment stage, as they are already being sourced in the most economical means possible (or the culture of the organization is simply not prepared to embrace the change). However, for a large number of high-profile, high-spend areas, the process will typically yield better results. Even for an organization that manages its purchased dollars reasonably well, a well planned and executed strategic sourcing effort can yield an additional 10 to 15 percent savings.
There is great pressure for a change in the approach to sourcing across all sectors of business and within all sizes of organizations. Strategic sourcing is a proven framework to support such a change. This approach identifies the right suppliers for the organization to align with. The key is to attack the spend category by commodity, ensure that major stakeholders agree to the sourcing process and the results, and effectively measure the results for further enhancement and improvement.
Editor’s Note: Roger L. Ball, CPPO, CPPB, C.P.M., A.P.P., is Director of Procurement Services at the District of Columbia Water and Sewer Authority, based in Washington, DC. He has 19 years of experience in managing purchasing and supply management organizations at federal, state, city, and county levels of government. Ball focuses on strategic procurement, process improvement, and increasing efficiency and credibility within the procurement function. Currently, he is an instructor for the National Institute of Governmental Purchasing (NIGP), and he has presented many workshops and seminars. During 2001 and 2002, Ball served as President of NIGP’s Metropolitan Washington Chapter. In 2001, he received NIGP’s Robin J. Zee “Best Practices” citation for successfully implementing trend-setting practices. Readers who have any questions or comments about this article can contact Ball via e-mail: [email protected]
The views expressed in this article are the personal opinions of the author and do not necessarily reflect the views of the District of Columbia Water and Sewer Authority.