Value-Chain Report -- Strategic Sourcing

For many companies, externally sourced materials and services represent a significant portion of total costs and revenues. For those companies, development and implementation of sound sourcing strategies can be a key competitive differentiator and often determines who wins and who loses in their industry. These strategies are not uniform; they must be tailored to the specific commodity and its importance to the business. The objectives for an effective sourcing strategy for each major commodity are likely to include:

Defining a strategic vision for the commodity which supports overall business objectives.

Developing a sourcing strategy for each commodity based on assessments of the commodity profile and validated opportunities; strategic imperatives and commodity segments; and total costs of acquisition and possession.

Developing a commodity strategy that clearly outlines how the commodity will be managed in the future and the performance targets to be achieved. Commodity Mapping One of the more useful frameworks for developing commodity-sourcing strategies is the Commodity Map. The purpose of this approach is to organize commodities according to the specific characteristics that lead to strategic alternatives. Typically there are four categories of commodity characteristics: Leverage. The characteristics of "Leverage" commodities include high expenditure levels, many alternative products/services, numerous suppliers, and readily available sources of supply. Strategic. The characteristics of "Strategic" commodities include complex specifications, few qualified supply sources, typically large individual expenditures, and product/service quality is critical. These commodities tend to be highly important to profitability and operations. Routine. The characteristics of "Routine" commodities include many existing alternate products/services, many sources of supply, relatively low value items, small individual transactions that are easily purchased (meaning "anyone" could buy it). These commodities are often unspecified items for everyday use. Bottleneck. Bottleneck characteristics include very complex specifications requiring complex manufacturing or service processes, few alternate products available and few qualified sources of supply. These commodities may have a significant impact on ongoing operations or maintenance or may involve new technology or untested processes involved in provision of the product or service. Understanding the characteristics of each major commodity enables development of specific sourcing strategies using the commodity-mapping process. The commodity map can be thought of as a two-dimensional matrix in which one dimension reflects the degree of business impact of the commodity and the second dimension reflects the degree of supply challenge of the commodity. Business impact is based on expenditure levels, percentage of total spend represented by the commodity, relationship to strategic goals of the company, time sensitivity, and other relevant factors. Supply challenge is based on the availability of potential product substitutions (e.g., technical complexity), supplier alternatives, and other factors related to the buyer's leverage in the market. Strategies for Leverage Commodities The strategic objective for leverage commodities is to minimize total costs. Based on their characteristics, leverage commodities are likely to have a relatively high business impact and relatively low supply challenge. Sourcing strategies for leverage commodities are likely to: Use competitive advantage to reduce total costs; Use enterprise-wide sourcing volumes as a negotiation tool; and trade community and reverse auction solutions. Leading practices associated with leverage commodities include:

Competitive bid agreements

Consortium procurement

Break-out transportation costs/management separately

Pursue value-added services from suppliers that reduce cost (e.g., supplier managed inventory)

Use flexible agreements (within qualified supplier base)

Rapid response to market changes

Trading communities and electronic auction Strategies for Strategic Commodities The objective for strategic commodities is product/service differentiation. Based on their characteristics, strategic commodities are likely to have a relatively high business impact along with a relatively high supply challenge. Sourcing strategies for strategic commodities: Ensure long-term availability of supply; Focus on relationship building and process integration with supplier; and Interactive design collaboration solution. Leading practices associated with strategic commodities include:

Long term/service life agreements

Joint product/process design

On-site representation

Seamless supply-chain processes between companies

System linkages

Supplier manages product/service

Prepare contingency plans

Internet-based collaboration in design process Strategies for Routine Commodities The strategic objective for routine commodities is to minimize the cost of acquisition. Based on their characteristics, routine commodities are likely to have a relatively low business impact and also a relatively low supply challenge. Sourcing strategies for routine commodities: Simplify and streamline acquisition process to achieve efficiencies/cost reductions; Reduce number of suppliers and simplify sourcing process; and catalog aggregation and trading community solutions. Leading practices associated with routine commodities include:

Long-term, competitively bid/negotiated supplier agreements

Suppliers own specifications

Supplier incentive to substitute/standardize; use industry specifications

Reduce/eliminate inventory (e.g., supplier managed inventories)

Outsourcing

Consortium procurement

Budget holder empowerment (e.g., end-user release and decentralization)

Electronic catalog ordering Strategies for Bottleneck Commodities The strategic objectives for bottleneck commodities are to minimize the number of items in this category and to ensure reliability of supply. Based on their characteristics, bottleneck commodities may have a relatively low business impact, but will have a relatively high supply challenge. Sourcing strategies for leverage commodities should: reduce/eliminate risk and exposure to price increases/supply disruption; and secure existing sources of supply and search for possible substitutes. Leading practices associated with bottleneck commodities include:

Life of product/long-term agreements

Provide supplier reason to become 'preferred' (e.g., knowledge/technology transfer, market exposure, expanded relationship, process improvement, product development)

Ownership stake

Manage the whole supply chain

Develop new suppliers Effective management of the supply side of the supply chain can be a primary differentiator that provides significant competitive advantage. Sourcing strategies must align with and support the overall strategic objectives of the company. In formulating commodity-sourcing strategies, the entire organization should be challenged to participate in decisions regarding such issues as:

Assessment of supply needs, existing supplier relationships, procurement processes, and supporting technology.

Examination of internal requirements compared with potential external options to identify the optimal total cost alternative.

Development of an integrated vision and direction for sourcing and procurement strategies, organization, processes, and technology.

Definition of strategies for each major commodity, including total cost of acquisition and possession, supplier performance, leading practices, benchmarks, and other relevant performance metrics.

Selection of strategic suppliers and trading partners.

Implementation of process and technology infrastructures that support the desired sourcing strategies. Kevin P. O'Brien is a Cap Gemini Ernst & Young practice leader for supply-chain consulting with high-growth and middle-market companies.