Strategic Sourcing by… A.T. Kearney 2004

This one is a nice one: The ‘7 step’ Strategic Sourcing approach described by a Vice President of AT Kearney. A reference.

Over the past decade, supply management professionals have developed a way of talking about purchasing that presumes understanding where it might not exist. At a recent ISM Board of Directors meeting, Board members were receiving some training for fielding questions from the media. One of the public relations trainers asked Motorola Chief Procurement Officer Theresa Metty what her role entailed. Metty started to say, “I am responsible for strategically sourcing all of the — ” and was interrupted by the trainer who advised her, “You will have to use terms that the general public understands; no one will know what you mean by ‘strategically source.'” In supply management, we think of strategic sourcing as an organized, systematic, collaborative way to identify competitive suppliers for longer-term agreements to buy materials and services that firms need for direct and indirect purposes. Simply put, strategic sourcing is an organized way of corporate buying.

A little more than a decade ago, purchasing managers were struggling to make their impact felt within their own companies. Except for key materials, senior executives didn’t view suppliers as strategic. “Market price” was what it was, and competitive advantage had to be gained through a collaborative, process improvement approach with key suppliers. Key users within the organization, people in manufacturing, engineering, marketing and information technology, often treated purchasers as tactical negotiators and keepers of contract terms and conditions. Too often, purchasing managers sank into a procedural, bureaucratic role of tracking requisitions and approvals, becoming a non-value barrier between the people who needed something and the suppliers who provided it.

But times changed; leading-edge firms are recognizing supply managers’ strategic sourcing as a value-add process that provides competitive advantage. In order for it to work it must be organized, systematic and collaborative. When we talk about these elements of effective and successful strategic sourcing, what do we mean?

Organized means that sourcing is part of an ongoing enterprise process. It covers all spend categories for materials and services. Sourcing strategies are reviewed and updated periodically by supply managers and by the executives for whom the spend is purchased. Suppliers are invited to be part of the process to varying degrees, depending on the class of category or market dynamics. Senior corporate executives are briefed on key spend categories and may enter the process when the financial or operating impact of an option is significant.

Systematic means that the firm has an agreed-upon process for pursuing strategic sourcing, and it’s applied to all spend category teams in all business units. The systematic process is a key component of the organization’s supply management training — presented in great detail for supply management professionals, in summary for collaborating using departments. Strategic sourcing results are tracked in terms of non-cost performance metrics as well as cost savings. Knowledge from applying the process to spend categories is captured, ensuring continuous improvement for future sourcing teams. Systematic also means that the process is regularly reviewed to incorporate new sourcing tools and approaches, new supplier market opportunities and developments in benchmarking and best practices.

Collaborative means that supply managers collaborate internally, with department managers who use the materials and services purchases, with senior executives on key spend categories and externally, with key suppliers, incumbent or potential, on major new supply opportunities. Collaboration demonstrates the value of supply management. The effective supply manager will not only “get a seat at the table,” but will be viewed as a “value advisor” on strategic supply issues.

Where Have We Come From?

These elements are accepted as key to strategic sourcing now, but how did this proven way of providing better supply management for business evolve? It came from purchasing — purchasing as it was viewed by 1970s era managers and executives. Perhaps you’re familiar with those antiquated perceptions: Purchasing people were brought in to finalize terms and conditions with the supplier someone had already selected — someone who knew far better what supplier would be best. Production planning had the important job of deciding when and how much product should ship to the factories; purchasing ensured on-time delivery. Engineers decided, manufacturers scheduled, quality checked, finance paid and purchasing negotiated the terms and conditions.

In the 1980s, there were signs of change. For example, in the automotive industry, leading thinkers started to investigate alternative sources of supply, outside the domestic, local suppliers qualified by the engineers. The alternative was called “global sourcing.” By challenging the selection process, by taking suppliers and engineers out of their comfort zone, supply managers provided improved pricing, prompt delivery and higher quality, making that car company more competitive than it had been.

This was all happening during the decade of “re-engineering,” when organizations were downsizing without the connected requirement of removing work from internal processes. The great “hollowing out” of business organizations had begun. When business consultants realized that addressing the 50 percent to 80 percent of a firm’s cost structure that came in from the outside might be less painful and more rewarding than identifying people to be downsized, the response from firms was alarming: “We don’t know what we are spending beyond major suppliers. Aren’t we already getting the best prices, set by the ‘market’?” Department managers were defensive: “We can’t afford to challenge those suppliers; we depend on them to keep our factories going, our computers running, our sales flowing, our warehouses full.” Purchasing managers were frightened: “I’ve spent years trying to get a seat at the table and now you are going to ruin it. If you get better pricing than me, they’ll fire me!”

The 1990s brought a three-pronged approach that began to make some headway with organizations that wanted to improve their competitiveness through better corporate buying. A business consultant could come in and address the above-mentioned concerns:

1. Executive involvement. Mr/s. Executive: You’re spending more than you think. Key suppliers are not as large a proportion of that spend as you think. We can address some of the unimportant spend categories with your people to save you significant dollars.

2. Department manager involvement. Mr/s. Administration, Information Technology, Marketing, Logistics: We can combine with your people to identify supplier requirements and apply a “proven” process, saving money and negating the need for downsizing.

3. Purchasing acquiescence. Mr/s. Purchasing Director: We will work with you to apply a “proven” process that will build your credibility with department heads and senior executives, thereby increasing the amount of spend that you influence and bringing you credit for achieving enormous savings.

What to call this “proven” process? “Global sourcing” incorrectly implied the necessity of foreign suppliers; “aggressive sourcing” sounded too literal. Finally, we decided on “strategic sourcing” because any approach that produced that extent of results had to be strategic, or should be.

The “proven” process was the seven-step process described below. One key lever behind the process was the use of multi-disciplined teams to apply it (teams that included other departments in addition to purchasing. Most of the time, the teams were led by non-purchasing people.). Another key lever, and most important, was a corporate-wide program of “waves” of sourcing categories sponsored by a committed senior executive. The wave structure enabled the communication of significant improvement and the recruiting of a cadre of successful sourcing “ambassadors” to the rest of the (still non-believing) company.

What Has Worked?

For the next 10 years, this formula worked. It worked in manufacturing companies and consumer products companies. It worked in retailers, telephone companies and pharmaceutical companies. It even worked in banks and other financial institutions. There has been no reason for it not to work in all companies; unfortunately, it has been applied successfully in only around 30 percent of North American companies, 20 percent of European companies and less than 10 percent of companies in the Asia-Pacific geography.

Why hasn’t it worked in a higher proportion of firms? There are three types of factors, with many individual reasons. The three factors are connected to philosophy, organization and technology. Let’s discuss these briefly before looking into our crystal balls to see what lies in the future.

Philosophical tension. There has always been a philosophical tension between the ideas around competition and collaboration with suppliers. Proponents of competition make the case that a competitive supply market uses economic laws to ensure the lowest possible price at a set quality and service level demanded from buying communities. Suppliers will adjust their plans and performance to meet market requirements or they will exit the market. Proponents of collaboration make the case that a strong supply or value chain requires the identification of best-of-breed innovation from a supply base that partners with its customers to provide the best value to its end customers. Proponents of collaboration seem to be as much fearful of the misuse of competition as they are convinced of the benefits of collaboration. Toyota is often used as an example of a company that has managed to be competitive and collaborative at the same time. AT&T, prior to divestiture, might be an example of a planned, collaborative value chain that was slow to introduce innovation, keeping higher consumer prices while maintaining inefficiencies in its supply base. A balanced approach between competition and collaboration is the ideal, but companies continue to avoid the benefits of one for fear of misusing the other.

Organizational misalignment. Organizational misalignment has also been a continuing deterrent to more widespread use of strategic sourcing. Senior executives lose interest after the first several waves of sourcing have taken place. A senior executive will think, “I thought I fixed that — aren’t we still using an organized, systematic, collaborative approach for supply cost competitiveness?” In addition, a corporate executive may be challenged by a divisional executive who resists complying with a corporate purchasing program. In fact, when there is an opportunity to leverage corporate spend and processes to improve a division’s competitiveness, there is no reason not to participate, particularly when it applies to non-core spending. Unfortunately, department managers gradually return to the less cooperative practices of the past. Those who did not participate in the original waves of sourcing have not experienced the value from the program. They are less willing to collaborate with purchasing to identify alternative suppliers or create improved supply chain and commercial opportunities. Purchasing managers also may lapse into pre-sourcing behavior — taking shortcuts in the seven-step process, avoiding the rigor in conducting the analysis, and giving alternative suppliers the impression that they’re only being used to hammer on the incumbents. Supply management executives have to continue to raise their level of performance, demonstrating that they have much more to offer than traditionally thought.

Tools and technology. Finally, tools and technology are often blamed for incomplete application of the process. “If we only knew what we spent by category, by supplier, by business unit, we could… We don’t have time to determine all the potential suppliers and proposals…” In fact the tools and technology have overcome most of the objections that were originally made against the software as it was introduced. The Internet is fast enough, secure enough and widespread enough. Suppliers will participate, users will report and finance will fund investments. Tools and technology continue to support and accelerate the process. The tools get better and better each year — it is executives’, department managers’ and supply management executives’ unwillingness to deal with change that is the barrier to their use, not the technology itself.

Where Do We Go From Here?

Beginning in 2000, a number of improvements were becoming part of the landscape of supply management, such as e-tools, consortia and public marketplaces. While the tools continually evolve and marketplaces have died out in some areas, they continue to be pursued, if at a much less frenetic pace than during the dot.com buildup. Indirect ordering and transaction software has become an accepted part of the landscape; companies have overcome some of the early catalog implementation issues; they are addressing more mundane change management issues now.

Strategic sourcing will continue as the basic approach for supplier identification, acquisition and implementation, but more and more, organizations will be looking for value beyond sourcing. That value may be connected with usage, such as demand or consumption management processes. Additional value may be derived from mega-supplier strategies for those suppliers that have an effective monopoly for categories or have complex customer-partner relationships beyond their supplier roles. Additional value may be gained from determining what supply categories are core and what are non-core, and investing in the former while outsourcing the later. Additional value may be gained from building an ongoing supplier risk assessment process, providing comfort in an increasingly dangerous world. Additional value may come from more systematic collaborative cost reduction programs with suppliers. Additional value may come from specialized category solutions that provide specialized operating support for users — temporary labor, promotional print and maintenance, repair and operating (MRO) solutions are examples that already exist.

Nonetheless, strategic sourcing will continue as the organized, systematic, collaborative process for establishing and maintaining spend category relationships with suppliers. It will struggle to get the attention that it deserves with executives and using departments and will constantly seek balance between competition and collaboration. Those who thought it was another “management fad” will be mistaken. Strategic sourcing has endured for a least a decade and it will continue to be an important component of supply management well into the future.

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. However, even before beginning with the first step with a particular category, the methodology begins with a diagnostic of a company’s spend. The diagnostic divides the total corporate spend into categories that roughly relate to the supplier markets. It typically further divides spend categories by the business units or locations, and it identifies each supplier. The diagnostic seeks only an 80 percent precision, not Six Sigma standards. You will see that in Step Three, beyond the initial diagnostic, when sourcing teams need to refine spend data for each category, the supplier may be a more accurate source (even if buyers are embarrassed to use it).

The diagnostic provides a spend map by category. Spend categories are then classified by the competitiveness for the supplier marketplace compared to their internal impact. This results in a spend category positioning matrix (the familiar four-quadrant grid), which directs supply managers to a potential sourcing strategy for the category. The matrix plots categories as critical (low supply market competitiveness, high business impact), leveraged (high supply market competitiveness, high business impact), bottleneck (low supply market competitiveness, low business impact); and non-critical (high supply market competitiveness, low business impact).

Once the diagnostic is complete, companies must decide which categories to address immediately and which to delay until internal and external conditions are better. For those categories it chooses to address, the seven-step process begins.

Step One

The first three steps are conducted concurrently by the sourcing team. In Step One, the team ensures it understands everything about the spend category itself. For example, if the category is corrugated packaging at a consumer products company, the team will make sure that it understands the definition of the category, confirms usage information and knows why the types and grades of corrugated were specified. Company consumers at all operating units and physical locations would be identified; other people with an interest in corrugated packaging would be identified — logistics people who need to know strength and other shipping specification, marketing staff who need to understand visual and quality or environmental characteristics (if applicable). Existing supplier relationships should be cataloged and understood, as well as the existing purchasing processes that users and suppliers are familiar with because there will likely be changes to them.

Step Two

At the same time, Step Two, the supplier market assessment, begins. Additional suppliers, other than incumbents, are identified. Key supplier marketplace dynamics are identified, and supplier and user should-cost information is determined. Major supplier cost components are evaluated, and the supplier’s supplier marketplace is analyzed for risks and opportunities. In the corrugated category example, it will be particularly important to set up a map of potential serving locations (versus need locations) due to the impact of transportation costs on the category.

Step Three

In Step Three, the sourcing team develops a supplier survey for both incumbent and potential alternative suppliers. The survey helps evaluate the suppliers’ capabilities to serve as well as their costs to serve. At this time, the team will also verify spend information with the data that incumbent suppliers may have from their sales systems.

Step Four

Step Four is developing the sourcing strategy. The combination of the first three steps — the internal assessment, the market assessment and updated supplier information — provides important input to developing a sourcing strategy in Step Four of the process.

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 or connected categories?

How competitive is the supplier marketplace? Armed with the information from Step Two (incumbents, alternatives, a “Five Forces” competitive assessment), you are ready to build the competitive tension in the supplier marketplace. This will demonstrate the “size of the prize” to be won to motivate alternative suppliers and to communicate the seriousness of a potential sourcing exercise to your incumbents.

How aligned is your organization to the need versus opportunity to test incumbent relationships? The sourcing team has two sets of constituencies: 1) the people who use the things that are bought, and 2) the executives who manage overall costs. The people who use the spend category accept cost reductions as long as they a) start in another department; b) don’t change incumbent suppliers; and c) don’t create any complaints from the supply base that might affect any part of the relationship — delivery reliability, service or payments. For users, all change is bad.

For executives, cost and service competitiveness is a key objective, but they too are users of various corporate services, so they often have a split personality between executive pursuit of cost improvement and being users who resist change. (“Get better costs for my key components, but don’t change my travel agent” is a typical manifestation of this split personality.)

In order to mobilize users and executives to support the category sourcing strategy, it is necessary to communicate benefits (particularly to the executive) and overcome potential risks (particularly to the users).

What alternatives to a competitive assessment exist for your organization in this or connected categories? If the supply base is competitive, you will be able to harness those forces for better pricing or terms due to increased volume of streamlined product specification. Once the result of the competitive sourcing effort is determined, you will then set up a collaborative program that will continue until the next logical, appropriate competitive sourcing event takes place.

If you don’t use a competitive approach to sourcing, what are your alternatives? The alternatives consist of collaborating with suppliers 1) to reduce complexity to build increased productivity into their process; 2) to create joint process improvements that reduce the cost of doing business; and 3) to set up relationship restructuring where firms invest in supplier operations to guarantee access to supply, new technology or process improvements. These alternatives are typically pursued where the buying company has little leverage over its supply base; consequently, buying companies are relying on good faith sharing of benefits from their suppliers.

Your sourcing strategy will be an accumulation of the levers depicted in the “sourcing gemstone” below. A high-buying, cost-based power approach toward the competitive marketplace will enable global alternatives, best price comparison, volume concentration advantages and perhaps, product specification improvements. Collaboration will begin to be addressed by competitive proposals and will continue after supplier selection.

Step Five

For most of the spend categories, a competitive approach is used, requiring Step Five, preparing a request for proposal and preparing and soliciting bids. This will define the basis for competition to the prequalified suppliers. It includes product or service specifications, delivery and service requirements, evaluation criteria, pricing structure and financial terms and conditions. Also in Step Five, a communication plan will be executed that will attract maximum supplier interest, ensure that every supplier will be competing on a “level playing field” and enable the buying organization to come to an optimum selection decision. The RFP is then sent out to all suppliers and they are given enough time to respond completely, with follow-up messages sent to encourage supplier response and field questions.

Step Six

In Step Six, negotiate and select suppliers, the sourcing team applies its evaluation criteria to the supplier responses. If more information beyond the RFP response is needed, it’s requested. The negotiation process is conducted first with a larger set of suppliers then narrowed to a few finalists, if it is done manually. If the sourcing team uses an electronic negotiation tool, more suppliers may be kept in the process longer, giving alternative or diversity suppliers a greater chance at winning the business. Award scenarios are conducted to compare a series of outcomes in terms of total value or implementation cost differences. Using departments are brought into the final selection process. Senior executives are briefed on the selection outcome; their approval is obtained, and they understand the rationale so that they are prepared to receive calls from any disappointed suppliers.

Step Seven

Finally, the winning supplier(s) are notified and invited to participate in Step Seven, 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. These are communicated to the users as well. The company may have received significant improvements from the process; it’s important that those are recognized by the company 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 company’s process that is touched by the spend category. Receiving docks, using department, finance and customer service are often impacted by a change, and their risk antennae will be up 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 during that sensitive time.

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 corporate memories should questions arise.

There are three important feedback loops in the seven-step process:

1. Measure and report

2. Capture learning

3. Ensure compliance

Measure and report is a way to measure the benefits from the sourcing exercise through the life of the new arrangement and report results to using departments and executive groups, addressing all-too-frequent comments like, “They say they saved a lot in that category, but I’ve never seen it.”

Capture learning begins with the internal and external assessments in Steps One and Three and continues to capture learning throughout the process. Supplier market dynamics change, supplier contacts change, new entrants appear in supplier marketplaces and people change 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 supply management. 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. Supply management must maintain contact with the supplier to build on the relationship during the ongoing relationship.

Used accurately and thoroughly, this seven-step “proven” process that is strategic sourcing can give enterprises the competitive advantage that ultimately elates corporate executive, users and supply management professionals alike.