Putting the “Strategic” Back Into Sourcing

Putting the “Strategic” BackInto Sourcing

by

Matt [email protected]

Harriet [email protected]

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Putting the “Strategic” Back Into Sourcing

The vice president of purchasing at a major high-tech company emerged from another beat-ing at the monthly leadership team meeting. He had just proposed the centralization of the purchasing department, including the idea of bringing the company’s supplier quality and com-ponent engineering groups under the purchasing umbrella. Not only did none of the other manag-ers support this concept, but his boss rejected the idea outright without any hope of future dis-cussions. The VP was sure that the only way to control spending and increase savings in this key part of the supply chain is to centralize the department. He was similarly rebuffed when he initially proposed a supplier scorecard last year, cross-enterprise sourcing teams the year before, and the use of e-Sourcing tools the year before that. When those initiatives were eventually imple-mented, they reaped millions of dollars in cost savings for the company. Nevertheless, the VP continues to encounter roadblocks whenever he tries to introduce the latest sourcing concepts into the company. Why, he wonders, does it feel like he is trying to move a mountain every time he proposes new ways to increase cost savings through purchasing?

As the case of this high-tech company illustrates, despite the fact that “strategic sourcing” programs

began to proliferate in the 1990s, sourcing is still largely relegated to a nonstrategic position. Purchasing departments do not gain the respect that they deserve, although sourcing-related programs have produced hundreds of millions of dollars in cost savings for many companies. At issue is the manner in which purchasing departments usually seek these cost savings. Initiatives are generally piecemeal, tactical, and narrowly focused. Last year’s supplier scorecard is not linked to this year’s department reorganization or previous strategic sourcing efforts or technology implementations. Management is continually asked to support these disorganized programs with precious resources. Upon completion of these initiatives, budgets often get cut throughout the organization, and business units, which bear the brunt of the budget cuts, are asked to back yet another new purchasing plan that will monopolize additional resources in the following years.

When companies choose to back strategic purchasing programs, savings are usually achieved, but these sav-ings are curtailed when enterprise support is limited. The primary reasons: Without full buy-in from the entire company, contracts aren’t adhered to, policies aren’t followed, and technologies aren’t fully utilized. A recent Booz Allen Hamilton survey found that when there is cross-functional participation in supply chain planning, purchasing savings increase by more than 20 percent.

Despite the difficulties and company friction, we believe that now is the time to take the procurement agenda to a higher level, by adopting a strategic, integrated

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approach to purchasing throughout the organization. To reach the full potential of the procurement agenda, organizations must take a broader, more holistic, and more strategic approach to purchasing.

A successful procurement agenda needs to address four key dimensions: processes, organization, technol-ogy, and performance management (see Exhibit 1). These dimensions must be developed into a compre-hensive plan and should be addressed one by one on the basis of corporate and business unit objectives, goals, and strategies. The Booz Allen supply chain survey found that companies that are willing to take a broad approach and break the constraints of their supply chains achieve purchasing savings 55 percent higher than those of companies just optimizing the chain within its current constraints.

Evolution of Procurement

For many years, the purchasing department served largely as clerical support for the business units. Its primary function was to send suppliers purchase orders based on requisitions received from other departments, which, in many cases, had already selected the supplier and negotiated the price. Purchasing would also follow up on the orders and make sure that the proper paperwork was completed. In addition, the purchasing department was occasion-ally involved in administering contracts, and it kept track of supplier contact information.

In the 1980s, many companies began to recognize the importance of the purchasing function as they reduced their vertically integrated structures and began to look

Exhibit 1Strategic Purchasing Agenda

Source: Booz Allen Hamilton

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To overcome this chaotic approach to purchasing and to gain the greatest returns from procurement initia-tives, companies should start by viewing procurement as a broad, cross-functional activity that extends well beyond the purchasing department. They must address the multidimensional nature of procurement, and develop and execute a coordinated multiyear internal transformation program to adopt a successful purchasing strategy.

The Home Depot Inc. has done this, and to good effect. The home improvement chain’s approach to pur-chasing dovetails perfectly with the company’s strategy of everyday low prices and regional variety. In 2001, Home Depot CEO Robert Nardelli consolidated its purchasing of core products—75 percent of the items the retailer sells—in a central purchasing unit at corpo-rate headquarters in Atlanta. The main reason for this move, Mr. Nardelli said, was to gain better control over inventory (the number of products that Home Depot carried had proliferated in the previous years) and to use bulk procurement leverage to purchase goods at the lowest cost. And even while instituting this strat-egy, Mr. Nardelli continued to allow regional units to make purchasing and inventory decisions regarding specific products needed to satisfy their own markets. Today, the company backs this approach with propri-etary technology used to forecast materials needed and to track both imported and domestic materials in real time. Technology is also used to control maverick buying, as only invoices from system- generated orders are processed. In addition, systems provide exception reports that measure anomalies in the performance of suppliers. With this strategic approach to purchasing as a critical earnings driver, Home Depot’s operating income rose 14 percent between 2001 and 2003.

Setting the AgendaTo achieve purchasing success similar to that ofHome Depot and other leading companies, the strategic agenda must address the four elements identified earlier.

outside for suppliers. As a result, purchased goods and services became a bigger part of the cost struc-ture of many companies. The purchasing department, however, was typically not equipped to take a larger role in managing these outlays, and the business units were hesitant to cede this control.

With costs of purchased goods and services growing, in the 1990s there was a proliferation of “strategic sourcing” programs designed to cut back on expendi-tures. Companies organized cross-functional commod-ity teams to pursue more effective supplier strategies. The number of suppliers was reduced on many com-modities so that companies could build stronger rela-tionships with fewer, more critical suppliers. Moreover, new purchasing ideas began to attract attention. For example, Booz Allen’s “Balanced Sourcing” concept described a methodology for reducing costs and at the same time building cooperative relationships with sup-pliers (see “Balanced Sourcing,” page 4). Long-term corporate contracts were signed, especially for indirect items (i.e. expenditures not directly related to produc-tion, such as travel and office supplies). Later in the 1990’s, with the Y2K upgrades, technologies flooded the market with promises of revolutionizing purchas-ing and the Internet age introduced new concepts like Web-based exchanges and auctions, e-Sourcing, and other online transactional programs.

Many companies claimed huge savings as a result of such initiatives. These nascent strategic sourcing efforts yielded cost cuts on indirect materials of an average of 10 to 15 percent. Furthermore, reverse auctioneers touted savings of up to 35 percent on a variety of custom and commodity products in many industries. But despite these gains, purchasing depart-ments have continued, in many cases, to maintain an arm’s-length relationship with the business units, their clients and the mechanism to realizing those savings. And too many companies have adopted the latest pur-chasing fad without connecting it to other initiatives. Consequently, these sourcing efforts often generate confusion within the organization, especially with regard to how they fit into an overarching company strategy and how business units or the company will benefit.

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Balanced Sourcing

Tim Laseter wrote the book Balanced Sourcing: Cooperation and Competition in Supplier Relationships(Jossey-Bass) in 1998 while a Vice President at Booz Allen Hamilton to establish a framework and methodology for developing cooperative relationships with suppliers and simultaneously achieving needed cost savings. Based on the firm’s experience and research, the book discusses the development of a broader set of organizational purchasing capabilities:

1. Modeling Total Cost 4. Integrating the Supply Web 2. Creating Sourcing Strategies 5. Leveraging Supplier Innovation 3. Building and Sustaining Relationships 6. Evolving a Global Supply Base

The first three capabilities are the core processes for defining and developing the supply base; as such, they are universally applicable to any type of company. The second three highlight different ways to leverage the supply base for competitive advantage. Most companies focus on one of these latter capabilities at most; only the largest and most sophisticated companies can afford to pursue all three.

1. Modeling Total CostUnderstanding the economics and the cost drivers of purchased goods and services through cost modeling is the most fundamental capability. It provides focus to cooperative efforts and ensures that prices reflect underlying economics.

2. Creating Sourcing StrategiesA sourcing strategy is analogous to a business strategy. Done well, both can create a competitive advantage that will deliver superior returns. Just like a business plan, a well thought-out sourcing strategy reflects a deep understanding of industry economics and dynamics and, by quantifying the potential returns, presents a compelling case for investment.

3. Building and Sustaining RelationshipsHow a company approaches the challenge of building and sustaining supplier relationships sets the tone for long-term cooperation. Setting improvement targets, structuring incentives, and investing in supplier development all play a role in finding the right balance.

4. Integrating the Supply WebAs companies’ relationships with suppliers grow ever more complex, the supply chain increasingly resembles a web. Managing such a complex network becomes even more critical because the cost of an inefficient supply web can be dramatic. Opportunities for improving the supply web have been a focal point for many years, but are far from tapped out.

5. Leveraging Supplier InnovationCompanies employ a variety of techniques to manage technology development with suppliers. Setting aggressive but valid supplier cost targets, for example, drives cost improvement without ruining a cooperative relationship. In recent years, many companies have shifted their attention from cost reduction to growth, enhancing their ability to innovate.

6. Evolving a Global Supply BaseExpansion of the supply base outside a home market may be prompted by a desire to find low-cost suppliers or to support global expansion of the company’s operations. Whatever the motivation, the challenges of purchasing materials and parts from a distant location, currency exposure, and cross-cultural communication mandate a substantial upgrade in capabilities for most organizations.

These six capabilities still resonate today. However, in addition to the development of procurement processes and relationships with key suppliers, businesses also need to think about organizational attributes, technology, and performance management. And the procurement agenda should include the development of a vision to achieve results that can be measured in the form of profitable operations and competitive advantage.

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1. ProcessesProcurement process development needs to span the strategic, tactical, and executional (see Exhibit 2). Well-defined processes should be driven by the over-all company strategy and should bridge the extended enterprise by connecting customers’ needs (via the business units) to the supply base. Strategic pro-cesses should be defined by the overall procurement policy. These processes establish which commodities will be needed and from whom they should be pro-cured. Tactical processes address product and service specifications, as well as how much of each commod-ity will be needed and when. In addition, companies must determine the types of supplier relationships that they require and design a plan to achieve those rela-tionships. Executional processes set up the procure-to-pay system: how requisitions, purchase orders, and

invoices should be processed. All processes should be interlinked to form the overall aligned process architec-ture. For example, a decision to employ a global sourc-ing strategy should define supply base relationships and require executional processes that govern how purchase orders must be processed.

2. OrganizationPurchasing processes need to be supported by the appropriate organizational model. Organizational design can frequently be a point of real contention within a company. Business units want their “own” employees managing their procurement to ensure that decisions are made in their best interest, but corporate manage-ment wants to ensure that initiatives benefit the orga-nization as a whole. Many companies view the orga-nizational model as a decision between centralized,

Exhibit 2Best Practice Procurement Process Framework


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decentralized, hybrid, and other structures (see Exhibit 3). But a full organizational strategy needs to address questions of:

Spend Segmentation: How should commodities be pri-oritized to reflect the company’s strategic priorities?

Roles and Responsibilities: What role should p ur- chasing play for the various commodities (e.g., managing the program, driving the agenda)? How and when should the business units be included in the sourcing process?

Organizational Alignment: Will a centralized, decentral-ized, or hybrid structure best meet the organization’s needs? Should any purchasing be outsourced? What positions should be internal to purchasing and which functions in other parts of the organization need to have “dotted-line” reporting relationships to purchas-ing? Should purchasing employees be organized by commodity or by business unit?

Organizational Skill Matrix: What skills does the pur-chasing organization need to have? What skills are currently in place? What is the training plan to ramp up the necessary skills?

Incentive Plans: What incentives does the organiza tion need to have in place to ensure that the company is motivated to support the purchasing strategy? How can employees be rewarded for their contributions?

The overall organizational design not only needs to mirror the overall company organizational approach (e.g., a centralized purchasing organization would be out of sync in a decentralized model), but also needs to honestly assess the needs of the entire organiza-tion. A staged approach to redesign may be necessary. For instance, if the department does not currently pos-sess the skills needed to support a change from a decentralized to a centralized model, it may ultimately make more sense to build the skills first and change the structure later.

Exhibit 3Purchasing Organizational Options


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3. TechnologyCompanies have multiple tools at their disposal to enable a successful purchasing strategy. Tools can help with strategic, tactical, and executional processes (EDI, electronic auctions, electronic RFPs, online cata-logs, e-Sourcing, contract databases); performance management (supplier scorecards, compliance man-agement); and strategy development (expenditure analysis, cost modeling). Individual tools might be right or wrong for any given company. The key is for technol-ogy investments to be made as integral components of the purchasing strategy—they cannot be “bolted on” as an afterthought. In addition, the company needs to have a realistic view of how these systems fit into the overall systems architecture, how much training will be made available, and what the expected benefits will be, as well as a realistic view of the extent to which users will actually employ the technology.

4. Performance ManagementTo ensure that the processes and organization are functioning at the highest level, companies should design performance metrics that provide ownership, visibility, transparency, and accountability (see Exhibit 4). Metrics need to be robust and explore the manage-ment of both internal stakeholders and suppliers. It is critical that information be timely so that the orga-nization can react to problems quickly before they go too far. It is also important to understand the drivers behind performance so that appropriate corrective action can be taken. For example, a supplier who is failing to meet stated lead times could be doing so either because of its own poor performance or because it chronically receives last-minute orders from the com-pany. These two scenarios would lead to vastly differ-ent corrective actions.

Exhibit 4Procurement Performance Management Framework


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Leaders recognize that creating a strategic sourcing program is a multiyear journey, and they think and plan accordingly. Each of the four elements described above must be addressed in an organization’s three- to five-year plan. The order in which the elements should be addressed will depend on recent initiatives and the current state of the company. It is essential not to bite off more than an organization can chew at one time. Companies should work to ensure that each element is linked to the others and the overall com-pany agenda with a common strategy. Furthermore, the strategy should be self-funded. Credibility is quickly established when executives apply a portion of savings to future purchasing initiatives rather than request additional investments. In this way, the business recognizes the benefits, and purchasing is viewed as a core contributor to the company strategy and bottom

line. For example, one of our clients, a major oil and gas company, paid for multiyear initiatives through significant post-merger savings racked up by the pur-chasing department.

For those companies looking to implement compre-hensive strategic purchasing programs, a first step is to conduct a quick calibration of where the organiza-tion stands relative to cross-industry best practices in purchasing to assess the major gaps. Over time, companies can make an assessment of their progres-sion toward best practice to determine if the strategy is working or if some element needs to be tweaked. Taking a strategic approach to purchasing will allow the organization to fully recognize what sourcing practitio-ners have known for years: Purchasing can and should drive sustainable results across the organization, and it therefore merits CEO-level attention.

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Putting the “Strategic” Back Into Sourcing

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