Strategic Sourcing Implementation
Kathy | April 1, 2007
Too many dollars are being left on the table by U.S. companies because of poor sourcing strategies. How do yours measure up?
Estimates show that mid-sized U.S. companies miss the opportunity for supplier savings in excess of $134 billion due to inadequate sourcing competencies . This much money left on the table could mean the difference between profitability and bankruptcy. That’s where Strategic Sourcing comes in.
There are two ways to view Strategic Sourcing.
- On the operational side, we can look at benefits such as cost improvements, cycle time reductions, improved inventory turns, transaction reductions, higher service levels, inventory reductions, improved quality initiatives, etc.
- On the strategic side, we can look at increased profitability, competitive positioning, improved reaction time to market conditions, utilization of supplier expertise, outsourcing possibilities, true partnering with suppliers, etc. Worldclass companies that have successfully implemented Strategic Sourcing initiatives recognize that a strong commitment internally, partnered with an innovative supplier base, are a valuable part of an organization that focuses on reducing waste, non-value added activities and costs.
The Strategic Sourcing Model (as shown in Fig. 1) is based on a series of activities that must take place for the model to be successful. Without following through all the necessary steps to discover where the spending trends are and where opportunities lie, we are simply purchasing in traditional ways. Companies that have implemented Strategic Sourcing policies report a reduction of inventories between 50% and 70% . This six-step model links the entire process together from Data Collection, and leveraging that data, through Supplier Management & Monitoring. Each step has very specific needs and requirements.
Step 1. Data collection & analysis
In this step, the entire inventory is evaluated for similarities and broken down into commodity categories. There is significant “Data Scrubbing” at this initial stage. Part numbers must be accurate; part descriptions must be “Smart” coded for easy search criteria; obsolete materials must be identified and disposed of. Once all of this is completed, a listing of commodities is agreed to and the inventory is then broken down and placed in those “Buckets.” In effect, the CMMS or ERP system must be cleansed before any other step.
After the “Data Scrubbing” is complete, a history or baseline can be developed. This is crucial in order to allow for the making of informed and intelligent decisions going forward. The data can be examined to determine buying patterns, one-time purchases, high-volume buys, what volume is with what supplier, etc. From this baseline, the needs can be determined-needs being where the biggest or greatest opportunities lie.
Fig. 2 can be used to decipher the data and make decisions on where to concentrate efforts. In the first cut or wave, certain criteria are used to determine the largest opportunities, including whether enough data is available to make a business decision and if used across divisions or departments, can a business case be rationalized to move forward, etc.
So far, we’ve identified the commodity, baseline data and opportunity and made a business case to support our efforts. The final step in this process is to clearly identify the specifications for each item in that product category. If we are to leverage our spending and negotiate preferential contracts, then we better understand what exactly we are buying. For instance, health and safety laws differ from county to county, state to state and, absolutely, country to country. If the decision is made to purchase safety equipment from an offshore source, it must meet all country, state and local laws.
Step 2. Develop a sourcing strategy
After all the research, data analysis, specification development and commodity classifications, the next step is determining the sourcing strategy that will be used. The decision as to what to buy, where to buy and how to minimize risks is next. It’s not as simple as finding a supplier with the lowest price. We need to consider total cost of ownership (TCO) as well.
Offshore sourcing is becoming a necessity in today’s global economy. Companies must look at opportunities outside of traditional borders to maximize margins and profitability and assure no interruptions to the supply chain. If the decision is made to go offshore for sourcing, it is crucial to know the supplier and the risks involved, including current technology knowledge, communication, government stability, currency fluctuations, etc. Included in the total cost of acquisition and management of risks are:
Step 3. Leverage consolidation
Leverage consolidation is simply taking the data that has been collected, analyzed and commoditized and identifying trends for family product lines, substituting like products for less costly ones, reducing the supplier base, etc.
Fig. 3 depicts the traditional purchasing model, with many suppliers specializing in one focus area. Having multiple suppliers provide what otherwise could be classified as a commodity is NOT Strategic Sourcing.
Performing Steps 1 and 2 would yield this information. Data analysis would track how much we’re spending on electrical componentry and amount spent with each supplier. By combining all electrical purchases across all divisions and/or departments, we would begin to see the benefits related to leveraging aggregate pricing discounts, transaction cost reductions, preferential payments terms, etc. Moving toward a single source supplier (as illustrated by Fig. 4) begins the process of true partnership. As they say: What’s good for the goose…
Step 4. Relationship restructuring
We’ve done the research, data analysis, specification development and commodity classifications, determined the sourcing strategy and consolidated family products lines. Now we’re ready to move into the bidding, supplier selection process and negotiations for a successful relationship.
Successful strategic assessment will develop an understanding of the market. Strategic professionals will, therefore, understand the true importance of the supplier, the balance of supply and demand, new entrants into the marketplace, consolidations, alternatives, supplier capabilities and overall strategic alliances. Once this is embraced, the ultimate “Lowest Total Cost of Ownership” will be achieved.
The package can be put together for any specific commodity. It is time to send out for bidding. Today’s electronic E-commerce opens the door to a whole new world. The marketplace is no longer defined by geographic constraints. With the help of the Internet, an operation in East Littletown, USA can now compete successfully, on a level playing field, in global commerce just like any other company. Do your research and find the appropriate portal or B2B Website for your specific needs. The following links offer some useful starting points:
The identification of suitable suppliers is as critical as any other step. You can negotiate the best price, delivery, payments terms, etc., but if the supplier isn’t stable or in partnership, what good will great pricing do for your company? When seeking suitable suppliers, look for the following:
- Strong commitment to environment, health and safety
- Lean manufacturing & 5S principles that are in place and visible
- Cost competitive culture
- Financial stability
- Progressive management with clear and visible metrics
- Understanding and use of Web-based paperless systems
- Registered ISO or QS certifications
- Actively seeking solutions to problems without your intervention
- Commitment to your organization’s requirements 24/7
- Willingness to share ideas and processes improvements
At this point, we’ve nearly completed a full 5S Strategic Sourcing exercise. All the steps have been taken to Sort, Standardize, Strategize and Study.
Now we’re ready to select the best Supplier. The first step is to negotiate the total cost of product. Using the previous steps, we should have a clear understanding of what we want at what price and when. Before the meetings between customer and supplier even begin, some basic negotiating skills must be assured.
- Do Your Homework. Know who you’re negotiating with prior to the meeting and know what you want.
- Anticipate. The smart negotiator tries to anticipate what the other party thinks you want.
- Build Trust. Negotiation is a highly sophisticated form of communication. Without trust, there won’t be communication.
- Know Your BATNA (Best Alternatives To a Negotiated Agreement). Before you begin a negotiation, know what your other options are.
- Recognize a “Win/Win” situation. Both parties are in the business to make money. If you can reach an agreement within your settlement range, that’s a Win!
Step 5. Best practice evaluation
One of the key steps companies fail to take is trying to renegotiate prices and payment terms. There is no harm in asking. You don’t get what you don’t ask for.
Remember, though, that your suppliers are in business to make money-squeezing the last nickel from them is not a best practice.
There are other options that benefit the operation. Negotiate preferential payment terms. Change from FOB shipping point to FOB dock. Look at capitalizing on deliveries that best suit the operation-not supplier convenience. Measure total inventory value and break it down by costed inventory vs. consigned or vendor-managed inventory (VMI). The higher the consigned or VMI is, the better your managing of inventory.
Look at freight costs-which can be a very big expense these days. Negotiate with your carriers on fuel surcharge percentages. Clearly document the baseline cost the freight company is using for a gallon of diesel. Negotiate percentages from that baseline and discuss rebates. Have an open conversation with your carriers and ask if they have other customers using the same lanes as you are, then negotiate a “piggyback” fee instead of an LTL charge (less than truckload).
Issue credit cards for small MRO purchases instead of issuing a PO for each order. It makes good business sense to process one check for many low-cost items as opposed to many checks for many orders.
Use online or E-commerce B2B portals to obtain best pricing and research a broader assortment of suppliers. More and more companies are using the Internet to do business. E-commerce decreases the cost of processing purchase orders and, ultimately, overall costs. Fig. 5 reflects the trend of Internet usage for online purchase orders.
Step 6. Supplier management and reporting
Track results and restart assessment (continuous cycle)…
- Track % of total spending with your strategic suppliers (including capital expenditures). This is a wonderful tracking measurement as it tells you whom you’re spending your money with. This instantly communicates who your largest suppliers are and what percentage of expenditures are spent and where.
- Track and trend total number of suppliers. This will indicate how successful you are at strategically aligning your buying power(leverage).
- Track price increases vs. CPI (Consumer Price Index). Are the price increases your supplier is passing on to you higher or lower than the consumer price index (CPI)? This is a very good indication if your supplier is actively pursuing cost reductions, process improvements, self imposed strategic sourcing policies, etc. A bit of caution on this metric: prices may be increasing because of the current cost trends of raw materials. This should be taken into account and can be verified by checking the Wall Street Journal for current raw-material pricing and trend analysis.
- Purchase Price Variance (PPV) tracking. Is what was quoted what was invoiced? Other than the obvious cost discrepancy there is additional cost to the business when the invoices don’t match the purchase order. The process to correct intertwines from accounting to purchasing through the supplier. Few companies truly understand the costs associated with PPV’s and what they respresent to many organizations in manual labor.
- Track % of POs manually vs. E-commerce. As noted previously, this measurement is very important and it can be tracked. Very few companies know how much it truly costs to place a purchase order. It simply is not placing an order over the phone. The real cost is incurred from the time the need is discovered to when accounting matches the invoice with the PO and makes payment. IBM calculated its cost to place a purchase order at $120; Raytheon used $86 as average cost; Kodak justified $102. as the cost to place a PO. Now, however, these corporate giants average less than $10.00 for placing a purchase order. As noted previously, the average manual purchase order cost is $82. After implementing Strategic Sourcing and E-commerce based systems, that cost drops to $8.00. You can see the immediate cost benefits and reduction.
- On-time delivery. One of the most important indicators of how well your supplier is performing is when the order hits your dock. Not only is it critical that your suppliers meet the expected delivery but the order quantity as well. The best planning can go south real quick if the order that you were expecting is late. It costs money to schedule the labor, equipment, contractors, etc. If the supplier fails to meet an obligation, there is a cost associated with it. Early shipments are just as bad. You’re not in the business to pad your salesmen’s monthly numbers or for your suppliers to meet their revenue goals by shipping everything before the end of the month. The same concept applies to quantity accuracy. If the order is for 100 pieces and your supplier short ships, then there is a cost associated with that, with regard to min/max levels, reorder points and potentially short-shipping your customer. It goes the other way as well. Over-shipments are not acceptable. There is no quicker way to increase your supplier’s sales than by accepting anything over the order quantity. Accept the original order and thank your supplier for the extra samples. There is a high probability that your supplier will not over-ship again.
The six major steps to implementation of Strategic Sourcing have been highlighted here, but you still have some work to do before the benefits are realized. Once captured, however, these benefits can have a significant positive impact on your bottom line.
Successful implementation starts with data collection and categorizing the products lines. After that has been completed, a business decision can be made based on facts as to where the greatest opportunities are.
Selecting and negotiating with the identified suppliers is an integral part of supply chain management that offers unique opportunities. Today’s marketplace is not based on who offers the lowest cost, but, rather, who delivers the lowest Total Cost of Ownership.
After your sourcing strategy decision has been made, including where to go and with whom, the management of that decision must be tracked. Measuring the supplier based on performance benefits both parties and clearly defines the expectations of each.
It is vitally important for companies to elevate the awareness and criticality of sourcing across their organizations. Implementing the six steps of Strategic Sourcing will assure that those organizations are proactively managing their operations.
Andy Gager, CPIM, has over 20 years experience in Operations and Materials Management. Working with Life Cycle Engineering, based in Charleston, SC, he specializes in the areas of warehouse configuration, inventory reduction programs, supply chain management and inventory accuracy. Telephone: (843) 744-7110; or e-mail: Agager@LCE.com