Executive Briefings

Power in Procurement: Three Approaches to Consider

Analyst Insight: Outsourcing continues to grow, yet the news is full of outsourcing agreements that didn't work as planned. Far too often firms rely solely on power to get what they want. This leads to confusion, resentment, lost productivity, and at times, missed market opportunities. Suppliers and buyers need to better understand the use of power, and how this relationship will impact performance. - Karl Manrodt, professor of logistics and supply chain management, Georgia College and State University

Power in Procurement: Three Approaches to Consider

Sourcing isn't just about using power. 2007 Nobel Laurate Oliver Williamson suggests there are three basic ways to think about sourcing relationships: muscular, benign and credible. Each has a different approach and outcomes.

As the term would suggest, muscular buyers use their economic power over the supplier, not only to use them, but to use them up and discard them. Power extracts value from the supplier, but doesn't provide an environment where value can be fostered and created. According to Williamson, power is a trap that is both "myopic and inefficient."

Organizations that use their "muscle" to gain an advantage over suppliers may have a short-term win, but they will lose in the long term. This myopic trap can be seen all around it. It serves as the basis for the Kraljik model, A.T. Kearney’s Purchasing Chessboard and even the theme of most negotiation books — such as Karrass’s “The Negotiation Game”. While this approach can work in some instances, it is incomplete and unsustainable. Companies will ultimately face higher market costs and transaction costs from switching or transitioning suppliers, or at a minimum from suppliers being forced to use conventional negotiations to put in myopic and costly contractual provisions and behaviors that simply drive up hidden costs. From the bullied suppliers’ perspective, it is logical to devise covert actions to protect themselves and receive additional compensation.

There is a better way, and that is to enter negotiations with what Williamson refers to as a credible approach. The focus is insistence of clarity of expected results and accountability. The credible style results in fairness to both parties and a challenge to unlock inefficiencies instead of simply looking for an individual win.

A credible, collaborative approach will require a significant change in how we view and treat suppliers. It will require more open discussions, understanding mutual limitations and rewards, and trust.

Does it work? Professor Willcocks of the London School of Economics studied and contrasted power-based and trust-based outsourcing contracts. After looking at over 1,200 organizations he found that trust-based relationships had a 40-percent cost savings advantage over power-based contracts. Our own research continually finds buyers and suppliers not only saving money, but creating new products or opportunities. Using a credible approach, one of our students reported how they helped a supplier develop a new leasing product. This resulted in his firm saving 25 percent on their current equipment lease, and removing approximately $3m in end-of-lease costs. The student then introduced the supplier to a potential client — and ended up with a sale three to four times larger than the student’s. It was successful because, in their own words, “both firms were committed to helping each other achieve success as much as they were focused on their own internal success.”

The Outlook

In their book The Procurement Value Proposition, Handfield and Chick challenge short-term, cost-focused approaches to procurement and emphasized the importance of value-based approaches. Getting to consider value means reconsidering the path that will get you there. Reliance on power alone is insufficient in an age of collaboration. Suppliers and buyers have to find new and better ways to harness their power in the new economy. Sometimes you have to power down to create value.

Sourcing isn't just about using power. 2007 Nobel Laurate Oliver Williamson suggests there are three basic ways to think about sourcing relationships: muscular, benign and credible. Each has a different approach and outcomes.

As the term would suggest, muscular buyers use their economic power over the supplier, not only to use them, but to use them up and discard them. Power extracts value from the supplier, but doesn't provide an environment where value can be fostered and created. According to Williamson, power is a trap that is both "myopic and inefficient."

Organizations that use their "muscle" to gain an advantage over suppliers may have a short-term win, but they will lose in the long term. This myopic trap can be seen all around it. It serves as the basis for the Kraljik model, A.T. Kearney’s Purchasing Chessboard and even the theme of most negotiation books — such as Karrass’s “The Negotiation Game”. While this approach can work in some instances, it is incomplete and unsustainable. Companies will ultimately face higher market costs and transaction costs from switching or transitioning suppliers, or at a minimum from suppliers being forced to use conventional negotiations to put in myopic and costly contractual provisions and behaviors that simply drive up hidden costs. From the bullied suppliers’ perspective, it is logical to devise covert actions to protect themselves and receive additional compensation.

There is a better way, and that is to enter negotiations with what Williamson refers to as a credible approach. The focus is insistence of clarity of expected results and accountability. The credible style results in fairness to both parties and a challenge to unlock inefficiencies instead of simply looking for an individual win.

A credible, collaborative approach will require a significant change in how we view and treat suppliers. It will require more open discussions, understanding mutual limitations and rewards, and trust.

Does it work? Professor Willcocks of the London School of Economics studied and contrasted power-based and trust-based outsourcing contracts. After looking at over 1,200 organizations he found that trust-based relationships had a 40-percent cost savings advantage over power-based contracts. Our own research continually finds buyers and suppliers not only saving money, but creating new products or opportunities. Using a credible approach, one of our students reported how they helped a supplier develop a new leasing product. This resulted in his firm saving 25 percent on their current equipment lease, and removing approximately $3m in end-of-lease costs. The student then introduced the supplier to a potential client — and ended up with a sale three to four times larger than the student’s. It was successful because, in their own words, “both firms were committed to helping each other achieve success as much as they were focused on their own internal success.”

The Outlook

In their book The Procurement Value Proposition, Handfield and Chick challenge short-term, cost-focused approaches to procurement and emphasized the importance of value-based approaches. Getting to consider value means reconsidering the path that will get you there. Reliance on power alone is insufficient in an age of collaboration. Suppliers and buyers have to find new and better ways to harness their power in the new economy. Sometimes you have to power down to create value.

Power in Procurement: Three Approaches to Consider