Executive Briefings

Strategic Sourcing in a New Economy

Analyst Insight: Procurement departments have spent the last 20 years perfecting procurement by automating procurement systems and standardizing highly competitive Request for Proposal processes. This works well when buying commodities and transactions, but falls short for organizations looking for collaborative supplier relationships where flexibility and innovation are essential. Today's progressive procurement organizations are re-evaluating their approaches and are making a conscious shift along the sourcing continuum. - Kate Vitasek, faculty member, University of Tennessee's Haslam College of Business Administration

Strategic Sourcing in a New Economy

Awareness is increasing that conventional "buy-sell" sourcing methods based on risk-averse transactional thinking just don’t fill the bill in the modern economy — especially for more strategic spend areas and outsourcing deals that require innovation and supplier collaboration as part of their strategic relationships.

University of Tennessee researchers studied the effectiveness of sourcing and contracting approaches that are purposely designed to build more collaborative supplier relationships. UT’s work identified seven sourcing business models, building on the Nobel Prize-wining concepts of economist Oliver Williamson. The models are the inspiration for the book, Strategic Sourcing in the New Economy: Harnessing the Potential of Sourcing Business Models in Modern Procurement.

The seven Sourcing Business Models fall into three categories along the sourcing continuum.

1. Transactional

• Basic Provider Model

• Approved Provider Model

2. Relational

• Preferred Provider Model

• Performance-Based/Managed Services Model

• Vested Business Model

3. Investment

• Shared Services Model

• Equity Partnership Model (e.g. joint ventures, subsidiaries)

The transactional models (basic provider and approved provider) are best suited for buying low-cost, standardized goods and services. The key difference is that in the approved provider model, goods and services are purchased from prequalified suppliers that meet certain performance or other selection criteria.

As the nature of the supplier’s work becomes more strategic or risky in nature, organizations should shift up the sourcing continuum to relational contracting models. The most common relational model is the preferred provider model. These relationships typically have longer-term contracts where there the supplier is providing value-added services to meet the buyer’s strategic objectives. Preferred provider relationships still use transactional-based economics (pay per unit, per shipment, per hour, per mile).

Two relational sourcing business models are starting to get traction. These are a performance-based model and a Vested model. A performance-based agreement is generally a formal, longer-term supplier agreement that combines a relational contracting model with an output-based economic model. It seeks to drive supplier accountability for output-based service-level agreements (SLAs) and/or cost-reduction targets and typically creates incentives (or penalties) for hitting (or missing) performance targets.

A Vested sourcing business model is a highly collaborative relationship that combines an outcome-based economic model with shared value (win-win) economics in order to achieve transformational, collaborative and/or innovative objectives. These arrangements are designed to create and share value for buyers and suppliers above and beyond conventional buy-sell economics of a transaction-based agreement. The Vested model works well when the supplier is seeking innovation and/or operates in an environment that requires a great deal of flexibility.

Investment models — shared services and equity partnerships — involve the development of internal organizations or acquisitions and joint ventures when organizations do not opt for direct outsourcing.

The Outlook

If you are not getting value out of your strategic relationship, perhaps you should evaluate whether you are using the appropriate sourcing business model for your situation. Many companies are finding that shifting along the sourcing continuum to a performance-based or Vested model is a good fit for driving increased value with strategic supplier relationships.

Awareness is increasing that conventional "buy-sell" sourcing methods based on risk-averse transactional thinking just don’t fill the bill in the modern economy — especially for more strategic spend areas and outsourcing deals that require innovation and supplier collaboration as part of their strategic relationships.

University of Tennessee researchers studied the effectiveness of sourcing and contracting approaches that are purposely designed to build more collaborative supplier relationships. UT’s work identified seven sourcing business models, building on the Nobel Prize-wining concepts of economist Oliver Williamson. The models are the inspiration for the book, Strategic Sourcing in the New Economy: Harnessing the Potential of Sourcing Business Models in Modern Procurement.

The seven Sourcing Business Models fall into three categories along the sourcing continuum.

1. Transactional

• Basic Provider Model

• Approved Provider Model

2. Relational

• Preferred Provider Model

• Performance-Based/Managed Services Model

• Vested Business Model

3. Investment

• Shared Services Model

• Equity Partnership Model (e.g. joint ventures, subsidiaries)

The transactional models (basic provider and approved provider) are best suited for buying low-cost, standardized goods and services. The key difference is that in the approved provider model, goods and services are purchased from prequalified suppliers that meet certain performance or other selection criteria.

As the nature of the supplier’s work becomes more strategic or risky in nature, organizations should shift up the sourcing continuum to relational contracting models. The most common relational model is the preferred provider model. These relationships typically have longer-term contracts where there the supplier is providing value-added services to meet the buyer’s strategic objectives. Preferred provider relationships still use transactional-based economics (pay per unit, per shipment, per hour, per mile).

Two relational sourcing business models are starting to get traction. These are a performance-based model and a Vested model. A performance-based agreement is generally a formal, longer-term supplier agreement that combines a relational contracting model with an output-based economic model. It seeks to drive supplier accountability for output-based service-level agreements (SLAs) and/or cost-reduction targets and typically creates incentives (or penalties) for hitting (or missing) performance targets.

A Vested sourcing business model is a highly collaborative relationship that combines an outcome-based economic model with shared value (win-win) economics in order to achieve transformational, collaborative and/or innovative objectives. These arrangements are designed to create and share value for buyers and suppliers above and beyond conventional buy-sell economics of a transaction-based agreement. The Vested model works well when the supplier is seeking innovation and/or operates in an environment that requires a great deal of flexibility.

Investment models — shared services and equity partnerships — involve the development of internal organizations or acquisitions and joint ventures when organizations do not opt for direct outsourcing.

The Outlook

If you are not getting value out of your strategic relationship, perhaps you should evaluate whether you are using the appropriate sourcing business model for your situation. Many companies are finding that shifting along the sourcing continuum to a performance-based or Vested model is a good fit for driving increased value with strategic supplier relationships.

Strategic Sourcing in a New Economy