Strategic sourcing is very much like patriotism. Everybody proudly says they practice it. Few can really articulate what it means. A small handful faithfully make it part of their lives. But when a crisis hits, it can save the day.
Take Palm, the world leader in handheld computers, that as recently as 1999 had a market capitalization greater than General Motors. But when the tech bubble burst in 2001, the company was almost wiped out. The problem was that sales prices were dropping three times as fast as material cost reductions. The company was hemorrhaging cash. It had to write off a quarter billion dollars in inventory.
"What saved us was a strategic sourcing road map and a supplier price targeting program," Angel Mendez, Palm's senior vice president of global operations and accessory solutions group explained at FreeMarkets' WorldSource 2003 conference earlier this year.
The company first looked at where pricing was going for its new products three to five quarters out and where gross margins needed to be for Palm to survive.
"We wanted to look at where our market was going and use that as the engine for our cost targeting for direct and indirect goods," said Mendez.
Palm knew exactly what it could afford to pay for every part, and that "should-cost" knowledge was the basis for its sourcing. No part was bought, and no contract manufacturer was awarded a contract without a target. When a new design experienced the usual "feature creep" and upset the tight balance between gross margin and supply cost, products were "de-featured" to get as close as possible to the targets.
FreeMarkets played an important role in the process, both with its spending analysis tools and its FullSource managed service offering.
"We believe in reverse auctions strongly," said Mendez. "It is like going from a hand saw to a circular saw. Everything happens a lot faster, but you still need the wood and the carpenter and the plan."
Palm's should-cost methodology and its auction strategy are working. Costs for Palm's new family of products are down 26 percent. Gross margins rose from negative numbers to 25 to 30 percent. Like most companies in this space, Palm still has a long way to go to return to previous levels of profitability.
"We are not going to get there unless strategic sourcing drives more cost reduction and productivity continues to be ahead of average sales prices," said Mendez.
While aggressive price negotiation is an inherent part of strategic sourcing for most companies, it is far from being the only approach.
"Every company leans on the supplier to get the lowest price, but the real value comes from getting the supplier involved early in the sourcing process, ideally at the design stage," says Michael Adam-Sampson, vice president of product strategy for MatrixOne, a provider of product lifecycle management (PLM) applications for manufacturers.
"An automotive company using standard sourcing tools to buy fuel tanks will probably get an excellent price. However, those tools will never inform the auto company that the proposed fuel tank won't fit into a standard autoclave and needs to be redesigned to meet expected production costs. Working closely with key suppliers and using PLM applications like ours is the only way to deal with these types of issues."
But Which Approach?
In addition to reverse auction tools and highly collaborative PLM solutions, other approaches to strategic sourcing include supplier relationship management (SRM) suites and complete outsourcing of the procurement process. The problem that few companies have even addressed is deciding on which approach will have the most favorable long-term impact on their supply chains and their bottom lines.
"Most companies still spend two thirds of their procurement time and budget on highly repetitive operational tasks such as purchase order (PO) processing and supplier scheduling," says Chris Sawchuck, director of e-procurement for the consulting firm, AnswerThink.
Such companies have a lot of basic process efficiency work to be done before they can think about effective strategic sourcing, says Sawchuck, whose company offers best practice consulting through its Hackett Group subsidiary.
The good news is that once these companies get serious about strategic sourcing best practices, many solutions in the SRM space provide libraries of best practices configured for various industries, which helps maintain consistency throughout the organization.
"Having these tools is great, but companies still have to adopt the best practices," says Sawchuck. "That linkage is often missing."
PeopleSoft is one vendor that has earned Hackett's best practice certification for is SRM solution, and its management has recognized the importance of process change.
"Strategic sourcing begins with aligning strategies with the business goals and objectives of the organization," says Bob Shecterle, PeopleSoft's vice president of SRM, who adds that most companies skip this important step and focus on quick fixes such as driving supplier prices down in a particular category.
"The ultimate goal is to make strategic sourcing part of the regular, tactical business process," he says. "It is not something you do once a year at the front end of negotiating big contracts."
PeopleSoft's SRM suite contains 16 different modules for all aspects of sourcing to guide users through all of the critical processes. The two most critical components, according to Shecterle, are spend management and supplier measurement. He says that even large companies have poor understanding of what they spend on various categories of direct and indirect materials, and with whom they spend it.
"Best-practice companies have real-time access and visibility tools into all of their spend," he says. "That information becomes the basis for all strategic sourcing."
The other area that Schecterle believes is a vital component of SRM is supplier performance measurement. PeopleSoft's SRM suite, for example, includes the capability to rationalize different metrics, come up with a given performance rating for each supplier and roll these ratings back into the system as an input into the strategic source process.
"The main objective of the rating tool is to make suppliers perform better as they go along, so you don't have to constantly replace suppliers," he says. He adds that if some weeding out is necessary, the analytics tool makes it clear which are the poor performers over time.
"Some companies every year just eliminate the bottom 5 or 10 percent of performers and replace them with new ones or give the business to high performers," says Schecterle.
SRM Applications and Functions
Randall E. Berry, a partner in Accenture's supply-chain services group, agrees that SRM applications can play an important role in helping companies interact with suppliers in real time, as well integrate internal supply-chain processes.
"SRM has to be integrated with other supply-chain technologies, such as traditional planning and forecasting applications, as well as with those involved with product development and design," says Berry.
For example, by integrating the ongoing sourcing process with design engineering, companies can make sure they are not creating new part designs when an existing part with equivalent functionality exists and may even be in stock.
"SRM can help companies learn as they perform their sourcing processes," he says.
This collaborative aspect of SRM becomes even more important when OEMs embark on manufacturing outsourcing, because a certain amount of sourcing responsibility often gets outsourced as well. Berry says that before OEMs sign up with a contract manufacturer (CM), they have to ask themselves: How much control do I want to give up in the sourcing process to my CM, and how much visibility do I have to have into what is happening with the suppliers that the CM uses? OEMs do not want to build in redundant processes with what the CM is doing, but they often want control over strategic components. They may also want visibility into what the CM is sourcing.
"The ultimate goal is to make strategic sourcing part of the regular, tactical business process."
"We worked with one SRM vendor's module so it allowed the OEM to view the CM operation as if it were one of its own manufacturing sites," says Berry. "The primary reason for having this capability is to allow the OEM to use its leverage when sourcing strategic components. This approach introduces another level of complexity, so there has to be a compelling reason to do it. The OEM has to decide who is going to handle supplier relationships based on who has the better leverage, and who is better able to work with the supplier on an ongoing basis. The technology is there, but it's more a matter of who should be in control."
Such multi-tier visibility and control is a controversial subject, according to MatrixOne's Adam-Sampson. He says that tier one suppliers, especially in the automotive industry, resist allowing the OEM to have any more visibility than absolutely necessary with their suppliers. The tier ones vigorously resist visibility into the pricing relationships with tier two and three suppliers.
"The tier ones have total responsibility, so they don't want the OEMs constantly looking over their shoulders," says Adam-Sampson.
In the high-tech industry, however, Adam-Sampson says that OEMs often want to control the highly engineered parts. Nokia for example, has outsourced final assembly of its phones to CMs, but there are contracts with Philips to make the LCDs and with Texas Instruments for key chips. The contracts for these items are between Nokia and the component supplier - not with the CM.
"Nokia has to enforce its contracts with these suppliers," says Adam-Sampson. "For all the other parts that are not as critical, it is up to the CM to manage that supply."
These collaborative capabilities are among the most advanced functions within most SRM applications. For users new to SRM, learning how to implement these applications is a step-by-step process that focuses on much more basic activities.
"SRM applications can be quite complex," says Accenture's Berry. "Companies first need to master basic processes such as understanding their enterprise-wide spend, then they can move on to the many other capabilities these applications offer. The advantage of a comprehensive tool like SRM is that the learning process is essentially built in."
Berry says SRM solutions need to provide at least five key basic capabilities:
1. Actionable corporate wide visibility: Historical and project-specific data for materials and suppliers to include spend and product information.
2. Sourcing analytics and modeling: Supplier and industry analysis, total cost-of-ownership models and evaluation frameworks for modeling sourcing scenarios.
3. Workflow management and data repository capabilities: Approval processing and tracking for all sourcing activities and contracts to include audit trails.
4. Negotiation and transaction tools: Electronic request for quote, proposal and information capabilities (RFx); web-based auctions; and contract management to include the ability to evaluate if the transactions are in compliance with the contracts.
5. Supplier performance: A standard set of performance metrics and tools for monitoring suppliers and providing reports.
"SRM vendors will claim that they can provide all five functions equally well, but that is never the case," says Berry. "Each is strong in a few of the five areas, and will have only basic functionality in the others. Companies should select the SRM package that provides the tools that will have the most impact on their operations."
The Execution Gap
Even after companies implement sourcing tools and practices, expected savings often do not materialize, according to Brian Hodgson, vice president of product management for SupplyWorks, a provider of sourcing applications.
"Strategic sourcing has to be tightly linked with execution capabilities," says Hodgson. "Otherwise, all the negotiated savings have a way of slipping through cracks and never getting to the income statement," he says.
He says purchasing managers can do a great job of negotiating cost reductions with suppliers. Technical buyers can reengineer products to drive out cost. As companies introduce new products, they can leverage their supply base more effectively. But unless there is a built-in way to communicate and monitor compliance throughout the supply chain, execution of the sourcing plans is likely to fail. The SupplyWorks MAX solution is designed to link planning and execution by providing role-based access to the application for both internal users and outside suppliers.
Managers responsible for negotiating prices, obtaining quotes, setting up the contracts and planning year-over-year cost reductions use the sourcing tools in SupplyWorks MAX such as the spend management, bid package and reverse auction modules. Just as important are the plant-level users who execute on the POs, work day to day with the suppliers to make sure the right goods arrive on time, collaborate over schedules and develop supply-chain plans. They access sourcing plans directly and act on them. If there are any problems, they can interact with the sourcing managers, who have the ability to monitor execution performance.
Part of the execution role in SupplyWorks MAX is to allow two-way collaboration with suppliers, so if one cannot meet its schedule, the right person immediately knows about it.
"Purely sourcing applications provide a schedule to the supplier after the negotiation, and it is up to the supplier to meet it," says Hodgson. "That is not reality. Things go wrong, and if the schedule cannot be met it is better to know early on. We provide a rich synchronization between what the plant needs in terms of inbound demand and what the supplier can provide on that plan."
This combination of sourcing planning and execution has made SupplyWorks MAX the choice for 21st Supplier, a new division of Ingersoll-Rand that handles sourcing for the parent's Hussman unit and, more recently, outside manufacturers.
"We leverage Ingersoll-Rand's existing supplier relationships for other companies," says Bill Lindquist, business unit leader for the start-up. "We might have $70m in spending on a commodity, while a small company will only spend a few hundred thousand dollars."
Just as important, Linquist says that 21st Supplier actually manages the sourcing process by executing on the contracts that it negotiates on behalf of the client. This approach is very much in keeping with the Supply Works application that is the sourcing platform that 21st Supplier uses.
SupplyWorks gives suppliers and the manufacturer real-time visibility of the available parts inventory, both for current orders and orders planned well into the future.
"SupplyWorks optimizes parts inventories and determines times and quantities to ship," says Lindquist. "There is true collaboration on execution of the sourcing plan. Both the manufacturer and the supplier can look at the plan in real time and react to changes in the production and order processes."
By focusing on supplier performance, specifically response time, Lindquist is able to show potential customers how better performance translates into more sales and lower operating costs.
Large Company Challenges
Even very large companies often have difficulty effectively managing their basic sourcing needs. For example, Unilever, the multibillion-dollar consumer packaged goods company, has found that its many different divisions and global business-unit structure makes effective sourcing across the entire organization very difficult.
According to Guillaume Oudin, global supply management coordinator for plastics in Unilever's home and personal products division, the company has more than 100 plastics buyers around the world just for rigid plastic bottles. It spends several hundred million dollars for these materials around the world. Most of their sourcing activity with suppliers is done using just spreadsheets. Transactional data is maintained in different ERP systems that are not integrated.
"We have long needed a global view of our suppliers and the technology to allow our buyers to have access to that information in real time," says Oudin. "We don't really even know how many suppliers we have and how much we spend with each of them."
To get their arms around this sourcing issue, Unilever is using an application called Category Business Center (CBC) from Tigris Consulting.
"Our software operates across ERP systems, divisions and geography to capture and analyze all data related to sourcing of specific commodity categories," says Brent Habig, chief executive officer for Tigris Consulting.
Using this organization-wide data capability, CBC performs two important strategic sourcing functions for its customers. First, it allows widely dispersed companies such as Unilever to manage spend and leverage buying power. Secondly, for products that are constantly changing, CBC includes algorithms to project target costs for new buying programs based on historical data pulled from past contracts for similar materials.
With Tigris, Oudin says that internal users anywhere in the world can access 50 fields of data about category supply data. Suppliers can also enter a web-based system to see requirements, as well as to update their own pricing and profile information.
With global data pulled from the CBC system, Unilever is able to fix price targets worldwide. Where possible, they will buy regionally for an area. Supplier performance, product quality and other metrics are planned. The idea is to use a global database to support global supply strategy to include linking ERP systems, for all categories of buying.
According to Habig, the CBC system is most effective for those commodities that change frequently and require repurchasing in different configurations. Packaging is the common example because marketing strategies demand that new sizes, colors and versions be produced to support new products and promotions. The product category is constantly being reordered, but usually with slightly different specifications.
Based on historical procurement data pulled from systems across the organization, the CBC system uses a costing model built into the systems to do "should cost" analysis for new orders. The model develops target prices for the new item based on prices of other packaging items.
"Without such a tool, you are inviting price creep," says Habig. "The supplier will try to jack up the price more than they should every time a new source event takes place. That is what suppliers will naturally do, but this tool prevents this. You can anticipate what the price should be, and let the supplier know what you are willing to pay. Both large companies and small ones have to make full use of their strategic sourcing power."
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