Reaching New Levels of Supply Chain Effectiveness and Sustainability · Achieving a Strategic...

Reaching New Levels of Supply Chain Effectiveness and Sustainability

Practical Considerations for Achieving a Strategic Sourcing Model

1Protiviti • reaching New Levels of Supply Chain Effectiveness and Sustainability

Executive SummaryBy examining the current state of strategic sourcing through the lens of an ongoing effort at a large U.S.-based manufacturing company, this paper presents practical guidance and examines how strategic sourcing capabili-ties are evolving among leading practitioners. This guidance begins with a revealing question: How do we want to move our strategic sourcing activities forward? The question is important at a time when many efforts have reached a plateau in their evolution.

Strategic sourcing is not new. Most procurement and supply chain decision-makers have long understood and applied the concept to their domains. But how effective have these efforts been? The case example and field reporting contained herein indicate that certain strategic sourcing efforts have been extremely effec-tive – in one case, achieving a savings of 14 percent to 20 percent in one global category (totaling in excess of US$100 million).

If more companies are to achieve this sort of success and take their sourcing efforts to the next level, they should start by looking at the practices presented herein and then focusing on a continuous “lifecycle” approach to strategic sourcing.

The insights in this paper include a discussion of the obstacles – internal reluctance, supplier resistance and research challenges – that most strategic sourcing efforts encounter. The paper also examines the key drivers of success, including executive support, fact-based research, concrete action plans and a commitment to continuous improvement, so that strategic sourcing operates as “lifecycle sourcing.”

That commitment can deliver significant benefits in addition to cost-savings; namely, by fortifying procure-ment’s credibility as a strategic business partner with a seat at the decision-making table.


iNtroduCtioN

Strategic sourcing endeavors are designed to forge more collaborative, sustainable and profitable supply-chain relationships, and the success of these efforts hinges on preparation. The more prepared supply chain and procurement managers are in their dealings with suppliers, the more likely it is that the final agreements will maximize the benefits such that both parties in the supplier-buyer relationship consider it a “win.” Preparation, it is important to note, hinges on more than the sheer force of effort. Successful preparation requires organizations to recognize and overcome several common obstacles, including:

•Initial internal reluctance

•Challenging and often difficult research

•Supplier resistance

Successful strategic sourcing efforts and capabilities, including the detailed example presented in the following pages, address these obstacles. Such efforts are successful, in large part, because they typically adhere to several common leading practices, including (as is generally the case) visible executive support along with:

•Credible, fact-based research

•Relationship-rebuilding

•A commitment to continuous improvement

Understanding strategic sourcing’s common obstacles and key determinants of success has never been more important. Intensified market pressures – rising commodities, labor and other input costs, as well as new and emerging risks – make it clear that many strategic sourcing efforts would benefit by being fostered to the next level. Procurement and other supply chain managers can get a sense for the current state and quality of their strategic sourcing capabilities by asking two critical questions:

1. How effective are our current strategic sourcing efforts?

2. How do we plan to improve these capabilities moving forward?

The Strategic Sourcing Payoff

A continuous “lifecycle” approach to strategic sourcing yields many benefits, including:

•Cost savings

•Total cost of ownership clarity

•Should-cost models

•Spend visibility

•Market intelligence

•More integrated supply chain

•Procure-to-pay optimization

•Supply risk mitigation


These questions not only should stimulate discussions over cost-savings, but also extend beyond those types of benefits. The key question for procurement managers centers squarely on value: “To what extent are our activities delivering value to the company?” For example, if a company’s profit margin is deteriorating and procurement negotiates a new deal that does not improve margin, it is not adding value to the company. World-class procurement functions, according to a leading benchmarking and research firm, deliver 5 percent to 7 percent savings annually.1 That figure represents a useful goal to strive to attain.

Ultimately, answers to each of these questions about sourcing capabilities should serve as sufficient motivation for seeking ways to elevate strategic sourcing to a higher level of success. If not, cost pressures and/or the realization of risks that spark severe supply chain disruptions and changes can serve as more pressing motivators.

Why ANd hoW to SourCE StrAtEgiCALLy

Both the development and use of strategic sourcing are based on a straightforward principle. The most profitable and sustainable supply chain relationships are governed by collaboration and knowledge rather than a command-and-control mindset that focuses almost exclusively on price.

When both parties understand each other’s businesses and where they fit into each other’s operations, the relationship can move beyond a merely transactional level to a point where innovation can take root and thrive. When commodity price volatility, supply chain disruptions and other external challenges arise, and they frequently do, innovative solutions become incredibly valuable. A mindset of, “If your company has a problem, both of our companies have a problem,” is better suited for addressing challenges within supply chains that exist in a highly global, connected and risk-laden business environment.

Strategic sourcing methodologies can take on many shapes and forms, but all contain essentially the same basic steps. The adjacent graphic highlights a six-phase approach:

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SOURCING ASSESSMENT

STRATEGIC SOURCING APPROACH

STRATEGY DEVELOPMENT

STRATEGY EXECUTION

SUPPLIER NEGOTIATIONS

SUPPLIER AWARD

IMPLEMENT AGREEMENT

• Opportunity assessment

• Define the stakeholder team

• Project kickoff• Obtain line item

information• Create market

basket and sourcing group profile

• Complete current state assessment

• Develop supplier recipient list

• Determine optimal packaging builds

• Develop sourcing strategy

• Optional: Build requests for proposals (RFPs) for each sourcing group

• Analyze supplier pricing response

• Evaluate qualitative responses

• Develop fulfillment strategy

• Assess incumbent supplier impact

• Prepare for supplier negotiations

• Conduct incumbent supplier negotiations

• Conduct short-listed supplier negotiations

• Select supplier finalists

• Conduct testing and validate adherence to requirements

• Determine volume allocations

• Award contracts to selected suppliers

• Support supplier contract process

• Finalize fulfillment strategy

• Complete final savings analysis

• Establish supplier management structure

• Institute the buy• Knowledge transfer

1 Source: The Hackett Group, www.thehackettgroup.com.


The initial purpose of strategic sourcing is to equip organizations with a holistic view of a global supply category. This understanding requires substantial analysis to understand all aspects of the category and supply market, including industry value chains, production processes, and supply and demand dynamics, among others. Specific techniques include process mapping, cost analyses, parametric modeling and regression analysis. The holistic understanding this work produces provides insight into ways to negotiate and establish more optimal supply chain partnerships. It can also lead to internal improvements, such as a strategic decision to relocate a factory. The ultimate outcome of strategic sourcing is to provide business value.

Some organizations launch or rekindle strategic sourcing efforts when key supply chain agreements come up for renewal. Other companies apply the approach in a more methodical manner, such as reviewing their sourcing strategy for major categories on a recurring basis.

Although strategic sourcing can benefit most types of agreements, those involving categories with complex products or supplies that are vulnerable to sudden and/or significant cost pressures (e.g., materials tied to certain commodities subject to dramatic price swings) typically benefit the most from a strategic sourcing mindset and approach.

CASE ExAMPLE: rENEW or tErMiNAtE?

Last year, a large U.S.-based manufacturer (which we will refer to as the “company”) with global operations identified an opportunity to take its strategic sourcing capabilities to the next level. By conducting this initiative over the course of almost 10 months, the company elevated its capability to a higher level of proficiency and saved an estimated US$100 million annually as a result.

The company adhered to the six-phase methodology detailed in the accompanying graphic, tailoring it to meet its needs where necessary.

As is the case in many sourcing situations, the company’s prime motivation for its strategic sourcing effort related to an expiring contract with an important supplier. Although the company represented the supplier’s top customer in North America, the company’s procurement team as well as its senior leaders initially felt they were not in a position of power as they entered negotiations. This was cause for concern. If negotiations did not result in an agreement, the company would face the arduous and expensive task of finding another supplier or suppliers. And the company was well aware that alternative suppliers of this material – at the same price and quality and with the same sustainability certifications – were limited.

In the past, the company typically would consult with an expert to identify what the price of the materials should be and then enter into negotiations with its suppliers equipped with that figure. Instead, with external assistance, the company elected to enter into the negotiations armed with a much larger trove of information.

ALTHOUGH STRATEGIC SOURCING CAN BENEFIT MOST TyPES OF AGREEMENTS, THOSE INvOLvING

CATEGORIES WITH COMPLEx PROdUCTS OR SUPPLIES THAT ARE vULNERABLE TO SUddEN ANd/OR

SIGNIFICANT COST PRESSURES TyPICALLy BENEFIT THE MOST FROM A STRATEGIC SOURCING MINdSET

ANd APPROACH.


This information took weeks to amass through comprehensive research, which enabled the company to develop a “should-cost” model. The model detailed what the company and its expert advisors believed, based on the data, what all of the supplier’s costs should be. The model addressed questions such as:

•What does it cost to produce one ton of the material?

•What does it cost to ship the material from the supplier’s port to North America, Europe and other places where the company’s factories are located?

•What should production and shipping costs be?

As these and many other figures were identified, calculated and reviewed for accuracy, some qualified as major revelations (e.g., gross margin per unit compared to total gross margins) and would play a pivotal role in the ensuing negotiations.

Tracking down these key figures required substantial investigative work, including some creative sleuthing. The company and its advisers consulted specialized industry publications that contain cash costs and cost inputs for the materials in question. The company, with external guidance, also combed through the supplier’s financial reports to find, and then deconstruct, the costs related to producing the material. The company also contacted shipping companies in an effort to identify the costs of shipping the material from the supplier’s location to the company’s global port locations.

This work required significant time and effort, and the project initially encountered resistance within the company. This is understandable, and even natural, given the dramatic departure in approach that it represented. Rather than negotiating to close the gap between two different price proposals, the company needed to be prepared to say, “Here’s what we believe you currently make from a gross margin perspective, and here’s how much we think you should make.”

The company also recognized that the supplier needed revenues from its relationship with the company in order to continue making debt payments; in other words, the company, by dint of its top customer status with the supplier, helped the supplier secure its fixed costs. By understanding the precise nature of its importance to the supplier, the company further strengthened its negotiating position throughout the ensuing discussions.

That gap between actual cost and “should cost,” as well as the dramatically different approach to negotiations in general, also created tension during the negotiations – a common occurrence. Although one of the underlying purposes of strategic sourcing is to create win-win relationships over the long term, many of these partnerships need to be reconfigured because they previously provided a greater “win” to one of the parties. In this case, the supplier’s negotiating team was taken aback the moment the company presented its detailed account of the supplier’s current costs and profit margins as well as its recommendation for a new arrangement at a significantly lower overall price.

Three Elements of Sourcing Success

To ensure the continuous governance, growth and success of strategic sourcing, procurement leaders should focus on the following three lifecycle enablers:

1. Training: Critical for team member maturity and acceptance of the proven strategic sourcing process

2. Senior leadership engagement: drives overall mission and creates alignment among team members

3. Growth and continuous improvement: Generate acceleration of adoption and best-in-class process leadership


The discussions progressed from there, taking place throughout most of the year. At each step of the way, the company’s negotiating team offered their counterparts the opportunity to refute the cost figure; the offer was essentially put this way: “If you think that your pricing should be at a certain level, show us why and how it should be. We’re in business to make money and so are you. We want this to be fair, and our research indicates that a fair margin is x percent. Tell us where we are wrong and we’ll give it to you.”

The company’s research focused on the entire supply chain for the material in question. That education and understanding – along with the clear support for the approach the company’s senior leadership team expressed throughout the process – helped the company’s team hold its ground when, in the middle of the year, negotiations turned even more contentious. At that point, the supplier announced that the agreement would likely be terminated at the end of the year.

In what may have appeared to be a risky maneuver, the company stuck to its negotiating position, choosing not to concede certain points in an effort to avoid termination. In reality, the risk was not that great; the company anticipated the bluff, which it interpreted as a frustrated response to its cost and margin figures (ones that the supplier had not refuted at any point in the ongoing discussions). The company, thanks to its newfound knowledge of the entire supply chain surrounding its product and its essential raw materials, also expected that the supplier would restart negotiations soon after issuing termination warning. The reality was that replacing the company with one or more other customers would be significantly less profitable for the supplier.

And that is exactly what happened. Both sides returned to the table and a new agreement was completed at the end of the year. The new agreement saved the company approximately US$100 million annually. Additionally, the strategic sourcing delivered the following benefits to the client:

•Supply security

•World-class pricing

•Freedom to focus on innovation

•Significant value to the business

The final two points are crucial. Conducting the strategic sourcing effort represented a bold call by the company’s procurement leadership. The ensuing effort engaged the highest level of leadership in the organization as well as a wide variety of operations across the enterprise. All of this engagement served to elevate procurement’s recognition and helped fortify the strategic credibility of procurement in the eyes of executive leadership and the entire organization.

As a result, the company’s procurement team is not viewed as an administrative function but rather as a strategic function. This is illustrated by the fact that procurement has a seat at the table when new projects, products and marketing ideas are being discussed, rather than being handed a list of specifications or a blueprint after these decisions are made.

Indeed, the company’s procurement team subsequently played a central role in enabling a first-of-its-kind product to get to market by finding a crucial supplier during, rather than after, the strategic planning process for this new product.


obStACLES to ovErCoME

As the manufacturer’s experience demonstrates, the collaborative nature of strategic sourcing requires hard work to achieve the best results.

This experience, as well as many others like it, also poses other common obstacles that companies must recognize and address if strategic sourcing is to optimize supply chain relationships. These stumbling blocks include:

Initial internal reluctance

One of the most common responses managers express when presented with detailed accounts of a supplier’s actual gross margins is disbelief. “There’s no way that’s correct,” procurement managers routinely exclaim when seeing these figures for the first time. “That’s not what the supplier told us.” For the uninitiated, moving from a traditional procurement negotiation to a strategic sourcing mindset often represents a dramatic transition. Many traditional supplier relationships can be somewhat distant in nature; they are almost entirely price-based arrangements forged through negotiations rather than deep knowledge of the supplier’s industry, business and challenges. Shifting from that mindset to a much more knowledge-based – and information-intensive – approach to managing the relationship represents a major change, and one that should be undertaken carefully.

Difficult research

The nature of the research conducted during the sourcing assessment and strategy development phases of this process also poses a challenge. For example, when the company in the case study evaluated how its supplier might supplant its business, it concluded that the supplier would need to find five to seven “replacement” customers (due to the manufacturing company’s size) to match the revenue generated from the manufacturer/supplier relationship. This meant that the supplier would need to ship to multiple locations rather than a single location. This, in turn, meant that the supplier’s shipping and logistics costs would increase significantly.

That calculation marked an important component of the research, but it was only one of hundreds of components of the overall research effort. What’s more, these types of evaluations cannot be conducted until the research team nails down more fundamental price and profit figures and calculations. If the supplier is a publicly listed company, many of these figures can be found in annual reports. However, these reports and the financial statements they contain rarely present the information the research team seeks in a straightforward or intuitive manner. Subsidiary-company financial information must be scoured. Top-line sales must be deconstructed to ferret out more specific pricing information. And due to the complex nature of pricing factors, this research almost always includes consultation with industry-specific research sources, databases and calculations.

To be sure, the research is difficult but not impossible; this information is also incredibly valuable. Although the research often produces some revelatory moments (and information that proves pivotal in negotiations), it can also run into numerous dead ends. So long as the investigative effort produces a sufficient amount of accurate information, it is likely to sway a supplier (or, at the very least, prevent the supplier from mounting an effective disproval of the information provided) at the negotiating table.

SUPPLIERS MAy RESPONd TO STRATEGIC SOURCING WITH RELUCTANCE, IF NOT HEATEd RESISTANCE.

THIS IS UNdERSTANdABLE GIvEN THAT THEIR TRAdING PARTNER HAS PEEREd dEEPLy INSIdE THEIR

OPERATIONS ANd IdENTIFIEd WHAT THEIR MARGINS ARE ANd WHAT THEy SHOULd BE.


Contentious interactions

As illustrated in the case study, suppliers may respond to strategic sourcing with reluctance, if not heated resistance. This is understandable given that their trading partner has peered deeply inside their operations and identified what their margins are and what they should be (according to the customer company’s information). The initial discussions may not be pleasant, but they are necessary. When the discussions are conducted in a highly fact-based, objective manner – “Here’s what we think the price should be and here’s why; please let us know where our thinking and figures are off the mark” – a prickly atmosphere should dissipate over time. In its place, genuine collaboration materializes as both parties seek to address problems together (related to the supply) in either organization.

LEAdiNg PrACtiCE: CoNtiNuouS iMProvEMENt

Executive support is pivotal to the success of any significant organizational initiative or change effort, and strategic sourcing is no exception. In most cases, strategic sourcing is a major initiative that requires a commensurate change in mindset, both within the organization and among external trading partners.

While executive support is obvious when it exists, it is often difficult to cultivate (where it does not exist) due to several obstacles that many procurement functions confront, including:

1. Lack of stakeholder alignment

2. Lack of dedicated methodology

3. Resource prioritization and capacity

4. Inability to leverage/negotiate effectively

5. decentralized sourcing functions/rogue buying

Procurement leaders can work toward strengthening executive support by first addressing these common procurement obstacles and then working on changing the organization’s mindset toward sourcing.

The comprehensive research effort conducted during the initial phases of strategic sourcing provides a strong foundation for effective change management inside and outside the organization. By basing the sourcing analysis, selection and negotiations on credible, fact-based research, procurement and supply chain managers can more effectively keep the focus on the “why” (i.e., the supporting evidence) rather than on the “what” (i.e., price alone).

Additionally, credible, fact-based research can help keep discussions with suppliers as objective as possible. This objectivity also helps rebuild relationships in the event that negotiations become overly contentious.

Sometimes, the rebuilding of a relationship can be nurtured with the help of the insights strategic sourcing generates. For example, a company’s analysis of its supplier’s production process may yield improvement opportunities that can be shared with the supplier. This type of collaboration differs from traditional sourcing, which yields new price points and little else.

By BASING THE SOURCING ANALySIS, SELECTION ANd NEGOTIATIONS ON CREdIBLE, FACT-BASEd

RESEARCH, PROCUREMENT ANd SUPPLy CHAIN MANAGERS CAN MORE EFFECTIvELy kEEP THE FOCUS ON

THE “WHy” (I.E., THE SUPPORTING EvIdENCE) RATHER THAN ON THE “WHAT” (I.E., PRICE ALONE).


To exploit fully the opportunities that strategic sourcing insights point to, companies should develop action plans to execute following the implementation of an agreement. These plans should be created based on the insights generated during all phases of the effort, and from the research, in particular. These insights, which should focus on sourcing requirements, typically relate to one or more of the following areas:

Specifications

For some products, the specifications are inescapably cumbersome. For example, a supplier may need to retool its machinery each time it produces a run of a particular product. That’s a difficult problem and an extremely important issue to understand as it relates to price. In addition, it possibly changes how the purchasing company does business.

Supply Chains

In many cases, the strategic sourcing effort unearths new insights about supply chain costs and challenges. For example, a company may have a longstanding relationship with a supplier based a mile away from its main plant; the logistics costs appear to be negligible and it is incredibly easy to have the supplier make unscheduled deliveries when the need arises. yet, the strategic sourcing process may reveal that this relationship, despite its proximity and convenience, may actually be significantly more expensive from a total cost of ownership (TCO) standpoint compared to an arrangement with a different supplier based in another state or country.

Locations

Strategic sourcing analyses also produce insights related to a company’s own locations. For example, factories located 50 miles away from the nearest highway may be far more costly to operate over time than an investment in a new factory located next to the nearest regional distribution center of a major retailer.

iN CLoSiNg: PrEPArE to SuCCEEd

Not all of these insights can be poured easily into tidy plans for process improvements that are then immediately executed to deliver cost savings, efficiency gains and other benefits. Legacy distribution and manufacturing models often require large investments and disruptive, time-consuming efforts to reconfigure. However, these efforts can yield lucrative returns. To be in a position to achieve these returns, companies should start by identifying the current state of their sourcing capabilities. The adjacent maturity model can be useful:

How would you best describe your current strategic sourcing methodology and process?

Level 1very few long-term contracts and inadequate or no spend visibility, utilizing one-off tactics or approaches to address large purchases

Level 2decentralized procurement functions and poor spend visibility with minimal or no focus on category management

Level 3Limited category management and basic spend visibility while using only portions of a six- or seven-step strategic sourcing process

Level 4Centralized sourcing function with robust spend visibility (80%+ of spend under management) and utilizing a formal six- or seven-step strategic sourcing process


Once procurement leaders have identified the current state of strategic sourcing, they can develop improvement plans.

The ultimate objective – as demonstrated by world-class procurement functions that consistently deliver value to their companies – is to strengthen the strategic credibility of procurement while managing strategic sourcing as a continual process.

About Protiviti

Protiviti (www.protiviti.com) is a global consulting firm that helps companies solve problems in finance, technology, operations, governance, risk and internal audit. Through our network of more than 70 offices in over 20 countries, we have served more than 35 percent of FORTUNE® 1000 and Global 500 companies. We also work with smaller, growing companies, including those looking to go public, as well as with government agencies.

Protiviti is a wholly owned subsidiary of Robert Half International Inc. (NySE: RHI). Founded in 1948, Robert Half International is a member of the S&P 500 index.

About Our Supply Chain Solutions

Using our proven approach and tools, we work side by side with our clients to implement a sustainable strategic sourcing process and methodology that can be applied across the organization to leverage purchasing volume, rationalize the supply base, and create optimal procurement strategies for each commodity or spend category.

We continually look for ways to keep our customers’ cash-flow positive throughout sourcing engagements, as this can both fund the efforts for sourcing savings as well as identify additional monies that may otherwise remain unknown.

In addition, we aim for continued, realized savings for our clients and work hard to train company personnel on the proper monitoring and contracting of sourcing events so that savings continue long after we leave the worksite.

Our methodology provides a structured and disciplined approach to sourcing, including program planning, analysis and sourcing execution. Utilizing our extensive experience in conjunction with direct involvement from our clients’ purchasing professionals and key stakeholders, we believe maximum potential is identified and achieved.

Contacts

dom Champa +1.203.905.2918 [email protected]

Tripp Piper +1.404.926.4339 [email protected]

Michael Chiock +1.404.443.8219 [email protected]

Christopher Monk +1.713.314.4970 [email protected]

©2012 Protiviti inc. An Equal opportunity Employer. Pro-0812-103045 Protiviti is not licensed or registered as a public accounting firm and does not issue opinions on financial statements or offer attestation services.

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