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MATERIAL SOURCING STRATEGIES

AND

BUYING

Critical Aspects to Future Success of Supply Management Organizations | Special Report

Aqua MCG Special Report MATERIAL SOURCING AND BUYING STRATEGIES

MATERIAL SOURCING AND BUYING STRATEGIES

Critical Aspects to Future Success of Supply Management Organizations

INTRODUCTION
Being a boundary function, the role of the sourcing function is to link the company's business needs with the capabilities of external suppliers. For this linkage to provide real value supply must be able to interface with two very different worldsthe external world of the marketplace and suppliers and the internal world of business units, projects, and functions- and the perspectives and approaches of these two worlds can be very different. Solving the Rubiks Cube provides a strong analogy to implementing an effective sourcing strategy- It is not good enough to get two colours right while disrupting the rest of the cube.

MATERIAL SOURCING AND BUYING STRATEGIES

The strategies for effective sourcing simultaneously balance design elements of structure, information, people, goals and measures and external alignments. Research on extant literature and gleanings from on-ground experience across sourcing professionals in the country reveal the following aspects critical to future success of supply management organizations:

STRATEGIES FOR EFFECTIVE SOURCING

The strategies for effective sourcing simultaneously balance design elements of structure, information, people, goals and measures and external alignments. Research on extant literature and gleanings from on-ground experience across sourcing professionals in the country reveal the following aspects critical to future success of supply management organizations:

ONE SOURCING STRATEGY DOES NOT FIT ALL- NEED FOR DEVELOPING CATEGORY
A typical purchaser of raw materials, operating goods and services for a large manufacturing entity buys more than 300 unique categories from more than 10,000 unique suppliers. Intuitively, it would be easy for a sourcing professional to envision the need for a wide variety of sourcing strategies for categories that possess characteristics that vary as widely as life insurance, corrugated packaging, MRO supplies and janitorial. Key characteristics of different category types need to be analysed and understood on a category-by-category basis, which can be done by asking and answering the following key questions: o Are expenditures in the category large enough to create buyer power, relative to suppliers and other buyers (or large enough to make a sourcing impact)?

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 Aqua MCG Special Report MATERIAL SOURCING AND BUYING STRATEGIES

o o o

Is the category strategic/proprietary to the buyer? Are there any current or future risks of supply continuity? Does the sourcing/procurement department own/control sourcing decisions and supplier management or is the sourcing/procurement department an influencer? Does the souring/procurement department have professional knowledge of the category and sourcing best practices in the category? Does the sourcing/procurement department fully understand the supply market cost and pricing models and structures? Is the expenditure and the specs/volumes in the category recurring/repeatable or project based? How complex/fragmented are the purchases in the category (skus, service level types, lanes, tariffs, drawings, prints, specifications, etc.)? Are the supply markets consolidated and duopolistic / monopolistic in nature or fragmented and extremely competitive? Is the supply base local, national or multi-national? Are the products/services purchased easily substitutable and not differentiated (commodity-like)? Who are the internal users/stakeholders associated with the category and what is their historical exposure to sourcing activities and different sourcing approaches? What is the current state of sourcing strategy for the category in terms of number of suppliers (w/ and w/o contracts) and the fragmentation level of suppliers and the dollars expended with the suppliers? What are the switching costs and how will the supply base view them? What other internal goals and objectives may exist beyond typical sourcing objectives (such as building new customer relationships with entities who are also suppliers or diversity expenditure hurdle rates)?

o o o o o o o o o

Figure 1: Different sourcing needs basis material category

Decision Criteria: 1) Purchase Volume 2) Business/ Site 3) Supplier 4) Usage Commonality Commonality Mix Across Categories Procurement Coordination Needs High Example Buying Structure
Central buyer

Even Distribution Across Users Even Distribution Across Users Majority Users

Example Geographic Sourcing Market

Global

Common Suppliers

Multi Users

Increasing Coordination Requirements

Central buyer

Global/Region

Unique Suppliers

Lead business buyer with network to other buyers

Majority Users

Large Single Users Common Suppliers

Lead business buyer

Category of Materials or Services

Small

Business buyer with network to other buyers Business buyer Business buyer Local Local

Unique Suppliers

Low

V ALUE B ASED SOURCING

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Aqua MCG Special Report MATERIAL SOURCING AND BUYING STRATEGIES

In companies blazing the trail in supply management, sourcing is increasingly taking on a more strategic, futureoriented role. Companies excelling in category management as detailed above will, in future, not limit their thinking to the current form an item takes, or even the market that supplies it. The best companies are instead broadening their procurement horizons and focusing on the items basic functionality and then searching for alternatives. The outcome of such an approach leads to decisions for example on make-vs-buy decisions, embedding the supply functions role more holistically in the companys supply chain. In other cases, companies focus on upstreaming to lock value. For example, a leading beverage manufacturer has over the years shifted from buying caps and closures at market prices to working collaboratively with its suppliers to backward integrate their raw material supply. Leveraging global scale, the company has locked input PET resin prices for its converters; ensuring input price control which the company can then translate into price-point based marketing techniques. One key tool to such holistic analysis of supply needs is the total-cost approach. For example, a leading Indian stainless steel manufacturer has shifted from sourcing pure Nickel (a key input material) to stainless-steel scrap as a Nickel source, after assessing total costs for manufacture, thereby changing its supply material (pure to scrap), market equations (dependency on a few large global manufacturers to a broad supplier base, thereby increasing its negotiation power).

In future, as highlighted by Robert Z. Monczka (Supply Management in the Decade Ahead) companies will increasingly use value-based sourcing for higher business impact.

MANAGING SUPPLIER B ASE & SUPPLIER RELATIONS BETTER

Improving the overall supply base and increasing the value achieved from it is critical to supplys value proposition. While literature is replete with details & case studies, two areas of focus are highlighted below: Source Base: Twin forces at work determine the source base for a category. Consolidation is expected to decrease the source base for companies, especially once more and more categories come under the purview of central procurement and with reduction of maverick spend, especially in case of indirect spend categories but also

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to an extent on direct categories. Given this phenomenon, leading companies are defining the roles of individual companies more exactinglyfor example, by determining whether a particular supplier is expected to provide the lowest possible price or to take on a value-based role by contributing through technological advancements and other innovations. A critical element in this decision making is a clear articulation of the sourcing functions goals, which need to include elements of not only price, but also preferential access and business partnership development, while meeting quality, and service requirements and ensuring responsiveness. Juxtaposed with the phenomenon of consolidation, leading companies continuously renew and reinvigorate their supply base, bringing in new players who not only add competitiveness-led market benefits but also new technology and a willingness to learn, improve and develop capabilities. Relationship Management: Finding supply chain partners & ensuring a healthy alliance requires attention to a short list of commonsensical considerations. Not heeding one or more can mean the difference between a business combination that succeeds with the hoped-for synergy and one that limps along at less than its full power to realize anticipated benefits. (See sidebar for ten ways to ensure that your alliance stays healthy and thrives)

Ten ways to Ensure Successful Supplier Partnerships 1. Balance the benefits among the parties: Each party must believe that the benefits of the relationship are mutual and equitable a win-win situation. 2. Align strategic goalsIf long-term strategic goals of the parties to a relationship arent explicitly aligned at the outset, the result can be failure to capture all the benefits of the combination. 3. Clarify objectives, and be specific about expectations 4. Create a prenuptial agreement; dont go in without a way back out: Defining how each party can get out of an agreement is as important as identifying why to get into it at the start. 5. Clearly define processes and specify the ways the parties will work together; include performance measures and follow-through 6. Commit enough people to do the job, and commit the right kinds of peopleStrategic sourcing alliances require dedicated talent to provide content knowledge about the science and technology, businesses, customers, and operations, and to provide leadership competencies. 7. Communicate, communicate, communicate: Develop a communications program and ensure that information systems are compatible and equal to the communications expectations. 8. Get top leadership to commit, visibly and earlyA clear, open, and explicit mandate from the top of both alliance partners is absolutely essential. 9. Make rules for governance and decision-making, and align written and unwritten rules 10. Tend to the cultural issues constantlyCulture is defined as The way things really are around here. Cultural issues underpin virtually all of the recommendations on this list. Organizational alignment, strategic alignment, post-alliance integration, and all the associated process adjustments are deeply dependent on communication and at the most fundamental level, cultural issues.

LEVERAGING INFORMATION AND T ECHNOLOGY ENABLERS AS

KEY DIFFERENTIATORS

For the supply function, information is the raw material from which sourcing is fabricated; without information, sourcing professionals will make flawed decisions with catastrophic business results. As the building block of sourcing, information is a critical design element. Organizational structure needs to consider where information comes from, where it goes, where it resides, and how it is controlled. There are several different types of information: transactional information (such as specifications, prices, and purchase orders), business management information (volume and cost plans, exception management, and new product introductions), and market information (commodity supply and demand and industry and supplier analytics). Internal information like transactional information has been covered adequately through enterprise resource planning systems- web based tools are enabling companies to capture and share operational information across the supply chain to all its partners.

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Aqua MCG Special Report MATERIAL SOURCING AND BUYING STRATEGIES

Key focus areas in mature sourcing companies is the focus on tracking, analyzing and using market information. For example, an FMCG company with a significant direct material spend on a commodity like sugar has a core commodity desk tracking information on industry capacities and inventories, daily auction prices, sugarcane recovery, and even tehsil-wise reports from government cane assessors, apart from index-tracking- this information has served the company in good stead while sitting across and negotiating forward contracts with millers.

FOCUS ON INDIRECT MATERIALS AND SERVICES

Although indirect materials and services for a typical manufacturing entity are individually small areas of spend, collectively these represent up to 10% of procurement spend on average (and frequently much higher), and have significant potential for driving efficiencies. A few salient aspects of this category: Usage and Rate are typically mixed: For Consumables as well as services, people talk of total spends more than the per-unit cost. Most of the accounting systems do not inventorize the consumables and book them as expense on receipt of materials at plants. Usage variance and price variance are not tracked separately. In many cases, even the baseline cost data is not available. Large number of quality attributes for service: For a service such as Travel there can be multiple attributes of quality viz. speed of service, no inaccuracies in bookings, ability to change bookings on a short notice, ability to get visas on a short notice, get the best discounts in the market, 24 hours availability all parameters evaluated across a large number of people, not possible to record all data. One has to depend on Customer Surveys for feedback on quality of service Limited flexibility in suppliers: Once we enter into a contract with a particular service provider, it is difficult and costly to move to another service provider for a short duration or a smaller business. A good example is Mobile Phones it is quite expensive to change the service provider just for a few users. Wider role of technology: Almost in all services, technology is changing fast and hence the service provider has to be in touch with the latest technological developments. This aspect becomes an important criterion for supplier evaluation. Effective spend management in this category depends more on monitoring than other aspects discussed till now, with effective performance management & KPIs, which should track contract compliance, customer satisfaction, cost competitiveness, continuous improvement programs as well as requisition turn-around times.

PROCURING & NURTURING THE R IGHT T ALENT

Procurement requires a very strong technical background such as understanding of the product, manufacturing processes, financial analysis, statutory requirements, import-export laws. At the same time it requires a set of soft skills that are absolutely critical to be able to forge effective relationship with the Suppliers while ensuring that the company objectives are delivered both tangible and intangible. Hence it is critical that a company attracts, develops and retains the best talent- people having a unique skill-set comprising of technical acumen as well as people skills. Best-in-class companies provide for clear development paths, support training and participation in industry and trade events, and provide clear career paths and rotation plans, while providing for succession planning. And if a small to medium sized organization does not have the time and resources for this kind of development program, then it makes sense to hire trained resources from the bigger companies may be at a little higher costs, while providing them with a lot more independence.

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TOOLS TO OPERATIONALIZE S OURCING STRATEGIES

The key to strategic sourcing is to integrate sourcing with procurement through analytics and contract management. The following design tools are key enablers in ensuring the same: o o Formal, preferably multi-year Procurement Plan to project, audit and regularly validate procurement savings Design Aspects: o o o o o o o o o Procurements impact on strategic vision, business plan and key financial metrics need continual focus Analysis of current costs (direct, expense, capital) and cash flow forecast Prioritized listing of key spend categories, savings targets and benefit goals 3-5 years buying strategy for each material Actions to measure key supplier relations Touch-points with other business initiatives Assigned business, finance and procurement resources A time phased savings plan Cash flow elements such as Working Capital, Trade Financing, Payment Terms to be part of Procurement savings goals

o o

Focus on all items & services- not only direct items. (On an average 18.5% of revenue is still uncovered by Procurement, per an Aberdeen Research report) Design Aspects: o o o o Minimize maverick buying; track % unplanned / unstructured buying Track actual vs. Plan for indirect items & expenses as well. Expense Automation System Instituting a system and periodic expenses analysis can deliver 67% savings. Volume Leveraging Concept applies not just to big ticket items but in other categories also, eg. MRO items.

o o

Effective Contract Management Design Aspects: o o o Create Contract based on Bid Awards Share Contracts internally & externally to obtain necessary approvals Publish Contracts to Backend system

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Monitor consumption, expiry, and compliance

There is 20 25% leakage in savings due to poor compliance of contracts, according to some leading sourcing experts o o Better Analytics Capability Design Aspects: o o o o o o o o Supplier Performance Measurement and Contracts based on data-based performance measures Suppliers SWOT Analysis Total Cost Analysis Capture Suppliers Cost Structure Multi-attribute decision making models and what-if scenarios Competitive Benchmarking

Efficient Buying Tools : E-Auction & E-RFP/Q Design Aspects: o o o o o Share RFPs for internal approvals Distribute RFQs to existing & potential suppliers Train suppliers on RFx / E-Auction Conduct the Auction & Share Results Track entire process with graphical display

o o

Procurement Performance Scorecard Design Aspects/ Key Variables: o o o o o o o o o o Material Price Variance # Stock Outs Lot Sizes & Lead Times Supplier Reliability on Quality, Quantity & Timeliness of deliveries Trade financing options & payment terms Purchase Cycle Time Ownership of material price variance by Procurement Performance tracking against last year, market, competition & imports Cost targets to flow out of competitive value chains Balanced focus on Cost & Supplier Capability (quality, service, innovation, flexibility)

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There is a strong need for Standard definition & tracking of Savings across the organization. It leads to an estimated leakage of 30-40% in savings- As per an Aberdeen group research conducted in 2006, out of total possible savings, only 34% finally go into P&L while what is reported by procurement at the beginning of the year is as high as 75% - 80%

FOUR STAGES OF PROCUREMENT MATURITY

Imbibing, incorporating and internalizing above highlighted aspects takes the spend management function along the road to procurement maturity. How mature is your organization? Organizations can judge where they are on this road using the following diagram:

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For more information, please contact: Mumbai: Ram Mantravadi Shiv Kumar Bengaluru: Gopal Anandan Manish K Singh Technology: Anshuman Mukherjee ram.mantravadi@aquamcg.com shiv.kumar@aquamcg.com gopal.anandan@aquamcg.com manishkumar.singh@aquamcg.com anshuman.mukherjee@aquamcg.com

Or contact us through our website: Click Here About Aqua Management Consulting Group

Aqua Management Consulting Group (Aqua MCG) is a premier advisory and execution group committed to delivering superior supply chains and maximizing business value for our clients. We help transform and manage supply chains for better business performance. We do this by providing High value consulting advice and complete execution support Business and functional leadership, on a BOT model Supply chain outsourcing solutions and services Steady-state operations monitoring & continuous performance improvement

Our team comprises professionals with strong consulting experience, good domain knowledge and execution leadership. We use structured methodologies, analytical rigor and defined metrics to deliver value for every project we undertake. Our vision is to be globally recognized as highly valued partners for achieving supply chain leadership.

Visit us at: www.aquamcg.com

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