Applying The Principles of Strategic Sourcing to Modern Procurement
The events of 2020 have shaken the very pillars of global supply chain and manufacturing organizations. The effects have been widespread and costly, but they have also revealed the need for us to revisit and rethink our approach to sourcing and procurement. While strategic sourcing has been a known method since the first 8-step model was introduced in 1994, the practice is more relevant than ever in our modern era.
It’s time to go back to basics and look at how we can leverage this proven approach in supply chains going forward.
Strategic Sourcing Vs Traditional Procurement
When we use the term “strategic sourcing” we’re referring to a process that comes about as a result of a specific goal or necessity. As part of this process, we must evaluate our opportunities and supplier relationships, assess both value and relevance for the business and supply chain in the long-term, and finally create a plan of action for commodities or supply networks.
Given this, let’s take a look at traditional procurement first. This approach is highly focused on seeking out the lowest cost among suppliers and managing the execution process from PO, to invoice, to payment.
Strategic sourcing pulls the scope out, instead opting to seek out long-term relationships with suppliers that provide quality, value, collaboration, and flexibility in an ever-changing supply chain. It’s ultimately a limited approach versus a holistic one.
After all, the purchase price is the tip of the proverbial iceberg. Factors like risk, guidelines, processes, drivers of demand, inventory planning, and technical capabilities are all factors that directly affect the ability to complete the procurement process.
This applies to both direct materials spend and indirect spend as well. While the former is focused on purchasing all the required materials, components, and services needed to produce a product, the latter focuses on expenses required to operate the business. Both, of course, can benefit from a strategic approach, but the indirect spend is primarily focused on cost-efficient collaboration with suppliers.
Focusing on direct materials spend, strategic sourcing allows us to define some traditional objectives that set the stage for how the organization stands to benefit:
- Share best practices
- Make contact with new suppliers and establish partnerships
- Increase overall quality
- Improve operating efficiency
- Reduce costs
Applying this method to your procurement elevates the process in numerous ways that provide benefits far beyond cost savings. Let’s get started.
A Modern 7-Step Model For Strategic Sourcing in Your Organization
The first 8-step model for strategic sourcing came about in 1994, thanks to Toshihiro Nishiguchi. By looking at the differences in automotive sourcing across Japanese, German, and U.S. markets, Nishiguchi identified the key differentiator and created a generalized strategic sourcing process based on multiple manufacturers, in particular with a focus on Toyota.
For our purposes, we’ll look at a 7-step model which will vary from company-to-company, but carries with it universal and actionable items for modern supply chains:
Step 1: Procurement Plan
Start by selecting your team and beginning with a project kickoff. In this beginning stage, it’s important to gather together your current analysis of the industry, customers, and suppliers. Regular team meetings will allow for a base-level understanding of the scope and opportunities to review all existing contracts.
Finally, determine procurement expenditures before moving on to the next step.
Step 2: Supply Market Analysis
In the second step, we turn our attention to external market data. As you compile this data, consider both team members and stakeholders and their priorities, which will offer guidance as you move forward. Issue detailed requests for this data from stakeholders and suppliers as needed to create a unified document.
The specific focus will vary, but things like trends, best practices, procurement strategies in other areas of the industry, and overall market pricing will all play a crucial role. The creation of a Total Cost of Ownership (TCO) model will help the team understand all cost drivers and cost reduction opportunities.
Step 3: Develop a Strategy
For step three, we turn our attention to the future based on supply and demand forecasts. As you develop your unique strategy, remember to summarize and segment suppliers to identify the key areas of opportunity where you will focus your efforts.
A segmentation model could be helpful here, allowing you to connect your TCO from the prior step to a yearly cost forecast, which can also identify savings later on. Your strategy summary should account for both cost and operational importance as you weigh things like availability, alternatives, savings, and quality or innovation.
Step 4: Requirements and Evaluation Criteria
The fourth step introduces the need to establish the requirements for your suppliers, and how you wish to evaluate them. Examples include service, quality, transparency, delivery time, and total unit cost. Weigh these based on their importance and an evaluation score of your choosing. Multiply these scores together to get the result and quickly establish a ranking for your current suppliers.
Step 5: Supplier Selection and Negotiation
Next, you should prepare for negotiations with selected suppliers. Establish your wants, your needs, and where you can accept alternatives before you begin the process. While your goals will differ, it should be established that the best cost and minimum requirements will be a major focus.
Step 6: Implementation
Your implementation plan will establish the required activities to implement the contract. This includes a work plan, communication strategy, and benchmarking. Variance analysis based on the cost forecast and actual determined costs will also reveal any savings as well.
Step 7: Review and Establish Areas For Improvement
The final step is an ongoing one. Once you’ve established the basis for a strategic sourcing framework, there will always be opportunities to improve and adjust based on your results. Maintaining suppliers relationships is key, but being aware of potential risks and revisiting the strategy annually are also essential elements of your ongoing success.
While 2020 has been a tumultuous year for the manufacturing and supply chain industries, this is an opportunity to readjust the focus and reaffirm the best practices that will ultimately give us the recovery and resiliency we need going forward.