If you are a procurement professional you should have heard about 7 step strategic sourcing process, but if you are not a hardcore procurement pro it is likely you might don’t know what it is about. This blog explains 7 step strategic sourcing process with no non-experts.
There is a difference between Strategic Sourcing and Purchasing. Strategic sourcing is a cyclical process of gathering and analyzing information about a company’s buying requirements and suppliers’ markets along with individual vendor performance in order to find the most suitable sourcing partners for a company’s unique business goals. In most cases, the main emphasis in strategic sourcing is on reducing the Total Cost of Ownership (TCO) instead of focusing efforts on purchasing price per item. In some cases, the main goal of a team performing sourcing analysis would be increased supply chain resilience, speed of delivery, transparency into their suppliers, or other factors outside of price reduction. It is worth adding that strategic sourcing principles could be successfully applied to evaluating potential outsourcing or consulting partners as well.
Before we dig deeper into the strategic sourcing concept, it is important to define how to calculate TCO. Generally, the formula looks like this:
Initial Cost + Expanses – Remaining Value
While it’s simple to calculate your Initial Cost (in other words: purchase price) and Remaining Value (if we could resell the product after it’s usage, it is the price for which we could sell it), things became a little bit more complicated in the case of Expenses.
For Expenses, you could refer to everything from the cost of transportation per item, transactional costs per item, storage costs per item, expenses on supplier inspections, or audits converted to a per-item basis. The more detailed numbers you can gather in a reasonable amount of time, the more accurate a picture you will get.
Going back to the topic of strategic sourcing, 7 step strategic sourcing process starts with:
1) Getting a Picture of a Current State of Affairs
Because this step is done internally, it could be one of the most labor-intensive. This part of the 7 step strategic sourcing process aims to specify the spend overview of the product or service you are procurement.. The basic questions you should be able to answer after the first step are:
Who is an internal user of this product or service?
For instance, in manufacturing companies, the product that we are sourcing might be a raw material or component used directly in the manufacturing process, or it might be a finished good that is used to secure good and safe working conditions (such as gloves or protective shoes).
Which quantities of this product or service are used?
It’s important to distinguish what quantities of our purchases we are using. Often, if not always, we buy more than we need because we have experienced issues previously such as bad quality, damage during transportation, and delayed deliveries. The previously mentioned variables are omnipresent, but we want to avoid them. We want to find a supplier that will offer us 100% on-time delivery. Even if he or she would have a slightly higher price per item, after calculating the costs associated with order delays, we might end up signing a contract with them since we will be able to more accurately control our supply chain without having to carry excess inventory.
What are the characteristics and specifications of this product or service?
In other words, is the current supplier somehow unique and are they the only ones who could make a product that will fulfill our needs? Probably not, but in most cases, suppliers would have to incur additional costs before launching the manufacturing of our product. The bigger the number of unique characteristics and specifications our product poses, the higher such costs would be.
Which of the characteristics and specifications are critical to our company or brand?
Referring to the previous point, the more standardized our products would be, the easier it is to switch suppliers. The easier is to switch a supplier, the less dependent we are on external enterprises. However, standardizing the product and giving up its unique characteristics and specifications is not always the best economical decision because our specification might be our competitive advantage.
2) Learning the Supplier’s Market
It is important to be aware of trends and main players of a market your vendor is in. We should know which competitors have the best representation in that market. While performing your supplier market analysis, it is important to define the power of suppliers and their overall industry in the supply chain of a particular market. To understand the power of suppliers and their industry, you should consider:
- Vendor’s industry intensity – typically, the more companies are working in an industry, the weaker a single company is.
- Willingness and ability of buyers to integrate backwards and opposite – if buyers can integrate backwards, it means that suppliers should keep margins low to not give financial reasons for their buyers to acquire them.
- How essential are a supplier’s goods to their buyers – if the supplier’s goods are essential to the buyer’s business activity, they have more bargaining power.
- Is it easy for a buyer to switch a supplier? – the easier it is for a buyer to switch a supplier, the lower supplier’s power would be. In these situations, long-term cooperation between supplier and buyer are less common.
- Is the industry growing? – if the industry is not growing (or even shrinking), then rivalry among suppliers will grow, and it would make them weaker.
- Are an industry’s barriers to entry high for a new company? – the easier is to create a company in a particular industry, the more competitive the industry would be, which will lead to weaker suppliers.
- What is the market participants’ size ratio in a supplier’s industry – if there are a lot of companies of the same size, the competition is higher, which will lead to weaker industry players.
You might even dig deeper to find out information about salaries, working conditions, margins, and prices in that marketplace. In some cases, this information is hard to find, and it may be useful to use professionals for such tasks. Right now, during unpredictable times that are caused by a coronavirus, you might consider local suppliers more so than you have in the past. If you are from a high-income country, it is probably less economically effective to cooperate with local suppliers, but to obtain additional resilience, control, security, transparency, and tighter cooperation, the pros may outweigh the financial costs.
3) Strategy Formation
Strategy development should be done in cooperation with key stakeholders of the product or service that we are going to purchase. Their requirements on quality, specifications, and classifications are essential and we, as supply chain or procurement specialists, must adjust to these requirements. Besides that, our sourcing strategy should be fully aligned with the overall business goals of a company we are working for. For instance, a company that pursues a cost-leadership business strategy will be more focused on TCO than a company that is an innovator and first mover in the industry.
During the strategy formation step, we should decide all requirements that need to be communicated for our suppliers to be prepared for the next step. We should determine:
- Number of suppliers for the particular product/service along with supplier segmentation
- Geographical locations of such suppliers (if there are more than one)
Other examples of criteria for potential partners:
- Financial stability
- Lead times
- Level of communication (quick and easy exchange of information)
- Level of customer service
- Return process
- Order volume (minimum and maximum)
- Payment Policy
- Delivery methods
- Suppliers production process development
- Supplier flexibility
- Knowledge and experience
- Development of the distribution process
- Environmental impact
- Organizational Culture
In our view, this is one of the most important steps of the 7 step strategic sourcing process.
One of the key challenges during the negotiation process is to form the best possible team. Such a team should consist of a negotiator and an expert that knows the product/service that we are going to purchase and the key processes involve in either manufacturing of product or delivery of service.
Strategic sourcing software exists to help in this process, such as Bid Ops, who automate the strategic negotiation process and drive savings opportunities by introducing AI-Driven Intelligent First Offers. You can plan out your strategic sourcing project pipeline and get instant opportunity analysis, forecasts, and recommendations with Bid Ops to help you focus on the line items that drive the most value for your organization.
6) Implementation and Integration
After your negotiations are finished, it is important to communicate to the supplier that you are going to be strategic partners with them, not merely a transactional relationship. The more important a product for your company the supplier provides, the tighter such cooperation and partnership should be. To ensure that the vendor understands what is expected of them, you should integrate them into your strategic discussions to illustrate what is most important to your business.
Alluded to earlier, strategic sourcing is a cyclical process. After signing a contract with a supplier, your work isn’t finished yet. Governance is key; it is essential to establish an effective way of measuring supplier performance over time. When executed properly, if discrepancies occur, you can quickly inform your vendor about such situations and allow them to address the issue with minimal to no business impact. Over time, with more experience on both sides, the volume of problems associated with supplier’s products or services should go down. If you don’t see an improvement over time, you should find the root cause as it may be due to a vendor’s low motivation for a long term partnership.
In conclusion, it is worth remembering that in today’s unpredictable times of global crisis caused by a coronavirus, global political leaders and international corporations started noticing the disadvantages of globalization. The main disservice of the globalized world is enormous dependence on a few low labor cost countries as the main source of raw materials, components, and even finished goods. According to most experts, the coming years may be characterized as a “deglobalization” period. This leads to an even greater focus on strategic sourcing to find the best sourcing partner today. Being able to adjust to your specific needs, strategic sourcing is essential to successful supply chain management strategies in both the short and long-term.
About Author- Vladyslav Bahniuk
Current occupation: Supply Chain Professional, Energizer Holdings
Previous experience: Logistics Function, Whirlpool Corporation
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About the Author- Dr Muddassir Ahmed
Dr MuddassirAhmed is the Founder & CEO of SCMDOJO. He is a global speaker, vlogger and supply chain industry expert with 17 years of experience in the Manufacturing Industry in the UK, Europe, the Middle East and South East Asia in various Supply Chain leadership roles. Dr. Muddassir has received a PhD in Management Science from Lancaster University Management School. Muddassir is a Six Sigma black belt and founded the leading supply chain platform SCMDOJO to enable supply chain professionals and teams to thrive by providing best-in-class knowledge content, tools and access to experts.