A Succinct Guide to Strategic Sourcing
Strategic Sourcing is a fundamental strategy for organizations seeking to maximize the value suppliers provide. Strategic sourcing aims to optimize costs, mitigate risks, and drive a sustainable competitive advantage. Do you understand exactly what it is, or how it fits into the traditional procurement organization? This article will define strategic sourcing, outline its processes, and lastly examine the impact procurement can make in the organization.
What is Strategic Sourcing?
At its core, strategic sourcing is the process of finding, evaluating, selecting, and implementing supplier relationships to align suppliers with the organization’s goals. With the heavy reliance on suppliers, nowadays the only way to forge a competitive advantage is to have a resilient higher value producing supply chain. Strategic sourcing is the fundamental procurement process used to develop this advantage.
It is different from day-to-day purchasing, which seeks to make sure the right goods and services are in place at the right time. It is different from supplier development and supplier management, which seeks to measure and improve the performance of existing suppliers. Strategic sourcing is not issuing a quote to a few suppliers. We call this, 3 quotes and a cloud of dust. It might satisfy management, but it is not strategic sourcing.
Strategic sourcing is about making sure you are with the best suppliers in the marketplace. Why would you want to waste your time developing an inferior supplier while your competitor is building a market advantage by leveraging the capabilities of a better supplier?
The marketplace is constantly changing. Therefore, strategic sourcing and relentlessly reviewing the marketplace is your first step towards ensuring a superior supply chain.
Professional strategic sourcing organizations never stop reviewing new suppliers, have 80% or more addressable spend on agreements, spend about 35% of procurement’s time on strategic sourcing, and review agreements against the entire marketplace of suppliers on a 1-to-3-year rotating basis.
At the risk of being redundant, the strategic sourcing process is always making sure you are with the best partners at the best total cost to build the supply chain into a competitive weapon and achieve the business’s long-term objectives.
Here is a simple example of using strategic sourcing to use the supply chain as a competitive weapon. Early in my career, I was able to negotiate a 25% cost reduction on a category of items with savings reaching 40% on some of the higher volume items. I asked the CFO if we could give up a portion of the 40% savings and run a sales promotion. The answer was, “Absolutely, if it makes business sense.” I met with the sales leader letting them know about the potential to reduce costs and still be profitable. Could they run a promo? Again, the answer was yes.
Home Depot picked up the promotion across all stores and almost tripled our volumes. With this leverage, I was able to capture another 7% savings from the supplier. Competitors could not match our price and it became a top selling market share grabbing item. Here is the process I used, am still using, and you can use, to help your organization compete.
The Process of Strategic Sourcing:
The goal of strategic sourcing is to maximize value delivery and optimize the organization’s supply base by following a systematic review of expenditure categories. Though customized for each category and unique situation, the strategic sourcing process typically consists of the following 7 steps: category and stakeholder analysis, building the strategy, supplier identification and initial qualification, publishing your request, negotiating with suppliers, final qualification and due diligence, establishing agreements and implementation.
1. Category & Stakeholder Analysis
The first step is to understand the organization’s objectives, the market, and the various stakeholder goals. Included in the objectives and goals are the mandatory and desired capabilities a supplier must possess. One needs to understand the current situation including the supplier’s impact on the organization’s profitability as well as the risk to continuity of operations.
Category managers review the macroeconomic market, the category’s microeconomic situation, geopolitical risk, regulatory changes, the impact of technology, and other risks. A top procurement professional is both an economist and geopolitical advisor. Additionally, sharpen your journalism skills because you need to be an exceptional interviewer, researcher, and writer.
Pro tip: When I hear a category manager saying we have long-term relationships working with the same few suppliers and the buyer doesn’t know a lot about the market it is one of the strongest signals, maybe even a beacon, that there is a tremendous opportunity to unlock the potential of the supply chain through better strategic sourcing.
2. Building the Strategy
Now that you understand everything about the category, the market, and the stakeholders you can combine all that information to design the future state. Once you know the desired future state you select strategic sourcing strategies that are going to move you in that direction. Some common strategies include renegotiating contracts, entering an RFP process, consolidating suppliers, de-risking by looking at multiple sources in multiple countries, building supply chain resiliency through reshoring and nearshoring, global sourcing, and even mergers and acquisitions. Well-defined sourcing strategies direct decisions toward optimizing the value of supplier relationships. In other words, maximizing every dollar spent while minimizing organization risk.
3. Supplier Identification & Initial Qualification
Strategic sourcing professionals keep their finger on the market. Markets change rapidly, and unless you are watching there is no way you can tell you are partnered with the best supplier(s). The first step in strategic sourcing is to identify potential suppliers that can meet your organization’s needs. Researching sites, trade journals, trade shows, research firms, network referrals, stakeholder knowledge, AI supported searches and, good old-fashioned search allows one to cast the net wide. Be careful using research firms to identify supplier lists. While they offer some level of validation, they typically miss many suppliers and research firms main source of revenue is those same suppliers advertising dollars. Solely relying on a research firm immediately introduces bias.
Work through a funneling process to quickly narrow down suppliers. When conducting direct material global sourcing events, it is common for K2 Sourcing to screen 100 to 200 suppliers and then quickly narrow the list by utilizing screening questions and our RFI supplier assessment tools. Pro tip - make a list of mandatory requirements that you can use to cut loose suppliers early in the process.
4. Publishing Your Request
80% of category strategies are executed via some type of strategic sourcing activity. The most common method is utilization of the RFP process. However, organizations tend to use the RFP term as a catchall. The actual competitive review depends on the amount of knowledge your organization possesses. If you know little about potential solutions, you will start with a request for information. If you know a great deal about the supply base and exactly what you want, a request for quote is more fitting. If you know mostly what you need but are not sure how supplier’s solutions meet your needs, the RFP is the right choice. Many times, before going into an RFP we conduct an RFI as part of the supplier identification and initial qualification process.
Here is the key to drafting an excellent RFP, RFQ, or RFI. Recall in step one, category and stakeholder analysis, you put those investigative journalism skills to work interviewing and researching? Now it is time to take everything you have learned and convert stakeholder wants and needs into questions that are specifically designed to uncover supplier strengths and weaknesses.
An easy way to start is with a template. K2 Sourcing has over 200 RFP templates. You can request a free template here. When writing your document avoid writing every question you can think of and asking for every software function as a checklist. Sales managers look for thoughtful RFPs and, unless your company is well known, they will quickly decline opportunities they feel are questionable. Before publishing, allow stakeholders a round of feedback because it will spur additional clarifications and ideas.
5. Negotiating with Suppliers
Suppliers have made it through your screening process and your RFI. They have completed your RFQ or RFP. Time to decide your negotiation strategy. Typically, you are going to request some feedback from stakeholders. Concise side-by-side comparisons and visual data representations allow the group to quickly understand total value. If you set up the questions correctly in your RFP, you can also understand the cost levers and how to move suppliers. Using an application like K2 Sourcing automates much of the analysis and reporting and makes evaluation with teams easy.
It is common to have about 3 rounds and negotiation, asking suppliers for more information like presentations, tours, or visits throughout the process. You are getting deeper engagement from them while at the same time narrowing down the list and providing market feedback to get improved offers. Go beyond price. Include additional services and risk mitigation.
Procurement professionals should be the best negotiators in the organization. Here are some resources that can help. Karrass negotiation has been a popular choice for business leaders. Additional books I enjoyed include The One Minute Negotiator, Win-Win Negotiations, and more recently, Never Split the Difference: Negotiate like Your Life Depends on It. The last book is a little too aggressive for most procurement negotiations, but there are still fantastic tips, and it is an interesting read.
Take the time to understand your leverage. I run into both too many procurement professionals and sales professionals that think the aggressive bullying approach is the way to go. When you have a lot of market power it sometimes works very effectively. Most buyers think they have more power than they do. Use that power sparingly and switch to influence methodologies and you will achieve much better results and foster a better working relationship.
In a competitive market where you can very clearly define your requirements, consider running a reverse auction. You can learn more about reverse auctions in the K2 Sourcing webinars or reverse auction solution page, but reverse auctions automate the negotiation process allowing suppliers to bid against each other in real time. K2 Sourcing has run over 19,000 RFPs and to this date the reverse auction, when applied correctly to the right situation, offers the fastest most effective means of generating superior value.
6. Final Qualification and Due Diligence
At this point, you are probably down to your final two or three suppliers. It is time to conduct the detailed assessments that will allow the team to make a final decision. How do you do this? Different organizations have different qualification procedures and the qualification for a service provider is different from a direct material supplier which is different from a software provider. That being said, let us see if we can find some commonalities.
The final qualification process typically involves some combination of reference checks, additional sales presentations, plant visits and audits, software demonstrations or product sampling, financial due diligence, organization risk assessment, and a security audit.
Resources, outside your core team, will be needed to support this phase. This could be engineering, product management, quality, IT support, finance, etc. The greater the impact on your organization’s profitability and the higher risk the category, the deeper the qualification and due diligence required. The inverse is also true.
7. Establishing Agreements and Implement
Once you have selected your final supplier(s) it is time to document the understanding of your partnership, better known as an agreement or contract. Review the RFP and all your meeting and negotiation notes. Bullet point the supplier promises and assumptions. These become the details that need to be included and added to your standard agreement templates.
Strategic Sourcing in Action
To fully grasp the application of strategic sourcing, consider the following case study. We will apply each of the 7 steps above in order starting with the category strategy and ending with implementation.
K2 Sourcing was recently asked to review an organization’s chemical procurement. The client was not happy with several core suppliers and had been taking cost increases. We compared their data against other recently completed events. There was an opportunity to generate savings, and we felt we could fix the performance issues. We formed a team whose charter was to define the category strategy, permanently address performance issues, and capture savings.
We started by reviewing all suppliers in the category and developing a strategy. First, categorizing the annual spend into subclasses and conducting interviews with the key stakeholders, we identified 3 subcategories. Next, suppliers were assessed based on risk and their impact on profitability. We then defined the organization’s needs and wants. By integrating this information, we created the overall category strategy. This case study specifically focuses upon one of the 3 subcategories whereby the end goal was to drive cost savings via supplier consolidation.
Once we established the long-term goals for the category, we decided to engage new suppliers. Thus began the supplier identification and initial qualification step. Are you wondering why we entertained new suppliers when our goal was to consolidate suppliers? There are two reasons. First, while there had been basic quoting occurring on a regular basis, historically there was no robust RFP run on the entire subcategory. Secondly, very little research was conducted on the marketplace outside of the current suppliers. To find the best supplier(s) a thorough market review needed to be conducted. We spoke with about 30 of the top chemical Distributors. To quickly narrow down the list we had several mandatory requirements. This narrowed the supplier pool to a group of eight.
Concurrently, we drafted an RFP (step 3) with about 40 total questions focused on supplier service capabilities, delivery methods, and capital support for tanks. The questions were derived from our chemical RFP template, which was then customized to match stakeholder needs and the organization’s long-term plans. The RFP was set up in our strategic sourcing application. This allowed us to automatically analyze results in real time and quickly review multiple award scenarios.
After supplier responses were received, we narrowed the playing field to 4 suppliers. We then reviewed our negotiation strategy including contemplating the utilization of a reverse auction. We felt the best methodology at this point was to utilize one-to-one negotiations. Each supplier received a customized discussion designed to improve their value proposition. As part of the discussion, the suppliers knew they made the first cut and were given clear directions on how to make the next. Suppliers were afforded the opportunity to log back into Cloud Source, the K2 Sourcing RFP application, and update their proposals. This provided real-time updates to the analysis and potential award scenarios.
Based on those responses 2 suppliers were selected to continue. We request them to conduct site audits, provide sales presentations, and once again update their proposals. Post update we met with the group and decided we would move forward with a single source for this subcategory. Prior to awarding the business to the supplier, we again requested very targeted updates to their proposal.
The result of the RFP included an 18% annual cost savings, shorter lead times, lower inventory, and improved payment terms. We let the supplier know that our intent was to award the business to them while separately we thanked the rest of the group for participating. Pro tip, to keep suppliers that have not won engaged, give them feedback. Suppliers are ever improving, and good category managers keep the door open.
But intent is, well, just intent. It is an indication that we want to move forward with the relationship, but additional activities need to be completed. In this case, the supplier required additional qualification. Product samples were reviewed, references called, financials examined, and quality plant audits were conducted. Once all the financial and operational boxes were checked, we drafted and issued the agreement.
Moving on to our final step, establishing the agreement and implementation, a simple service agreement was integrated into the blanket purchase order. We included the key price change mechanisms, additional services, and guarantees and remedies we had negotiated through the RFP process. In addition, a transition schedule was created for each item and based on inventory depletion, the actual savings forecast was produced.
Checking back months later, service performance looks excellent, and invoice audits show the price changes have been correctly implemented. We successfully met the project and category goals by consolidating the supply base, generating 18% cost savings, and improving performance.
Like any good sourcing team, we celebrated the success and shared the results widely within the organization. The win was used to build support to move on to the next category.
Strategic Sourcing’s Impact on the Organization
When taken in total, expenditures on suppliers for most companies represent the single largest impact on company profitability. According to the Center for Advanced Purchasing Studies the average amount a company spends on suppliers is 40% to 60% of every dollar in revenue. Manufacturers and retailers can easily be in the 60% to 70% range. Here is a quick comparison for you. One dollar of cost savings is one dollar of profit as compared to one dollar of revenue which equates to about $0.10 of profit.
Organizations that have excellent category management and strategic sourcing practices enjoy a 9% to 14% cost advantage over their competitors. What does this look like? Let us examine a company with $100,000,000 in revenue producing a 10% profit. Now let us say $50,000,000 of that revenue is spent on suppliers and a great strategic sourcing program will yield a 10% improvement in overall cost. The reduction yields $5,000,000 directly to the bottom line. Profit improves from $10,000,000 to $15,000,000.
Profits increased by 50%. The company went from 10% profitability to 15% profitability. This is just from improving strategic sourcing and is well within the procurement leader’s ability to control. Without the cost savings, to achieve the same incremental $5,000,000 of profit increase the company would have to increase revenue to $150,000,000.
It goes to follow that companies that have a more competitive supply chain win in the marketplace. After all there is more money to invest in R&D or pass on to potential customers to gain market share. Additionally, companies that apply best practice strategic sourcing methodologies build a more resilient supply chain. Great strategic sourcing balances cost and risk and sets the stage for a company to compete more effectively in the marketplace.
Strategic Sourcing Consulting Services
This article discussed the strategic sourcing process, provided a specific example of applying the concept, and examined how strategic sourcing improves the organization’s ability to compete. We hope that you found tips to help you enhance your strategic sourcing and found several strategic sourcing best practices you can apply today.
Do you have any barriers preventing you from providing world-class strategic sourcing support to your organization? Maybe it is resources, technology, expertise, global sourcing reach, or something else preventing you. K2 Sourcing’s strategic sourcing consulting services and sourcing software will help you fill those gaps and break those barriers. Embracing strategic sourcing as a core business strategy is not merely a choice, but a necessity for organizations aiming to develop a competitive advantage in an ever-evolving business environment. Contact us today to get started.