Table of Contents

WHAT IS THE CORRECT DEFINITION OF STRATEGIC SOURCING? 3
DEVELOPING AN EFFECTIVE FRAMEWORK 4
OBSTACLES TO A SUCCESSFUL INITIATIVE 7
THE IMPACT OF COMMODITY CHARACTERSITICS 9
THE INHERENT DANGERS OF A PULL-THROUGH STRATEGY 11
THE MYTH OF TRANSACTIONAL REDUCTION 14
A STRATEGY OF ORDER 15
A STUDY IN CONTRASTS – SEEING BEYOND THE ORG CHART 16
THE IMPORTANCE OD SUSTAINABLE SAVINGS AND THE EMERGENCE OF SAAS 18
NYCDOE 2004 – A CASE IN POINT 19
NYCDOE 2007 – (UPDATE) 21
MURDOCH 2007 – (UPDATE) 22
ABRIEF NOTE REGARDING THE PROCUREMENT OF SERVICES 25
CLOSING SUMMARY 23
ABOUT THE AUTHOR 25

Appendices

APPENDIX A 27
SUCCEEDING IN A DYNAMIC WORLD: SUPPLY MANAGEMENT IN THE DECADE AHEAD – A CAPS, ISM AND AT KEARNEY STUDY, 2007
APPENDIX B 29
ACRES OF DIAMONDS: THE VALUE OF MANAGING LOW-DOLLAR PAPER, 2005
APPENDIX C 33
RETHINKING PROCESS: REDUCING COSTS AND MAXIMIZING RESOURCES IN ED PAPER, 2004
APPENDIX D 35
MURDOCH UNIVERSITY – FINANCE EFFECTIVENESS PROGRAM OUTLINE, 2003
APPENDIX E 39
SERVICES PROCUREMENT – CASE STUDY, 2005

© Hansen Consulting and Seminars Inc. 2008

Defining Strategic Sourcing

Strategic sourcing is the process of leveraging buying power, reducing the number of suppliers, verifying vendor compliance to negotiated agreements, and reducing the number of procurement transactions and cycle times. The idea is that, in evaluating opportunities to outsource, organizations can drive down unit costs and purchase commodities at the lowest possible cost of ownership.

“Institutions and school systems need to look at what they spend and the number of suppliers they have and compare that to external benchmarks,” said Hrusovsky. “Typically, a large organization such as a university or a large school district spends a significant amount of dollars on routine and recurring purchases. If they purchase things more strategically, they'll usually find significant savings.”

Rethinking Processes: Reducing Costs and Maximizing Resources in Education Strategic Sourcing Report by The Center for Digital Education, 2004

What is the Correct Definition of Strategic Sourcing?

Based on a contract creation/compliance management framework traditional thought leaders have historically promoted what is now referred to as Strategic Sourcing as the lynchpin of an organization’s procurement practice. The belief that an enterprise-wide adherence to process centralization was the only way to achieve true savings was also the impetus behind the simultaneous introduction of vendor rationalization and transaction reduction as key elements of the strategy.

While there are certainly instances in which this combined approach will deliver savings, it is not necessarily the best approach to take for all commodity type purchases.

With studies by organizations such as IDC confirming that 85% of all e-procurement initiatives fail to achieve the expected savings there is a growing belief that the traditional definition of Strategic Sourcing does not reflect the way in which the real-world actually operates. As a result organizations are now beginning to examine factors such as the impact of commodity characteristics on the procurement cycle more closely.

With the emergence of new revelations such as the one referenced above it is becoming increasingly clear that the broad application of a Strategic Sourcing strategy (let alone any strategy) as traditionally defined in the 2004 Rethinking Processes report, is not conducive to achieving sustainable savings.

Unfortunately, and as demonstrated by a number of recent studies, there remains a handful of mainstream players from within the software, consulting and even association communities that continue to advocate an traditional enterprise-wide approach to Strategic Sourcing. The reason for this steadfast commitment to a “shrinking ideal” appears to be based more on self-preservation than operational gains.

Developing an Effective Framework

One example of the lingering commitment to the evanescing precepts of traditional thinking, a just released ISM, CAPS and AT Kearney study titled Succeeding in a Dynamic World: Supply Management in the Decade Ahead (see Appendix A), identified Category Strategy Development as one of the “key” elements of an effective procurement practice.

Specifically, Category Strategy Development is defined as “consolidating your supply base for each category into a small number of preferred suppliers that can be efficiently managed while mitigating risk.”

Based on this definition, Category Strategy Development, which to some is a primary element of a Strategic Sourcing initiative, is the epitome of the two edged sword. While a minimalization strategy may be easy to grasp at a conceptual level, its applicability from a real-world perspective is considerably limited.

There are a variety of reasons for this assessment, the most prevalent being the persistent commitment to rationalizing or reducing the number of suppliers.

Obstacles to a Successful Initiative

Industry studies such as a 2004 automotive sector investigation into off-contract purchasing revealed a startling trend in contract non-compliance. The findings clearly illustrated that even though centrally negotiated contracts were in place, 33% of all purchases in the United States were from non-contracted suppliers. In Canada, that number ballooned to 79%. This is the direct result of technological misalignment resulting from an effort to broadly consolidate spend under a single banner through a traditional Strategic Sourcing model. And the consequences of this flawed strategy even extend beyond the confines of the organization itself, as the fallout relative to supplier relations is also significant.

In the case of the automotive industry example, the revenues for the approved suppliers never seemed to materialize. This led to an increasing level of supplier skepticism reflected in their reluctance to allocate valuable resources to respond to future RFQ’s. Comments such as “we spend too much time working on RFQ’s . . . the RFQ process chews up dollars and time for something that is going to bring us no return,” by supplier-side senior automotive executives emphasizes this point.

Exacerbating these challenges is the buying organization’s commitment (re legislated or enforced compliance) to implementing a traditional Strategic Sourcing model, which means that a large percentage of the potential supply base is never actually cultivated, developed or maintained.

In fact, to the majority of suppliers, the RFx process associated with the introduction of a Strategic Sourcing program is generally seen as nothing more than an elaborate fact finding mission that is geared toward bolstering and justifying a pre-ordained outcome. In short, an exercise in decision justification in which a “gravitational leaning” toward particular vendors already exists.

Therefore, new supplier expectations of realizing any tangible results are virtually non-existent, while existing suppliers see the process as either a potential threat to a comfortable stream of business or as an exercise in futility whereby projected revenues are never fully realized.

In essence a traditional Strategic Sourcing strategy actually euthanizes the supply base, hastening its erosion over time resulting in an imperceptible but steady increase in the Cost of Goods (CoG) - often referred to as creeping margins, as well as diminished vendor performance. The irony is that the very control mechanisms the strategy is meant to incorporate into the purchasing process are actually neutralized as a shrinking supply base can no longer provide a real-world real-time window on market conditions. An outcome that has negative (some would say catastrophic) consequences relative to the procurement of commodities that demonstrate a Dynamic Flux characteristic. (We will review commodity characteristics in the next section.)

Besides recognizing the high level of supplier skepticism toward most e-procurement initiatives including Strategic Sourcing, removing the supplier-related obstacles that undermine the majority of programs is directly linked to understanding the nature or characteristics of an organization’s spend.

Properly aligning your purchasing activity with the strengths of a dynamic (nee growing) supply base will enable you to maximize rather than minimize supplier participation. More to the point, by playing to the strengths of your vendors you will create a truly competitive environment in which best result decision-making on the part of your front line buyers will occur on a consistent basis. The necessity to implement a Category Strategy

Development program as defined in the ISM, CAPS and AT Kearney report or, “drive appropriate behaviors” as stated in a 2007 IBM, SciQuest and Penn State study will become moot.

The Impact of Commodity Characteristics

In my paper Acres of Diamonds: The Value of Effectively Managing Low-Dollar, High Transactional Volume Spend (Appendix B), I referenced 14 years of research in which two distinct commodity “characteristics” were identified (Dynamic Flux and Historic Flat Line). Based on my findings, leveraging volume savings through vendor consolidation (re Strategic Sourcing) with Dynamic Flux commodities will not work.

The reason for this conclusion is based on the fact that a Dynamic Flux commodity is characterized by a dramatic and consistent fluctuation in cost that is mirrored by a steady downward price performance over an extended period of time. It is further accentuated by a wide (usually significant) floor to ceiling chasm. This means that a centrally negotiated contract in which a volume discount has been negotiated will be irrelevant within a matter of weeks, even days. Front line compliance issues then arise due to the fact that the local or regional buyer can usually pick-up the phone and secure a better price point with a single call. We will discuss the wide ranging ramifications associated with this occurrence later in this white paper.

Indirect Materials and in particular Maintenance, Repair and Operations (MRO) commodities commonly exhibit Dynamic Flux characteristics. (Note: Indirect Materials that fall under the Operating, Resource and Management (ORM) classification tend to exhibit both Dynamic Flux and Historic Flat Line characteristics depending on the individual commodity.)

TO OBTAIN A COPY OF THIS PAPER IN ITS ENTIRETY CONTACT THE AUTHOR AT procureinsights@rogers.com WITH “SOURCING” IN THE SUBJECT LINE.