Strategic e-Sourcing Best Practices
Strategic e-Sourcing Best Practices
A Total Value Management Perspective
With today's focus on efficiency, lean "just in time" inventories, outsourcing, supply base reduction, centralized distribution, more products with faster launches, low cost country sourcing and supply chain globalization in highly volatile markets, companies need e-Sourcing now more than ever before. Especially when consumers expect prices to remain the same (or drop) while product quality and capability increases; or when investors expect EPS (earnings per share) to continue increasing despite inflation and flat prices; or when management expects profits to increase quarter after quarter despite rising salaries in a tight marketplace.
This document defines Total Value Management Strategic Sourcing, a framework for getting the most out of sourcing efforts through the use of e-Sourcing tools and processes. Also outlined are best practice and technology enablers that help overcome barriers to success. After all, the Aberdeen Group has found that every dollar under the control of a leading sourcing organization can yield a 5% to 20% savings. The average organization often spends 80% or more of revenue on SG&A. And every dollar saved by strategic sourcing can impact the company by as much as five dollars (or more) on every one dollar of sales. It is easy to see that sourcing has a significant effect on an organization's overall profitability.
Total Value Management is the next evolutionary step from Total Cost of Ownership. Total Cost of Ownership, the most commonly used metric by today’s sourcing teams, is good, but like its predecessor (Total Cost of Acquisition), is still very cost focused. When misunderstood, Total Cost of Ownership can detract from strategic sourcing's ultimate goal, the optimization of the supply chain from a total value perspective (not just a total cost perspective). In comparison, Total Value Management quantifies the overall cost of each acquired unit relative to the overall value of the spend category as it relates to the organization’s sourcing strategy and supply chain goals. This measure allows sourcing professionals to determine the highest value to cost ratio (value : cost) of a spend category through the use of integrated decision optimization. It is the decision optimization that aligns the spend decision with the organization’s overall sourcing goals.
The Total Value Management Sourcing Cycle defined herein consists of seven generic steps:
- Spend analysis
- Data collection
- e-RFx and supplier management
- Bid collection and negotiation
- Decision optimization
- Award and contract
- Post-bid management
Also defined are common barriers to success, broken down into leadership, team, and project categories. The recognition of these barriers allows organizations to proactively address barriers by using either a process enabler and/or a technology enabler.
This paper is the first in a series of Iasta sponsored Total Value Management sourcing documents. Each subsequent paper will focus on one of the seven generic steps to Total Value Management. The papers will provide greater definition to each step as well as highlight success barriers and the technology/process (best practices) success enablers.
The Evolution of Sourcing:
"Almost 50% of best-in class enterprises that source strategically using best practice strategic sourcing techniques report more than four times greater procurement cost savings, better supply performance, and greater profitability than industry peers."
The Echo Boom in Supply Management,
Aberdeen Group, December 2005
In the beginning, there was purchasing. Firms needed raw materials and supplies to operate, so organizations hired someone to order those materials. A simpler time, most organizations manufactured their goods completely in-house. As a result, material costs represented a smaller ratio of the overall cost of operations, while labor represented a larger ratio.
Then change started happening -- quickly. New concepts, procedures and products helped introduce mass production, mass consumption, and, eventually, the computer and the Internet to businesses and people.
No longer a simpler time, purchasing needed to keep up with the world around it. And adding even more complexity, a company’s competition, potential/current supply-base and customer-base became more global. To help companies manage the increased global nature of business, purchasing transformed into global supply management and supply chain strategy. The Purchasing Team’s responsibilities increased to cover a wider range of tasks to include understanding the complete supply chain as it relates to the company. Not only is the Purchasing Team responsible for knowing what a company needs to buy, from who and when to buy, but also the location of current/potential supply sources, who the suppliers’ suppliers are, and, finally, market dynamics facing the related supply markets. Purchasing became Sourcing, and now, strategic sourcing. As noted in Wikipedia:
"Strategic sourcing is a systematic corporate/institutional procurement process that continuously improves and re-evaluates the purchasing activities of a company. It is one component of supply chain management. While most organizations implement strategic sourcing initiatives for the purposes of saving money, other reasons for implementing strategic sourcing include improving supplier performance and minimizing risk."
In today’s world, it has become vitally important for organizations to make the right sourcing decisions – especially when there is more and more focus (and visibility) on the bottom-line. In today’s business environment,
- Many companies now spend more than half their operating costs on direct materials, indirect materials and services, with manufacturing companies typically spending between 50 and 70 percent of revenue on direct purchases. (Aberdeen Group, The Procurement Outsourcing Benchmark Report)
- In many markets customers expect prices to remain flat or drop while product quality or capability increases.
- Investors expect EPS (earnings per share) to continue increasing while prices remain flat and the salaries of talented executives steadily increase.
With all these pressures, often the only way to improve the bottom-line is to reduce spending through strategic sourcing methodologies. Now elevated within many organizations, Sourcing Professionals are regarded as key to the overall success of a company. After all, every dollar under control of procurement yields a 5 to 20% savings. (Aberdeen Group, The CPO’s Agenda Report)
Measuring Sourcing Value:
As Purchasing evolved into Sourcing, so did the ability to measure value. No business activity should be performed unless it delivers value. This section reviews some basic metrics often used to measure sourcing value. The newest metric for measuring sourcing value is Total Value Management (TVM). It builds on earlier measurement methodologies, but takes them further by leveraging today’s sourcing technology.
Level 1 - Price Per Unit (PPU)
PPU is a comparative cost metric that quantifies a sourcing plan according to the cost paid for each acquired unit. Although very easy to implement, it does not produce a complete picture of the true cost of each acquired unit. Sometimes prices wildly fluctuate due to market conditions, thereby skewing value over time. Sometimes a lower PPU might result in higher overall costs if the product quality is lower and results in costly returns or lost customers. The PPU value measurement allows companies to obtain the lowest unit cost in a commodity category where quality and market dynamics are constant. However, unit cost is only one component in a Total Cost of Ownership (TCO) model, therefore, it is an antiquated metric.
Level 2 - Total Cost of Acquisition (TCA)
TCA, the logical successor to PPU, is a comparative metric that quantifies how much it costs to acquire each unit. TCA takes into account multiple variables – PPU, transportation costs, duties, tariffs, temporary storage costs, and any other external cost that is incurred from the time an order is placed to the time the product is received. Although harder to implement, it presents a much better picture of the total cost of each unit of product purchased. However, it does not take into account the costs associated with contracting a supplier, maintaining or adjusting operational processes, bundling or unbundling costs, or incurred costs associated with a specific product, specifically if it is of lower quality. Therefore, it is also an antiquated metric.
Level 3 - Total Cost of Ownership (TCO)
TCO is the most commonly used metric today by analysts, consultants, and vendors. It is a comparative cost metric that quantifies the overall total cost of each acquired unit. TCO takes into account all direct costs (such as PPU, transportation, tariffs, etc), indirect costs (product utilization costs, switching costs, transaction costs, etc), and quantifiable market costs (quality, brand, etc.). In essence, it captures every cost associated with the product and gives a total usage cost and it is often considered the best comparative cost metric.
Although TCO is significantly better than TCA, (which is better still than PPU), it is still a very cost centric approach. When misunderstood, TCO can distract Sourcing Professionals from strategic sourcing’s ultimate goal, which is optimizing the supply chain from a total value perspective and insuring that each sourcing project yields long term gains, and not just short term cost savings gains.
TCO is a good measurement tool and is used by many Sourcing leaders. It is simple and effective. However, there is still room for a new and improved value measurement metric.
Level 4 - Total Value Management (TVM)
TVM is a comparative cost metric that quantifies the overall cost of each acquired unit relative to the overall value of the spend category as it relates to the organization’s sourcing strategy and supply chain goals. This measure allows Sourcing Professionals to determine the highest value to cost ratio (value: cost) of a spend category through the use of integrated decision optimization that aligns the spend decision with the organization’s overall sourcing goals.
In reality, most sourcing projects do not capture all of the identified/projected savings due to “leakage”. The reasons are numerous and can include situations such as the correct product is ordered late; causing additional costs such as increased transportation cost or additional expediting fees. Or situations where planned award allocations are not strictly ordered, resulting in a capacity shortfall based on a specific timeframe, thus additional penalty fees. In these situations, the identified savings of a TCO-based sourcing project deviated from the reality of implementing the savings and the overall supply chain strategy.
A TVM metric not only takes into account the overall total cost of each acquired unit from a direct, indirect, and quantifiable market cost viewpoint, but the impact costs of deviating from the overall sourcing and supply chain strategies. After all, a 5% savings on TCO for a specific sourcing project could actually yield a 10% loss over the course of a three-year contract if the implemented terms do not account for the reality of allocation constraints, penalties and risk aversion tactics.
TVM, a natural extension of TCO, augments TCO to align the projected reality of sourcing decisions with corporate sourcing and supply chain strategies. TVM takes into account current and future costs associated with deviating from the overall strategy. This means that all metrics, tools and frameworks that support TCO can also support TVM once the impact costs of a sourcing decision are quantified.
TVM is the next evolution in measuring value in the strategic sourcing cycle. With the advent of true decision optimization tools for strategic sourcing, TCO is no longer enough. When TCO is the primary value metric, sourcing decisions usually award based on the lowest identified cost. This practice has some significant drawbacks and can lead to short-term thinking. Short-term decisions can lead to increased long-run costs if the implemented award does not adhere to capacity constraints, lead-time windows or high quality standards, among many others. It can produce unintended consequences that pose major barriers to success. Another critical drawback is that TCO often ignores other strategic aspects of sourcing such as risk mitigation, Low Cost Country sourcing strategies, complimentary partnership relationships, and diversification strategies.
Strategic sourcing is sourcing for value, not lowest cost. Sometimes value is gained by selecting a lower cost provider, and sometimes value is gained by selecting a higher cost provider with greater quality and reliability. Producing poor quality products or failing to meet demand hurts both current and future sales. TVM insists all value-based measures and costs are included in the model, thus minimizing potential risks.
Sourcing based on a TVM approach is easily obtainable for all organizations – especially ones already following a TCO approach. TVM sourcing decisions weigh different award scenarios based on various constraints and corporate goals. TVM-based decisions leverage decision analysis tools.
Strategic Sourcing: A TVM Approach
Optimizing and Sustaining Supply Savings,
Aberdeen Group, September 2004
From a best practices perspective, there are seven key steps to strategic sourcing. Each step leverages technology, but is neutral to the specific technology or vendor.
The sections that follow will discuss each of these basic steps of a sourcing process.
Spend Analysis and Opportunity Assessment
One of the best practices in any sourcing process is "Know Your SMOCS" (Suppliers, Market, Opportunities, Customers, and Spend”. Companies cannot fully qualify the success or failure of a sourcing project if they do not know what overall opportunities exist for improvements and cost savings. Also, if there are limited resources, it is important to start with the most promising opportunities first, the "low hanging fruit", as the team builds competency and efficiency.
In this phase Sourcing Professionals consolidate and analyze spend across the entire organization, categorize the supply base and corresponding spend, enrich the data, develop high level commodity strategies, and then prioritize categories and projects.
Strategy selection includes identifying the methodologies that will be used for information gathering, bid acquisition, decision analysis, award notifications, and performance monitoring; identifying the e-Sourcing technologies to use when implementing the sourcing strategy, the overarching supply chain objectives such as low cost country sourcing, supply base reduction, and risk avoidance, and finally the business constraints such as minority supplier diversification, quality levels, and budgetary constraints.
Project Data Collection
After analyzing spend and prioritizing sourcing projects, it is time to focus on a specific sourcing project or series of projects. Thus begins the Data Collection phase where the Sourcing Team collects both price and non-price requirements. The types of information collected include benchmarking statistics, market dynamics, product/service specifications and current costs.
Also important is the identification of current and potential suppliers. This list can be collected from key stakeholder contact lists, current contracts, previous engagements, and marketplace research. Always conduct a quick supplier pre-qualification exercise involving key stakeholders so as to not include obviously inferior suppliers.
Additionally, Sourcing Professionals should develop demand estimates and forecasts. Suppliers submit quotes based on estimated demand. If demand targets are dramatically over-estimated or under-estimated, a company may not obtain the optimal value. When demand is significantly higher than forecasted, the company may have lost the opportunity to negotiate an even better price using economies of scale or to guarantee supply availability in a tight market.
While gathering information, it is critically important to seek out feedback from all of the internal stakeholders. Some key stakeholder groups include:
- Product Development and/or Manufacturing – who require selected suppliers’ capabilities to meet corporate specifications/requirements.
- Shipping and Receiving – who help identify potential logistics, import / export, or compliance issues.
- Finance and Administration – who help identify any potential contractual issues related to new or existing supplier contracts.
- Leadership – who ensure the strategy and selected suppliers are consistent with the overall company goals.
- Sales and Marketing – who may provide unique insights into the strategic value of specific supplier relationships.
e-RFX and Supplier Management
The primary goal of this step is to prepare the organization and potential suppliers to bid and negotiate a deal for the exchange of goods and/or services. There are three key elements in this phase.
Develop project strategy
Based on articulated project goals and information collected in the previous phase, Project Data Collection, it is time to develop a project strategy. The project could be a compliance project (ensuring all contract terms are met by supplier and the organization uses the contracted vendor), a cost savings project, or a supplier consolidation project, to name a few. Part of strategy development is the determination of a methodology and an appropriate e-Sourcing tool for managing the project. The methodology could be a multi-stage project with several rounds that include RFIs, RFPs and finally an auction, or it could be a simple RFI or a simple auction or a sealed bid.
Create RFI/ RFQ / RFP
After determining the sourcing project strategy and methodology, the Sourcing Professional should create the RFI, RFP and/or the RFQ that will be used throughout the sourcing project. The RFI/RFP/RFQ will represent to potential suppliers the company’s goals, terms and conditions, project guidelines/rules, bid collection/negotiation method, project timeline, decision-making criteria (such as post-bid qualification) and any product and service requirements. All externally facing materials and specifications should have stakeholder approval. After all, they will be the ones using the products and/or services.
This step requires a great deal of activities and requires skilled project management and communication skills. Fortunately many e-Sourcing tools have integrated project management functionality built into the e-RFx technology. The required activities include:
- Distribute RFI / RFQ / RFP – All potential suppliers should have equal access to the same information throughout the project. Multi-stage projects involve all three RFx-types. Single-stage projects, such as auctions, only require an RFQ.
- Evaluate supplier responses and select qualified suppliers – This is especially important in multi-stage projects where the Sourcing Team is identifying new supply sources. It is important to only include suppliers of similar or comparable quality. All less-qualified suppliers should not be invited to participate in active bid negotiation because it can potentially corrupt the project’s outcome. When a low quality supplier submits a low bid that they cannot support, it may create negative outcomes (refusal to participate, damaged relationships) for the participating high quality suppliers. Additionally, a company could lose more through high return costs and poor brand image than saved if business is awarded to a low quality supplier. If there are too many suppliers (and one goal is to rationalize the supply base), Sourcing Professionals must perform an initial ranking using scorecarding techniques based on supplier capabilities, responses, and sourcing strategy. Cut low ranking suppliers by starting at the bottom of the list. Remaining suppliers can be subjected to an additional detailed scorecard to insure that they can meet the buyer's needs before they are issued a RFQ.
- Address ongoing supplier questions – With every project, there are always questions about the process, deadlines and requirements. It is important to clarify and address all questions. It is especially important that all suppliers have access to the responses, regardless of who asked the question.
- Train participating suppliers (if needed) – This step is only necessary if a supplier is unfamiliar with e-Sourcing technology and/or the vendor platform. A well-trained supplier is prepared to compete in the sourcing project with viable quotes.
- Collaborate and refine specifications – Often suppliers identify gaps in specifications. Collaboration with suppliers, especially via RFPs, helps close and refine specification gaps so the company obtains the optimal sourcing value.
Bid Collection & Negotiation
Once all the relevant sourcing information is collected, constraints identified, suppliers qualified, and demand forecast is updated, it is time to collect the bids. The project strategy, determined earlier, dictates how bids are collected – sealed bid, auction, or RFQ. It is very important to honor the integrity of the project and not collect bids outside the articulated process. If the Sourcing Professional deviates outside the process, the project can be ‘contaminated’ and supplier relationships damaged.
After collecting bids, the Sourcing Team, along with key stakeholders, must make award determinations. Utilizing a decision optimization tool helps the Sourcing Team quickly build award scenarios and evaluate them based on a TVM-perspective. A decision analysis tool, preferably one that uses optimization technology, evaluates potential allocations from a TCO perspective. The analysis takes each cost variable and relates it to business constraints as well as potential impact costs. It is decision optimization that transforms a TCO-based decision into a TVM-based decision.
Award and Contract
Once the optimal award allocation (with respect to the sourcing strategy) has been determined, suppliers must be notified. If there is a post-qualification phase, notify those suppliers who have entered this phase. The message should remind suppliers that the final award decision is based on successfully passing the post-bid qualification phase. Non-awarded suppliers should also be notified as a business courtesy. Non-awarded incumbent suppliers should be handled with additional sensitivity, especially as business is transitioned to a new supplier. It is important not to disrupt ongoing supply.
When the final decision is made to award the business, new contracts need to be put in place or existing contracts updated. Many teams leverage a contract management tool to help manage new and existing supplier contracts. Make sure that all financial systems recognize the new terms and rates. Additionally, make sure the key stakeholders and users are aware of the new terms, rates and supplier relationship through a specific transition and communication strategy.
Identified savings are not actual savings. To insure that the organization realizes all expected savings from a TVM-based award, compliance should be monitored internally and externally throughout the term of the contract. Buyers need to place the right orders at the right time to the right suppliers. Suppliers must ship on time and use the approved carriers where guaranteed rates have been locked in. Billing and invoices should be confirmed accurate and paid on time.
Some experts state that, on average, up to 70% of identified savings from e-Sourcing enabled awards are never realized because the associated supply chain activities are not tracked nor performance carefully monitored. However, in TVM-based decisions, 100% of identified savings are realizable – but only with follow through! Sourcing does not stop at the award decision. It is a continuous process of monitoring and improvement.
At the end of every sourcing cycle, when all of the contracted awards have been fulfilled, but before the next sourcing cycle, a review should be conducted to evaluate overall performance. Some questions to ask:
- What percentage of savings was actually realized?
- If there is a shortfall, why?
- Were inefficiencies encountered?
- Were process improvements discovered?
- What lessons were learned?
There are always lessons to be learned and it is these lessons that form the basis for improved strategies and cost reductions in the next sourcing cycle. Auctions might be good for quick hits, but once a supplier’s profit margin has been squeezed as low as it can go, a Sourcing Professional must find other avenues for savings.
The following chart illustrates how a complete TVM-based sourcing cycle fully utilizes each and every step of the sourcing cycle as compared to its predecessors.
Barriers to Success
The Echo Boom in Supply Management,
Aberdeen Group, December 2005
Before presenting a best practices checklist, here is a review of some success barriers commonly encountered in sourcing. Key barriers have been divided into three broad categories - leadership, team, and project issues. Although this is not meant to be a complete list, it defines the major barriers that must be addressed to allow a sourcing team to focus on clearing the path for strategic sourcing. Following the discussion on success barriers is an overview of success enablers.
Of our nine major barriers to success, three of them are tied to leadership. For sourcing to be successful, it requires a senior executive champion and support at the CxO level. Sourcing should be managed daily by a seasoned executive with deep sourcing experience and strong communication skills.
Leadership invisibility is the result of limited visibility of a senior sourcing leader - whether there is no C-level representation, or there is no strong, vocal leadership at the C-level. Most importantly, it affects the Sourcing Team's credibility across the entire organization. Leadership visibility can affect different areas.
- C-level visibility: A visible sourcing leader drives credibility across the entire company. A strong leader builds organizational structure, ensures Sourcing Team integration with other business units and actively manages a budget.
- Sourcing Team visibility: A strong Sourcing Team takes ownership of global sourcing processes, sets priorities and aligns priorities with the company through goals and objectives.
- Project team visibility: A strong project team takes ownership of the project, drives participation across the stakeholder community, manages progress and fights for results.
Contradictory Organizational Goals
The organization needs a clear, concise sourcing strategy that is consistent with the overall organization. A finance mandate of lower cost and an engineering mandate of higher quality cannot have equal weighting, since generally higher quality products cost more. Goals need to be:
- Balanced - not too many, nor too few
- Aligned - see above
- Measurable - save $20 million dollars, run 100 e-Sourcing projects
- Long-term - no 'goal of-the-month' philosophy
Motivated people are successful people - and financial incentives can be very effective, but only if they make sense. If a significant part of the Sourcing Team's compensation package is a bonus based on PPU or TCA reduction, chances are she will be attracted to the absolute lowest cost award, which might be inconsistent with overall corporate goals. To ensure goals are aligned, incentives should be tied to the individual, the team's success and the company's success.
Three of our nine barriers to success relate to team dynamics.
If the team (and / or organization) is resistant to change, it will not embrace today's efficiency-producing software tools or leverage best practice sourcing procedures. The team will be resistant to acquiring new skills needed to operate in the global, fast-paced economy. Rigidity manifests itself in multiple ways:
- A 'yes, but…' attitude: it will work great for the other commodity, but not mine
- Animosity to new ideas
- Reliance on old methodology
- Over-reliance on relationships (and incumbent suppliers)
Information Hoarding / Lack of Sharing
Lack of information sharing refers to the unwillingness of an organization to share goal and cost information among internal and external partners. Some organizations are so ultra-competitive that they undermine their own success by hoarding information about:
- Best practices for a market, commodity, incumbent communication strategies, etc.
- Supplier information - whether the supplier is a strong or weak partner
- Successes and learnings
Collaboration issues affect both internal stakeholders (users and influencers of a product or service) and external stakeholders (suppliers and business partners). Collaboration is often scary because it requires someone to give something away in order to get something. The fear is that the value given away is more than the value received. Additionally collaboration often involves a great deal of work and strong communication skills. However, the value collaboration provides is usually a better product (through collaborative design) and lower costs (through better procedures or material costs).
The last three of our nine major barriers to success fall under the project umbrella. Though bad data is generic to all business processes, it has drastic consequences on the sourcing process, therefore it is included in the list.
From a project perspective, having spend that is not meaningful means that the supply base is not interested in the business. It may mean that:
- The dollar value of the potential business is too small to be interesting to suppliers
- The quality standards are overly stringent and too costly to support over the contract duration
- The bidding and qualification process is too cumbersome and costly to warrant supplier participation.
Sometimes spend is meaningful not because of the overall value, but because the supplier wants to have a recognizable reference customer or the supplier needs to utilize excess capacity.
It is important to build sourcing projects with current, detailed and accurate data so that suppliers can provide correct quotes. Data must be correct and complete before making major buy decisions or Sourcing Teams run the risk of making costly mistakes. Examples of bad data include:
- out of date specifications and drawings
- incomplete specifications and drawings
- supplier owned specifications (where only one supplier can fulfill requirements)
- inconsistently distributed data where not all suppliers receive the same information bundles
Limited use of e-Sourcing Tools Strategic sourcing is a complex and involved process. Previously, Sourcing Professionals relied on traditional paper RFQs/RFIs/RFPs, spreadsheet-based project management, checklists, conferences calls, face-to-face meetings and email/fax communication and distribution methods. With today's fast-paced, global economy, Sourcing Professionals need access to tools that are equally fast-paced and globally accessible. E-Sourcing tools should enhance communication and improve access to information. E-Sourcing tools should not replace communication or relationships. Failure to use today's e-Sourcing tools results in longer, more expensive sourcing projects with reduced delivered-value. It is important to note that e-Sourcing does not equal auctions. Not all sourcing projects should use auctions, but many can. However, all sourcing projects can use the project management, RFx distribution and communication tools found in today's e-Sourcing applications.
Success Enablers: Best Practices and Technology
The Echo Boom in Supply Management,
Aberdeen Group, December 2005
After identifying some key barriers to success, it is now important to understand how an organization can minimize the effect of these barriers. Fortunately there are many success enablers to help organizations effectively meet business goals. Success enablers fall into two broad categories:
- Process enablers (best practices): help companies procedurally overcome barriers and accomplish goals.
- Technology enablers: help companies leverage technology to overcome barriers, enhance best practices and accomplish goals.
As with the list of barriers to success, this is not necessarily a complete list of every best practice, but a prioritized list of major process enablers that Iasta has found to be effective. Process enablers/best practices fall into three categories:
Organizational best practices are designed for the macro level - to cement the proper perspectives and processes across the organization and ensure that the proper strategic elements of supply chain management and sourcing are addressed.
- Enlist senior-level executive support
Enlist and ensure continuous executive support at all senior levels. This is extremely important so as to fund resources and enforce policy changes required for success. It also deters intra-company battles for ultimate sourcing responsibility. In addition, the executive team should agree on common processes and goals as well as encourage collaboration across all teams.
- Form a dedicated team
Form a dedicated strategic Sourcing Team, lead by a senior officer (example, Chief Purchasing Officer, CPO) who follows generally accepted project management principles (such as the PMBOK from PMI) and processes (such as Six Sigma) to manage the complexity. Truly successful strategic sourcing projects are never done on an ad-hoc or stand-alone (after-thought) project basis. The CPO, part of the senior management team, ensures proper visibility and support of the team. It is also important that the CPO be a strong, vocal proponent that draws attention to the many opportunities good sourcing processes bring organizations.
- Adopt a company-wide supply chain focus
Organizations that excel in strategic sourcing have adopted, developed, and enforced best-in-class strategic sourcing procedures across the organization. These sourcing procedures are consistent with an overarching "destination" supply chain design. With a continual focus on process improvement, these organizations often develop formal, multi-year plans to project, audit, and validate savings.
In addition, they align goals across the different business units of the corporation and have centrally controlled spend strategies through sourcing centers of excellence.
As part of a supply chain focus, successful companies do not overlook indirect categories. Chances are some categories (such as office equipment, professional services, etc.) consume a significant part of the total organizational spend and will also benefit from a review. Strategically source everything. (Often strategic sourcing means outsourcing procurement of non-critical, low value spend, or commodity categories to external organizations that also follow strategic sourcing principles.)
- Focus on compliance
Companies lose large amounts of money through leakage - stakeholders do not order from the correct vendor (often called maverick spending), new pricing is not universally rolled out, etc. Successful organizations align processes, systems, and incentives to ensure compliance with sourcing plans and adopt procedures, systems, and metrics to measure internal and external performance.
After establishing the right organizational outlook, companies need to develop supply chain and commodity (category) sourcing strategies. As with any effort of merit, this is easier said than done. However, the right processes and practices can greatly simplify the job.
- Acquire the expertise
Locate and hire sourcing and commodity expertise for major spend categories. Hire experienced personnel and use consultants to augment and mentor in house capabilities. Constantly seek to validate and improve knowledge, methods, and capabilities at every opportunity.
- Engage stakeholders
Engage all relevant stakeholders throughout the organization for each appropriate spend category in sourcing strategy development and constraint identification (used to determine award scenarios). Activities include:
- Outlining Sourcing Team goals
- Defining requirements
- Determining timeframes
- Communicating to both internal stakeholders and external suppliers and partners
Companies should establish a communication channel for relaying information about strategies and results. Vagueness lengthens sourcing cycles, induces suboptimal award decisions, and strains internal and external relationships. Moreover, a lack of clarity and transparency fail to convey critical processes and roles. Goals and objectives should be cross-team and processes should involve all relevant business units.
Corporate spending and demand forecasts should be accessible to all stakeholders, as should related analyses and analysis tools. Sales, marketing, production, logistics, and even partners should all be working from the same numbers.
- Encourage supplier innovation
Support supplier creativity through:
- Flexible bidding methods with advanced cost models
- Category strategies for future cost reductions in key categories
- Strategic relationships
Innovative suppliers improve processes and find new savings opportunities. A strong supply base focus is a key to success.
- Evaluate alternatives that focus on quality and supply assurance
To better understand what a business rule, business requirement or business practice costs, remember to evaluate constrained and unconstrained alternatives. There may be alternatives that focus on supply assurance, quality and TVM - not just the acquisition price.
- Develop meaningful performance incentives
People are the most important part of any supply chain. Offer appropriate financial rewards based on TVM-based metrics based on measurable goals and objectives.
Good strategy is a great start. But a strategy must be properly implemented to produce the desired effects:
- Use Decision Analytics Up Front
Use advanced decision analytics up front to address sourcing strategies, demand management, and initial product design where as much as 80% of the final product costs are locked in. These tools should support flexible bidding and allow for realistic comparisons on otherwise "apples to oranges" comparisons through appropriate weightings, metrics, and transformations. Accurate, relevant data is a key factor in building decision analytic models and forces the team to focus on quality up front.
- Know Your SMOCS (Suppliers, Market, Opportunities, Customers, and Spend)
Pre-qualify all suppliers before accepting bids or outlining award allocations. Make sure they can deliver high quality products based on the company's needs - what, when, how and where. Also important, knowing what are the primary demand triggers of the market. What does the end consumer want? What effect does this have on quality, time-to-market requirements and sourcing cycle time? What are past consumption levels; over what timeframe? How does this affect demand and the next sourcing cycle?
Companies need to be proactive about predicting and managing change so surprises are minimized. Unexpected turbulence significantly increases spend costs. Inaccurate or outdated data also affects future spend costs. Data must be reviewed and refreshed throughout the link on the supply chain. Sourcing Teams also need to identify opportunities for improvement that include alternative products, potential improvement targets, cost savings, and costs associated with the specific business requirements and constraints.
- Use e-Sourcing Tools
E-Sourcing tools combine the "art" (cost models, supply market knowledge, and constraint analysis) with "science" (collaboration and analytics). The tools, based on standard processes and workflows, decrease cycle time, eliminate errors, and increase the overall result quality for strategic sourcing projects. E-Sourcing tools support collaboration and allow various stakeholders to easily work together. Include training for each system and business process to maximize success.
- Select the Right Mix of Software and Services
Strategic sourcing requires the right blend of software and support services to help the Sourcing Team select the best strategy, set of tools and methodologies. Use both complementary product and service solutions, centered on common processes, to achieve maximum returns in strategic sourcing efforts. The balance of software to services should change over time as the Sourcing Team evolves and technology improves. The correct balance depends on many issues facing the company.
- Some teams may require more support services as they start using e-Sourcing tools for the first time, then reduce the reliance on those services as they gain experience.
- Some teams completely outsource entire categories, such as indirect materials, and standardize on one sourcing platform.
- Some teams rely on service providers to augment the team based on expertise and/or number of projects to be completed.
- Some teams simply standardize on a sourcing platform and completely self-support.
- Develop Metrics
Define appropriately aligned metrics for assessing results for spend categories. Apply and update the metrics on a regular basis. Look for total cost productivity opportunities such as increased capacity utilization, more efficient production or delivery processes, and alternative lot sizes or order quantities in the constant quest for quality improvement. For example,
- Rate Reduction
net reduction in prices paid for items procured when compared to prices in place for the prior 12 months [old price - new price] * volume
- Demand Reduction
measures the result of a proactive program to reduce usage [volume reduction] * price
- Compliance Improvement
the improvement in contract compliance from 12 months ago [current compliance rate] - [prior compliance rate]
- Engineering & Specification Improvement
the result of a proactive program to change the manufacturing product specifications and design to reduce costs [old bill of materials - new bill of materials] * volume
- Rate Reduction
- Develop a process-centric focus
Continually look for ways to improve processes. A process works until it doesn't. This applies to sourcing processes. A process may not work because technology advances replaced the process (example, collecting fax-based bids vs. an auction). A process may not work because the market has changed (example, the introduction of Sarbanes Oxley). A process may not work because the company has changed (example, a division has been bought or a sold). Regardless, just like product specifications, business processes must be fresh to ensure quality decisions. Each project has learnings that potentially can be applied to global sourcing processes - whether it was a successful project, or unsuccessful project. Take the time to review projects and apply the learnings so the entire business can benefit from better decisions.
A summary of process enablers (best practices)
The Echo Boom in Supply Management,
Aberdeen Group, December 2005
The Echo Boom in Supply Management,
Aberdeen Group, December 2005
In a simpler era, the best tools available to a Sourcing Professional were a catalog, an updated monthly inventory report, and a pen to ink the purchase order. In today’s world where information flows instantaneously via the Internet, a Sourcing Professional has access to real-time automation and decision support tools for every aspect of the sourcing process from spend analysis and SMOCS assessment through the final review and evaluation process. Technology enhances sourcing processes and decision making – it does not replace them. Technology helps overcome barriers to success – it does not eliminate them. Technology enablers fall into three categories:
- TVM drivers
Foundation tools collect, analyze, and present data in a fashion that can help a Sourcing Professional determine which commodities are candidates for strategic sourcing efforts, which strategies should be pursued, and what metrics should be monitored and tracked.
- Spend Analytics
Spend analytic tools aggregate data into a comprehensive, high-quality database to improve enterprise spend visibility. Once consolidated, Sourcing Professionals can view spend data from a detailed or high-level perspective. These viewpoints highlight areas of significant spend and distill potential cost savings opportunities. Leading spend analytics tools incorporate common classification schema, category specific metrics, efficient and repeatable data cleansing and classification capabilities and advanced reporting and decision support tools.
A scorecard is a strategic measurement system that enables an organization to assess its capabilities and those of its suppliers in a fair and informative manner. It qualifies business processes, capabilities, and outcomes with the end goal of continuous improvement in strategic performance and results. It collects data from the financial, business, growth, and customer perspectives to build an overall view of the organization. For example, a supplier scorecard might include weightings on market value, cash on hand, profitability, response times, quality, management, growth plans, planned improvements, projections, brand image, delivery times, and defect rates.
- Forecasting Tools
Demand forecasting tools use advanced statistics, algorithms, historical data, and current market data to forecast demand for a particular item. With data and advanced simulation techniques, they can often predict demand with greater confidence than a traditional mathematical formula or business process.
- Contract and compliance management
"Contract Management (known alternatively as Contracts Management or Contract(s) Administration) encompasses all the activities that an enterprise or an individual engages in, while entering into a business transaction with one or more trading partners and fulfilling all the obligations of the terms and conditions agreed upon in the contract.
Almost all the transactions that occur in the business world are governed by a contract in some shape or form. Some common examples of contracts encountered in day-to-day life are employment letters, sales invoices, purchase orders, utility contracts." (Wikipedia)
A Contract Management engine not only translates a sourcing award into a supplier contract, but manages, monitors and stores the contract through various stages of the supplier relationship. It increases visibility, reduces variability, and automatically notifies the team of deadlines through triggers. The Sourcing Team should also monitor compliance by the user community and the supplier to ensure contracted rates are the same as the negotiated rates.
These tools drive TVM in the strategic sourcing process – the primary means by which process efficiency is increased, cost decreased, and value delivered to the organization.
An e-RFx, or an electronic Request For Information / Proposal / Quote system automates the process of distributing information to and collecting information from suppliers in a manner that supports apples-to-apples comparisons. Many e-RFx systems incorporate templates that allow teams to initiate strategic sourcing events quickly and easily.
An electronic auction is a powerful web-based software solution that allows Sourcing Teams to carry out auctions (the most recognized being the standard English reverse) in very short timeframes. It automates invitations, customizes supplier views, and allows an auction to take place in real-time over the web. Both the buyer and supplier save time because price negotiation is done at a specific, scheduled time with a definitive conclusion (the auction closes). Some commodity markers work better using a sealed bid auction for bid collection rather than open head-to-head auction. Regardless, a sealed bid enables suppliers to submit bid information and Sourcing Professionals to collect bid information in a short timeframe. Sourcing Professionals can also use forward auctions when liquidating company assets. With forward auctions, the company is the seller rather than the buyer.
- Decision Optimization
Optimization is the most effective way to solve complex business problems that involve several, hundreds, thousands, or even millions of interdependent variables. Traditional spreadsheets manipulated by a human cannot fully analyze a complex set of data. In addition to the increased analysis time of spreadsheets, is the increased time needed to export data and build spreadsheets. There are even greater efficiencies when decision optimization tools are integrated with the sourcing tool, thereby saving time and reducing errors that may appear through data export and import.
A true decision optimization engine takes into account all submitted bids, costs and constraints. With the cost elements, the Sourcing Professional can build different award scenarios based on different organizational goals and constraints. For example, a goal might be to limit the number of suppliers, or ensure supplier diversity exists, or combine certain products across specific distribution centers – there are a limitless number of goal/constraint examples. The decision optimization engine builds award scenarios based on the goals/constraints, and then produces an optimal award that meets the organization’s goals at the lowest possible cost (which may not be the lowest possible TCO cost). This exercise yields the highest strategic sourcing value (TVM) as supply chain goals and impact costs are taken into account.
A good decision optimization tool can handle flexible bid structures that include:
- Allocation constraints
- Risk mitigation constraints
- Qualitative constraints
- Business rules
- Fixed costs
- Variable costs
- Tiered costs
- Multiple costs (unit, transportation, incurred)
Additionally, a good decision optimization tool can support the creation and comparative analysis of unconstrained, partially constrained, and fully constrained scenarios. Once created, these scenarios allow what-if analyses and deeper understanding of what each constraint or rule costs the organization.
Collaboration and enhancement tools simplify the sourcing process for the Sourcing Professional. They automate project management and work flow aspects, make it easier for key stakeholders to share input and knowledge, and enable organizational knowledge repositories for best practices, documents and forms.
- Project Management / Work Flow
A good strategic sourcing platform will facilitate the strategic sourcing process by providing the appropriate workflow, and allow the team to track project status in the sourcing process. Project management helps track participation levels of internal (stakeholders) and external (suppliers) participants. Sourcing Professionals can set-up triggers and threshold activities for complex, multi-stage projects or simple one-stage projects.
One key benefit to project management/workflow capabilities is that it captures best practice knowledge for use across the team. The Sourcing Team can create workflow templates that are commodity-specific, business-specific or region-specific. The use of templates also saves time since the Sourcing Professional does not need to build one from scratch every time they run a project.
- Integrated Communication and Documentation
A good strategic sourcing platform will enable web-based communication and collaboration between all relevant parties. It also captures the flow of information between companies and associates it with the sourcing project. Additionally, it documents the decision making process as the project proceeds through the various sourcing stages to the final award. This is especially important in light of Sarbanes Oxley.
- Integrated Knowledge Management
Integrated knowledge management tools manage the organization’s sourcing documents and institutionalize organizational knowledge. A centralized document repository provides easy access to sourcing processes, best practice learnings, standard terms and conditions, non-disclosure agreements, organizational charts and user training materials. All documents can be kept ‘fresh’ and relevant to the Sourcing Team.
A summary of technology enablers
The Echo Boom in Supply Management,
Aberdeen Group, December 2005
Gone are the days when a sourcing manager only needed a catalog, a phone, and a pen to ink the purchase order. In today's sophisticated operational environment where lean "just in time" inventories, outsourcing, supply base reduction, centralized distribution, more products with faster launches, low cost country sourcing and supply chain globalization in highly volatile markets are the norm, a sourcing professional needs sophisticated technologies and methodologies to succeed.
This paper briefly discusses the evolution of sourcing and associated costing methodologies from price per unit through total cost of acquisition to total cost of ownership to the next evolutionary step, Total Value Management. Total Value Management quantifies the overall cost of each acquired unit relative to the overall value of the spend category as it relates to the organization's sourcing strategy and supply chain goals.
Also described is the seven step process for Total Value Management Sourcing. This process leverages best-in-class e-Sourcing technologies to help organizations get the most from sourcing in a vendor neutral manner. The process starts with spend analysis, where companies identify and prioritize opportunities. It moves on to project data collection where teams collect requirements, benchmarking statistics, market dynamics data, and current costs. Then it proceeds to an e-RFx phase where sourcing teams develop project strategy, create questionnaires and forms, and manage supplier relationships. This is followed by bid collection and negotiation, decision optimization, and contract of the award with the greatest total value to the organization. The process concludes with a post-bid management phase that tracks compliance until the last unit is delivered, since this is the only way to avoid leakage which, according to some experts, can cost an organization up to 70% of projected savings.
Barriers to success are a very important topic. The various success barriers include leadership, team, and project barriers.
- Leadership barriers include invisibility, contradictory organizational goals and ineffective incentives
- Team barriers include rigidity, information hoarding and collaboration issues
- Project barriers include meaningful spend, bad data, and limited availability of e-Sourcing tools.
Though there exist many barriers to success, there also exist multiple success enablers to overcome those barriers. Success enablers come in the form of processes (best practices) and technology.
- Best Practices/ process enablers:
- Organizational: enlist executive support, form a dedicated team, adopt a supply chain focus and focus on compliance
- Strategic: acquire expertise, engage stakeholders, encourage supplier innovation, evaluate alternatives and develop meaningful performance incentives
- Tactical: use decision analysis upfront, know your SMOCS (Suppliers, Market, Opportunities, Customers, and Spend), use e-Sourcing tools, balance the use of service and software, develop metrics and continually improve processes
- Technology enablers:
- Foundations: forecasting tools, spend analytics, scorecards and contract and compliance management tools
- TVM drivers: e-RFx, auctions, decision optimization
- Enhancers: project management/workflow tools, integrated communication / documentation tools and integrated knowledge management tools
The final result of sourcing with a Total Value Management perspective is better overall business decisions.
[Aberdeen 09/2004] Best Practices in E-Sourcing: Optimizing and Sustaining Supply Savings, Aberdeen Group, September 2004
[Aberdeen 12/2005] Strategic Sourcing in the Mid-Market Benchmark: The Echo Boom in Supply Management, Aberdeen Group, December 2005
[Aberdeen 06/2005] Success Strategies in Advanced Sourcing and Negotiations: Optimizing Total Costs and Total Value for the Next Wave of E-Sourcing Savings, Aberdeen Group, June 2005
[AMR 12/2002] Strategic Sourcing Brings Stunning Returns to Retailers, AMR Research Report, December 2002
[AMR 2005] The Procurement and Sourcing Applications Report, 2004-2009, AMR Research Report, 2005
[ARC 06/2002] 10 Symptoms of Poor Supply Chain performance, ARC Insights 2002-26E, Simon Bragg, June 20, 2002
[ATK 07/2003] Managing Supply Chains in the 21st Century, Executive Agenda, AT Kearney, Third Quarter, 2003
[Busch 11/2005] Spend Management: Changing Business, A Case for Reexamining Procurement’s role in Organizations of All Sizes, Jason Busch, November 2005
[CAPS 09/2001] Buyer-Driven Electronic Marketplaces: Developing Business Models for an Integrated E-Procurement Strategy, CAPS Research, Volume 5 Issue 1, September 2001
[CAPS 2003] The Role of Reverse Auctions in Strategic Sourcing
[CAPS 2005] Strategic Performance Measurement for Purchasing and Supply, Dr. P.L. Carter, Dr. R.M. Monczka, & T. Mosconi, CAPS, 2005
[EFT 06/2005] Fortune 500 Companies' views on the supply chain & logistics landscape 2005/2006 Report, Eye For Transport Supply Chain Directions Report, June 2005
[ESF 01/2006] Fundamental Goals of e-Sourcing by David Bush, January 3, 2006
[ESF 06/2006] Implementation Strategies for e-Sourcing by David Bush, June 27, 2006
[ESF 10-1/2006] Optimized e-Sourcing Strategies by David Bush, October 13, 2006
[ESF 10-2/2006] Sustaining and Growing e-Sourcing Success by David Bush, October 26, 2006
[ESF 11/2006] e-Sourcing is Here to Stay by David Bush, November 20, 2006
[ESF 03/2007] e-Sourcing - Where are you and what should you do? by David Bush, March 26, 2007
[ESF 04/2007] (The) Benefits of an End-to-End e-Sourcing Suite by Michael Lamoureux, April 18, 2007
[ESF 05/2007] Issues in e-Sourcing: Adoption and Penetration by David Bush, May 1, 2007
[ESF 06-1/2007] e-Sourcing Project Management Tips from Confucious by Michael Lamoureux, June 26, 2007
[ESF 06-2/2007] Supplier Communication Best Practices by David Bush, June 28, 2007
[ESF 08-1/2007] Optimal E-Tool Selection by Michael Lamoureux, August 15, 2007
[ESF 08-2/2007] Driving Operational Excellence with e-Sourcing by David Bush, August 21, 2007
[ESF 08-3/2007] 5 Ways to Take Your Sourcing to the Next Level by Michael Lamoureux, August 23, 2007
[ESF 01-1/2008] Process Integration for e-Sourcing by David Bush, January 10, 2008
[ESF 01-2/2008] Improve Your e-Sourcing Results by David Bush, January 16, 2008
[ESF 01-3/2008] (The) Sourcing Grid by David Bush, January 25, 2008
[ESF 02/2008] Put the Science into Sourcing by David Bush, February 7, 2008
[IBM 02/2004] Helping Your organization reduce spend and increase operational efficiencies, IBM Sourcing and e-procurement solutions white paper, February 2004
[SCMR 11/2003] Getting to the Root Causes, Supply Chain Management Review, James B. Ayers, November/December 2003
[SI 10/2006] Key Concepts for Major Procurements by Michael Lamoureux, October 10, 2006
[SI 11/2006] Best Practices from Lessons Learned by Michael Lamoureux, November 8, 2006
[SI 03/2007] Comparing Apples with Oranges by Michael Lamoureux, March 11, 2007
[SI 08/2007] Selling Your e-Sourcing Pilot: The Perfect Pitch by Michael Lamoureux, March 8, 2007
[SIG 01/2005] Recognizing the contributions of strategic sourcing and procurement, Sourcing Interests Group Study, January 2005
[UPS 2005] Strategic Sourcing: Building a foundation for success - understanding the difference between sourcing and strategic sourcing and its impact, UPS Supply Chain Solutions White paper, 2005
[Waer 2004] The Nine Basic Rules of a Successful Supply Chain, Will Scot & Chas Oldfield, Waer Systems, 2004
Michael Lamoureux, PhD of Sourcing Innovation
Melissa Beuc - Iasta
David Bush - Iasta