Strategic Sourcing – A Bridge Too Far?

You are missing out!

It is no secret that purchasing has a significant influence on cost. External purchases represent over half of cost in many firms. While savings of up to 40% or more can be realized on these cost [Anderson and Katz, 1998]! Most companies have spent significant energy on volume consolidation and supply base optimisation, thus realizing up to 15% savings. Good sourcing processes and sourcing as a true strategic function can help your company realize up to 25% more saving. It can even help increase revenue. Imagine, sourcing as a profit centre, not just a cost centre.

A lack of sourcing skills can have dramatic results, as the recent Dutch government construction fraud case shows. In the past years, the government paid 30% too much for its construction projects. Public opinion speaks of fraud from the construction companies. However, a good government sourcing function might have prevented this from happening. Structural supply analysis and a thorough insight in supply cost structures could have made a whole lot of difference.

Introduction

The concept of sourcing is gaining popularity and impact in both organisation and management studies. There is no argument about that. Yet sourcing is still as far away from becoming an autonomous discipline as ever. The term sourcing is used for too many different purposes. There is just not one definition. Sourcing might be used in dialog with the purchasing process, or as a part of this process. Sourcing might be used for the process of acquiring input from multiple countries. Or sourcing is used as a synonym for outsourcing. When the concept of strategy is being introduced to sourcing, the definition becomes even more confusing. How can strategic sourcing be used if there is not even common ground on what sourcing actually means? This article will first create common ground by analysing definitions in search of a common denominator in order to suggest a new definition. Secondly, it will show that strategic sourcing is, in many cases, not as strategic as it is claimed to be, and suggests how strategic sourcing should be defined. Furthermore, a conceptual framework will be presented on how sourcing can be used as a true strategic function. Sourcing has come a long way; this article tries to make a first step on an even longer road that is still ahead.

Sourcing: finding a definition

As stated earlier sourcing is becoming increasingly popular and a very relevant topic in organization and management studies. Basically, the goal of all companies is sustainable and competitive selling of goods and/or services. In order to produce these goods and services input is needed. This input can be tangible, like raw materials or employees, or intangible, like information or skills. They all originate from some source and this is were sourcing activities come into play.

Several definitions of sourcing have been given in literature. ‘Sourcing is researching the market for potential input sources, securing the continuity of these sources, searching for alternative sources and keeping the relevant knowledge up to date’ [Vollman, Berry, Whybark, 1984, p. 148; van Weele, 1994].

Sourcing Management (Kraljic, 1983) is labelled as ‘Bottleneck Supply’ and consists of supply that is also uncertain, but of relatively low importance for companies in terms of volume purchased, total purchase cost, or impact on product quality or business growth. Bottleneck suppliers can be found in Figure 1.

‘Sourcing is the way an organisation acquires its needed goods and services in such an integrated manner that functional and hierarchical organisational boundaries are permeated’ [Groeneveld, Hofstra, 1995].

‘Sourcing is the process of finding and subsequently managing a source for the input of production’ [Mol, 2001, p. 1].

Figure 1: Supply Management Model. Source Kraljic (1983)

The definitions are different but have some things in common, for example, ‘sources for the input of production’.

The definition used in this article is:

“Sourcing is the process of analysing potential input sources, choosing and securing the continuity of these sources for input of production and, subsequently, managing these sources”.

This definition is chosen for several reasons. First, for the purpose of analysis of potential sources, not just existing sources. Secondly, there is an emphasis on continuity. Thirdly, because it concerns not just closing a deal, but true management of the source. This article emphasizes both external and internal sources.

Historic overview

As can be concluded from the sourcing definition, sourcing is a specific topic but highly related to purchasing. The rise of sourcing is also related to the way we think about purchasing. For a short historic impression, some points of development of purchasing are presented here [Ellram, Carr, 1994]. In the early 1970s Ammer noted that top management looked at purchasing as playing a passive role in business organization. Ansoff supported this view, stating that purchasing could be described rather as an administrative than a strategic function. The 1973-74 oil crisis and related raw material shortages drew significant attention to the importance of purchasing and sourcing. However, in spite of the crisis, the role of purchasing and sourcing did not improve. Later on Porter, in his seminal work on forces that shape the competitive nature of industry, identified buyers and suppliers as two of five critical forces. Thus, the strategic importance of suppliers and the company as a purchasing entity (acquiring sources) began receiving recognition in main stream strategy literature. In the 1980s many authors noted the benefits of greater strategic involvement of the purchasing function. However, until late in the decade only limited gains appeared to have been made. During the early 1990s the research focus appeared to have shifted towards integration, and how the purchasing and sourcing function can become recognized as a more significant contributor to the company’s success.

Purchasing and Supply Management Trends

So the position of purchasing and sourcing in management literature changed over time. Purchasing was once regarded as a reactive activity capable of only neutral or negative contribution. Nowadays the purchasing and sourcing process at leading companies is at the forefront of responding to and creating change. The ability of purchasing and sourcing-often in collaboration with other functional groups to affect cost, quality, time, technology and ultimately customer satisfaction-is substantial.

Now what trends influenced this change in view? Based on a research survey among purchasing and sourcing executives the following categories of change and trends can be identified [Trent, Monczka, 1998]:

1. Performance improvement requirements;

2. Supplier and purchasing and sourcing importance;

3. Organization;

4. Systems development;

5. Performance measurement;

6. Supply base management;

7. Purchasing responsibilities and activities.

Performance improvement requirements

The need for continuous improvement is a widely accepted necessity. Commonly expected targets are continuous improvement of cycle time, cost, quality and delivery performance, both internally and from external suppliers. While quality and cost have always been important, time-related capabilities are rapidly becoming the next generation of ‘order winning’ characteristics.

Supplier, purchasing and sourcing importance

The shift in supplier importance is a result of at least five factors which affect most industries:

– The need to control unit cost;

– The need to reduce the total cost of acquisition;

– The increasing influence that suppliers have on the purchaser’s ability to respond to end customers particularly as it affects time-related requirements;

– An increased reliance on fewer suppliers;

– A willingness of purchasers to rely on suppliers to design and build entire subassemblies and subsystems.

Organization

The right organizational structure is essential for implementing leading-edge procurement strategies and plans. Today this often means using higher level teams to evaluate, select, manage and develop sources. Furthermore, there is a shift towards end-item focus instead of commodities, which results in hybrid structures reflecting a growing need for purchasing and sourcing to become more integrated with other parts of the organization.

System development

There is an emphasis on purchasing and sourcing systems development due to the need to co-ordinate purchasing and sourcing activities across buying locations, assuming an organizational rather than a functional perspective, and take on complex and strategic responsibilities with existing staff.

Performance measurement

Performance measurement is essential for gauging the overall effectiveness of functional and team-based strategies and plans. Specifically, purchasing and sourcing managers should rely on measurement systems to identify:

– supplier performance and opportunities for improvement;

– performance trends;

– the best suppliers to select, both for routine purchase requirements and critical items that would benefit from long-term purchase agreements;

– where to commit limited supplier/source development resources, the overall effectiveness of source management improvement efforts.

New measurement areas will emphasize purchasing and sourcing effectiveness rather than efficiency, reflecting a shift toward an increasingly strategic sourcing perspective.

Supply base management

Not long ago, it was common practice for buyers to play suppliers off against each other, switch suppliers frequently and offer only short-term contracts. Now changes are occurring in the way companies approach and manage their supply base. Most companies will continue to reduce the total number of suppliers they maintain. Another related trend is to rely on larger full-service suppliers to design and build entire subsystems, instead of many suppliers providing components of the subsystem. Many supplier base reductions involved a smaller group out of the original group of suppliers. Supply base improvements might have been greater if purchasing and sourcing had broadened their supply/source search. Supplier/source optimisation can create a foundation to pursue more complex activities that will further accelerate improvement.

Purchasing and Sourcing responsibilities and activities

If an increase in purchasing and sourcing importance is taking place, then shifting responsibilities over time should reflect this importance. A continued increase in strategic and external focus can be expected. Furthermore, a decrease in tactically oriented tasks can be expected.

Case: Siemens

In 1997, purchasing at Siemens Medical Systems was a strictly local affair [Carbone, 2001]. It was then decided that a strategic purchasing organization should be created. Its mission would be to leverage Medical Systems group material purchases with suppliers, tap into their technical expertise, and form long-term relationships with them. The idea of strategic purchasing was to reduce cost, guarantee supply and making sure Siemens had access to the latest and best technology needed for medical equipment. In order to make the reorganization a success, Siemens developed a survey in order to identify problem areas it needed to address. This survey was based on a benchmarking study of the purchasing organizations of IBM, Hewlett-Packard, ABB, Ericsson, Nokia and others. The survey was used at Siemens’ various purchasing departments at various facilities. The results were evaluated and the departments were rated to determine their strengths and weaknesses.

Strategic sourcing

So historic developments and trends all push towards a more important role for sourcing and show a need for a more cross-functional and strategic focus.

What is this new strategic role of sourcing and what sorts of strategies are possible? It appears that there are three distinct types of strategies for purchasing [Ellram, Carr, 1994] which can also be used for sourcing:

1. Specific strategies employed for the sourcing function;

2. Sourcing’s role in supporting the strategies of other functions and those of the company as a whole;

3. Utilization of sourcing as a strategic function of the company.

While these three issues are related, they are distinct areas in terms of their execution and impact on the sourcing function. At the first level sourcing draws up its own strategies and plans, while at a larger level these might prove to be dysfunctional for the organization as a whole. At the second level the sourcing strategies are drawn up to maximally support the company strategy. At the third level sourcing is an integral part of the strategic planning process of the company. One of the statements in the introduction was that strategic sourcing is in many instances not as strategic as it is claimed to be. Two gaps can be identified to explain this.

Firstly, although the sourcing function is reported to be strategic there is no empirical evidence of this.

Example: the intention gap

The purchasing function is caught in a gap between strategic intentions and tactical realities [Moody, 2001]. In a study called “Purchasing’s strategic Role and team usage” researchers looked at what purchasing leaders regard as important strategic work, applying their knowledge about suppliers and technologies to help the company make decisions on outsourcing, new product development and market planning, and compare it with what their organizations actually do. Their findings indicate a wide gap between intentions and reality. To determine purchasing’s role in strategy, the researchers asked chief purchasing officers to rate their involvement in 13 major corporate activities using a five point Likert scale. Even top-ranked outsourcing was rated at 3.46, only a moderately important level; the 13th parameter had a 2.01 standing, indicating that purchasing departments were only slightly involved in marketing planning. Clearly the buzz about strategic purchasing is supported by the data.

Secondly, while strategic sourcing or purchasing is being reported, the question is what type of strategy is being referred to.

Example: Strategic buying

An article on strategic buying [Sherer, 2000] has the subtitle: ‘nine steps for getting the right IT system for your organization’. Instead of dealing with the strategy of the sourcing function or sourcing as a strategic function, a nine-step method is being described which secures the right purchase of an information system for a healthcare organization. In light of the three strategy types, this would be at best a ‘type one’ strategy.

The authors claim that most of the employed strategies are of type one or two and that strategy of type three is still very unusual.

In this article strategic sourcing is considered to make an explicit contribution to the organizational strategy and long term success. Therefore it is either level two or three.

The definition of strategic sourcing used here is:

The process of analysing potential input from internal and external sources, choosing and securing continuity of these sources for the input of production and subsequently managing these sources in order to create sustainable competitive advantage for the organization.

This definition contains the popular activities of in- and outsourcing.

Some differences between traditional sourcing and strategic sourcing are presented in Figure 2.

Figure 2: From traditional to strategic sourcing. Source Nolan Norton Institute (1999)

Pathway to improvement

There is probably no such thing as a ‘big bang scenario’ to introduce strategic sourcing from scratch. The development of strategic sourcing within an organization is more like an evolving process. Most literature refers to several ‘phases’ or ‘stages’ sourcing must go through before it can truly become strategic in nature, and contribute to organizational strategy. This evolving process includes development of new skills for the sourcing function and a different mindset by top management and other functional areas. Sourcing must be considered an important contributor to the organizations long-term success and strategy. Now if sourcing grows in strategic posture, what kind of gains can be realized? In figure 3 several levels of procurement development are discussed. In order to achieve higher levels of development, the sourcing function must also gain in sophistication and strategic posture.

Figure 3 Source Anderson (1998)

For each level of development, higher value adding for the organization can be achieved. The first three levels are mainly focused on cost, taking a total cost of ownership (TCO) view, and furthermore on quality and making time related issues predictable. Level 4 is focussed on achieving higher extra value for the end customer, thus realizing higher revenues. Value drivers in level 4 are again cost and quality, but also shorter time to market and leverage technology and skills from the entire value chain.

Case: Siemens

Forming a strategic purchasing organization allowed Siemens to improve its purchasing coordination and streamline its logistical and information flows. This took Siemens into to the second improvement level. However, the strategic purchasing project did not stop there. Siemens formed eight material groups to handle its strategic sourcing issues. This resulted in reduced complexity and increased standardization. Furthermore, suppliers were involved in the process of new product development, thus taking Siemens into the third improvement level. All these reorganizations did not go without reward. Siemens reduced its material costs by 25% over a three year period and brought products to the market quicker.

What do these levels mean for the three types of sourcing strategy? With a specific strategy for the sourcing function an organization can reach level 1 or 2. To really make the most out of level 2 and reach level 3 the sourcing strategy must really be aligned with the organization strategy. In order to make more out of level 3 and to reach level 4 sourcing must be fully integrated within the organization’s strategic planning, thus really achieving the strategic sourcing posture.

Example: why improve?

By improving the sourcing function significant benefits can be realized. Reaching level one yields cost savings between 5-15%. Level two 5-25%. Level three varies widely and level four will increase revenue. Leaders in procurement are highly developed at the first three levels. Level four is a “new frontier”; few companies are pursuing its potential in their situation [Anderson and Katz, 1998]

Concluding Remarks

Enterprises are increasingly turning to multiple internal and external sources, making sourcing a hot topic within companies. Each company must define its intended sourcing strategy and most appropriate implementation in order to create sustainable competitive advantage for the organization. There is probably no such thing as a ‘big bang scenario’ to introduce strategic sourcing from scratch. The development of strategic sourcing within an organization is more like an evolving process.

As can be concluded, different levels of improvement in the sourcing function can be attained. Each higher level yielding an increased payoff. Attaining a higher level does also acquire a more sophisticated sourcing function. Most companies do not seem to surpass the basic cost cutting level and are losing out on additional cost savings and increased revenue. Acquiring your input for less is only the beginning. A company should assess how strategic their sourcing function really is. Changes are the sourcing strategy comes closer to transactional optimisation than a cross-functional process to attain competitive advantage. Furthermore a company should asses its sourcing goals. Most likely the goals will correspond with buying for less or taking the total cost of ownership view and thus try to buy better. Most companies do not make the most of their sourcing function and are losing out on a change to gain competitive advantage.

This article gives the initial impetus to the overview of strategy in sourcing. While the topic strategic sourcing is not a new phenomenon, much research is still needed.

As the concept of sourcing matures, a need to validate and build on sourcing concepts exists. There is still much academic work required in creating sophisticated concepts that will help organizations to actually acquire higher levels of improvement for their sourcing function.

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