Last October, Supply Chain Management Review launched a series of articles on our web site called “Back to Basics.” The articles in this series were authored by educators at the University of Tennessee, one of the nation’s leaders in logistics and supply chain education. Each installment in the seven-part series examined how excellence in the core logistics and supply chain activities leads to overall business success.
The Back to Basics series focused on different core competencies of supply chain management—sourcing and procurement, transportation, warehousing, returns management, service, and collaboration. Our premise in developing this series was that excelling at these activities and then integrating them into a customer-responsive supply chain lays the groundwork for sustained success.
This article synthesizes the key messages of the Basics series. It offers proven techniques and strategies for making the supply chain a forceful driver in your organization’s survival and success. It’s important to note that we concluded the series—and this article—with a discussion of supply chain collaboration, which enables the benefits of operations excellence to extend to all of the supply chain partners.
For managers working in the supply chain space for a number of years, a logical question is, “why do we need to revisit the ‘basics’ in the first place?” The short answer is that the basics are changing as the supply chain expands dramatically in scope and complexity.
Supply chain professionals still need to be proficient at managing the core functions such as transportation, warehousing, inventory management, and reverse logistics—but within the context of this broader supply chain process. That process today extends end-to end and even outside the firm, including the relationships with suppliers and customers on a global basis. Our aim here is to explain and explore the basics within that broader context.
Sourcing and Purchasing
The supply chain process kicks in with the sourcing and procurement of a product, component, or raw material from a supplier. Strategic purchasing—the goal to which companies should aspire—involves finding innovative ways to use supplier capabilities to drive sales, achieve or maintain a competitive advantage, or strengthen the company’s strategic position.
Yet purchasing historically has been overlooked as a strategic contributor and instead viewed more as a tactical function with a largely internal focus. The tendency of even the most seasoned buyers has been to react to problems rather than proactively respond to the current operating environment. The primary goal of procurement is to support the firm’s operational requirements by ensuring uninterrupted flow of needed materials, products, and services. However, purchasers must accomplish this efficiently and effectively—often with limited resources—while minimizing risk to the organization.
To avoid supply disruptions and leverage the organization’s buying power, purchasers should assess and segment purchased materials, services, and components in terms of importance to the organization and difficulty in accessing the materials. This segmentation process leads to a more strategic perspective on managing supplies and the supply base while facilitating the application of appropriate cost management tools and negotiation strategies.
One proven segmentation strategy was developed by Peter Kraljic and described in his 1983 Harvard Business Review article titled “Purchasing Must Become Supply Management.” Kraljic identified four major categories, each of which requires a distinct procurement approach. (See Exhibit 1.) These are described below:
Non-critical or generic purchases. For these low-importance, low-supply risk items the focus is on finding the lowest possible purchase price from a field of many suppliers. These purchases entail low switching costs, allowing for easy “supplier hopping.” Typical procurement approaches to the non-critical purchases include purchasing cards (p-cards) and short-term contracts. Relationships with the suppliers of these items are often arms-length and transactional.
Leverage commodities. These have great importance to the buying company in terms of volume purchased, percentage of total purchase cost, and impact on quality or business growth. Yet they are essentially commodities that many suppliers are capable of providing. The purchasing decision for these items is generally based on consolidation; leveraging volumes is key to success. Supply base reduction and reverse auctions are among the approaches used to leverage volume. The idea is to combine the requirements of different operating units and capitalize on supplier fixed cost allocation and improved productivity.
Strategic, critical. Products in this category have more complexity and risk involved in the purchase, often because of limited availability or limited number of suppliers with the technical capabilities to provide the goods. These are the most critical items for the organization to obtain to ensure success and meet the demand for their products. There is much more collaboration and integration between the buying and supplying firm with a focus on continuous improvement. Buyers often enter into long-term, cost-based contracts with the suppliers of these items and may, in fact, engage the suppliers early in the process of new product development. Buyers look to these suppliers for innovation and cost- reduction ideas.
Bottleneck items. These types of purchases are more product oriented or unique, and have a high level of market complexity. They often consume a disproportionate amount of time relative to the item’s value. The focus here for purchasing is to simplify the procurement of these items, or if possible get them out of this quadrant and into the leverage or strategic quadrants. Companies buying products or services that fall into the bottleneck category could participate in buying consortiums to better leverage the spend and minimize the associated risk.
Organizations need to take a long-term perspective at all times, avoiding the low-price temptation without considering the total cost and the total value provided by the product and by the supplier relationship.This requires a clear understanding of what is being purchased, the importance of the purchase to the organization, and the value of the purchase to the customer. The segmentation approach we just described helps on all three counts.