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Sourcing reloaded

  1. 1. Sourcing Reloaded:Targeting Procurement’s NewStrategic AgendaA strategy+business Reader
  2. 2. Sourcing Reloaded:Targeting Procurement’s New Strategic AgendaA strategy+business ReaderEdited by Jeffrey Rothfeder and Georgina GrenonWith an introduction by Patrick W. Houston, Detlef Schwarting,Robert Spieker, and Martha D. TurnerIn today’s risky global business environment, supplier networks are the ulti-mate lifeline for many companies — delivering the far-flung materials,goods, and services that drive worldwide commerce. The sourcing functionhas thus become an indispensable contributor to strategic goals and competi-tiveness in every industry. But charting a course that positions the corporatepurchasing department as a catalyst for growth is no easy matter.This strategy+business Reader, Sourcing Reloaded: Targeting Procurement’sNew Strategic Agenda, is packed with insights and prescriptive advice thatsenior leaders and purchasing executives can use to navigate today’s mostvexing sourcing problems. Its main theme: how to balance traditionalsourcing strategies with the new, collaborative approaches needed to drivesourcing’s effectiveness and help it attain its full potential in the face of thedemands of globalization, resilience, sustainability, complexity, andcustomization.The Reader’s 14 chapters, written by Booz & Company’s foremost sourcingexperts, cover the latest ideas and trends, including the next wave of sourcingexcellence, the new role of the CPO, green sourcing, collaborative supplierrelationships, improved strategies for commodities procurement and supplychain resilience, and global and low-cost-country sourcing.Sourcing Reloaded is aimed directly at companies that are determined to buildfresh purchasing capabilities that leave behind old, unprofitable sourcingroutines forever. For them, this Reader will be a helpful guide to arevolution in the making.
  3. 3. Sourcing Reloaded
  4. 4. Sourcing Reloaded:Targeting Procurement’s NewStrategic AgendaA strategy+business ReaderEdited by Jeffrey Rothfeder and Georgina GrenonWith an introduction by Patrick W. Houston,Detlef Schwarting, Robert Spieker, and Martha D. Turner
  5. 5. A strategy+business ReaderPublished by strategy+business BooksCopyright © 2008 by Booz & Company Inc.All rights reserved.No reproduction is permitted in whole orpart without written permission from Booz& Company. For permission requests,contact Virginia Brosnan by e-mail Booz & Company online atwww.booz.comVisit strategy+business online atwww.strategy-business.comIncrease your intellectual capital by subscribingto strategy+business. To subscribe for one year(four issues), visit orcall toll-free 877 829 9108. (Outside the U.S.,call 850 682 7644.)Design: Opto DesignCover art: Pelato, Duarte, Lopez Pereyrastrategy+business BooksPublisher: Jonathan GageEditor-in-Chief: Art KleinerExecutive Editor: Rob NortonManaging Editor: Elizabeth JohnsonDeputy Managing Editors: Laura W. Geller,Debaney ShepardSenior Editors: Theodore Kinni,Melissa Master Cavanaugh
  6. 6. Contents Introduction: Sourcing Transformation Sourcing’s New Frontier Reinventing Procurement to Drive Growth and Profitability7 Win-Win Sourcing18 The New CPO Getting Creative: Efficient Sourcing in Marketing27 Green Sourcing: Seeking the Payoff in Environmentalism40 The Building Blocks of a New Sourcing Approach48 The Collaboration Game: Building Value in the Retail Supply Chain59 Procurement’s New Operating Model by Patrick W. Houston, Detlef Schwarting, Robert Spieker, and Martha D. Turner78 by Harald Dutzler, Peter-John Liberoth, Detlef Schwarting,86 and Robert Spieker by Bill Jackson and Michael Pfitzmann by Simon Harper and Fabrice Saporito by Harald Dutzler and Martha D. Turner by Patrick W. Houston and Martha D. Turner by Simon Harper, Pertti Heinonen, Amit Kapoor, and Marco Kesteloo by Patrick W. Houston, Robert Hutchens, and Alan S. Pincus
  7. 7. Contents, continued Coping with Record-setting Commodity Prices and Volatility Be Prepared to Bounce Back Sourcing Basics That Enable Success96 Smoothing the Path for Procure-to-Pay: A New IT Approach109 Make or Buy: Three Pillars of Sound Decision Making Buy Globally, Think Globally122 Lessons from China: The Importance of Knowledge-based132 Sourcing in Low-cost Countries145 Off the Table, Into the Pocket: Capturing Procurement Savings150 About the Authors162 by Patrick W. Houston, Matthias Mueller, and Martha D. Turner172 by Rich Kauffeld, Dermot Shorten, and Robert Spieker by Jeffrey Barta, Bernhard Rieder, and James Weinberg by Simon Harper, Michael Pfitzmann, and Dermot Shorten by Simon Harper and Laura Thompson by Ronald Haddock, Michael Pfitzmann, and Reid Wilk by Harry Hawkes, Patrick W. Houston, and Martha D. Turner
  8. 8. Introduction:Sourcing Transformationby Patrick W. Houston, Detlef Schwarting,Robert Spieker, and Martha D. TurnerIN TODAY ’ S RISKY global business environment, supplier networksare the ultimate lifeline for many companies — delivering the far-flung materials, goods, and services that drive worldwide commerce.The sourcing function has thus become an indispensable contribu-tor to the strategic goals and overall competitiveness of companiesin every industry. This is quite a turnabout. Not long ago, procurement waslittle more than a back-office function, responsible for the down-stream process of negotiating price-based contracts and extractingscale benefits from increasingly unyielding groups of suppliers. Year-over-year price improvements and day-to-day supply assurance Introduction 7often represented the extent of purchasing executives’ involvementin corporate activities. Today that antiquated notion of sourcing is scarcely recogniz-able in leading purchasing departments. Inexorably, these depart-ments and their leaders have extended their sphere of influencewithin the organization by proving that, given the opportunity, theycan generate substantial value. This value comes in many forms. For instance, procurementdepartments have taken a leading role in driving cross-functionalcollaboration at several large companies. They are breaking down thesilos that have isolated R&D, marketing, sales, and other corporate
  9. 9. Sourcing’s Challengedepartments from suppliers, because such isolation significantlyinhibits cost savings and other performance improvements. Theyare using their newfound muscle to great effect — facilitating inte-grated sourcing processes, acting as liaisons between internal depart-ments and suppliers, and coordinating projects that are aimed atdeveloping innovative products and minimizing sourcing and life-cycle costs. Leading purchasing departments have also demonstrated theirimportance by elevating their activities to new heights, to a strategiclevel far above mere cost cutting. Procurement executives can befound at the center of critical aspects of organizational performance,such as maximizing supply chain efficiency, reducing product devel-opment and manufacturing cycles from design to delivery, buildingoperational resilience, enhancing marketing effectiveness and effi-ciency, and collaborating with suppliers to leverage capabilitiesthroughout the supply chain. Given this wide-ranging set of activities, it is scant surprise thatin many industries, purchasing departments now influence half ofthe annual operational budget. And that figure rises to 80 percent insuch sectors as manufacturing and retail.8 strategy+business ReaderDespite sourcing’s promise and power, many companies have notyet successfully charted a course that positions their purchasingdepartments to become a catalyst for creating and capturing value,including profitability and growth. Even as chief procurement offi-cers (CPOs) relish the notion that they may finally earn spots on thesenior leadership teams of their companies, they must also under-stand that only superlative performers will retain this privilegedposition. Indeed, in a recent Booz & Company survey, 46 percentof senior purchasing executives recognized that a high level of lead-ership ability, a strong business sense, and strategic savvy are the
  10. 10. Globalization. Rich opportunities for profitability and productmost important traits CPOs need for the future. Conversely — andclearly representing a sign of the times — the more traditional skillsof purchasing executives, such as tactical supply management and Resilience. As supply chains extend ever further into regions thatcategory experience, did not rank as priorities in the eyes of 95 per-cent of the respondents. The opportunity to raise purchasing to the level of other criticalcorporate functions also means that its leaders must shoulder theirshare of the responsibility for addressing the increasingly challeng-ing business landscape. When purchasing is managed well, compa-nies can gain a competitive edge because they are able to overcomethe obstacles on which their competitors founder, such as:and service supply lie in the expanding economies and growing Complexity/Customization. The proliferation of products and ser-markets of India, China, and many other emerging nations; thevast new supply alternatives driven by low-cost labor pools and newfactories opening in these countries; and the rising demand foressential commodities. But so do difficult challenges. The com-panies that most adeptly develop, manage, and optimize their sup-ply networks to serve end markets around the world will have aclear advantage. Introduction 9were nearly untouched just a few decades ago, their exposure to nat-ural disasters, computer network attacks and failures, and politicalupheaval is increasing. There are many ways that companies canprotect their supply chains from disruption, but few companies haveactually done so. In fact, a recent Booz & Company survey of lead-ing supply chain executives found that 68 percent believe the great-est risks they face are interruptions in the flow of products andservices from key suppliers, but only 46 percent of their companieshave developed well-thought-out plans to avoid such calamities.vices that has been enabled by digital and other innovations has
  11. 11. Sustainability. Concerns among all stakeholders — from custom-Four Rules for Approaching Sourcing Excellencebeen a boon to growth for most companies. This is an era ofmass customization in which marketing efforts as well as productsand services can be tailored to individual customers. However, asany good operations leader knows, this level of variation comes at acost — increased complexity. Those companies that can balance thevalue of variety with the incremental costs of supply will be bestpositioned for significant profitability. The trick for sourcing isto work collaboratively across the company and with suppliersto provide what customers truly value in a way that minimizes sup-ply costs. Honda Motor Company has developed a no-nonsense way toers to investors to governments and increasingly to end consumers— about global warming, large carbon footprints, and increasedwaste are compelling companies to link green initiatives closely tooverall strategy. Much like quality, sustainability is evolving into anintegral part of the supply equation, and its dictates must be recog-nized in the way companies produce and design their products andservices. Sourcing’s role in facing this challenge is especially impor-tant because, for most companies, nearly two-thirds of green oppor-tunities reside externally, in the supply chain.10 strategy+business ReaderSimply put, in no other period has sourcing had so much power tomake a significant impact in support of a company’s strategic direc-tion and overall competitiveness. And those organizations that arestriving to achieve sourcing excellence will enjoy the competitiveadvantages it yields. For example:eliminate the enmity that typically paralyzes purchasing’s relation-ships with suppliers, replacing strident negotiations with opencollaboration. Ideas for collaboration are often displayed openly onwhiteboards during joint meetings, and then agreed upon by the
  12. 12. Procter & Gamble Company has begun a comprehensive analysis to Vodafone Group PLC has shifted from purely transactional procure-end of the session. In the process, the automaker has lowered itscosts and raised overall performance.determine how its supply chain must be transformed in the nextdecade. Through this study, the company plans to develop ways toreduce product size, create green packaging, and predict consumerdemand so that it can place its factories and distribution pointsnearer its key sales markets.ment to a much more strategic approach that includes a comprehen-sive range of demand-side and supply-side levers and that is focusedon creating value and optimizing the total cost of equipment own-ership in its global mobile telephony business. This transformationhas enabled the company to better utilize supplier capabilities, todevelop systematic measurement and insight into supplier perfor-mance, and to create extensive cross-functional collaboration inter-nally and with suppliers. These three examples are leading companies in the sourcingarena, but in our view, no single organization has yet achieved all thebenefits of sourcing transformation. And no matter the stage ofdevelopment at which its sourcing function stands, any company Introduction 11can gain in the short and long term by “reloading” its sourcing func-tion if it closely aligns procurement with the overall businessagenda and continuously challenges the function to enhance itscapabilities. Further, more companies should do what the best do:improve their sourcing skills in those areas that are organizationalpriorities — a tactic that begins, of course, with precisely identify-ing those areas. From there, the path to purchasing improvement isan incremental activity that ultimately creates a full-fledged and fun-damental transformation. As sourcing leaders undertake this transformational process,they can benefit from these four rules of the road:
  13. 13. 1. Pick your spots. 2. Create total transparency in purchasing costs and trade-offs. 3. Collaborate fully with internal and external stakeholders. A more Companies should start their sourcing trans-formation by redesigning procurement procedures in simple, con- 4. Become an influential corporate leader. Successful CPOs buildcrete ways that can produce measurable and significant value. Theseinitial successes will build momentum within the organization forgreater levels of change.A Source of Best PracticesWhether it be the costs, savings, and benefits of environmentallyfriendly product options; the weighing of whether to buy or makea product; or the design of a more resilient manufacturing foot-print, the issues, implications, and ramifications of sourcing changesshould be clearly articulated and openly shared throughout theorganization.robust sourcing process depends on participation throughout theproduct life cycle, from the concept stage in R&D to the disposal orsalvage of spent products by a recycler. This requires the combinedefforts of key company departments and suppliers in the quest todeliver innovation, reduced costs, supply chain efficiency, improvedproduct launches, and the reduction of silos.their confidence and power by leveraging their position in the exec-12 strategy+business Readerutive suite. They ensure that purchasing plays a greater role in devel-oping and defining the company’s strategic direction. And theycreate a road map for sourcing transformation, as well as buildingthe skills and capabilities required to support business partners.To help your company chart a winning course through today’ssourcing demands, priorities, and opportunities, this strategy+business Reader, Sourcing Reloaded, offers a compendium of bestpractices culled from our experiences with purchasing executivesin companies that have successfully undertaken this work. Sourcing
  14. 14. Sourcing’s New Frontier. The five chapters in this section areReloaded shows that businesses have many ways to achieve thehighest level of procurement excellence. Whether companies areconcerned with getting the basics right or elevating the sourcingfunction to new heights, this Reader includes the perspectivesand insights they need to begin the difficult but ultimately lucrativeeffort to transform sourcing into a wellspring of significantadded value. Toward that goal, this Reader is divided into three sections:devoted to exploring the newest sourcing ideas and trends. In “Re-inventing Procurement to Drive Growth and Profitability,” the freshchallenges and responsibilities of purchasing departments areplumbed through descriptions of some of the best companies’ strate-gies for staying ahead of the revolution in procurement’s potential toadd value. “Win-Win Sourcing” explains how the conventional rules ofprocurement are being rewritten by a knowledge-based sourcingapproach that allows manufacturers and suppliers to establish along-term commitment aimed at improving each other’s capabilitiesand performance. “The New CPO” examines the job of today’s chief procurement Introduction 13officer and finds that, far from being a career backwater, sourcingleadership now involves delivering significant strategic and finan-cial value. “Getting Creative: Efficient Sourcing in Marketing” exploressourcing’s often neglected role in the purchase of marketing prod-ucts and services, often a very sizable portion of a company’s spend-ing that should be managed with the same rigor as other criticalfunctions. Indeed, all strategic services in a company, including legalcounsel, back-office operations, and retail partnerships, can applythe lessons in this chapter. The final chapter in this section, “Green Sourcing: Seeking the
  15. 15. The Building Blocks of a New Sourcing Approach. The four chapters ofPayoff in Environmentalism,” describes how sourcing, supported byits growing credibility in the C-suite and the ability to encouragecollaboration among corporate functions and business units, is in aperfect position to enable a holistic, multifunctional strategy forreducing environmental impact while cutting costs and buildingbetter relationships with suppliers and communities.the second section of this Reader examine the tools and techniquesthat enable a strategic sourcing program. “The Collaboration Game: Building Value in the Retail SupplyChain” details how building holistic, cross-functional, and collabo-rative relationships with selected suppliers across the value chainhelps drive benefits in both revenue and cost far beyond theoutdated and ineffective tradition of haggling over the terms of sup-ply contracts. “Procurement’s New Operating Model” points out the ways inwhich flawed and otherwise incomplete operating models cost mostcompanies 5 to 10 percent of their total purchasing spend in unre-alized savings. The primary causes: End-users do not have the toolsand processes to optimize procurement strategy, decision-makingroles are not clearly delineated, and information systems fail to pro-14 strategy+business Readervide the data needed to ensure compliance with procurement poli-cies and objectives. “Coping with Record-setting Commodity Prices and Volatility”examines how to reduce the tremendous pressure that escalatingcommodity and material costs are bringing to bear on companiesand on traditional procurement strategies. It offers fresh approachesto older methods that create more transparency and a detailedunderstanding of key cost drivers that can help reduce near-termcost variability as well as achieve supply, price, quality, and sustain-ability objectives. “Be Prepared to Bounce Back” explores how to combat the new
  16. 16. Sourcing Basics That Enable Success. The third section of thisfragility of supply chains caused by the rapid growth in outsourcingto geographically remote partners, the increase in sole sourcing, andthe potential loss of data integrity due to the outsourcing of noncoreservices such as IT.Reader revisits perennial sourcing issues, offering insights and pre-scriptions that CPOs can use to reload in their efforts to deal with aglobalized procurement landscape and ensure that a company’sextended supply chain and its technology dovetail perfectly with theneeds and strategies of the organization. “Smoothing the Path for Procure-to-Pay: A New IT Approach”introduces procure-to-pay, an IT strategy that eliminates the needfor one-size-fits-all purchasing systems and replaces them withhighly efficient individual modular applications, each of whichaddresses a specific area of the procurement process. “Make or Buy: Three Pillars of Sound Decision Making” revis-its a classic sourcing decision and offers CPOs a rigorous processfor making more objective and informed “in-house or outsource”decisions. “Buy Globally, Think Globally” explores how a more robustunderstanding of the economic and geopolitical dynamics of the Introduction 15markets in which their companies participate enables CPOs to helptheir organizations take advantage of opportunities that have beenoverlooked by their competitors as well as create a competitive edgewhere it seemed none was available. “Lessons from China: The Importance of Knowledge-basedSourcing in Low-cost Countries” examines the fast-changing con-siderations in dealing with suppliers in low-cost nations. This chap-ter describes how companies can use knowledge-based sourcingto develop strong relationships with such suppliers that extendbeyond supplier costs into a careful assessment of manufacturingand transportation economics, lead-time requirements, schedule sta-
  17. 17. this revolution in the making. +bility, product design changes, and the technical skills of suppliers. Finally, “Off the Table, Into the Pocket: Capturing ProcurementSavings” offers companies a way to identify and capture a large por-tion of procurement initiative savings and drive these savings to thebottom line. Sourcing Reloaded is intended to provide foresight and insightinto how companies can tackle some of today’s most vexing sourc-ing problems. It emphasizes that successful sourcing transformationsdepend on carefully balancing traditional sourcing approaches withnew approaches, earmarking a portion of the gains from new pro-curement strategies for building fresh capabilities that can driveprofit and growth in the future, and building superior purchasingcapabilities over time, in much the same way that Toyota, Honda,and Procter & Gamble developed their sourcing functions. Toachieve similar levels of success, companies must encourage substan-tially more proactive and radical behavior in their CPOs and ensurethat their organizations leave behind old, unprofitable sourcing rou-tines. We hope that Sourcing Reloaded will serve as a helpful guide to16 strategy+business Reader
  18. 18. Sourcing’s New Frontier
  19. 19. Reinventing Procurement toDrive Growth and Profitabilityby Harald Dutzler, Peter-John Liberoth, Detlef Schwarting,and Robert SpiekerAlso contributing to this article were Simon Harperand Marco KestelooOVER THE PAST 10 years, company procurement departments havedone well, on the whole, in meeting a series of new challenges.Whether it meant working with an increasingly global vendor baseor managing partnerships with back-office service providers, pro-curement generally accomplished the task at hand. With each suc-cess, the visibility and importance of the function in the overallorganization grew — so much so that procurement now controlshalf of the annual budget in many industries and up to 80 percentin sectors such as manufacturing and retail. As confidence in procurement departments soared, companiescounted on them to take on even more challenging projects. Now,18 strategy+business Readerprocurement chiefs are being asked to undertake a host of newresponsibilities: decrease supply chain complexity, speed products tomarket, stimulate supplier innovation, enhance operational security,and even consider the social and environmental impact of the sup-plier in sourcing decisions. Addressing issues like these requires a higher level of talent andcommercial acumen than anything procurement departments havetackled before. Indeed, these aims demand a reach beyond thatof the organizational supply nexus: They require a transformationin the way we traditionally think of sourcing. In leading companies,sourcing is evolving from a stand-alone function that ensures
  20. 20. that materials move through the supply chain at the lowest possiblecost to a nerve center that monitors, anticipates, and responds to avariety of needs throughout the company — and even those ofits suppliers. More cross-functional integration. Many companies covet the potential rewards of this kind ofholistic, integrated approach to sourcing, but few are prepared toimplement the organizational changes such an approach demands.Often, the sheer scope of the challenge can overwhelm manage-ment’s ability to visualize the steps necessary to tackle it. To learn how some leading companies plan to meet this trans-formational sourcing challenge, Booz & Company interviewed chiefprocurement officers at more than 100 global companies with areputation for procurement excellence. Through these conversa-tions, we discovered that companies will need to make four keyorganizational adjustments to stay in front of the next wave ofchange in sourcing: • More cross-functional integration • Better supply networks • More collaborative supplier relationships • Greater supply chain resilience and risk management Reinventing Procurement to Drive Growth and Profitability 19 At present, the silos and bordersthat separate functions often limit opportunities for cost savings andvalue achievement. For example, the walls that separate R&D, mar-keting, and suppliers inhibit jointly executed and coordinated proj-ects aimed at such goals as developing new products and services ordriving down sourcing and life-cycle costs. Breaking down thesebarriers can have a substantial impact. Two-thirds of the survey’s respondents told us they believethat procurement has a crucial role to play in integratingdepartments within their organizations. And 73 percent saw a needfor similar procurement-led, cross-functional integration with
  21. 21. external suppliers and partners. The procurement function is well positioned to serve as the cat-alyst for bringing internal departments and external suppliers closerto each other: After all, the function often serves as the communica-tion link between them. Many procurement leaders point to bettermanagement of specifications as a key catalytic mechanism in thiseffort. One CPO told us he wanted his department to learn to takean “active role in challenging the core value” by questioning engi-neers on their product specifications. This, the CPO believed, Better supply networks. Today, most supplier interaction happenswould encourage the procurement team to move from simply iden-tifying unnecessary design elements to better defining the product’sabsolute needs. The advantages of this kind of dialogue are not limited to theCPO’s organization. Large global retailers, such as Wal-Martand Gap, have discovered that closer contact with their suppliersallows the suppliers themselves to integrate logistics and returns-management solutions, as well as to adopt new supply chain tech-nologies such as RFID more rapidly. Greater integration, and the looser boundaries that may comewith it, should not be confused with less discipline. On the contrary,many CPOs complain that buying procedures must become both20 strategy+business Readermore rigorous and more widely applied. “There is still too muchmaverick buying,” declared one CPO. A vast majority of respon-dents — 86 percent — believe that creating global purchasingprocesses and systems will be increasingly important over the nextfive to 10 years.within a point-to-point relationship — procurement to supplier.This relationship has evolved in some industries, such as theautomotive sector, where it is standard practice for companies tomanage deeper into their supply chains, down to Tier Two andTier Three suppliers. But soon, even this extended management
  22. 22. will not be enough. As we interview leading executives, increasing numbers aretelling us that the ability to orchestrate a vast network of supplyrelationships will become more important. Such networks will lookat the supplier not just as a source of a material or a component,but as a partner that will help improve delivery systems and design More collaborative supplier relationships. Many unrealized opportu-products. These executives anticipate using a variety of strategies toimprove their ability to manage supply networks. Fully three-quarters of respondents believe supplier cost modeling will becomemore important over the next five to 10 years, as buyers seek agreater understanding of their suppliers’ underlying expenses. And81 percent of respondents see low-cost-country source modelingas a crucial emerging skill. Another important opportunity, CPOsbelieve, is joint action with suppliers in the continuous reductionof waste: 47 percent see the challenge to reduce waste as a top pri-ority, and an additional 30 percent say they will be focusing moreintently on waste reduction in the future. All these tools speak to the growing need of companies to gaina deeper, more differentiated understanding of their supply net-works. “How to manage strategic partnerships will become key,” Reinventing Procurement to Drive Growth and Profitability 21one CPO told us. Another agreed, but warned that, at present,“there is a lack of clear approach and tools to manage this.”nities for value arise within a company’s supplier network in areasthat neither the buyer nor individual suppliers can identify on theirown. Collaboration is needed to optimize cost, to drive top-linegrowth, and, sometimes, to develop breakthrough concepts. CPOs still see a tremendous untapped potential in collabora-tion. Although 86 percent of the procurement leaders we surveyedsaid they have worked hard to develop collaborative partnershipsover the last three to five years, most believe their work is nowhere
  23. 23. Linking Functions for Improved ResultsThe experiences of a global toy company requirements generated, a practice exac-demonstrate the potential inherent in erbated by lax procurement compliancecross-functional process improvements. rules. Over years of incremental “scopeOver time, this maker of construction creep,” the company lost its scale advan-kits had evolved from making a relatively tage as a major resin buyer and added alimited product line requiring parts in tremendous amount of waste and ineffi-a few primary colors and basic shapes ciency to the supply offering an extended line of kits The solution to the problem wasrequiring parts in hundreds of colors and found in rewriting the purchasingshapes. In the process, a low-cost product road map and adding a step that ensuredbased on molded resin blocks had grown regular communication between theinto something complex and expensive engineers and procurement. This cross-to produce. functional link led to a reduction in This had occurred because the compa- the number of unique resins andny’s engineers were encouraged to create colors needed by manufacturing, lower-innovative products without regard to ing the costs of materials and alsocost of supply. As a result, few engineers simplifying production. Interestingly,thought much about the real price of reducing the number of resins also stim-materials or the additional costs — such ulated innovation, as engineers discov-as inventory expense and the capital ered new ways to make do with fewerrequired to maintain it — that their material options.near complete. In fact, 44 percent still see the development of thesepartnerships as a top priority over the next five to 10 years, and eventhose who don’t see such partnerships as a top priority say they22 strategy+business Readerintend to pursue a greater level of collaboration (38 percent). Typically, collaboration with suppliers occurs in the areas of newproduct development, order delivery and fulfillment, and manufac-turing. In a recent example, a northern European airline uncoveredvaluable synergies while working with a private airport to improveits luggage handling and check-in facilities. By ignoring organiza-tional boundaries, the two were able to design a jointly executedcheck-in process that was much more cost-effective for each partner— and more convenient for passengers. In this new collaborative world, competitiveness will be basedon a detailed understanding of the suppliers’ costs, not the back-
  24. 24. Greater supply chain resilience and risk management. Many CPOsand-forth of negotiations. Companies will gain an advantage overtheir competitors not by squeezing an extra nickel out of theirsuppliers’ margins, but by working with suppliers to boost the levelof efficiency in the supply network or to develop new cutting-edge products. The benefits of supplier collaboration are becoming well recog-nized. One study by the Toyota Motor Corporation found thatwhereas negotiations can reduce costs by about 5 percent, collabo-rative practices can yield as much as a 38 percent cost reduction.Toyota analysts estimate that the benefits of collaboration stack upthis way: 5 to 10 percent in cost reduction from engineeringimprovements, 5 to 8 percent in lower inventory levels through just-in-time shipping, and, most productive of all, 15 to 20 percent insourcing raw materials and finding low-cost sourcing strategies forthe supplier.believe they will need to focus more on risk and resilience than theyhave in the past, because they fear that today’s extended supplychains have made their companies vulnerable to new kinds ofdangers. A total of 68 percent of respondents believe their greatestrisk is the interruption of deliveries from key suppliers. (By compar- Reinventing Procurement to Drive Growth and Profitability 23ison, less than half as many, 31 percent, fear physical damage tocompany-owned facilities or breakdowns in information security.) “Risk management becomes more important as a larger part ofproduction and development is done by partners,” said one CPO.In fact, this heightened dependence on external partners hasexposed companies to new problems that are falling under thepurview of procurement. Issues such as a contractor’s level of socialresponsibility in its labor practices are fast becoming an importantpart of due diligence. One new kind of resilience many CPOs say they must developis the ability to work with their suppliers to create products that are
  25. 25. Meeting the Next Wave Challengemanufactured and distributed with less carbon. And as environmen-tal sustainability or “green” business practices become more andmore popular with customers and even become a regulatory neces-sity in some markets, such an ability will become a greater priority. To build resilience and manage risk, one CPO told us, “we needto be broader in our understanding and have people working in dif-ferent functions across the disciplines.” Consequently, nearly half ofrespondents — 45 percent — say they will be hiring professionalswith the strategic knowledge and business sense that would enablethem to tackle as-yet-unidentified social, regulatory, and environ-mental roadblocks. Risk management is a much-needed capabilityas well, according to 18 percent of the CPOs. (For a detailed examination of green practices, see “GreenSourcing: Seeking the Payoff in Environmentalism,” by Patrick W.Houston and Martha D. Turner, page 59. For more on supply chainresilience and risk management, including how to protect the sup-ply chain, see “Be Prepared to Bounce Back,” by Rich Kauffeld,Dermot Shorten, and Robert Spieker, page 109.)The last wave in sourcing’s evolution was based on disaggregation —24 strategy+business Readerthat is, evaluating the potential value of each supplier and then mak-ing sourcing choices based on that more granular understanding.The next wave of sourcing will build on that foundation and extendit in a holistic sense, propelling companies still further beyond theold zero-sum approach to purchasing. First, the purchasing department will encourage cross-functionalintegration to develop greater insight into the needs of the business.Next, it will work more closely with suppliers to help them addressthese insights in ways that go beyond simple price cutting. To dothis, procurement will build networks of suppliers who work togeth-er to optimize the efficiency of the entire supply chain and engineer
  26. 26. innovative new ways to create value. Finally, purchasing will apply these new capabilities to find ways to better manage the business risks their companies face and to boost resilience. (See Exhibit 1.) Exhibit 1: “Next Wave Sourcing” Key Themes Better knowledge management will be essential in meeting the next wave challenge. At minimum, purchasing needs to understand the cost drivers of its suppliers. But that’s just the beginning. In the future, a much deeper understanding will be necessary in all direc- tions — among suppliers, between suppliers and procurement, and between procurement and other departments within the company. This requires a complex and systematic web of cross-reporting and continual dialogue to ensure that the supply network learns and keeps on learning as needs continue to evolve. Value Creation (From price to cost and value focus, i.e., Finally, an elevated organizational commitment will be required. growth, profit, return on capital employed) For example, to release sourcing’s potential to drive growth and Cross- Supply networks Collaborative Business risk functional supplier and resilience profitability, the procurement department will need a strong board- integration relationships level presence: This will ensure that the company’s purchasing From silo to From one-to-one From transaction From risk to cross-functional supplier manage- to collaboration and resilience value perspective ment to managing capability leverage management and strategy incorporates and is aligned with its long-term goals. supply networks sustainability More critically, it will help the company realize important changes, such as arranging the sourcing footprint in a way that reflects People Supplier Organization Institutionalize Knowledge and Learning Source: Booz & Company Reinventing Procurement to Drive Growth and Profitability 25 Successful leadership strategiesChanging business environment
  27. 27. next wave of procurement strategies and opportunities. +the expected growth of the market or anticipates future require-ments for limiting carbon output. But board support — or, for that matter, senior managementsupport — should not be a blank check. It must be given only ifprocurement’s values, processes, and key performance indicators arealigned with corporate projections and tactical plans. To accomplishthis, CPOs will need to develop a culture of continuous learningwithin their departments, ensuring that the procurement team isable to adapt to changing business conditions. At the same time,they will need to build an infrastructure to continually raise the levelof performance management and controls. As one CPO told us,“We need to professionalize the total procurement organization.” Sourcing is at an important juncture. Many companies are readyfor a procurement transformation; others are not. But simple aware-ness is a first step. Companies that recognize the importance ofholistic sourcing practices are on their way toward implementing the26 strategy+business Reader
  28. 28. Win-Win Sourcingby Bill Jackson and Michael PfitzmannIT ’ S AN INTRIGUINGway to create a contract. At Honda MotorCompany, during meetings with suppliers, the executives write theirproposed actions and agreements on a whiteboard. When all theitems have been discussed, the meeting is over. The contents of thewhiteboard are then typed up, two copies are printed, the supplierand the automaker sign them, and the contract is complete.Thereafter, both sides focus on executing the plan. Honda and itssuppliers thus avoid the drawn-out, querulous negotiation processthat is common at other automakers, a process that can last monthsand even then sometimes blows up without a resolution. This is one of many methods by which innovative manufac- Win-Win Sourcing 27turers like Honda and the Toyota Motor Corporation rewrite theconventional rules of procurement. Their unorthodox techniquesadd up to a form of procurement based on shared information andinsight: We call it knowledge-based sourcing. In this approach,manufacturers and suppliers share a long-term commitment toimproving each other’s capabilities, starting by working togetherto eliminate wasted effort and other inefficiencies. Instead of beingat odds, the two sides collaborate openly to lower costs and raiseoverall performance, with the expectation that this mutual effortwill continue over many years and benefit both companies.Businesses pursuing knowledge-based sourcing use sophisticated
  29. 29. costing tools and industry data, as well as discussions with othersuppliers, equipment manufacturers, and competitors, to producerealistic cost targets that change over time. They set prices thatreflect the supplier’s true economics for each process, part, compo-nent, and system. These prices include a reasonable profit marginfor the supplier as well as incentives for lowering costs, improvingquality, expanding innovation, and making design changes in subse-quent years. Contrast this with the alternative ingrained in many purchasingdepartments: price-based sourcing. Essentially, this approach pitsthe interests of the supplier against those of the manufacturer. Eachside reveals as little information as possible, for fear of giving theopposing side an edge. Components, parts, raw materials, and fin-ished goods are purchased through a competitive bidding process,with specific volumes and deadlines spelled out in advance (hencethose agonizing negotiations). The primary cost-cutting option available to manufacturers ina price-based sourcing approach is squeezing every possible cent outof procurement contracts. Purchasing managers focus exclusivelyon attaining cost savings greater than those of the previous year;their compensation hinges on it. Suppliers, in turn, focus on calcu-28 strategy+business Readerlating bids that will win them the jobs. Once they have made a suc-cessful bid, suppliers are stuck with its terms. They have no reasonto speak openly about their true costs, because they believe thattheir customers won’t pay a penny more. They have no incentive toimprove their product, its design, or its manufacturing processes.They often feel they have no recourse except to game the systemby overstating their expenses or charging exorbitantly for designchanges. Both sides lose, and mutual suspicion and resentmentare rooted so deeply in the system that they are almost impossibleto overcome. This all-too-common story ends with rising costs,increased time-to-market, a loss of any shared innovation practice,
  30. 30. Exhibit 1: Sourcing Philosophiesand, in the worst of cases, supplier bankruptcies. Indeed, many suppliers today are in serious trouble. With rawmaterial prices rising, margins cut to the bone, and purchasingdepartments struggling to meet corporate expectations for costThe perspective associated with each type of sourcing can be deeply ingrained. Managers may takethem for granted — until they switch their approach.reductions, suppliers are under pressure from all directions. In themotor vehicle industry, many suppliers, including Collins & Price-Based Customer Knowledge-Based CustomerAikman, Dana, Delphi, Dura, Federal Mogul, and TowerAutomotive, have filed for bankruptcy. Even suppliers with a longrecord of success have been squeezed, with profit margins oftenView of the A market of competitive, independent An integral part of the business network,falling below the cost of capital. These financial crises, in turn, aresupply base providers bidding against one another essential for competitive advantagepresenting a huge cost to buyers. The expenses associated with theCost management • Seeks leverage on suppliers for price and • Sets targets with suppliers that are based on product improvements cost and performancebankruptcy of major suppliers can easily swamp contract savings. • Will switch suppliers to gain improvement • Increases efficiency through sharing knowledge or a slightly lower price and making a long-term commitment to No wonder knowledge-based procurement models, and the suppliers • Constantly monitors market for new suppliers to drive competition primarily on price • Encourages suppliers to achieve anmanagement philosophy underlying them, are becoming more advantage over the market through continuous improvementattractive to many manufacturers. (See Exhibit 1.) Although they • Promotes competition through dual sourcing and being the buyer of choiceThe relationship • High level of mistrust — relationship hinges • High level of cooperation — relationship iswith suppliers on leverage focused on improvement • Customer does not want to be too dependent • Creates integrated relationships based on on one supplier (for fear of losing leverage) mutual learning, teaching, and quality-related efforts • Often ends up combative or antagonistic • Demands operational excellence and relentless improvementSource: Booz & Company Win-Win Sourcing 29
  31. 31. are not perfect, the Toyota and Honda sourcing models consis-tently earn high marks from suppliers — along with favorable terms.As one automobile manufacturing executive put it recently, “Hondacost estimators can tell suppliers their own costs within 1 percentaccuracy.” That’s meaningful because suppliers are often unable toidentify their own manufacturing expenses with anything near thisdegree of certainty and, thus, often suffer cost overruns. Backed byaccurate cost information, automakers and suppliers can jointlydevelop a performance improvement plan to reach their cost goals. Manufacturers are equally rewarded. For companies that adoptthe Toyota/Honda approach, the acquisition costs for parts such aspistons, exhaust manifolds, and cylinder heads are 35 to 55 percentlower than for those using traditional procurement models. Severalfactors account for this. First, product and part designs can be deliv-ered at lower costs. Second, productivity and quality improve assuppliers practice joint process coordination and improvement.Third, manufacturers’ purchasing departments can be quite smallbecause they work with fewer, more strategically chosen suppliers.Fourth, warranty costs drop as much as 3 percentage points. Finally,fewer components need to be reengineered after launch, and as aresult, both the manufacturer and the supplier avoid the added30 strategy+business Readercosts of changing product designs at the most expensive time —during production. For all these reasons, in everyday practice, knowledge-basedsourcing consistently outperforms the traditional bid-based model.This is true for companies in a variety of industries, and particular-ly for repeat purchases of anything that is not a true commodity. In most cases, even taking into account annual price cuts ofapproximately 5 percent, the quoted price under competitive bid-ding doesn’t approach the agreed-to cost under knowledge-basedsourcing for the life of the contract. (See Exhibit 2.) More impor-tant, this form of win-win sourcing ensures that the knowledge
  32. 32. Exhibit 2: Two Pricing ModelsPrice-Based Sourcing: –5%A Recipe for MediocrityCustomers pressure suppliers to reduce prices, often –5%demanding annual price cuts of, say, 5 percent. Althoughthis approach appears advantaged because of the significantyear-over-year savings, customers actually pay more as –5%suppliers inflate their initial price in expectation of future Agreed-to costdemands for price cuts.Knowledge-Based Sourcing:A Win-Win Approach Ideal Agreed-to costCustomer and supplier work together to achieve the lowest costcost design up front. They agree on a price that is close to Updatebut higher than ideal cost; this price reflects the supplier’s cost Suppliertrue costs plus a reasonable margin for the supplier. Over standards quotetime, the price is further reduced to reflect productivityimprovements. This approach consistently outperformstraditional price-based sourcing on an absolute basis. Supplier improvement Agreed-toSource: Booz & Company program cost TimePricegained and improvements made on one program or product will betransferred to the next. Meanwhile, the improvement plan contin-ues to achieve new levels of success each year, until productivitygains draw the supplier ever nearer to ideal cost expectations, whichreflect more closely the supply and demand realities. Yet as advantageous — and profitably innovative — asknowledge-based sourcing can be, many companies, particularlyWestern ones, have had a hard time adopting it. Some executives Win-Win Sourcing 31find it difficult to accept the idea that knowledge-based purchasingsavings of 3 percent per year could be more profitable than the 5percent annual savings mandated under the price-based system.“Impossible,” one chief financial officer protested. But it’s not im-possible. It merely requires a company to overcome its ingrainedhabits and internal obstacles. The path to knowledge-based sourcingincludes reframing supplier relationships, building and sharingknowledge along the supply chain, and instituting new employeetraining in factory processes, product development, and industryoperations so that employees can accurately gauge ideal costs andpotential cost improvements.
  33. 33. Don’t Copy ToyotaFor executives and procurement managers who want to adoptknowledge-based sourcing, but who have not grown up with Asianpurchasing techniques, a framework can translate these techniquesinto more familiar Western-style rubrics. American and Europeanbusinesses that adopt knowledge-based sourcing often need a newset of formal cost and performance metrics and new employeeincentives. These standards replace old price-based sourcing metrics,which were most likely aimed at attaining those old-fashioned an-nual procurement cost savings. The new metrics are designed tohelp managers work closely with suppliers, in an atmosphere ofmutual trust, to achieve the ideal cost for each item. They incorpo-rate improved supplier measurement techniques, worker evaluationprograms, and a system of salaries and bonuses geared to meetingperformance goals — not to meeting narrowly defined purchaseprice or cost objectives. Such metrics should not be direct copies of the Toyota or Hondametrics. Indeed, the best knowledge-based sourcing practices are tai-lored to each company’s situation. For example, Toyota typicallyfavors suppliers whose factories are in close proximity to theautomaker’s plants, and so does Honda; the automakers frequently32 strategy+business Readeracquire an ownership stake in the businesses. Although at times thisleads to somewhat higher costs because suppliers are located in moredeveloped and expensive regions, both Toyota and Honda prefer thissystem because it minimizes product lead times, eliminates qualityand disruption risks, affords them more control, and dovetails wellwith just-in-time, lean manufacturing philosophies. But this approach overlooks the favorable economics found inlow-labor-cost nations like China, India, Vietnam, and thePhilippines, benefits that should be strongly considered — thoughnot necessarily as the dominant factor — in a procurement pro-gram. Through carefully constructed strategic relationships with key
  34. 34. 1. Establish suppliers as strategic long-term partners. Toyota investssuppliers elsewhere around the world, Western companies can coun-terbalance the advantages that Japanese companies gain from prox-imity and ownership. Every company has internal strengths that can allow it to changemodels. But for an organization to fully make the transition toknowledge-based sourcing, it must take four critical actions:directly in its suppliers — using a keiretsu model of interlockingownership — to manage its alliances. But that isn’t necessary. Moreimportant is an alignment of goals and cultures. In fact, one of Toyota’s preferred suppliers is not part of itskeiretsu. Johnson Controls Inc., a U.S.-based company that makesautomotive interior and battery products, has been cited by Toyotafor perfectly matching the automaker’s standards of quality, on-timedelivery, diversity, and performance excellence. By sharing opera-tions, knowledge, and expertise, Toyota and Johnson Controls havedeveloped a mutual learning and development pact buoyed by asteady rate of manufacturing improvement. The same is true for most other Toyota suppliers. They oftendescribe the automaker as both their best customer (providing pre-dictable volumes and profitable margins) and their most demanding Win-Win Sourcing 33customer (requiring excellence in performance, continuousimprovement, and the highest quality at the lowest total cost). For suppliers to become willing partners, they must be con-vinced that the new knowledge-based practices — setting cost,quality, and delivery targets, and then more ambitious ideal cost andperformance levels — will not be used against them. It must be clearthat suppliers who meet the required standards and consistentlyimprove performance will benefit from more consistent business,which in turn will allow them to operate more efficiently and enjoyhigher profit margins in the future. Long-term partnership does not mean exclusivity. At times,
  35. 35. 2. Set up an ongoing system to eliminate waste through collaborationacross the supply chain.when these relationships are not producing the expected returns,Exhibit 3: Supplier Support Modelmanufacturers choose a second supply source as a backup. Chiefly,this creates competition that encourages the original supplier tomeet its targets and protects the manufacturer from receiving partsthat are lower in quality, more expensive, or delayed. If a supplier iscontinually unable to raise its performance to agreed-on levels, man-Manufacturers who follow a knowledge-based sourcing model must often educate their suppliers.As suppliers gain proficiency, their role changes — from novice to full-fledged partner in a leanufacturers should transfer some volume to the secondary source,production network.always in hopes of eventually improving the initial supplier’s opera-tions so that it can take on more business again. Stable suppliers One facet of knowledge-based sourcing that ers pli Ma tur upmany manufacturers readily embrace is the drive for transparency in ces es up Novi plie SUPPLIER rscosts. Suppliers are asked to reveal their ideal cost performance, or STAGEthe cost to produce components under perfect circumstances. In atrue collaboration, this knowledge would then lead to a mutual Objective Achieve stability Improve production Operate in a lean networkeffort between suppliers and manufacturers to improve production Focus Reactive; address Proactive; concentrate Forward looking; quality issues and on continuous seek even greaterthroughput, quality, and delivery, with the ideal cost performance capability gaps improvement sophistication Level of customer Hands-on Facilitation Very little; suppliers involvement are self-directed Customer role Teaching, training, Teaching, training, Networking, showcase problem solving facilitating, strategic benchmarking partneringSource: Booz & Company34 strategy+business Reader
  36. 36. demonstrating the potential savings that suppliers could achieve. Inmany current cases, however, the ideal cost performance becomesyet another target, a new form of leverage that manufacturers useto press suppliers to cut their margins. This defeats the entireknowledge-based effort; rather than providing incentives to collabo-rate, it gives suppliers every reason to obfuscate their true costs. Instead, deliberately design the costing approach as a self-reinforcing learning process for both buyer and supplier. Establishup front that the ideal performance levels in cost, quality, delivery,and innovation are expected to continually change. For each compo-nent, suppliers should submit a cost breakdown — that is, what theybelieve it would cost at their current level of productivity to producethe item. Working with suppliers, manufacturers then reset thisprice on the basis of industry data, productivity benchmarks, and acompetitive analysis. Ultimately, this process is meant to produce an“agreed-to cost” that is acceptable to both the manufacturer and thesupplier, providing competitive cost and performance for the manu-facturer and profit margins and stable volume for the supplier. As they collaborate to achieve these continually changing per-formance goals, manufacturer and supplier develop a manufacturingimprovement plan together. This plan lowers the supplier’s cost fur- Win-Win Sourcing 35ther over time while improving the quality of the output and theperformance of the factory. The extent of the manufacturer’sinvolvement depends on the supplier’s capabilities and processsophistication. (See Exhibit 3.) Although more hands-on assistancemay be required to address quality issues and build capabilities atsome suppliers, the most mature suppliers are largely self-directed intheir continuous improvement efforts. Even with the most sophisti-cated suppliers, a consistent focus on open communication andmutual assistance helps reduce waste along the supply chain. One fascinating example of this virtuous learning circle occurredin the late 1990s, when Toyota asked the Exxon Mobil Corporation
  37. 37. 3. Get it right the first time. Because the price-based system favorsto produce motor oil at 30 percent below its bid. At first, the oil giantwas convinced that this was impossible and told Toyota managementso, adding a few choice words about what the automaker knew — ordidn’t know — about motor oil. But six months later, after exploringToyota’s offer more closely, ExxonMobil had a change of heart. Itturned out that Toyota’s assignment was possible, and ExxonMobilagreed to the deal and used the knowledge gained to improve its coststructure for all its jobs. ExxonMobil likely would never have realizedthis performance reward without the benefit of Toyota’s sourcingmodel. It helped that Toyota’s executives were willing to challengeestablished attitudes. Indeed, a capability for constructive challengewill make more of a difference to a knowledge-based sourcing initia-tive than any number of borrowed best practices.cost reduction over quality, it often leads companies to launch prod-ucts on deadline but with unresolved flaws — which must then becorrected in subsequent releases, recalls, and updates. Engineersoften end up tinkering with aspects of the post-release product,sometimes for months, trying to justify the additional retoolingcosts by arguing that the changes will add product value. Somemanufacturers even demand from suppliers the option of reengi-36 strategy+business Readerneering products after launch, billing the requirement as a costreduction measure. But no matter how it is justified, the net effect of the price-basedsystem is to raise design and engineering costs — for three reasons.First, it sanctions sloppy engineering; if suppliers know thatredesigns are likely, they may feel less pressure to insist on flawlessengineering the first time. Second, and more pragmatically, suppli-ers figure out the game very quickly; they build in features that willthen be removed to give the appearance of saving costs. In amoment of candor, one designer at an automotive company said, “Ialways overdesign the product so I can hit my cost reduction targets
  38. 38. 4. Respect and develop human capabilities. Underpinning knowl-after launch.” Third, when overhead and marketing costs are fac-tored in, engineers working on an already launched program createonly a third of the value of those involved in a new effort. With knowledge-based sourcing, a short time after productlaunch, the engineers are pulled from the project and redirectedtoward developing new products or new versions of existing prod-ucts. The manufacturing function, meanwhile, can focus attentionon in-plant productivity improvements, not on retooling for prod-uct redesigns. In other words, by creating a well-managed up-frontphase, manufacturers gain a long-term, significant, and often unex-pected benefit. Suppliers are equally enthusiastic. “U.S. automakersreinvent for each program,” said one supplier. “They make eight to10 design changes for each program, while Toyota makes maybetwo. What’s more, [the Detroit manufacturers] continue to changeup to the last minute but don’t want to pay for the changes.”edge-based sourcing is a significant degree of people development.Toyota and Honda, as well as many other Japanese companies, workto instill in their employees a profound sense of cooperation. Theyalso build a deep and company-specific well of product and processknowledge, identifying and codifying their best practices and Win-Win Sourcing 37pursuing ideal performance levels with their supply base. FewWestern companies can claim this type of educated workforce, soa major training effort is needed to improve overall procurementperformance. In companies that pursue knowledge-based sourcing successful-ly, we see the following skills present among a wide range of employ-ees, whether on the shop floor or in the purchasing department: • They can map the underlying processes, materials, and tech- nologies that lead to or promote competitive performance. • They can produce cost models that accurately reflect supplier and industry economics.
  39. 39. • They can identify world-class factory output. • They can help suppliers reach recognized top-of-the-line standards.The Path to a New Model Shifting from a traditional manufacturing model to this newknowledge paradigm is culturally difficult. Managers at many com-panies change jobs often; this makes it virtually impossible toacquire the depth of experience and information needed to workclosely with suppliers on continuous cost and performance improve-ment. Moreover, compensation is usually based on straightforwardcost and revenue benchmarks, not on quality and performanceimprovements. That is why one of the first steps for a company totake is to design creative incentives that reward employees for suc-cessful long-term supplier relationships and for improved commu-nication among purchasing, engineering, and the executive suite.These incentives can alter old-fashioned perceptions quickly. Otherforms of support include focused training — on topics such as sup-plier relationship management and development, cost modeling,and industry economics — and career tracks that allow people togrow and develop without shifting positions. Some companies havesuccessfully developed and implemented a training and certification38 strategy+business Readerprogram for cost management that encompasses much of the engi-neering organization and all of purchasing.The practice of knowledge-based sourcing is still evolving; a “next-generation” approach is emerging now as more companies in a vari-ety of industries adopt Japanese techniques and incorporate theminto their own corporate cultures. The most effective manufacturerswill build up supply chain management teams with differentiatedcapabilities, balancing commercial, technological, and managerialskills. They will align their values, incentives, and key performance
  40. 40. tain of reaching the end. +indicators with the relationship-based system, focusing on perfor-mance management and support instead of by-the-book cost reduc-tions. They will build networks of suppliers who will work togethermore regularly and effectively across the value chain, ensuring com-patibility among components and seamlessness among their pro-cesses. Finally, they will adopt more modular approaches, in whichcomponents are distinctive when necessary but standardized whendistinction matters little to customers. In short, careful attention tosourcing quality and logic will finally be seen as the strategic capa-bility it deserves to be, positioned with a top management mandate. To be sure, a knowledge-based sourcing model is not appropri-ate for every situation. If a company is buying a part or componentjust once and is unlikely to require the supplier in the future, thereis little need to spend resources on improving operational and sys-temic output. However, any company’s most important supplierEditor’s Noteagreements involve the most essential components. In those cases,manufacturing productivity improvements are critical in maintain-ing high quality, reliability, and a continuously advantageous costbase. The move to knowledge-based sourcing may not be easy, butby implementing the four steps outlined here, most companies willfind themselves on the road to making the transition, relatively cer- Win-Win Sourcing 39First published in strategy+business, Summer 2007.
  41. 41. The New CPOby Simon Harper and Fabrice SaporitoPURCHASING USED TO be a boring function that most companies tookfor granted; it involved a lot of transactional work and tedious rep-etition — important activities for day-to-day or even moment-to-moment operations, but not critical to the organization’s overallplanning and financial performance. Anyone with basic negotiating skills could manage procure-ment, it was often said; deeper strategic thinking and serious dealmaking took place elsewhere. For a nine-to-fiver, it wasn’t a bad wayto eke out a living. For an ambitious businessperson, however, pur-chasing was nothing but a dead end. But that’s all changed. The growth in outsourcing, the drive for40 strategy+business Readerefficiency, and the dramatic cost savings that can be delivered bywell-managed supply chains and pricing analytics have transformedpurchasing into a strategic function in many companies. The best ofthem now view procurement as a potential asset, one that is asimportant as research, product design, finance, and marketing.These companies realize that many of the questions that executivesmust answer correctly to succeed in today’s commercial environ-ment are intimately and directly linked to purchasing: What workshould we farm out? What work should we keep? With what com-panies should we partner? How many suppliers should we have?What should our relationship be with our suppliers? All of these
  42. 42. strategic questions now fall squarely on the desk of the chief pro-curement officer. Of course, recognizing that the procurement department is notthe career backwater it was once considered and capturing the sig-nificant strategic and financial value embedded in this function aretwo different things. Indeed, to profit from an elevated respect forprocurement, many companies will have to undo decades of badhabits in the recruitment, training, and development of their pur-chasing professionals. No longer can they afford to place competentbut unimaginative people in these jobs. Nor can they afford toignore their current procurement staffers by offering them fewchances of advancement and neglecting their skills. Hiring the merely good is not enough for organizations thatwant to build world-class purchasing departments. Instead, theymust make stellar appointments — filling the senior procurementjobs with people who can become tomorrow’s top corporate leaders.Managerial talent of this caliber doesn’t develop by accident.Businesses hone executive abilities by identifying and encouragingpromising individuals and providing them with the right opportu-nities over years, even decades. Slowly but inexorably, the programs that are needed to develop The New CPO 41top purchasing executives are being implemented at more and moreorganizations. In fact, procurement managers themselves evince abudding sense of optimism about their prospects, a sharp changefrom prior, gloomier assessments. In a recent Booz & Companysurvey of 100 CPOs and supply chain management leaders, 66 per-cent of respondents said the CPO will play a larger role in settingbusiness strategy in the next five to 10 years, and 44 percent ofrespondents said activities in the purchasing department will be atop priority. (See Exhibit 1.) The general conviction in the executivesuite seems to be, as one respondent put it, “Procurement needs tobe more strategic — closer to the CEO agenda.”
  43. 43. Exhibit 1: CPO Role in Business Strategy What is the role of the CPO in defining the How important will CPO involvement in business strategy of the company? defining business strategy be in 5–10 years? Major role 7% Top priority 44% More 22%Important role 27% Same 29% Limited role 27% Less 3% No role 39% N/A 2%Source: Booz & Company survey This suggests that although it will continue to be important for 1. Recruit from top schools. The bad news is that, by and large,the purchasing professional to have functional expertise enablinghim or her to get the best deal on paper clips (as well as to leveragemore value from the entire supply base), strategic capabilities, polit-ical savvy, and leadership talent are increasingly important prioritiesand prerequisites for CPOs. In fact, our survey revealed that 46 per-cent of senior purchasing executives believe that strategic under-standing and overall business sense will be the most important traits42 strategy+business Readerfor purchasing managers in the future. Meanwhile, two traditionalmeasures of purchasing professionals’ functional expertise — theirability to manage supplier networks and their understanding of theproducts or services they are buying — weren’t rated as the top pri-ority by even 5 percent of respondents. (See Exhibit 2.) The chal-lenge for tomorrow’s procurement officers, noted one CPO, will be“setting the strategic agenda through growth and innovation.” Companies determined to develop a new generation of corpo-rate procurement leaders — while maintaining a competitive supplychain — should take five steps in particular:
  44. 44. 2. Pay a competitive salary. The growing corporate realization ofcompanies have not bothered to seek out the best and the brightestfor purchasing; most recruiting has historically been internal. Theresult, of course, was a self-fulfilling prophecy: Second-tier candi-Exhibit 2: The Importance of Future Capabilitiesdates couldn’t raise purchasing to a strategic competence, and theirunderperformance seemed to justify the function’s relegation to asupporting role. If procurement is to achieve its promise, companiesmust seek out top performers to fill these jobs. The good news is that the level and quality of purchasing talentis rising. Responding to the new demand, some top business andindustrial management schools have added purchasing to their cur- Which two of the following capabilities do you believe will be most important for purchasing professionals in the future?riculum. For example, Helsinki University of Technology, a for-ward-thinking business school whose students consistently beattheir European and American peers in international business case Strategic understanding and overall business sense 46% 13%competitions, recently added a purchasing and supply managementCross-functional supply and value chain understanding 15% 21%curriculum within its industrial management major. The university Supplier cost modeling 4% 24%developed the innovative course of study with the support of lead- Risk management 18% 4%ing Finnish corporations. Ability to manage supplier relationships 9% 10% Most important Deep technical understanding of category 3% 13% Second most importantthe enormous business impact that procurement can create has stim- Ability to manage network supplier 3% 10%Source: Booz & Company survey 0% 20% 40% 60% The New CPO 43
  45. 45. 3. Rotate functional assignments. It is essential to the developmentulated healthy increases in the earnings of procurement and supplychain professionals. The magazine Purchasing reported in December2007 that on average, U.S. purchasing professionals earnedUS$84,611, up from $64,300 in 2002 — a 30 percent increase infive years. In the United Kingdom, purchasing directors’ compensa-tion rose steeply as well — to £76,000 ($157,000) in 2007, up a full14 percent from the year before, according to a survey conducted bythe Chartered Institute of Purchasing and Supply and compensationexperts the Croner Company. Underpaying for purchasing executives in such an environmentis a penny-wise, pound-foolish strategy. Worse, an insistence onclinging to old pay scales — that is, not paying purchasing execu-tives on par with other top managers — will simply ensure that thecompany hires the same old kinds of individuals, only worse.of future purchasing leaders that they obtain the widest possibletraining and experience within the organization. Leading corpora-tions already routinely move executive candidates from one job toanother to broaden their knowledge of overall operations. At IBM,for example, the most promising purchasing employees may spenda few years in finance, market intelligence, or even global services44 strategy+business Readerbefore being shifted back to supplier management. Similarly,Nokia’s procurement rotation plan gives its purchasing staff a tasteof what it’s like to deal with different types of expenditures or cate-gories of supplies and services. Rotation programs not only create new opportunities for theindividual procurement executives but also benefit the company.Two- to three-year rotations infuse fresh blood and new ideas intothe top purchasing ranks, prevent the development of counterpro-ductive personal relationships between buyers and suppliers, andreduce the risk that bottlenecks will arise from relying on a limitednumber of experts who specialize in buying an even smaller number
  46. 46. 4. Revise and expand training.of products and services. The training required to functioneffectively as a purchasing officer is much more complex than it wasjust a few years ago, because it must include both traditional pur-chasing expertise and broader financial and managerial skills. Procurement professionals still need such core skills as negotia-tion techniques, supplier market analysis, and cost modeling, buttraining programs involving these once-basic skills often require revi-sion as the field of purchasing becomes more advanced and challeng-ing. For example, traditional cost modeling involved little more thanshort-term analysis of commodities markets to lock in prices overperhaps a three- to 12-month period. But these days that’s only thebeginning. CPOs now must be adept at macroeconomics and havewider corporate finance skills to manage futures, puts and calls, fixed 5. Create career paths for purchasing talent. Ironically, althoughcontracts, and other strategies and instruments that are designed tocover purchases over many years. CPOs increasingly need the finan-cial acuity to accurately forecast supplier prices 24 months out ormore so they can make better decisions about long-term contractsfor oil and other commodities or the raw materials that should beused in their company’s manufacturing processes and products. In some industries, such as the airline industry, the last few years The New CPO 45have demonstrated that the cost management of a key commoditylike fuel oil can sometimes be the key not just to profitability butalso to corporate survival. For example, with long-term hedgingof more than 80 percent of its energy costs, Southwest Airlinesavoided the turbulence many airlines suffered when jet fuel pricesnearly tripled between 2002 and 2005. To help develop the broad areas of expertise that procurementofficers need to thrive in the new purchasing environment, compa-nies should turn again to top business schools for general manage-ment training.
  47. 47. capabilities training is an investment that yields a higher return inthe short term, it’s also one that carries a greater risk to the depart-ment. Equipped with a wider array of skills and more expertise,purchasing professionals will find it easier than ever to leave theircompanies for better opportunities — and high industry turnoverrates suggest that these budding executives aren’t shy about takingadvantage of new offers. To prevent such a brain drain and ensure that companies andindividuals are capturing the full potential of their purchasing tal-ent, it is essential that companies offer concrete and compellingcareer paths for procurement professionals. To determine whichprocurement executives deserve special treatment, human resourcesdepartments should build into performance appraisals and measure-ment the new set of skills needed by purchasing managers, such as ahigher degree of financial acumen and finely honed strategic think-ing. Moreover, the company must reward procurement officers whomeet certain cost and delivery targets with greater compensation. The purchasing department should be viewed as a trainingground for senior corporate positions. If the anecdotal evidence isany indication, the best senior purchasing officers are fully capableof filling those spots. For instance, Richard Purcell, former46 strategy+business ReaderMicrosoft CPO, is now chief executive officer of the Corporate Pri-vacy Group, a consultancy on business privacy practices. And PekkaOjanpää, after only a year as CPO at Kemira Oyj, the leading chem-ical supplier to the pulp and paper industry, was named president ofits Kemira Specialty division. In February 2008, he was named pres-ident of Kemira Water. Some might argue that thinking of well-trained and innovativepurchasing managers as indispensable talent assets is a short-termphenomenon that will generate only a modicum of real changewithin most organizations before it disappears. But we see the risingneed and desire for highly skilled purchasing professionals as a lag-
  48. 48. smart purchasing professionals to adopt a new perspective. +ging indicator in the long-term trend of supply chain revolution.Over the past 30 years, business thinkers have become increasinglyaware of the crucial role that the supply chain plays in corporate suc-cess. Yet even as they realized that the supply chain was a profitengine, executives and purchasing professionals alike remainedoddly unaware of the purchasing department’s contribution to theefficiency of that engine. It is time for both smart companies and The New CPO 47
  49. 49. Getting Creative:Efficient Sourcing in Marketingby Harald Dutzler and Martha D. TurnerTHE LARGE RETAIL bank’s approach to buying marketing-related ser-vices and materials was typical. On direct marketing efforts, decen-tralized business units worked with advertising agencies of theirchoice — agencies usually chosen on the basis of demonstratedcapabilities, their understanding of the nuances of the individualbusinesses, and the personal relationships they had built over time.The relative cost was hard to compare, as each of the bank’s businessunits negotiated its own agreements with its marketing partners.Pricing was usually project-based, with no standardization from onebusiness unit to another, even when it involved universally useditems, such as envelopes, mailing inserts, and postcards, or when48 strategy+business Readerunits shared the same vendors. This sadly common scenario speaks volumes about the sourcingside of marketing at large companies. Although creative develop-ment is met with great attention to detail — no marketer would letpoorly written direct mail copy or artwork go out to half a millioncustomers or approve a point-of-sale placard that was off-message —the sourcing of marketing materials or services rarely gets the samescrutiny. In a way, this is understandable. A marketer’s first currency isimage — what people see, hear, or touch that draws them to a prod-uct or service. But to focus on marketing’s end product at the
  50. 50. Leaving Money on the Tableexpense of the sourcing process is to miss a very large opportunityboth corporation-wide and for marketers themselves. After all, mar-keting materials and services can represent upwards of a quarter ofmany companies’ total purchasing costs.If marketing provides such a tangible opportunity for cost savings,why have so few companies found a way to increase the function’spurchasing efficiency? For one thing, when companies give theirlocal marketing departments an undue amount of autonomy towork their magic, including allowing them to select vendors andmake buying decisions independently, the result is a wide anduncontrolled proliferation of specification and service levels, alongwith a fragmented vendor base. One consequence is a lack of consistency in the bidding process.A provider to one business unit may get the job because it offers thelowest price, but a similar supplier to another business unit may wina contract simply because it has been the go-to vendor for manyyears and the local marketing manager can’t imagine switching sup-pliers. The results of narrow, relationship-based vendor selection canbe extremely damaging, both to the company and to the suppliers Getting Creative 49that are ostensibly benefiting. For example, a restaurant chain wasrecently forced to end its relationship with a fulfillment vendorbecause the growth of the chain’s footprint and associated marketingneeds outstripped the vendor’s capacity and capabilities. With theoverwhelming majority of its revenue gone, the fulfillment houseunfortunately went out of business. Another reason that marketing spending lacks controls and isoften wasteful lies in the limited interaction, at least historically,between marketing and purchasing departments. Even at companiesthat are trying to change that dynamic, purchasing directors oftendo not have enough direct experience working with creative agencies
  51. 51. and media buyers — marketing’s primary cost centers — to knowhow to implement more advantageous contracts. The results of companies with which we have worked demon-strate that the benefits of addressing this disconnect can be substan-tial. The cost savings from bringing marketing and procurementtogether in a dedicated program to raise the efficiency of marketingprocurement start at 5 percent and can climb as high as 40 percentacross spending categories. That can mean tens of millions of dollarsin savings at companies that depend heavily on marketing, such asthose in the consumer packaged goods, pharmaceutical, and autoindustries. And although some marketers have harbored concernsthat any efficiency gains would be achieved at the expense of mar-keting creativity, those fears, by and large, have not been justified. On the contrary, what chief marketing officers (CMOs) of someleading-edge companies have discovered is that more efficient sourc-ing actually leads to greater marketing effectiveness and a strongeremphasis on creativity. This is true because one by-product ofgreater procurement efficiency — say, in the form of designatingcertain suppliers as strategic vendors — is less time spent on man-aging processes and more time spent on developing core marketingprograms and activities. Further, when the CMO allows marketers50 strategy+business Readerto reinvest a portion of the savings generated from sourcing, theycan use the money to fund new creative efforts and invest more insuccessful campaigns. In short, in this era of cost cutting, efficientsourcing can enable marketing to do more with less. To gain the maximum benefit to their bottom lines and market-ing efforts, companies will have to ensure that marketing and pro-curement departments collaborate to an unprecedented degree. Thisis not an indirect way of saying that marketing should be preparedto relinquish control of its budget. Rather, it’s a prescription for anew paradigm, in which purchasing can bring a fresh rigor to theeffectiveness of marketing expenditures.
  52. 52. 1. Analyze Marketing Spending in Detail This tighter collaboration between marketing and procurementwon’t come naturally; it is a change that requires careful planningand oversight. And although there is no silver bullet for achievingthis task, there are steps that companies can take to begin the processof managing their marketing dollars more efficiently.It is hard to buy marketing products and services efficiently withoutknowing where and how the money is currently being spent. Yet thisis precisely the situation in which most CMOs of large companiesfind themselves: They don’t have a detailed understanding of thecomposition of their marketing expenditures or a comprehensiveprofile of their supply base. This is because most marketing budgets are complicated, di-vided between “above the line” items such as advertising and creativeservices, meant to build brand awareness, and “below the line”spending in targeted areas such as promotion, direct mail, andpoint-of-sale, as well as prepress, printing, and fulfillment services.Further, most marketers manage against budgets and campaignsrather than focusing on the compliance of individual vendors tocontractual terms. Also, because brands tend to operate in silos, Getting Creative 51many CMOs cannot get a clear picture of spending across brands.No wonder it’s so hard to keep it all straight: Marketing spendingisn’t a line item; it’s a scattergram. Nevertheless, setting a clear baseline by establishing where themoney is being spent is crucial to a CMO’s ability to identifyopportunities and develop insights for improvement. In the largeretail bank described above, the CMO was able to gain criticalknowledge of variations in prices and service-level agreements, aswell as the financial institution’s multiple internal points of contactwith suppliers, by conducting a thorough baseline diagnostic thatencompassed all of the bank’s marketing activities. That, in turn,
  53. 53. 2. Adopt a More Rigorous Approach to Spending Supply levers. Supply levers offer a broad opportunity to becomeallowed the CMO to drive toward more efficient sourcing by delin-eating points of synergy and opportunities for greater collaborationacross brands.Marketing can become more disciplined about controlling costs intwo ways. The first is attacking supply levers by rebidding and con-solidating the vendor base, a process that marketing and procure-ment can and should undertake together. The second is through themanipulation of demand and process levers, the requirementsplaced on suppliers by the marketing staffers themselves.more efficient. This is partly because upwards of 70 percent of themarketing budget lends itself to definition by a standard set of spec-ifications — e.g., trim size, paper weight, color, finish, and bindingfor printed materials. Companies that want to become efficientabout marketing sourcing must be willing to adhere to rigorouspricing levels for standard products and services. They should alsoestablish and maintain enterprise-wide rate cards or pricing gridsfor services such as graphics work, so that an individual businessunit knows what it can expect to pay for different design elements52 strategy+business Readerand for agency resources, such as the services of a copywriter or cre-ative director. This discipline should extend to special situations in which themarketing concept requires unusual purchases (think of a totempole, or a branded mobile that might hang in a store), creatingunique specifications so complex that it is not possible or does notmake sense to establish a rate card. In such cases, it is best to use a“market basket” approach, meaning that the company asks for pricesfor a representative set of services and uses those estimates to deter-mine a preferred set of vendors. As the need for special items arises,only these preferred vendors are asked to bid on the work.