The Value Basis for Procurement
As the procurement function has become more sophisticated, the perpetual corporate charge-for-growth has pushed the function to identify and deliver value across the organization on a constant basis. To this end, while many tools and techniques have been made available to the sourcing professional to achieve these aims, the most tangible means are, in many respects, the most fundamental i.e. optimal execution of the strategic sourcing process. But what is ‘optimal’ strategic sourcing?
While there are many ways to define the term and many constituent elements that comprise it, at its core, optimal strategic sourcing has four key characteristics. It is:
- Structured and systematic
- Fact based and data driven in nature
- Inclusive – of both internal and external perspectives
- Rigorously applied
In other words, optimal Strategic Sourcing is actionable and strategic–with its essential emphasis to deliver tangible benefits across a range of parameters (of which cost is but one). And strong execution of the process consists of understanding and applying fundamental tool sets that should form the core of any sourcing professional’s arsenal. In this article, we will overview three specific tools that can help the sourcing professional develop actionable intelligence, specifically:
- The Supply market analysis
- Should cost model
- Negotiations fact pack
Tool 1: Supply Market Analysis
The Supply Market Analysis (SMA) is an oft-used tool in many respects, in that various forms of such analyses are widely available for many categories on a syndicated and/or free basis, and as a result, many feel that they have this tool covered in appropriate depth as they embark on their sourcing programs. The stark reality is that, depending on the category in question, sufficient diligence is usually not observed – either in definition (what constitutes a strong SMA), or in execution (no, simply getting intelligence from your vendor set is not good enough).
So what is an effective SMA? A robust analysis covers seven essential elements, as depicted in the schematic below:
Note that the elements listed above are not all equivalent in terms of nature and sequence. Some are distinct, while others are dependent on the distinct elements. For example, understanding the competitive landscape and developing product and technology trends are distinct areas, but the Political Economic Social and Technology (PEST) analysis and the Porters Five Forces analyses are dependent on many of the other elements to develop. As such, the basis for developing a strong SMA is robust, structured and varied research in order to extract the essential information and data that will comprise the overall analysis:
- Extensive Secondary Research: Typical Tools here include subscribed databases, company websites, industry/market reports, ministry and association websites. Irrespective of source, it is important to:
- Define the market appropriately – identify current as well as emerging substitutes, for example Deploy a combination of top-down and bottom-up approaches to identify key players, positioning, market structure, etc.
- Qualify and caveat data sources – always corroborate numbers from multiple sources
- Consider the economic environment when evaluating forecasts – context is key to interpretation
- Targeted Primary Research: A must have for a strategic category, as rarely are all key questions answered through published literature alone. This means:
- Identify industry stakeholders – both Paid and Unpaid
- Evaluate the source – assess the individual’s agenda and hence the quality of the insight provided
- Look broadly – speak to vendors, market experts, buyers, etc. Do not limit your sources
- Interpretive Analytics: this is putting all of the above together i.e. thinking through the data and information to develop insight, including structural analysis (to understand the true nature of the competitive landscape), Porter’s Five Forces analysis, etc.
Tool 2: The Should Cost Model
The second major tool to deliver actionable intelligence is the should-cost model. A strong model provides a level of insight into the cost structure of any given product or service that allows for a detailed understanding of those key cost elements that drive the price of any given category. Effectively executed, the model:
- Dissects the various cost elements of producing a certain product
- Involves granular analysis where a representative facility operating at a certain throughout is considered for cost simulation
- Embeds product and sector knowledge including
- The commercial manufacturing process
- Proportions of various raw materials used at different stages
- Energy and other utility costs
- Direct labor and overheads
- Assesses and estimates producer margins
(In many instances (particularly Direct Categories), there can be commercial by-products, tax incentives, government rebates, etc., that need to be accounted for and then appropriately treated within the model.) Of course, it is critical that the cost model be considered at various levels – product/service, individual supplier and region-specific.
The process to develop it is three-pronged:
- Data Collection–This is the secondary data collection and primary research that needs to be done to arrive at the necessary parameters/inputs. The analysis at this phase should look to identify the cost elements, evaluate the production process, understand nuances behind raw material inputs and costs, etc.
- Data Analysis–This is the more technical phase of the analysis, where the individual variable costs are analyzed through fundamental derivation and validated through numerous sources. The assessment covers everything from material input levels, to production specifics, to overhead allocation approaches and limits
- Cost Element Estimation–In this third phase, the individual cost elements are summed up and the model is thoroughly checked and tested for validity at the overall level
Needless to say, a strong should-cost model relies on multiple points of information and data, with the information elements triangulated and validated based on both primary and secondary research. The output, though, is worth the time and effort put in, as it helps to provide a strong economic, fact driven basis for discussion with a supplier or as a key input to strategy.
Tool 3: The Negotiations Fact Pack
The third major tool we will discuss here is the Negotiation Fact Pack. Tackled in many different forms (of varying levels of rigor), a robust fact pack is a set of tools and frameworks that provide targeted support during negotiations across a range of specific parameters and specific suppliers.
In its most ideal form, the pack provides: All relevant market information focusing on a specific supplier’s bargaining power Insight into spend data – volumes, patterns, diversity of spend, etc. Relative positioning vis-à-vis its competitors, the buying company, the industry and beyond Insight into capacity, operating rate, costs, market conditions, etc., and implied leverage Thus, the specific components of a Negotiation Fact Pack are varied but can include the following:
- Supplier’s Product focus and related pricing power
- Supplier Cost pressures
- Supplier Industry vs. Buyer Industry bargaining power
- Impact of market events on the supplier
- Impact of competition on the bargaining power of supplier
- Impact of demand on industry pricing
- Industry structure and dynamics
Most tangibly, a thorough fact pack is of direct value during contract renewals, re-negotiations and price push backs with suppliers.
The above represent three core tools (among others) that should form the foundational basis for when a category leader undertakes the strategic sourcing process. The emphasis here is on the basics–facts, data, rigor and analysis. To ensure this is achieved (irrespective of the specific tools deployed), there are several common drivers for success:
- Senior-level commitment to intelligence as a tool to ensure sourcing success
- Rigorous due diligence – consistent, structured and methodical approaches
- Inclusion of a wide range of sources of insight – primary and secondary
- Ability to leverage ‘analysis’ beyond the data – what does the information mean?
By observing these principles, the sourcing professional is then able to drive the type of actionable intelligence that is essential to ensuring the success of his or her category strategy.
For specific examples and an application of the above tools, email firstname.lastname@example.org.