What is strategic sourcing
The strategic sourcing process in any organization is a clearly defined set of steps with starting and ending points in a specific sequence focused on selecting and managing suppliers to achieve the long-term goals of the business. This task provides one approach to developing a strategic sourcing process, and then gives examples from several organizations. This task defines strategic sourcing, and describes policies and procedures.
- Definition — The ISM Glossary 6th edition defines strategic sourcing as the selection and management of suppliers with a focus on achieving the long-term goals of a business. Strategic sourcing does not apply to all purchasing situations, but is generally applied when the purchase reaches a certain dollar threshold specified by the organization, or presents a certain level of risk or criticality to the organization.
There are five major category issues that are “core influencers,” shaping the direction and emphasis of the strategic sourcing process. These include the organization’s emphasis and perspective on the following issues: revenue generation and innovation; cost and value management; business strategy alignment and financial acumen; risk and compliance management; sustainability and social responsibility; and supply chain linkage, integration and supplier relationship management (SRM). In addition, there are support structures in place that provide a foundation for the successful execution of the strategic sourcing process: stakeholder alignment and engagement; operations; talent management and development; change and project management; and forecasting, inventory planning, information technology (IT), logistics, and warehousing.
Virtually all leading organizations have a variation of the strategic sourcing process for the execution of the supply management process that includes all these activities, although they may be divided into different steps. Typically, the five strategic sourcing process includes the following steps or phases.
- Data management and analysis.
- Category strategy and development.
- Cost analysis and management.
- Supplier selection and contract negotiation.
- Supplier development and relationship management.
The process begins with a thorough analysis of internal and external data to better understand the threats and opportunities in the internal and external environment. Next, specific strategies are developed for each purchase category, including services, and tactics for implementing those strategies are identified. Closely related to this, costs are analyzed to find ways to better manage, reduce costs and increase value. Suppliers are then identified through data analysis, selected through a bidding process or negotiation, and the contract is developed. Finally, ongoing supplier measurement and relationship management occurs, and may include supplier development efforts to improve supplier performance.
Strategic sourcing steps
To facilitate success a supply management professional must:
- Identify key stakeholders, and align with and engage stakeholders to understand and support their success, and work with them as partners. This can include internal customers, R&D, finance, marketing, and other areas that affect and are affected by supply management activities.
- Work closely with operations. Operations is core, as supply management supplies operations with materials to meet its objectives.
- Have an excellent talent management and development program to attract the best people in the organization, and offer opportunities for both growth and advancement, creating an excellent system for managing and developing the organization’s most valuable resource, its people.
- Be skilled in change management and project management, as both are essential elements of the success of supply management initiatives.
- Work closely with the people or groups in charge of forecasting, inventory planning, information technology (IT), logistics and warehousing, and seek alignment of objectives. These areas form the foundation for supply management decision-making and successful execution. IT provides the systems to link information quickly and accurately so that supply management can successfully execute the strategic sourcing process.
These elements, integrating the internal business needs with external forces, become the foundation on which supply management builds success.
Why strategic sourcing is important
- A strategic sourcing program requires policies and procedures to be successfully implemented at an organization. First, policies and procedures need to be clearly written, and they must support attainment of organizational goals. Several mechanisms can then be used to disseminate the information. It is most effective to use several of the following processes to ensure procedures are established and standardized.
- Senior leadership distributes a copy of the policies and procedures to all stakeholders.
- Host a meeting with key stakeholders to introduce strategic sourcing and the related policies and procedures.
- Identify leaders who have spend under evaluation and engage them as sponsors. These sponsors will help champion the strategic sourcing process for the categories under them. Engage these sponsors through a one-on-one meeting.
- Dedicate space on internal intranet or social media sites to strategic sourcing, and post relevant documents and marketing material on the site.
- Use office space to create awareness of strategic sourcing, and post relevant documents, announcements, photos from supplier conferences, and visuals of savings achieved versus goals.
- Create cross-functional teams.
Value of strategic sourcing
- Strategic sourcing is a data-driven process. Supply management professionals involved in strategic sourcing need to know how to collect and evaluate data, and then use that information to formulate and communicate compelling arguments. The essential analytical skills for supply management resources working in strategic sourcing include the following:
- Develop thoughtful questions and hypotheses to determine what data is needed.
- Understand how to collect and compile data from disparate systems and resources.
- Use various qualitative and quantitative analytic tools to evaluate information.
- Use data to formulate conclusions and reach decisions.
- Present data in a meaningful, compelling manner to support decisions and negotiation arguments.
Elements of strategic sourcing
This section explores supply management’s strategic role in the organization and details the first step in the eight-step sourcing cycle, recognizing needs and the key decisions to make when developing a sourcing strategy. Supply management professionals work with internal stakeholders to determine what resources are needed. Then, consistent with the category strategy objectives, they develop sourcing strategies that drive supplier selection to fill a resource need. Sourcing strategies consider factors such as whether internal or external suppliers should be used, whether existing or new suppliers are best, desired supplier locations and geographic coverage, the essential and ideal supplier capabilities, supplier size, and type of supplier relationship needed. The sourcing strategy guides the decisions made when identifying, evaluating, and selecting suppliers.
The initial steps of the sourcing cycle and the sourcing strategy influence the organization’s performance. For example, when Nintendo introduced its new video game console, the Switch, it single sourced display screens with a financially struggling supplier, Japan Display, most likely because of a low price.1 However, when Apple, which reportedly accounted for 50 percent of Japan Display’s sales, changed technology and dropped the supplier for future smartphones, Japan Display’s financial future was uncertain.2 Thus, supply management professionals responsible for the Switch, which was already experiencing part shortages, faced another challenge before the production ramp-up for the holiday shopping season.
Understanding Stakeholders’ Objectives in strategic sourcing
To be successful, organizations must make good decisions about which resources to purchase and which suppliers to use. Supply management professionals have an important role in shaping these decisions even before the sourcing cycle begins. First, they must understand the organization’s strategy and goals to make good sourcing decisions. For example, if an organization’s strategy is to be a leader in innovation, supplier product development and technical capabilities are likely to be more important than the lowest price when selecting key suppliers. Japan Display learned this the hard way when Apple switched to cutting-edge display screen technology for the iPhone 8® and did not use it as a supplier.3
Second, supply managers should proactively work with internal customers to understand how well their current needs are being met as well as their future plans, demand forecasts, budget expectations, and operating constraints. For example, if demand is forecast to increase, you should proactively determine if current suppliers have the capacity to meet the future delivery requirements. If not, by understanding supply market conditions and supplier capabilities, supply managers can work with internal customers to determine an appropriate strategy, such as collaborating with current suppliers to increase capacity or engaging additional suppliers. In this situation, current suppliers are external stakeholders, as they will be affected by the higher volume requirements so it is important to communicate with them as well.
In addition to internal customers, there are other internal stakeholders who are affected by sourcing decisions. Opportunities to create value through sourcing should be communicated to and supported by the executive management team, a group of important internal stakeholders as they are ultimately responsible for the organization’s overall performance. Depending upon the type of purchase, other internal stakeholders may include finance, engineering, operations, quality, and logistics. For example, a supplier’s quality will affect the quality department’s workload, and its delivery performance will impact planning, scheduling, and receiving. Thus, you must have a holistic view of how sourcing strategies will affect all internal and external stakeholders.
Strategic sourcing Vs Procurement
When a purchase is needed, the sourcing cycle begins. For routine purchases or rebuys, internal customers communicate their needs to supply management in three different ways. One way is for an internal customer to complete an electronic form (a purchase requisition) to describe the products or services needed. Purchase requisitions follow a standardized format and contain information such as a complete description of the purchase, the quantity needed, the date the product or service is needed, special requirements, and the account to be charged. Based on knowledge of the organization’s previous and current purchases and the supply market, you may suggest changes to the requirements that will enhance value for the organization. For example, the internal customer may have asked for a specific brand name product. If available, you can suggest purchasing a lower-priced or more readily available non-name brand product of equal quality.
For repeat purchases, a purchase requisition can also be generated by the inventory control department. For example, an order may be issued automatically when the inventory level reaches a predetermined reorder point. A requisition may also be generated by an organization’s materials planning requirements (MRP) system based on a bill of materials. A bill of materials is like a “recipe” that provides the list of quantities and descriptions of all materials required to produce one unit of a finished product.
When the organization is developing new products or services or doing other major projects, such as outsourcing or process upgrades, needs are identified collaboratively with internal customers or as part of a cross-functional team. In these situations, a needs analysis identifies the purchase characteristics that will meet the organization’s business requirements.4 During the needs analysis, it is important to distinguish between the “needs,” which are required, and the “wants,” which are desired but not necessary. Requirements that are nice to have are not essential and can reduce the number of suppliers that are available, increase delivery lead time, and increase costs. For example, when purchasing a new machine, engineering may want a ten-year useful life. However, if the product and its technology are expected to change in three years, a useful life of three years is needed, which is likely to reduce the machine’s purchase price.
There are many different considerations when determining needs and the importance of each depends upon the type of purchase. The technical requirements of the product or service must be identified. What are the performance expectations, under what conditions, and for how long? What features are essential? What quality is required and how will it be measured? Are there regulatory issues that need to be addressed, for example, for food products, conflict minerals, or hazardous materials? What is the demand forecast and expected product lifecycle? How does the supplier need to package, label, and ship the product? What is the order frequency and delivery timeframe? Will vendor-managed inventory be used?
After the purchase needs are identified, the next step is to develop a sourcing strategy that is consistent with and meets the objectives of the category plan. There are many strategic decisions that must be made at this stage concerning the choice of suppliers. Should suppliers be internal to the organization or external? If the decision is to buy rather than to make, should existing or new suppliers be used? What supplier location is best (domestic or international) for the organization? What capabilities and supplier characteristics are needed? For example, should the organization purchase from a distributor, or would it be best for the organization to work directly with a manufacturer? The remaining sections in this section describe these decisions.
Internal Versus External Suppliers in strategic sourcing
When resources are needed, organizations can either make the resources themselves using internal suppliers or purchase resources from external suppliers. This strategic decision is called the “make-or-buy” decision or an “insourcing/outsourcing” decision. The world’s largest airplane assemblers, Boeing and Airbus, continually evaluate if they should make or buy components.5 Because of consolidation in the supply market and the lost revenue from after-sales service and maintenance contracts, Boeing and Airbus are moving some outsourced components back in-house.
The activities needed to produce resources are classified as core, enabling, and ancillary. Core activities are a source of competitive advantage and are typically done within the organization. For example, the e-commerce giants Alibaba and Amazon have invested heavily in developing their own internal distribution centers and logistics capabilities rather than outsource these activities to suppliers.6 Enabling activities are necessary to create value but are not core to the organization’s business. The decision to insource or outsource enabling activities is typically based on a thorough analysis of the benefits and drawbacks. Many manufacturers, such as the consumer packaged goods company Procter & Gamble (P&G), outsource the enabling activities of distribution and logistics to third-party logistics providers such as DHL. This allows P&G to focus on its core competencies of product innovation and brand management while outsourcing enabling activities to suppliers whose core competencies are distribution and logistics. Ancillary activities are those necessary for operations but often generic, such as janitorial services; they are typically outsourced. For example, most corporations and universities outsource their cafeteria operations. Outsourcing ancillary and selected enabling activities frees up internal resources for core activities.
Strategic Considerations. Insourcing/outsourcing decisions are strategic and are made by an organization’s executive management team considering both strategic issues and costs. The strategic issues that must be considered include the following:
- Core competencies: Activities that create current or future core competencies that are essential for a competitive advantage should be insourced. Thus, it is essential that supply management professionals understand their organizations’ business objectives and strategic plans.
- Long-term supply implications: How does insourcing change the nature of competition in the supply market? If there are limited suppliers, insourcing can increase competition in the supply market. For example, in the aerospace industry, mergers and acquisitions have created larger, more powerful component suppliers, which is driving Boeing and Airbus to insource.7
- Access to technology/capabilities: In some cases the supplier has patented or proprietary technology or unique capabilities that can only be accessed through outsourcing. For example, Apple turned to its competitor Samsung to provide the OLED display screen for the iPhone8® because of the technology.8
- Supply chain risk: If a high degree of control or physical or information security is needed, activities are typically insourced. Many supply chain risks are from upstream suppliers, often located in emerging markets. What is the visibility to these risks, and is your organization or the supplier’s best positioned to manage these risks?
- Total cost of ownership (TCO): What are all the costs related to making or buying the resource before, during, and after the transaction? In the case of outsourcing this includes supplier selection, supplier qualification, and managing the supplier relationship.
- Product lifecycle: Outsourcing is often preferred in the early and mature stages of the lifecycle. In the early stages, when sales volumes are low and the product is not yet proven, outsourcing can be more economical and lower risk if investment in new equipment or tooling is needed. Outsourcing may allow for quicker new product introduction. For mature products, there is more competition in the supply market, driving prices down, so outsourcing is typically more cost effective.
- Labor considerations: If an external supplier is used, how are existing employees and departments affected? Job reductions that may occur after outsourcing negatively affect labor and public relations. What are the implications for the organization’s institutional knowledge and experience base and how will this affect competitiveness in the future?
- Capital investment and assets: If the organization decides to insource, what is the investment and timing required? Typically insourcing requires an organization to invest in assets while outsourcing allows the organization to reduce its assets. Having fewer assets can improve financial measures of performance such as return on assets (ROA).
- Flexibility: Outsourcing increases an organization’s flexibility because it is generally easier to change volumes by adding or reducing suppliers or to change suppliers when a new technology is needed than it is to change internal operations. However, the buying organization may not be able to insource in the future if it has not developed the needed capabilities.
Conducting a Make-or-Buy Analysis. In addition to strategic considerations, costs are analyzed in make-or-buy decisions. To do a make-or-buy cost analysis, the total costs to make products internally are estimated and compared to the total costs to buy the products. A break-even analysis identifies the production volume at which the costs or revenues to make and the costs to buy are equal to each other. For example, Boeing’s decision to insource some components is based on the opportunity to capture more revenue from after-sales service and maintenance. Make-or-buy decisions are typically longer-term, covering three years or more. In this case, the net present value (NPV) of cash flows should be compared. Further, a sensitivity analysis should be done to see how the break-even volume changes if labor costs, materials costs, transportation costs, the cost of capital, or other key costs change.
All direct costs (materials and labor) and indirect costs (e.g., inventory, materials, handling, maintenance, process engineering, equipment depreciation, leases, licenses, taxes, and insurance) associated with making the product must be estimated. Other costs of insourcing that are more difficult to quantify, such as start-up problems, quality problems, opportunity costs, headcount if applicable, and lack of flexibility must be considered.
Supplier proposals are the starting point for estimating the costs to buy. Other outsourcing costs to estimate include transportation costs; costs of negotiating with, qualifying, and managing the supplier; costs of quality problems or delivery delays; and potential issues with customer service. If international sourcing is used then additional costs such as tariffs, currency exchange, increased travel, longer lead time, expedited delivery, and greater managerial complexity need to be considered. Often it is difficult to fully estimate the costs associated with outsourcing so true costs are underestimated.