Chapter 9 Purchasing and business strategy

Program Purchasing and competitive strategy Cost leadership and differentiation Lean manufacturing Integrating purchasing into business strategy Towards purchasing excellence Purchasing portfolio analysis Global sourcing

Purchasing and competitive strategies Reasons for outsourcing those activities that are not considered ‘core business’: Increased outsourcing and subcontracting, as a result of make-or-buy studies Buying of finished products instead of components Turnkey delivery Technological development

Purchasing and competitive strategy The competitive situation of West European industry has changed over the past decade: More competition from countries like Korea, Singapore, China, Taiwan. Industry in W-Europe seems to be under-represented in areas of new technologies. Many industries seem to be at the stage of saturation or decline:

Purchasing and competitive strategy Introduction Growth Saturation Decline Textiles Chemicals Clothing Food products Rubber, plastics Leatherware/shoes Automobile industry Steel Machine construction Shipbuilding Telecommunications Computers Pharmaceuticals Medical equipment Optical industry Biochemistry

Cost leadership and differentiation Porter (1980) defines three strategies leading to a distinguishing market position: Cost leadership main focus: continually reducing the cost price of the final product. Differentiation aims at marketing products which are perceived by the customer as being unique Focus strategy aims at serving a particular, clearly defined group of customers in an optimal way The consequence of not making a choice between the strategic alternatives is that the company will be unable to build up a sustainable competitive advantage in the end-user market.

Lean manufacturing Fundamental to lean management is that: It transfers the maximum number of tasks and responsibilities to those workers actually adding value to the car on the line, and it has in place a system for detecting defects that quickly traces every problem, once discovered, to its ultimate cause. Womack et al. (1990)

Lean manufacturing Important features of lean management: Teamwork among line workers, who are trained in a variety of skills to conduct different jobs within their working group Simple but comprehensive information display systems that make it possible for everyone in the plant to respond quickly to problems and understand the plant’s overall situation. Total commitment to quality improvement on the shop floor.

Lean manufacturing Differences between Japanese and European new product development: Japanese manager in charge of new product development; greater authority to make decisions than his Western counterpart. Product and process engineering are integrated responsibility areas Engineering manager decides on who he wants to involve in his engineering team and for what period.

Lean manufacturing The Japanese way to manage supply base: Average supply base is much smaller than for Western manufacturers. Most Japanese OEMs have a ‘layered’ structure, which is often three or more tiers deep. Suppliers are usually involved in new product development at a very early stage. Suppliers are confronted with well-defined targets in terms of quality improvement, lead time reduction an cost reduction. They are informed as to whether they meet contractual obligations

Strategic triangle Customers Competitors Suppliers Marketing Company Competitive benchmarking Make vs. Buy Strategic sourcing Competitors Suppliers

Choices regarding the strategic triangle Primary customer groups Match product and customer Focused marketing plan Choose between specific vs. standard solutions Major competitors Sustainable competitive advantage Competitive benchmarking Major suppliers Investigate core competences Subcontracting if activities can not be performed in a competitive way

Towards purchasing excellence Monczka as quoted by Purspective www.purspective.com

Towards purchasing excellence Insourcing/outsourcing Clear policy regarding make-or-buy Develop commodity strategies Spend analysis (spend cube) Structure and classify purchasing expenses (category tree) Determine strategy Number of suppliers geographical dispersal, relation, contract form Involvement of specialists and internal customers in execution

Towards purchasing excellence World class supply base management Intensify relations with suppliers Database with supplier information Detailed audits with important suppliers Develop and manage supplier relationships Continuous improvements Classification of suppliers: Commercial suppliers Preferred suppliers Supplier partners Integration of suppliers in product development Suppliers with proved competences Using specific knowledge

Towards purchasing excellence Supplier integration into order fulfillment process Outsource logistic and administrative tasks Connect suppliers with information systems and production planning Develop plans to increase value for customer through purchasing Supplier development and quality management Suppliers are invited to participate in suggestions for improvement Suppliers are a source of new ideas Strategic cost management Detailed cost models Supply chain analysis and measures to decrease supply chain costs together with suppliers Sharing of advantages is necessary

Enabling processes

Purchasing portfolio analysis In developing effective supplier strategies, the following questions may be helpful: Does the present purchasing strategy support our business strategy and does it meet our long term requirements? What is the balance of power between our company and our major suppliers? Are the strategic products and services sourced from the best in class- suppliers? What percentage of our purchasing requirements is covered by contracts? To what extent are internal operations benchmarked against specialist suppliers? What opportunities exist for collaboration with suppliers with product development, quality improvement, lead time reduction? 20-80 rule: 20% of the products and suppliers represent 80% of purchasing turnover

Purchasing portfolio analysis Kraljic’s (1983) product portfolio based on two variables: Purchasing’s impact on the bottom line the profit impact of a given supply item measured against criteria such as cost of materials, total cost, volume purchased Supply risk measured against criteria such as short-term and long term availability, number of potential suppliers, structure of supply markets.

Purchasing product portfolio High Leverage products alternative sources of supply available substitution possible Competitive bidding Strategic products critical for product’s cost price dependence on supplier Performance based partnership Routine products large product variety high logistics complexity labor intensive Systems contracting + E-Procurement solutions Bottleneck products monopolistic market large entry barriers Secure supply + search for alternatives Purchasing’s impact on financial results Low Low Supply risk High

Supplier portfolio Leverage suppliers Strategic suppliers High Leverage suppliers many competitors commodity products Buyer dominated segment Strategic suppliers market leaders specific know-how Balance of power may differ among buyer-supplier Routine suppliers large supply many suppliers with dependent position Reduce number of suppliers Bottleneck suppliers technology leaders few, if any, alternative suppliers Supplier Dominated segment Supplier impact on financial results Low Low Supply risk High

Product categories Strategic products: Often high-tech, high-volume products Only one supply source available Significant share in cost price of end product Three situations possible: Buyer-dominated segment Supplier-dominated segment Balanced relationship  a partnership may develop over time

Product categories Bottleneck products: Routine products: Relatively low value, vulnerable regarding supply Few alternatives available Supplier is often dominating the market Routine products: Large variety in products Low value per product High transaction costs Leverage products: Choice between different suppliers Low switching costs Relatively high share in end product price

Purchasing portfolio-analysis Four basic supplier strategies: Partnership Competitive bidding Secure supply Category management and e-procurement solutions

Four basic supplier strategies Partnership: Objective create mutual commitment in long-term relationship Suitable for strategic products (gearboxes, axles, optics, engines) Activities: accurate forecast of future requirements supply risk analysis careful supplier selection ‘should cost’ analysis rolling materials schedules effective change order procedure vendor rating Decision level board level Cross- functional approach

Four basic supplier strategies Competitive bidding Objective obtain ‘best deal’ for short term Suitable for leverage products (commodities, steel plate, wire) Activities: improve product/market development search for alternative products/suppliers reallocate purchasing volumes over suppliers optimize order quantities ‘target pricing’ Decision level board level purchasing

Four basic supplier strategies Secure supply Objective secure short- and long-term supply reduce supply risk Suitable for bottleneck products (natural flavors, vitamins, pigments) Activities: accurate forecast of future requirements supply risk analysis determine ranking in supplier’s client list develop preventative measures (buffer stock, consigned stock, transportation) search for alternative products/ suppliers Decision level purchasing cross functional approach

Four basic supplier strategies Category management and e-procurement solutions Objective reduce logistics complexity improve operational efficiency reduce number of suppliers Suitable for routine products (consumables, supplies) Activities: subcontract per product group/ product family standardize product assortment design effective internal order delivery and invoicing procedures delegate order handling to internal user Decision level purchasing cross functional approach

Four basic supplier strategies Partnership Competitive bidding Secure supply Category management and e-procurement solutions Objective Create mutual commitment in long term relationship Obtain ‘best deal’ for short term Secure short and long term supply Reduce supply risk Reduce logistic complexity Improve operational efficiency Reduce number of suppliers Suitable for Strategic products (e.g. gearboxes, axles, engines) Leverage products (e.g. commodities, steelplate, wire) Bottleneck products (e.g. natural flavors, vitamins, pigments) Routine products (e.g. consumables, office supplies) Activities Accurate forecast of future requirements Supply risk analysis Careful supplier selection ‘should cost’ analysis ‘rolling’ materials schedules Effective change order procedure Vendor rating Improve product / market knowledge Search for alternative products / suppliers Reallocate purchasing volumes over suppliers Optimize order quantities ‘target’ pricing Accurate forecast of future requirements Determine ranking in supplier’s client list Develop preventative measures (e.g. buffer stock, consigned stock) Subcontract per product group Standardize product assortment Design effective internal order delivery and invoicing procedures Delegate order handling to internal user Decision level Board level Cross functional approach Purchasing Cross functional approach

Purchasing portfolio Remarks: The use of a purchase portfolio alone is often not sufficient to develop buying and supplier strategies. For a strategic relation acknowledgement from both sides is necessary The Dutch windmill, analyzing buyer-seller interdependence combining both the buyers portfolio approach and the suppliers customers portfolio approach, leads to more realistic expectations and plans with regard to future buyer seller collaboration.

Purchasing Portfolio Management Evaluate the impact of the supplier’s view within strategy development EXPLOITABLE Adversarial relationship Check power balance Consider other sources CORE Sound position Improve own profit EXPLOITABLE Great caution Raise mutual dependency Seek competition CORE Good match Potential long term relationship Relative value NUISANCE Mismatch Accept short term Change supplier DEVELOPMENT Supplier developm. opportunities Encourage participation NUISANCE Very high risk Seek competition Raise attraction DEVELOPMENT Potential match Work closely together to develop business LEVERAGE STRATEGIC ROUTINE BOTTLENECK Our Company’s attractiveness Relative cost EXPLOITABLE Moderate risk Monitor price trend Seek alternatives CORE Strong position Maintain relationship Offer other opportunities EXPLOITABLE Moderate cost risk Closely monitor price and service Change supplier CORE Good match Intensify relationship Maintain long term relationship Supply risk NUISANCE Possible mismatch Passive relationship Seek alternative supplier DEVELOPMENT Good supplier interest Offer incentives Raise mutual dependency NUISANCE High service risk Change supplier Offer incentives DEVELOPMENT Potential risk Raise mutual dependency Offer inducements

Global sourcing Definition: Advantages: Global sourcing may lower unit costs, benchmarking current suppliers, accessing new markets, etc. Disadvantages: much more complicated distribution and logistics, increasing handling costs, problems when dealing with different cultures, contractual problems, higher uncertainty about on-time delivery and quality, etc. Proactively integrating and coordinating common items and materials, processes, designs, technologies and suppliers across worldwide purchasing, engineering and operating locations.

Conclusions Purchasing and supply management is getting a more prominent position due to the strategic reorientation of many companies. The purchasing strategy cannot be separated from the corporate policy or from competitive strategy. The framework developed by Monczke et al. (2005) consists of strategic management processes on hand, and enabling processes on the other hand. When developing specific supplier strategies purchasing product portfolio of Kraljic (1983) may be very helpful.