Chapter 10 Category sourcing: Getting better performance from suppliers

Program Reasons underlying cost savings potential in purchasing How to identify cost savings potential Developing a sourcing strategy Category sourcing planning Getting better results from suppliers The myth of partnership Conclusions

Cost saving potential in purchasing (1) Companywide programs focused on cost reduction seem to be successful. Reasons for slack in materials cost and prices: Traditional purchasing (Buyers are involved late, if at all, in the purchasing decision-making process; the company deals with a fixed group of familiar suppliers) Continuous competitive bidding amongst a fixed group of suppliers Purchasers regularly sound out competition amongst a limited number of suppliers by playing them off against each other

Cost saving potential in purchasing (2) Price increases automatically passed on to the next in line Over -specification Technical requirements (defined by R&D departments) which are not necessary for the functioning of the product are imposed on suppliers. Supplier cartels in (international) supply markets In spite of the agreements made on EC level, cartels in most European economies are very common. In many industries, there are only a limited number of players, which enables silent agreements Suppliers’ customers relationship programs Relationship programs include offering fringe benefits to customers in order to create a preferred position at members of Decision Making Unit.

Identify cost savings potential Starts with analysis of the company’s purchasing spend by means of a spend cube Category tree based on direct and indirect spend categories Spend categories: A group of coherent products or services, bought from the supply market that are used in our company to satisfy internal or external customer demands

Example a category tree for non-production related purchasing spend

Identify cost savings potential Cost savings can depend on: Customize versus standard specifications Modular versus component buying Buyer-supplier dependence Number of suppliers involved in last tender Scope of last tender Type and age of contract Market price versus cost price differential Level of purchasing involvement

Developing a sourcing strategy Supplier relationship Sourcing strategy issues Global versus local sourcing: International supplier orientation necessary or is local, national orientation sufficient? Single versus multiple sourcing: Purchase the product at one or more suppliers? Partnership or competitive bidding? Buy from supplier with whom a partnership relation is preferred or keep the supplier at distance?

Developing a sourcing strategy Supplier relationship Contract strategy issues Buying on contract or buying on spot basis. Is the total volume of purchased products to be covered by a contract or is part of the volume bought on a spot basis? Price agreement versus performance agreement. Just a price agreement or is a detailed service level agreement (SLA) necessary with arrangements on time, tests, maintenance etc?

Category sourcing planning The category sourcing planning provides a strategy for every important purchasing category Content: Business strategy and business issues Analysis of historical data Customer requirements and purchasing process Objectives sourcing strategy Commodity sourcing strategy Planning of activities Organization and team composition

Getting better results from suppliers Towards performance based relationships. A stepwise approach: Set up the best legal contract, A thorough analysis of current contract arrangements with existing suppliers. Objective: agree on a performance based contract. Select the best supplier, analysis of (international) supply market, sounding out international competition. Objective: Select Best-In-Class supplier. Get the best solution from the best supplier, focus is on continuous improvement with the supplier based upon Total Cost of Ownership.

The myth of partnership Philips, one of the first European companies focusing on partnership, introduced the term ‘co-makership’. Objective of this type co-operation is to achieve improvements in: Cost Logistics Quality Product development

The myth of partnership Ellram and Hendrick (1993): A ‘partner’ is defined as a firm with whom your company has an ongoing buyer-seller relationship, involving a commitment over an extended time-period, a mutual sharing of information and a sharing of risks and rewards resulting from the relationship This research has demonstrated that: Less than 1% of supplier relations can be characterized as a partnership relationship. However, these suppliers were responsible for 12 % of total purchasing volume!

The myth of partnership A DTI (1994) study concludes that ‘in developing new working agreements with their suppliers most vehicle manufacturers still appear to deal more in rhetoric than in reality’ This comes a no surprise. Cooperation with suppliers requires internal teamwork between all disciplines and companies still operate in a functional manner. Developing a partnership with suppliers takes time. The road is long and difficult. There are no easy ways or short cuts to success here.

The myth of partnership Aspects Supplier Preferred supplier Supply partner Design Partner Relationship characteristics operational tactical strategic Time – horizon from order to order 1 year 1-3 years 1-5 years Quality as requested by producer quality control by and supplier ‘sign-off’ by supplier quality assessment by supplier sign-off by supplier early supplier involvement in design Logistics orders annual agreements + call- off orders periodical scheduling of materials requirement by producer electronic document interchange Contract annual agreement (1 year) (>1 year) quality agreement design contract life of type responsibility Price/cost price price+ rebate price + cost-reduction targets price based on open calculation continuous improvement

The myth of partnership “Partnership is the result of the contractors’ continuous effort to improve results in the relationship with suppliers, rather than a technique which can be adapted and applied in a short time”

Conclusions Effective supplier management is another cornerstone for a successful business strategy. The international competitive arena forces manufacturers to look continuously for ways to improve their value propositions to customers. The foundation of any category sourcing plan is a sound spend analysis. The purchasing spend is categorized in homogeneous product categories though a category tree. The road to partnership is long and difficult. There are no easy ways or short cuts to success.