Supply Management and Commodity Strategy Development Chapter 6

Aligning Objectives  What markets will firm compete in?  On what basis?  What are the long-term and short-term business goals?  What are budgetary and economic resource constraints?  How will these be allocated to functional groups and business units? 2

How Companies Create Shareholder Value 3 Raise prices Increase volume Reduce cost of employees (downsize) Reduce cost of process and waste Reduce cost of goods and services 1. Increase revenues 2. Decrease costs

Integrative Strategy Development Commodity/Category strategies Supply management strategies Business unit strategies Corporate strategies 4

Integrative Strategy Development  Corporate strategies  Definition of businesses in which to participate  Acquisition and allocation of resources to these business units  Business unit strategies  Scope or boundaries of these businesses  Basis of competitive advantage 5

Integrative Strategy Development  Supply management strategies  Support desired competitive business- level strategies  How to complement other functional strategies  Commodity/Category strategies  How to purchase commodities to support higher-level strategies 6

Translating Objectives  Goals  Cost reduction objectives  Be low-cost producer in industry  Reduce material costs by 15% in 1 year  Reduce levels of inventory required to supply internal customers  Reduce raw material inventory ≤ 20 days’ supply 7

Translating Objectives  Goals  Technology/new product development objectives  Outsource non-core competency activities  Qualify 2 new suppliers for all major services by end of fiscal year  Reduce product development time  Develop formal supplier integration process manual by 12/31 8

Translating Objectives  Goals  Supply base reduction objectives  Reduce number of suppliers used  Reduce total supply base by 30% in next 6 months  Joint problem solving with remaining suppliers  Identify $300,000 in cost savings with 2 suppliers by end of fiscal year 9

Translating Objectives  Goals  Supply assurance objectives  Assure uninterrupted supply from identified suppliers  Reduce cycle time on key parts to ≤ 1 week within 6 months  Quality objectives  Increase quality of services and products  Reduce average defects by 200 ppm on all material receipts within 1 year 10

Conducting a Spend Analysis  What did the business spend its money on over the past year?  Did the business receive right amount of products and services given what it paid for them?  What suppliers received majority of business? 11

Conducting a Spend Analysis  Did suppliers charge accurate price across all divisions vs. P.O. requirements, contracts, and SOWs?  Which divisions spent their money on products and services that were correctly budgeted for? 12

Conducting a Spend Analysis  Are there opportunities to …?  Combine volumes of spending from different businesses  Standardize product requirements  Reduce number of suppliers  Exploit market conditions for better pricing 13

Challenges in Conducting a Comprehensive Spend Analysis  Difficulty in obtaining timely and accurate information  Impact of mergers and acquisitions  Different recording procedures  Different accounting systems  Difficulty in translating data between systems 14

Best Practices in Spend Analysis 15 %

Spend Analysis Spreadsheet  Sort data by commodity  Find total spend by commodity  Chart top 10 by descending $ spend  Find number of suppliers by commodity  Chart top 10 by descending number of suppliers  Find average spend/supplier/commodity  Apply Pareto analysis for opportunities 16

Sample Spend Categories SupplierCommodityAnnual Spend Rebate CompanyRebate fulfillment & call center$329,873,663 Invest CompanyInvestments$130,328,512 Advert CompanyAdvertising$56,134,490 Repair CompanyService repairs$49,339,218 Benefits CompanyBenefits$48,969,149 Hardware CompanyHardware$40,572,450 PartcoService parts$39,910,372 TelecomTelecommunications$31,055,599 Display CompanyStore displays$30, Penpaper CompanyPaper$29,175,843 Labor CompanyContract labor$27,880,363 Supply CompanyPaper$23,844,707 Contract CompanyGeneral contracting$22,579,113 Office CompanyPaper$22,257,690 Graphics CompanyGraphic design$21,966,989 Payment CompanyBusiness & management services$20,380,275 Freight CompanySurface freight$19,369,010 Paper CompanyPaper$15,603,682 Service Plan CompanyService plan$15,478,827 Service CompanyService parts$14,868,023 Consumer CompanyConsumer financing$14,833,333 Energy CompanyEnergy$14,087,177

Spend by Commodity category 18 Millions $

Percent of Total Spend by category 19

Suppliers by Commodity 20

Spend/Supplier by Commodity 21

The Strategic Sourcing Process Step 1 Build the Team Step 2 Market Research Step 3 Strategy Development Step 4 Contract Negotiation Step 5 SRM 22 GOAL: Develop a statement of work and plan GOAL: Understand the supply market GOAL: Classify suppliers and define sourcing approachGOAL: Negotiate a win-win contract GOAL: Continuously improve performance INPUTS & TOOLS: Project leader; Other team members INPUTS & TOOLS: Interviews; Online research; Conferences INPUTS & TOOLS: Market research; Portfolio matrix; Forecasted spend INPUTS & TOOLS: Negotiation plan; Supplier evaluation tool Negotiation plan; Supplier evaluation tool INPUTS & TOOLS: Contract; Supplier scorecard OUTPUTS: Baseline data; Project charter; Work plan OUTPUTS: Report on supply trends, changes, pricing, capacity, etc. OUTPUTS: Supplier evaluation tool with desired relationshipOUTPUTS: Signed contract OUTPUTS: Supplier development plan; Communication

Step 1: Build the Team and the Project Charter  Identify key cross-functional team members and subject matter experts  Assign knowledgeable project leader  Define scope of category strategy  Publish project charter  Develop work and communication plan 23

Step 1: Build the Team and the Project Charter  Project summary document  What is prime motivation for project?  What is scope of commodity?  Who will be impacted by decision?  What is process that will be followed?  How much time and efforts will be required?  What is nature of potential savings and value created? 24

Step 1: Build the Team and the Project Charter  Consider stakeholder needs  Draw map of stakeholders and verify with key stakeholders  Identify success criteria for each stakeholder  Check perceptions of each stakeholder’s success criteria  Critically review all success criteria 25

Step 1: Build the Team and the Project Charter  Consider stakeholder needs (cont.)  Ensure success criteria are mutually consistent and in line with what can be delivered  Work with stakeholders to reconcile gaps and differences  Check and amend success criteria on ongoing basis 26

Steps in Identifying Stakeholders  Identify and name each stakeholder  Note degree to which they are ready for change  H, M, or L  Note their capability for change  H, M, or L 27

Steps in Identifying Stakeholders  Note their power (formal or informal) to make change happen  H, M, or L  Identify factors which will help or inhibit change  Identify stakeholders and factors you need to work with to make change happen 28

Sample Stakeholder MapStakeholder Example Needs Senior Management Creation and capture of both current and future value Adherence to the corporate business strategy Operations Assurance of supply and no discontinuity in deliveries Compliance to GMP quality standards Supply Chain Management Reduction of temperature control deviations Inventory visibility and control of expired product Strategic Marketing Product characteristics satisfying brand equity criteria Superb product quality Customizable product design Transactional Services Transactional service operational efficiency Feasibility of planned information sharing arrangements Non-Direct Material Internal Customers Freedom to customize specifications Lowest achievable purchase price and ownership cost Procurement (other) Absence of possible negative effects on other categories and geographies 29

Stakeholder Needs Analysis ToolStakeholders Example Needs Change (H, M, L) Conclusions (Issues to Be Addressed) 30

Sample Change SummaryStakeholderReadinessCapabilityPower HMLHMLHML President, Division A XXX Vice President, Marketing XXX Senior Vice President, Finance XXX Regional Director, Europe XXX Regional Director, East Asia XXX Vice President, Global Logistics XXX Vice President, Human Resources XXX 31

Level of Commitment Analysis Steps  Name individual or group stakeholders  Mark current status  Opposing the change  Passively letting it happen  Actively supporting it  Forcefully making it happen  Mark where stakeholder needs to be for project to be successful 32

Sample Commitment Analysis Model Individual (or Group)Oppose Let Happen Support Make Happen CEO √ X √ Corporate Sourcing CouncilX√ J. TorrezX√ E. Alegria √ X √ J. CoxX√ J. Gramma√X 33 Key: X = current position √ = where needs to be

Step 2: Conduct Market Research on Suppliers  Understand purchase requirement relative to business unit objectives  Conduct thorough spend analysis  Each commodity and supplier  Total expenditures as % of total spend  Identify specific internal users  Identify current suppliers  Research supply marketplace 34

Step 2: Conduct Market Research on Suppliers  Information required  Total annual purchase volumes  Interviews with stakeholders for forecasts  External market research on … 35Keysuppliers Available capacity Technology trends Price data and trends Cost data and trends Technical requirements Environmental issues Regulatory issues Other available data

Step 2: Conduct Market Research on Suppliers  Triangulation – explore, compare, and contrast data from multiple sources 36 Trade journals Annual reports InternetBooks Snowball sampling Trade consultants Category managers Headlines Suppliers Investment reports Industry analysts Other sources

Step 2: Conduct Market Research on Suppliers  Porter’s Five Forces Model  SWOT analysis  Supplier analysis  Establish benchmarks through industry databases  Requests for information  Value chain analysis  Supplier research 37

Porter’s Five Forces Model 38 Market Internal Competition Threat of New Entrants Pressure from Substitutes Supplier Bargaining Power Buyer Bargaining Power Source: Competitive Strategy Michael E. Porter (1980) Other possible forces: GlobalizationGlobalization DigitizationDigitization DeregulationDeregulation

Market Internal Competition  Speed of industry growth  Capacity utilization  Exit barriers  Product differences  Switching costs  Diversity of suppliers 39

Threat of New Entrants  Access to capital markets  Availability of skilled workers  Access to critical technologies, inputs, or distribution  Product life cycles 40

Threat of New Entrants  Brand equity and customer loyalty  Government deregulation  Risk of switching  Economies of scale 41

Pressure from Substitutes  Relative performance of substitute products and services  Relative price of substitutes  Switching costs  Buyer propensity to switch 42

Buyer Bargaining Power  Buyer concentration  Buyer volume  Buyer switching costs  Price sensitivity  Product differences 43

Buyer Bargaining Power  Brand identity  Impact on quality or performance  Buyer profits  Availability of substitutes 44

Supplier Bargaining Power  Price of major inputs  Ability to pass on price increases  Availability of key technologies or other resources  Threat of forward or backward integration  Industry capacity utilization  Supplier concentration  Importance of volume to supplier 45

Sample SWOT Analysis Strengths Weaknesses Opportunities Threats 46 Broad customer baseBroad customer base Established product rangeEstablished product range Established distribution channelsEstablished distribution channels Emergence of other uses and marketsEmergence of other uses and markets Emerging overseas marketsEmerging overseas markets High barriers to entryHigh barriers to entry Low product innovationLow product innovation Traditional, unionized business processesTraditional, unionized business processes Low patent protectionLow patent protection Emerging overseas suppliersEmerging overseas suppliers New product development costs are highNew product development costs are high Environmental regulationsEnvironmental regulations Internal Factors External Factors

Benchmarks  Identify critical performance criteria  Identify relative competitive performance  Use of industry benchmarks  Third party consulting firms  Use of external benchmarks  Not in same industry 47

Requests for Information (RFIs)  Use before specific requisition is issued  Use to obtain general information about services, products, or suppliers  Does not constitute binding agreement  Use when large or complicated purchase is considered and when pool of suppliers must be prequalified 48

Value Chain Analysis  Help identify cost savings opportunities  Provide insights to …  Origin of products  Where products end up  i.e., “cradle to grave” analysis 49

Supplier Research  Cost structure  Financial status  Customer satisfaction levels  Support capabilities  Relative strengths and weaknesses  Buyer’s fit with supplier  How company is viewed  Core capabilities  Strategy/future direction  Culture 50

Step 3: Strategy Development  Portfolio analysis  Critical commodity – strategic supplier  Routine commodity  Leverage commodity – preferred supplier  Bottleneck commodity – transactional supplier  Determine strategic importance of commodity to buyer 51

Portfolio AnalysisBottleneckCriticalRoutineLeverage 52 Complexity or Risk Impact Value Potential Low Low High High

Critical Commodity  Critical to profitability and operations  Few qualified sources of supply  Large expenditures  Design and quality critical  Complex and/or rigid specifications 53

Critical Commodity  Strategy  Form partnership with suppliers  Tactics  Increase role of selected supplier 54

Critical Commodity  Actions  Heavy negotiation  Supplier process management  Prepare contingency plans  Analyze market and competition  Use functional specifications 55

Routine Commodity  Many alternative products and services  Many sources of supply  Low value, small individual transactions  Everyday use, unspecified items  Anyone could buy it 56

Routine Commodity  Strategy  Simplify acquisition process  Tactics  Increase role of systems  Reduce buying effort 57

Routine Commodity  Actions  Rationalize supply base  Automate requisitioning, e.g., EDI, p-cards  Stockless procurement  Minimize administrative costs  Little negotiating 58

Leverage Commodity  High expenditures, commodity items  Large marketplace capacity with ample inventories  Many alternate products and services  Many source of supply  Market /price sensitive 59

Leverage Commodity  Strategy  Maximize commercial advantage  Tactics  Concentrate business  Maintain competition 60

Leverage Commodity  Actions  Promote competitive bidding  Exploit market cycles/trends  Procurement coordination  Use industry standards  Active sourcing 61

Bottleneck Commodity  Complex specifications requiring complex manufacturing or service process  Few alternate productions/sources of supply  Big impact on operations/maintenance  New technology or untested processes 62

Bottleneck Commodity  Strategy  Ensure supply continuity  Tactics  Decrease uniqueness of suppliers  Manage supply 63

Bottleneck Commodity  Actions  Widen specifications  Increase competition  Develop new suppliers  Medium-term contracts  Attempt competitive bidding 64

Supplier Evaluation  Capabilities  Process and design capabilities  Management capability  Financial condition and cost structure  Planning and control systems  Environmental regulation compliance  Longer-term relationship potential  Supplier selection scorecards 65

Step 4: Contract Negotiation  Establishing tasks and time lines  Assigning accountabilities and process ownership  Ensuring adequate resources are made availability  Strategy communicated to all stakeholders  Market and price analysis 66

Step 4: Contract Negotiation  Develop negotiation plan and ideal contract  Create contingency plan  Conduct negotiation  Sign contract 67

Step 4: Contract Negotiation  Preferred supplier lists  Preference in future contracts  Proven performance and capabilities  Types of final supplier selection  Competitive bidding  Negotiation 68

Price Analysis  Define marketplace  Best price  Average price  Business unit’s price  Expected trends in pricing 69

Effective Competitive Bidding  Buying firm can provide qualified suppliers with clear descriptions of items or services to be purchased  Volume is high enough to justify cost and effort  Buying firm does not have preferred supplier  Price is usually dominant criterion 70

Effective Negotiation  Item is new or technically complex, with only vague specifications  Purchase requires agreement on wide range of performance factors  Buyer requires supplier to participate in development effort  Supplier cannot determine risks and costs without additional buyer input 71

Step 5: Supplier Relationship Management  Continuous monitoring of both strategy and supplier  Continuous monitoring of supplier’s performance using predetermined criteria on goals and objectives  Supplier scorecard  Update, usually quarterly  Review results with supplier 72

Supplier Scorecards  Typical categories  Price  Quality  Delivery reliability  Responsiveness  May include feedback and input from suppliers 73

Types of Strategies  Insourcing/outsourcing  Supply base optimization  Supply risk management  Global sourcing  Longer-term supplier relationships 74

Types of Strategies  Early supplier design involvement  Supplier development  Total cost of ownership  E-reverse auctions 75