The Strategic Value of Proper Purchasing

Dirk-Jan F. Kamann

(Published in Management Clout)

Increased uncertainty in the world economy? What is the best response: just reducing

invoiced costs or building in flexibility and agility through proper supplier management?

The increased importance of purchasing

Purchasing is more than just buying things at the right price and getting them in at the right

time. For some time, purchasing became popular because of the spreading myth that one

Euro saved on inputs is one Euro more net profit. Since it was assumed to be easier to

reduce costs of inputs than to increase sales, companies went for cost cutting. Many

companies found out that the

invoiced

costs went down indeed, but the

organisational

costs

went up at the same time, leaving a net negative result at the end of the exercise in terms of

total costs. Also, companies became aware that they cannot achieve their goals alone but

that they badly need their suppliers to support them, to think up smarter solutions in terms of

inputs or processes or, simply sit out the storm together. For, it is not just the company that

serves the end-customer; it is the network of companies that together serve the customer.

The worst supplier determines the image of the total set of companies and the brand name

associated. So, bullying suppliers because of – temporarily - cost cutting requirements may

well result in loss of flexibility and agility because of lack of support when the company really

needs that (fires, urgent deliveries, wars, increased uncertainty, postponing deliveries etc.).

Should we than treat all suppliers as ‘friends’ or ‘partners’?

Squeeze them or pamper them?

Various analytical tools have been developed to differentiate supplier strategies, positioning

inputs – and their suppliers- into four quadrants of a portfolio (figure 1; Kraljic; 1983).

Figure 1: The portfolio instrument

Simulation studies and empirical evidence show that the division line between the upper and

lower part can be set at 3% of the total spend on inputs. A product group costing less than

3% of the total spend in a year, will be positioned below the line; product groups costing

more than 3% (each) will be positioned above the line. The division between “left” and “right”

is rather subjective: some of the key questions are

(1)

“is it easy to substitute that supplier or

leverage

+

services

strategic

partners

logistics;

routine

goods

bottleneck

high

low = many suppliers high = few suppliers

complexity of the supply market

low

high

not”;

(2)

“is the product very unique and supplier specific, or specially made for us?” Yellow

Page suppliers are grouped to the left; a rather unique supplier might be positioned to the

right. Usually, the division line runs at 2-3 suppliers available.

The appropriate strategy in the lower-left quadrant emphasizes

logistics:

here,

organisational

costs

involved are more important than the

invoiced

costs: time to specify the product, find

the right supplier, negotiate the right price, write and sign a proper contract, order, register,

expedite, pay, and evaluate the supplier. This total trajectory per resulting invoice is about 45

Euro in SMEs and up to 100 to 200 Euros in large multinationals and public bodies. The

products involved usually are rather routine products, easily available. Suppliers should be

selected on their ability and willingness to reduce the costs of logistics. Vendor Managed

Inventories, 2-bin methods, purchasing cards, electronic systems, electronic invoicing or

reverse invoicing are means to reduce organisational costs. Contracts usually last 1-2 years.

The top-left quadrant is characterized by

leverage and service:

high volume in money terms

and more suppliers available for the same product

.

Because of the volume, discounts are

interesting: the leverage effect. This effect also induces more services in reducing

organisational costs: ease of ordering, lead-time, flexibility, stock keeping, payment methods,

maintenance, and so on. Contract time is 1-2 year.

The top-right quadrant is characterized by

strategic partnerships:

high costs and unique

suppliers. Here, co-operation and long-term relations that gradually grow deeper are the

typical features. Relations rather than contracts are an issue; usual, in case of contracts, they

last 5 years or the total production life cycle of a particular product.

Finally, the lower-right quadrant, featuring specialised products from unique suppliers that

per se

are not so expensive: unique chrome vanadium rings. Typically, OEM-products

(Original Equipment Manufacturer) belong to this quadrant of

bottleneck products.

The best

strategy is to look for substitutes that are standard and widely available, or to ask one of the

suppliers in the leverage quadrant to secure supply as an additional service.

The port-folio in practice

When analysing the input portfolios of companies and or public agents of various sizes,

nobody had a properly analysed and acted upon input portfolio – in spite of the rhetoric.

Internal organisational issues, authority disputes or simply sheer ignorance were the causes.

Too many suppliers for one and the same product (in the leverage and service quadrant),

resulting in lost opportunities for discounts and total costs reductions. Usually, companies are

rather strict in procedures related to expensive goods or production related goods. They do

not realise how much money they waste on the routine products in the logistics quadrant.

Here, usually more than 85% of all suppliers are found, supplying less than 10% worth of all

inputs and causing at least 60% of all invoices and therefore organisational costs. Most

likely, 45% of all invoices a company receives amount to less than 200 Euro. The typical

supplier supplies only one product per year.

What to do?

Clustering products into

homogeneous articles that can be provided by a single provider reduces the number of

suppliers, invoices and administrative costs. The larger amount that results makes it easier to

ask for logistic services, even further reducing organisational costs. We also found in large

technical dominated companies that unique suppliers were created by the designers who

want very special inputs for their pet-product. Using standard products – especially when

customers do not even

see

that particular item - will significantly reduce the cost price

without losing brand image or customer satisfaction. In practise, 70% of the costs of inputs

are determined in the design stage; by being alert in that stage, much can be done.

Every strategic supplier my Friend?

In the strategic quadrant, many ‘semi’-monopolists end up. Regional monopolies in utilities

and “unique” companies like Microsoft do not act like friends or partners: they have

thousands of customers to deal with. That means that while some companies may be seen

as unique from the

buyers’

point of view,

they

have many customers. We therefore added a

second matrix with the

suppliers’ perspective

to the first one, turning it into a cube (figure 2;

Kamann, 1999).

Figure 2: Buyer-supplier relations in a cube

In the cube, we see the portfolio just discussed on the front side; the top part of the cube

represents inputs where for each category (e.g. transport, steel, construction) applies that

they cost more than 3% of the total spend. We also see four ‘columns’ dividing the cube.

Clockwise, we see

(1) Tailorised products:

products made employ modular assemblies

and/or flexible production technology; typical examples are Dell computers and ‘on line

clothing shops’ cutting uniforms to size;

(2)

Commodity products:

typically have industrial

standard codes and are available on the spot market. Customer influence on specifications is

nil. The only thing the seller can offer is additional added value services in terms of stock

holding, ordering flexibility and/or payment facilities;

(3)

Proprietary products:

the Microsoft

type semi-monopolies; when products are bought through agents or distributors, added value

services may be negotiated;

(4)

Custom design:

here, face-to-face contacts are important.

Unique suppliers and – ideally – unique buyers relate and create. We usually find long-term

relations, rather than contracts. Contracts do not seem to ensure cooperation, or creative

results. This contrasts with the opposite extreme case: commodities, where contacts and the

time span of relations and contracts may be very short (one off spot buying).

The cube enables companies to redefine their position towards their suppliers in a more

realistic way than the simpler two-by-two matrix.

The ideal portfolio: the POP model

How does the simple portfolio ’ideally’ look like? Unfortunately, there is no such thing. The

reason for this is that given their task environment, organisations adopt a certain strategy on

a particular technology-product-market combination: differentiator, cost leader etcetera. In

doing so, organisations act as part of an open system. This implies that the organisation has

to be shaped in accordance with its environment (Lawrence and Lorsch; 1967). The strategy

and technology chosen are translated into the policies – including goals - of the organisation

and are reflected in its processes and the way they are organised. These elements -

Policies

(P)

,

Organisation (O)

and

Processes (P)

- have to fit each other as well as they that have to

be congruent with their external context (Nadler & Tushman; 1979). The way the three POP-

complexity of supplier market

complexity of the buyer market

many buyers

1 buyer

1 supplier

many suppliers

high

low

leverage

routine

strategic

bottleneck

proprietary

tailorized custom

design

generic

elements are filled in for the

total

organisation is reflected in the corresponding POP-

elements for the

purchasing function

. In other words:

supplier

management is ultimately

determined by the

strategy

of the company on the market for its

outputs.

Following this line of

thinking, different task environments and different strategies lead to different ways the POP-

elements are filled in; resulting in different distributions of suppliers over the portfolio.

Innovativeness and technology choice: a typology

Looking for the nature of the external determinants, we learned that the degree of

dynamics

(Mintzberg, 1979) or turbulence (Emery & Trist, 1965) and

complexity

(cf. Gadde &

Håkansson, 1993) are seen as two main external factors. Variables related to 'dynamics' are

predictability of demand, intensity of competition, nature and speed of technological change,

changes in legislation and government policies, takeover and merger behaviour of

competitors, suppliers and/or buyers. Variables related to 'complexity' are e.g. the amount of

differentiation among buyers with different demands, demands from different stakeholders,

different types of inputs: materials, know-how, knowledge, and different types of

geographical markets. Dynamics and complexity determine

(1)

the type of

production

technology

and

(2)

the required degree of

innovativeness

of a company. We took the two

extremes for technology: process industry plus discrete series production being one, project

wise production being the other extreme (Woodward, 1965). The resulting typology is shown

in figure 3 (Kamann, Karásek & Aoulad El-Kadi, 2001).

Figure 3: Typology using innovativeness and technology

Archetype I ('teams'); examples: high value components and equipment manufacturing.

(1) External environment:

rapid and unpredictable market changes; unique and complex

products; 'engineer-to-order-environment' and 'design-and-construct-environment'; unique

and specialised orders.

(2) Strategy:

innovation-differentiation strategy; customer focused;

short time-to-market and throughput time.

(3) Purchasing function:

rapid changes in

technology, increased complexity, reduced life cycles and innovativeness of product require

integrated cooperation between buyers, suppliers and end-users; high degree of outsourced

non-core activities; share of value purchased goods is high; important purchasing function.

Archetype II ('calculating friends'); examples: building- and construction firms

(

1) External environment: s

table market; low need to innovate. Innovations originate from

suppliers; products are produced as a result of buyer specifications.

(2) Strategy:

marketing

differentiation strategy supports profile on service, quality, reliability and attractive total

project

oriented

process- &

discrete production

high level of

innovation

low level of innovation

standard

leverage buyers

with innovative

partners

outsourcing

innovative

partners

standard

leverage

buyers

standard

leverage buyers

with preferred

suppliers for

project'unique'

products

type I:

"teams"

type III:

"squeezers"

type II:

"calculating friends"

type IV:

"critical partners"

package for buyers; rarely first mover in innovations.

(3) Purchasing function:

end products

usually standard components that are assembled/combined according to customer

requirements and specifications; the combination of standard components and specific

customer specifications makes purchasing more ambiguous than with types I and III;

standard components come from several leverage suppliers; specific customer demands for

unique and/or complex components are fulfilled by preferred suppliers in the bottleneck

and/or strategic quadrant; turn-key projects tend to increase this share of suppliers.

Archetype III ('squeezers'); examples: packaging and glass industry

(1) External environment: s

table market, low need for product innovations; standard

products; 'make-to-stock-environment'; stock of end products should prevent negative out-of-

stock messages to customers and reduce lead times.

(2) Strategy:

low cost strategy with

standardised production technology leads to standardisation of inputs, outputs and

processes; emphasis on efficiency and cost minimisation.

(3) Purchasing function: s

tandard

non-complex inputs for standard processes obtained form leverage suppliers; less

outsourcing than Types I and II; competitive position towards suppliers focuses on cost

reduction, efficiency improvements, optimising order volume, vendor managed inventories

and general reduction of stock of inputs.

Archetype IV ('critical partners'); examples: PCs and heating appliances.

(1) External environment:

rapid, unpredictable changing market; fast product and process

innovations; high pressure from competition keeps margins under pressure.

(2) Strategy:

low

cost strategy

plus

innovation-differentiation strategy requires scale and efficiency effects in

production; R&D in new end products should improve the competitive position as well.

(3)

Purchasing function:

combining two different strategies may lead to ambiguous organisation,

including purchasing; minimal throughput times, short time-to-market and specialised know-

how among suppliers implies intensive co-operation with strategic and bottleneck suppliers;

tendency to ‘educate’ suppliers in low wage countries with good engineering backgrounds

(e.g. Czech Republic); large degree of outsourcing, both in the low cost and high value

components.

The differences between the four archetypes are reflected in their portfolios (figure 4). The

darker shaded surfaces are the products present in the company; the light areas should have

very few products (and therewith: suppliers).

Figure 4: Ideal portfolio matrices for 4 archetypes

type I

teams

routine bottleneck

leverage strategic

type II

calculating

friends

routine

type IV

critical

partners

type III

squeezers

strategic

leverage strategic

routine bottleneck

routine

bottleneck

bottleneck

leverage

leverage

strategic

lo w

h

ig h

co m p l e xi ty o f su p p l y m a rk et

lo w

h

ig h

c o mp l e xi ty o f su p p l y ma rk e t

Conclusions

In uncertain times like this, the need to build flexibility, agility and mutual support into

networks is a better way to secure long-term continuity than short time blunt price-cutting,

which only alienates suppliers from the company.

How

to build up such an agile network

requires knowledge of the different positions and roles of suppliers and the associated most

adequate supplier strategy. One way that fits all does not exist The product market

combination, the chosen strategy and the type of technology employed but most of all, the

required degree of innovativeness determine how the organisation should be organised, its

processes be engineered and its policies formulated in an harmonious way. That means that

we may roughly distinguish between four archetypes, but that since these are archetypes,

within each type quite some differences may occur. At the end, we just hand over a tool of

analysis, but it is entrepreneurship that will decide whether at the end the right choices where

made or not.

References:

-

Emery, F.E. & E.L. Trist (1965), The causal texture of organizational environments,

Human

Relations,

18, pp. 21-32.

-

Gadde, L.E. & H. Håkansson (1993),

Professional purchasing,

London: Routledge.

-

Kamann, D.J.F. (1999),

Inkoop vanuit een netwerkperspectief,

(Purchasing from a network

perspective), Inaugural address University of Groningen, Groningen: Charlotte Heymanns.

-

Kamann, D.J.F., E. Karásek and N. Aoulad El-Kadi (2001), External determinants of the

organisation of the purchasing function,

Paper,

presented at the IPSERA Conference, April,

Jonkoping.

-

Kraljic, P. (1983), Purchasing must become supply management,

Harvard Business Review,

September-October, pp. 109-117.

-

Lawrence, P.R. & J.W. Lorsch (1967), J.W.:

Organization and Environment

. Cambridge (Mass.),

Harvard Graduate School of Business Administration.

-

Mintzberg, H. (1979),

The Structuring of organizations,

Englewood Cliffs (NJ): Prentice Hall.

-

Nadler, D.A. & M.L. Tushman (1979), A congruence model for diagnosing organisational

behavior, in D. Kolb, I. Rubin & J. McIntyre,

Organizational Psychology: A Book of Readings,

3d

ed., Englewood Cliffs (NJ): Prentice Hall.

-

Woodward, J (1965),

Industrial Organisation

, Theory and Practice, London: University Press.