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Sourcing Reloaded:
Targeting Procurement’s New
Strategic Agenda




A strategy+business Reader
Sourcing Reloaded:
Targeting Procurement’s New Strategic Agenda
A strategy+business Reader


Edited by Jeffrey Rothfeder and Georgina Grenon
With an introduction by Patrick W. Houston, Detlef Schwarting,
Robert Spieker, and Martha D. Turner




In today’s risky global business environment, supplier networks are the ulti-
mate lifeline for many companies — delivering the far-flung materials,
goods, and services that drive worldwide commerce. The sourcing function
has thus become an indispensable contributor to strategic goals and competi-
tiveness in every industry. But charting a course that positions the corporate
purchasing department as a catalyst for growth is no easy matter.

This strategy+business Reader, Sourcing Reloaded: Targeting Procurement’s
New Strategic Agenda, is packed with insights and prescriptive advice that
senior leaders and purchasing executives can use to navigate today’s most
vexing sourcing problems. Its main theme: how to balance traditional
sourcing strategies with the new, collaborative approaches needed to drive
sourcing’s effectiveness and help it attain its full potential in the face of the
demands of globalization, resilience, sustainability, complexity, and
customization.

The Reader’s 14 chapters, written by Booz & Company’s foremost sourcing
experts, cover the latest ideas and trends, including the next wave of sourcing
excellence, the new role of the CPO, green sourcing, collaborative supplier
relationships, improved strategies for commodities procurement and supply
chain resilience, and global and low-cost-country sourcing.

Sourcing Reloaded is aimed directly at companies that are determined to build
fresh purchasing capabilities that leave behind old, unprofitable sourcing
routines forever. For them, this Reader will be a helpful guide to a
revolution in the making.
Sourcing Reloaded
Sourcing Reloaded:
Targeting Procurement’s New
Strategic Agenda
A strategy+business Reader

Edited by Jeffrey Rothfeder and Georgina Grenon


With an introduction by Patrick W. Houston,
Detlef Schwarting, Robert Spieker, and Martha D. Turner
A strategy+business Reader
Published by strategy+business Books

Copyright © 2008 by Booz & Company Inc.
All rights reserved.

No reproduction is permitted in whole or
part without written permission from Booz
& Company. For permission requests,
contact Virginia Brosnan by e-mail at
brosnan_virginia@strategy-business.com.

Visit Booz & Company online at
www.booz.com

Visit strategy+business online at
www.strategy-business.com

Increase your intellectual capital by subscribing
to strategy+business. To subscribe for one year
(four issues), visit www.strategy-business.com or
call toll-free 877 829 9108. (Outside the U.S.,
call 850 682 7644.)

Design: Opto Design
Cover art: Pelato, Duarte, Lopez Pereyra

strategy+business Books
Publisher: Jonathan Gage
Editor-in-Chief: Art Kleiner
Executive Editor: Rob Norton
Managing Editor: Elizabeth Johnson
Deputy Managing Editors: Laura W. Geller,
Debaney Shepard
Senior Editors: Theodore Kinni,
Melissa Master Cavanaugh
Contents




     Introduction: Sourcing Transformation




     Sourcing’s New Frontier
     Reinventing Procurement to Drive Growth and Profitability
7




     Win-Win Sourcing
18




     The New CPO


     Getting Creative: Efficient Sourcing in Marketing
27




     Green Sourcing: Seeking the Payoff in Environmentalism
40




     The Building Blocks of a New Sourcing Approach
48




     The Collaboration Game: Building Value in the Retail Supply Chain
59




     Procurement’s New Operating Model
     by Patrick W. Houston, Detlef Schwarting, Robert Spieker,
     and Martha D. Turner




78
     by Harald Dutzler, Peter-John Liberoth, Detlef Schwarting,




86
     and Robert Spieker


     by Bill Jackson and Michael Pfitzmann


     by Simon Harper and Fabrice Saporito


     by Harald Dutzler and Martha D. Turner


     by Patrick W. Houston and Martha D. Turner



     by Simon Harper, Pertti Heinonen, Amit Kapoor,
     and Marco Kesteloo


     by Patrick W. Houston, Robert Hutchens, and Alan S. Pincus
Contents, continued




      Coping with Record-setting Commodity Prices and Volatility


      Be Prepared to Bounce Back


      Sourcing Basics That Enable Success
96




      Smoothing the Path for Procure-to-Pay: A New IT Approach
109




      Make or Buy: Three Pillars of Sound Decision Making


      Buy Globally, Think Globally
122




      Lessons from China: The Importance of Knowledge-based
132




      Sourcing in Low-cost Countries
145




      Off the Table, Into the Pocket: Capturing Procurement Savings
150




      About the Authors
162
      by Patrick W. Houston, Matthias Mueller, and Martha D. Turner




172
      by Rich Kauffeld, Dermot Shorten, and Robert Spieker



      by Jeffrey Barta, Bernhard Rieder, and James Weinberg


      by Simon Harper, Michael Pfitzmann, and Dermot Shorten


      by Simon Harper and Laura Thompson



      by Ronald Haddock, Michael Pfitzmann, and Reid Wilk


      by Harry Hawkes, Patrick W. Houston, and Martha D. Turner
Introduction:
Sourcing Transformation
by Patrick W. Houston, Detlef Schwarting,
Robert Spieker, and Martha D. Turner




IN TODAY ’ S RISKY global business environment, supplier networks
are the ultimate lifeline for many companies — delivering the far-
flung materials, goods, and services that drive worldwide commerce.
The sourcing function has thus become an indispensable contribu-
tor to the strategic goals and overall competitiveness of companies
in every industry.
     This is quite a turnabout. Not long ago, procurement was
little more than a back-office function, responsible for the down-
stream process of negotiating price-based contracts and extracting
scale benefits from increasingly unyielding groups of suppliers. Year-
over-year price improvements and day-to-day supply assurance




                                                          Introduction   7
often represented the extent of purchasing executives’ involvement
in corporate activities.
     Today that antiquated notion of sourcing is scarcely recogniz-
able in leading purchasing departments. Inexorably, these depart-
ments and their leaders have extended their sphere of influence
within the organization by proving that, given the opportunity, they
can generate substantial value.
     This value comes in many forms. For instance, procurement
departments have taken a leading role in driving cross-functional
collaboration at several large companies. They are breaking down the
silos that have isolated R&D, marketing, sales, and other corporate
Sourcing’s Challenge
departments from suppliers, because such isolation significantly
inhibits cost savings and other performance improvements. They
are using their newfound muscle to great effect — facilitating inte-
grated sourcing processes, acting as liaisons between internal depart-
ments and suppliers, and coordinating projects that are aimed at
developing innovative products and minimizing sourcing and life-
cycle costs.
    Leading purchasing departments have also demonstrated their
importance by elevating their activities to new heights, to a strategic
level far above mere cost cutting. Procurement executives can be
found at the center of critical aspects of organizational performance,
such as maximizing supply chain efficiency, reducing product devel-
opment and manufacturing cycles from design to delivery, building
operational resilience, enhancing marketing effectiveness and effi-
ciency, and collaborating with suppliers to leverage capabilities
throughout the supply chain.
    Given this wide-ranging set of activities, it is scant surprise that
in many industries, purchasing departments now influence half of
the annual operational budget. And that figure rises to 80 percent in
such sectors as manufacturing and retail.




8   strategy+business Reader
Despite sourcing’s promise and power, many companies have not
yet successfully charted a course that positions their purchasing
departments to become a catalyst for creating and capturing value,
including profitability and growth. Even as chief procurement offi-
cers (CPOs) relish the notion that they may finally earn spots on the
senior leadership teams of their companies, they must also under-
stand that only superlative performers will retain this privileged
position. Indeed, in a recent Booz & Company survey, 46 percent
of senior purchasing executives recognized that a high level of lead-
ership ability, a strong business sense, and strategic savvy are the
Globalization. Rich opportunities for profitability and product
most important traits CPOs need for the future. Conversely — and
clearly representing a sign of the times — the more traditional skills
of purchasing executives, such as tactical supply management and




    Resilience. As supply chains extend ever further into regions that
category experience, did not rank as priorities in the eyes of 95 per-
cent of the respondents.
    The opportunity to raise purchasing to the level of other critical
corporate functions also means that its leaders must shoulder their
share of the responsibility for addressing the increasingly challeng-
ing business landscape. When purchasing is managed well, compa-
nies can gain a competitive edge because they are able to overcome
the obstacles on which their competitors founder, such as:

and service supply lie in the expanding economies and growing




    Complexity/Customization. The proliferation of products and ser-
markets of India, China, and many other emerging nations; the
vast new supply alternatives driven by low-cost labor pools and new
factories opening in these countries; and the rising demand for
essential commodities. But so do difficult challenges. The com-
panies that most adeptly develop, manage, and optimize their sup-
ply networks to serve end markets around the world will have a
clear advantage.




                                                          Introduction   9
were nearly untouched just a few decades ago, their exposure to nat-
ural disasters, computer network attacks and failures, and political
upheaval is increasing. There are many ways that companies can
protect their supply chains from disruption, but few companies have
actually done so. In fact, a recent Booz & Company survey of lead-
ing supply chain executives found that 68 percent believe the great-
est risks they face are interruptions in the flow of products and
services from key suppliers, but only 46 percent of their companies
have developed well-thought-out plans to avoid such calamities.

vices that has been enabled by digital and other innovations has
Sustainability. Concerns among all stakeholders — from custom-




Four Rules for Approaching Sourcing Excellence
been a boon to growth for most companies. This is an era of
mass customization in which marketing efforts as well as products
and services can be tailored to individual customers. However, as
any good operations leader knows, this level of variation comes at a
cost — increased complexity. Those companies that can balance the
value of variety with the incremental costs of supply will be best
positioned for significant profitability. The trick for sourcing is
to work collaboratively across the company and with suppliers
to provide what customers truly value in a way that minimizes sup-
ply costs.




     Honda Motor Company has developed a no-nonsense way to
ers to investors to governments and increasingly to end consumers
— about global warming, large carbon footprints, and increased
waste are compelling companies to link green initiatives closely to
overall strategy. Much like quality, sustainability is evolving into an
integral part of the supply equation, and its dictates must be recog-
nized in the way companies produce and design their products and
services. Sourcing’s role in facing this challenge is especially impor-
tant because, for most companies, nearly two-thirds of green oppor-
tunities reside externally, in the supply chain.




10   strategy+business Reader
Simply put, in no other period has sourcing had so much power to
make a significant impact in support of a company’s strategic direc-
tion and overall competitiveness. And those organizations that are
striving to achieve sourcing excellence will enjoy the competitive
advantages it yields. For example:

eliminate the enmity that typically paralyzes purchasing’s relation-
ships with suppliers, replacing strident negotiations with open
collaboration. Ideas for collaboration are often displayed openly on
whiteboards during joint meetings, and then agreed upon by the
Procter & Gamble Company has begun a comprehensive analysis to




    Vodafone Group PLC has shifted from purely transactional procure-
end of the session. In the process, the automaker has lowered its
costs and raised overall performance.

determine how its supply chain must be transformed in the next
decade. Through this study, the company plans to develop ways to
reduce product size, create green packaging, and predict consumer
demand so that it can place its factories and distribution points
nearer its key sales markets.

ment to a much more strategic approach that includes a comprehen-
sive range of demand-side and supply-side levers and that is focused
on creating value and optimizing the total cost of equipment own-
ership in its global mobile telephony business. This transformation
has enabled the company to better utilize supplier capabilities, to
develop systematic measurement and insight into supplier perfor-
mance, and to create extensive cross-functional collaboration inter-
nally and with suppliers.
    These three examples are leading companies in the sourcing
arena, but in our view, no single organization has yet achieved all the
benefits of sourcing transformation. And no matter the stage of
development at which its sourcing function stands, any company




                                                           Introduction   11
can gain in the short and long term by “reloading” its sourcing func-
tion if it closely aligns procurement with the overall business
agenda and continuously challenges the function to enhance its
capabilities. Further, more companies should do what the best do:
improve their sourcing skills in those areas that are organizational
priorities — a tactic that begins, of course, with precisely identify-
ing those areas. From there, the path to purchasing improvement is
an incremental activity that ultimately creates a full-fledged and fun-
damental transformation.
    As sourcing leaders undertake this transformational process,
they can benefit from these four rules of the road:
1. Pick your spots.




     2. Create total transparency in purchasing costs and trade-offs.




    3. Collaborate fully with internal and external stakeholders. A more
                       Companies should start their sourcing trans-
formation by redesigning procurement procedures in simple, con-




    4. Become an influential corporate leader. Successful CPOs build
crete ways that can produce measurable and significant value. These
initial successes will build momentum within the organization for
greater levels of change.




A Source of Best Practices
Whether it be the costs, savings, and benefits of environmentally
friendly product options; the weighing of whether to buy or make
a product; or the design of a more resilient manufacturing foot-
print, the issues, implications, and ramifications of sourcing changes
should be clearly articulated and openly shared throughout the
organization.

robust sourcing process depends on participation throughout the
product life cycle, from the concept stage in R&D to the disposal or
salvage of spent products by a recycler. This requires the combined
efforts of key company departments and suppliers in the quest to
deliver innovation, reduced costs, supply chain efficiency, improved
product launches, and the reduction of silos.

their confidence and power by leveraging their position in the exec-




12   strategy+business Reader
utive suite. They ensure that purchasing plays a greater role in devel-
oping and defining the company’s strategic direction. And they
create a road map for sourcing transformation, as well as building
the skills and capabilities required to support business partners.



To help your company chart a winning course through today’s
sourcing demands, priorities, and opportunities, this strategy+
business Reader, Sourcing Reloaded, offers a compendium of best
practices culled from our experiences with purchasing executives
in companies that have successfully undertaken this work. Sourcing
Sourcing’s New Frontier. The five chapters in this section are
Reloaded shows that businesses have many ways to achieve the
highest level of procurement excellence. Whether companies are
concerned with getting the basics right or elevating the sourcing
function to new heights, this Reader includes the perspectives
and insights they need to begin the difficult but ultimately lucrative
effort to transform sourcing into a wellspring of significant
added value.
     Toward that goal, this Reader is divided into three sections:

devoted to exploring the newest sourcing ideas and trends. In “Re-
inventing Procurement to Drive Growth and Profitability,” the fresh
challenges and responsibilities of purchasing departments are
plumbed through descriptions of some of the best companies’ strate-
gies for staying ahead of the revolution in procurement’s potential to
add value.
     “Win-Win Sourcing” explains how the conventional rules of
procurement are being rewritten by a knowledge-based sourcing
approach that allows manufacturers and suppliers to establish a
long-term commitment aimed at improving each other’s capabilities
and performance.
     “The New CPO” examines the job of today’s chief procurement




                                                           Introduction   13
officer and finds that, far from being a career backwater, sourcing
leadership now involves delivering significant strategic and finan-
cial value.
     “Getting Creative: Efficient Sourcing in Marketing” explores
sourcing’s often neglected role in the purchase of marketing prod-
ucts and services, often a very sizable portion of a company’s spend-
ing that should be managed with the same rigor as other critical
functions. Indeed, all strategic services in a company, including legal
counsel, back-office operations, and retail partnerships, can apply
the lessons in this chapter.
     The final chapter in this section, “Green Sourcing: Seeking the
The Building Blocks of a New Sourcing Approach. The four chapters of
Payoff in Environmentalism,” describes how sourcing, supported by
its growing credibility in the C-suite and the ability to encourage
collaboration among corporate functions and business units, is in a
perfect position to enable a holistic, multifunctional strategy for
reducing environmental impact while cutting costs and building
better relationships with suppliers and communities.

the second section of this Reader examine the tools and techniques
that enable a strategic sourcing program.
     “The Collaboration Game: Building Value in the Retail Supply
Chain” details how building holistic, cross-functional, and collabo-
rative relationships with selected suppliers across the value chain
helps drive benefits in both revenue and cost far beyond the
outdated and ineffective tradition of haggling over the terms of sup-
ply contracts.
     “Procurement’s New Operating Model” points out the ways in
which flawed and otherwise incomplete operating models cost most
companies 5 to 10 percent of their total purchasing spend in unre-
alized savings. The primary causes: End-users do not have the tools
and processes to optimize procurement strategy, decision-making
roles are not clearly delineated, and information systems fail to pro-




14   strategy+business Reader
vide the data needed to ensure compliance with procurement poli-
cies and objectives.
     “Coping with Record-setting Commodity Prices and Volatility”
examines how to reduce the tremendous pressure that escalating
commodity and material costs are bringing to bear on companies
and on traditional procurement strategies. It offers fresh approaches
to older methods that create more transparency and a detailed
understanding of key cost drivers that can help reduce near-term
cost variability as well as achieve supply, price, quality, and sustain-
ability objectives.
     “Be Prepared to Bounce Back” explores how to combat the new
Sourcing Basics That Enable Success. The third section of this
fragility of supply chains caused by the rapid growth in outsourcing
to geographically remote partners, the increase in sole sourcing, and
the potential loss of data integrity due to the outsourcing of noncore
services such as IT.

Reader revisits perennial sourcing issues, offering insights and pre-
scriptions that CPOs can use to reload in their efforts to deal with a
globalized procurement landscape and ensure that a company’s
extended supply chain and its technology dovetail perfectly with the
needs and strategies of the organization.
     “Smoothing the Path for Procure-to-Pay: A New IT Approach”
introduces procure-to-pay, an IT strategy that eliminates the need
for one-size-fits-all purchasing systems and replaces them with
highly efficient individual modular applications, each of which
addresses a specific area of the procurement process.
     “Make or Buy: Three Pillars of Sound Decision Making” revis-
its a classic sourcing decision and offers CPOs a rigorous process
for making more objective and informed “in-house or outsource”
decisions.
     “Buy Globally, Think Globally” explores how a more robust
understanding of the economic and geopolitical dynamics of the




                                                          Introduction   15
markets in which their companies participate enables CPOs to help
their organizations take advantage of opportunities that have been
overlooked by their competitors as well as create a competitive edge
where it seemed none was available.
     “Lessons from China: The Importance of Knowledge-based
Sourcing in Low-cost Countries” examines the fast-changing con-
siderations in dealing with suppliers in low-cost nations. This chap-
ter describes how companies can use knowledge-based sourcing
to develop strong relationships with such suppliers that extend
beyond supplier costs into a careful assessment of manufacturing
and transportation economics, lead-time requirements, schedule sta-
this revolution in the making. +
bility, product design changes, and the technical skills of suppliers.
     Finally, “Off the Table, Into the Pocket: Capturing Procurement
Savings” offers companies a way to identify and capture a large por-
tion of procurement initiative savings and drive these savings to the
bottom line.
     Sourcing Reloaded is intended to provide foresight and insight
into how companies can tackle some of today’s most vexing sourc-
ing problems. It emphasizes that successful sourcing transformations
depend on carefully balancing traditional sourcing approaches with
new approaches, earmarking a portion of the gains from new pro-
curement strategies for building fresh capabilities that can drive
profit and growth in the future, and building superior purchasing
capabilities over time, in much the same way that Toyota, Honda,
and Procter & Gamble developed their sourcing functions. To
achieve similar levels of success, companies must encourage substan-
tially more proactive and radical behavior in their CPOs and ensure
that their organizations leave behind old, unprofitable sourcing rou-
tines. We hope that Sourcing Reloaded will serve as a helpful guide to




16   strategy+business Reader
Sourcing’s New Frontier
Reinventing Procurement to
Drive Growth and Profitability
by Harald Dutzler, Peter-John Liberoth, Detlef Schwarting,
and Robert Spieker

Also contributing to this article were Simon Harper
and Marco Kesteloo




OVER THE PAST    10 years, company procurement departments have
done well, on the whole, in meeting a series of new challenges.
Whether it meant working with an increasingly global vendor base
or managing partnerships with back-office service providers, pro-
curement generally accomplished the task at hand. With each suc-
cess, the visibility and importance of the function in the overall
organization grew — so much so that procurement now controls
half of the annual budget in many industries and up to 80 percent
in sectors such as manufacturing and retail.
    As confidence in procurement departments soared, companies
counted on them to take on even more challenging projects. Now,




18   strategy+business Reader
procurement chiefs are being asked to undertake a host of new
responsibilities: decrease supply chain complexity, speed products to
market, stimulate supplier innovation, enhance operational security,
and even consider the social and environmental impact of the sup-
plier in sourcing decisions.
    Addressing issues like these requires a higher level of talent and
commercial acumen than anything procurement departments have
tackled before. Indeed, these aims demand a reach beyond that
of the organizational supply nexus: They require a transformation
in the way we traditionally think of sourcing. In leading companies,
sourcing is evolving from a stand-alone function that ensures
that materials move through the supply chain at the lowest possible
cost to a nerve center that monitors, anticipates, and responds to a
variety of needs throughout the company — and even those of
its suppliers.




    More cross-functional integration.
     Many companies covet the potential rewards of this kind of
holistic, integrated approach to sourcing, but few are prepared to
implement the organizational changes such an approach demands.
Often, the sheer scope of the challenge can overwhelm manage-
ment’s ability to visualize the steps necessary to tackle it.
     To learn how some leading companies plan to meet this trans-
formational sourcing challenge, Booz & Company interviewed chief
procurement officers at more than 100 global companies with a
reputation for procurement excellence. Through these conversa-
tions, we discovered that companies will need to make four key
organizational adjustments to stay in front of the next wave of
change in sourcing:
   • More cross-functional integration
   • Better supply networks
   • More collaborative supplier relationships
   • Greater supply chain resilience and risk management




                               Reinventing Procurement to Drive Growth and Profitability   19
                                     At present, the silos and borders
that separate functions often limit opportunities for cost savings and
value achievement. For example, the walls that separate R&D, mar-
keting, and suppliers inhibit jointly executed and coordinated proj-
ects aimed at such goals as developing new products and services or
driving down sourcing and life-cycle costs. Breaking down these
barriers can have a substantial impact.
    Two-thirds of the survey’s respondents told us they believe
that procurement has a crucial role to play in integrating
departments within their organizations. And 73 percent saw a need
for similar procurement-led, cross-functional integration with
external suppliers and partners.
     The procurement function is well positioned to serve as the cat-
alyst for bringing internal departments and external suppliers closer
to each other: After all, the function often serves as the communica-
tion link between them. Many procurement leaders point to better
management of specifications as a key catalytic mechanism in this
effort. One CPO told us he wanted his department to learn to take
an “active role in challenging the core value” by questioning engi-
neers on their product specifications. This, the CPO believed,




     Better supply networks. Today, most supplier interaction happens
would encourage the procurement team to move from simply iden-
tifying unnecessary design elements to better defining the product’s
absolute needs.
     The advantages of this kind of dialogue are not limited to the
CPO’s organization. Large global retailers, such as Wal-Mart
and Gap, have discovered that closer contact with their suppliers
allows the suppliers themselves to integrate logistics and returns-
management solutions, as well as to adopt new supply chain tech-
nologies such as RFID more rapidly.
     Greater integration, and the looser boundaries that may come
with it, should not be confused with less discipline. On the contrary,
many CPOs complain that buying procedures must become both




20   strategy+business Reader
more rigorous and more widely applied. “There is still too much
maverick buying,” declared one CPO. A vast majority of respon-
dents — 86 percent — believe that creating global purchasing
processes and systems will be increasingly important over the next
five to 10 years.

within a point-to-point relationship — procurement to supplier.
This relationship has evolved in some industries, such as the
automotive sector, where it is standard practice for companies to
manage deeper into their supply chains, down to Tier Two and
Tier Three suppliers. But soon, even this extended management
will not be enough.
     As we interview leading executives, increasing numbers are
telling us that the ability to orchestrate a vast network of supply
relationships will become more important. Such networks will look
at the supplier not just as a source of a material or a component,
but as a partner that will help improve delivery systems and design




     More collaborative supplier relationships. Many unrealized opportu-
products.
     These executives anticipate using a variety of strategies to
improve their ability to manage supply networks. Fully three-
quarters of respondents believe supplier cost modeling will become
more important over the next five to 10 years, as buyers seek a
greater understanding of their suppliers’ underlying expenses. And
81 percent of respondents see low-cost-country source modeling
as a crucial emerging skill. Another important opportunity, CPOs
believe, is joint action with suppliers in the continuous reduction
of waste: 47 percent see the challenge to reduce waste as a top pri-
ority, and an additional 30 percent say they will be focusing more
intently on waste reduction in the future.
     All these tools speak to the growing need of companies to gain
a deeper, more differentiated understanding of their supply net-
works. “How to manage strategic partnerships will become key,”




                             Reinventing Procurement to Drive Growth and Profitability   21
one CPO told us. Another agreed, but warned that, at present,
“there is a lack of clear approach and tools to manage this.”

nities for value arise within a company’s supplier network in areas
that neither the buyer nor individual suppliers can identify on their
own. Collaboration is needed to optimize cost, to drive top-line
growth, and, sometimes, to develop breakthrough concepts.
     CPOs still see a tremendous untapped potential in collabora-
tion. Although 86 percent of the procurement leaders we surveyed
said they have worked hard to develop collaborative partnerships
over the last three to five years, most believe their work is nowhere
Linking Functions for Improved Results

The experiences of a global toy company      requirements generated, a practice exac-
demonstrate the potential inherent in        erbated by lax procurement compliance
cross-functional process improvements.       rules. Over years of incremental “scope
Over time, this maker of construction        creep,” the company lost its scale advan-
kits had evolved from making a relatively    tage as a major resin buyer and added a
limited product line requiring parts in      tremendous amount of waste and ineffi-
a few primary colors and basic shapes        ciency to the supply chain.
to offering an extended line of kits            The solution to the problem was
requiring parts in hundreds of colors and    found in rewriting the purchasing
shapes. In the process, a low-cost product   road map and adding a step that ensured
based on molded resin blocks had grown       regular communication between the
into something complex and expensive         engineers and procurement. This cross-
to produce.                                  functional link led to a reduction in
   This had occurred because the compa-      the number of unique resins and
ny’s engineers were encouraged to create     colors needed by manufacturing, lower-
innovative products without regard to        ing the costs of materials and also
cost of supply. As a result, few engineers   simplifying production. Interestingly,
thought much about the real price of         reducing the number of resins also stim-
materials or the additional costs — such     ulated innovation, as engineers discov-
as inventory expense and the capital         ered new ways to make do with fewer
required to maintain it — that their         material options.



near complete. In fact, 44 percent still see the development of these
partnerships as a top priority over the next five to 10 years, and even
those who don’t see such partnerships as a top priority say they




22   strategy+business Reader
intend to pursue a greater level of collaboration (38 percent).
     Typically, collaboration with suppliers occurs in the areas of new
product development, order delivery and fulfillment, and manufac-
turing. In a recent example, a northern European airline uncovered
valuable synergies while working with a private airport to improve
its luggage handling and check-in facilities. By ignoring organiza-
tional boundaries, the two were able to design a jointly executed
check-in process that was much more cost-effective for each partner
— and more convenient for passengers.
     In this new collaborative world, competitiveness will be based
on a detailed understanding of the suppliers’ costs, not the back-
Greater supply chain resilience and risk management. Many CPOs
and-forth of negotiations. Companies will gain an advantage over
their competitors not by squeezing an extra nickel out of their
suppliers’ margins, but by working with suppliers to boost the level
of efficiency in the supply network or to develop new cutting-
edge products.
     The benefits of supplier collaboration are becoming well recog-
nized. One study by the Toyota Motor Corporation found that
whereas negotiations can reduce costs by about 5 percent, collabo-
rative practices can yield as much as a 38 percent cost reduction.
Toyota analysts estimate that the benefits of collaboration stack up
this way: 5 to 10 percent in cost reduction from engineering
improvements, 5 to 8 percent in lower inventory levels through just-
in-time shipping, and, most productive of all, 15 to 20 percent in
sourcing raw materials and finding low-cost sourcing strategies for
the supplier.

believe they will need to focus more on risk and resilience than they
have in the past, because they fear that today’s extended supply
chains have made their companies vulnerable to new kinds of
dangers. A total of 68 percent of respondents believe their greatest
risk is the interruption of deliveries from key suppliers. (By compar-




                             Reinventing Procurement to Drive Growth and Profitability   23
ison, less than half as many, 31 percent, fear physical damage to
company-owned facilities or breakdowns in information security.)
     “Risk management becomes more important as a larger part of
production and development is done by partners,” said one CPO.
In fact, this heightened dependence on external partners has
exposed companies to new problems that are falling under the
purview of procurement. Issues such as a contractor’s level of social
responsibility in its labor practices are fast becoming an important
part of due diligence.
     One new kind of resilience many CPOs say they must develop
is the ability to work with their suppliers to create products that are
Meeting the Next Wave Challenge
manufactured and distributed with less carbon. And as environmen-
tal sustainability or “green” business practices become more and
more popular with customers and even become a regulatory neces-
sity in some markets, such an ability will become a greater priority.
     To build resilience and manage risk, one CPO told us, “we need
to be broader in our understanding and have people working in dif-
ferent functions across the disciplines.” Consequently, nearly half of
respondents — 45 percent — say they will be hiring professionals
with the strategic knowledge and business sense that would enable
them to tackle as-yet-unidentified social, regulatory, and environ-
mental roadblocks. Risk management is a much-needed capability
as well, according to 18 percent of the CPOs.
     (For a detailed examination of green practices, see “Green
Sourcing: Seeking the Payoff in Environmentalism,” by Patrick W.
Houston and Martha D. Turner, page 59. For more on supply chain
resilience and risk management, including how to protect the sup-
ply chain, see “Be Prepared to Bounce Back,” by Rich Kauffeld,
Dermot Shorten, and Robert Spieker, page 109.)



The last wave in sourcing’s evolution was based on disaggregation —




24   strategy+business Reader
that is, evaluating the potential value of each supplier and then mak-
ing sourcing choices based on that more granular understanding.
The next wave of sourcing will build on that foundation and extend
it in a holistic sense, propelling companies still further beyond the
old zero-sum approach to purchasing.
     First, the purchasing department will encourage cross-functional
integration to develop greater insight into the needs of the business.
Next, it will work more closely with suppliers to help them address
these insights in ways that go beyond simple price cutting. To do
this, procurement will build networks of suppliers who work togeth-
er to optimize the efficiency of the entire supply chain and engineer
innovative new ways to create value. Finally, purchasing will apply
                           these new capabilities to find ways to better manage the business
                           risks their companies face and to boost resilience. (See Exhibit 1.)




                          Exhibit 1: “Next Wave Sourcing” Key Themes
                               Better knowledge management will be essential in meeting the
                           next wave challenge. At minimum, purchasing needs to understand
                           the cost drivers of its suppliers. But that’s just the beginning. In the
                           future, a much deeper understanding will be necessary in all direc-
                           tions — among suppliers, between suppliers and procurement, and
                           between procurement and other departments within the company.
                           This requires a complex and systematic web of cross-reporting and
                           continual dialogue to ensure that the supply network learns and
                           keeps on learning as needs continue to evolve.




                                                                         Value Creation
                                                            (From price to cost and value focus, i.e.,
                               Finally, an elevated organizational commitment will be required.




                                                           growth, profit, return on capital employed)
                           For example, to release sourcing’s potential to drive growth and




                                             Cross-        Supply networks             Collaborative         Business risk
                                           functional                                    supplier            and resilience
                           profitability, the procurement department will need a strong board-




                                          integration                                  relationships
                           level presence: This will ensure that the company’s purchasing




                                          From silo to     From one-to-one           From transaction        From risk to
                                        cross-functional   supplier manage-        to collaboration and       resilience
                                       value perspective   ment to managing         capability leverage    management and
                           strategy incorporates and is aligned with its long-term goals.




                                                            supply networks                                 sustainability
                           More critically, it will help the company realize important changes,
                           such as arranging the sourcing footprint in a way that reflects




                                                People                      Supplier                      Organization

                                                            Institutionalize Knowledge and Learning



                          Source: Booz & Company



                                                                     Reinventing Procurement to Drive Growth and Profitability   25
                                                                  Successful leadership strategies
Changing business environment
next wave of procurement strategies and opportunities. +
the expected growth of the market or anticipates future require-
ments for limiting carbon output.
    But board support — or, for that matter, senior management
support — should not be a blank check. It must be given only if
procurement’s values, processes, and key performance indicators are
aligned with corporate projections and tactical plans. To accomplish
this, CPOs will need to develop a culture of continuous learning
within their departments, ensuring that the procurement team is
able to adapt to changing business conditions. At the same time,
they will need to build an infrastructure to continually raise the level
of performance management and controls. As one CPO told us,
“We need to professionalize the total procurement organization.”
    Sourcing is at an important juncture. Many companies are ready
for a procurement transformation; others are not. But simple aware-
ness is a first step. Companies that recognize the importance of
holistic sourcing practices are on their way toward implementing the




26   strategy+business Reader
Win-Win Sourcing
by Bill Jackson and Michael Pfitzmann




IT ’ S AN INTRIGUINGway to create a contract. At Honda Motor
Company, during meetings with suppliers, the executives write their
proposed actions and agreements on a whiteboard. When all the
items have been discussed, the meeting is over. The contents of the
whiteboard are then typed up, two copies are printed, the supplier
and the automaker sign them, and the contract is complete.
Thereafter, both sides focus on executing the plan. Honda and its
suppliers thus avoid the drawn-out, querulous negotiation process
that is common at other automakers, a process that can last months
and even then sometimes blows up without a resolution.
    This is one of many methods by which innovative manufac-




                                                      Win-Win Sourcing   27
turers like Honda and the Toyota Motor Corporation rewrite the
conventional rules of procurement. Their unorthodox techniques
add up to a form of procurement based on shared information and
insight: We call it knowledge-based sourcing. In this approach,
manufacturers and suppliers share a long-term commitment to
improving each other’s capabilities, starting by working together
to eliminate wasted effort and other inefficiencies. Instead of being
at odds, the two sides collaborate openly to lower costs and raise
overall performance, with the expectation that this mutual effort
will continue over many years and benefit both companies.
Businesses pursuing knowledge-based sourcing use sophisticated
costing tools and industry data, as well as discussions with other
suppliers, equipment manufacturers, and competitors, to produce
realistic cost targets that change over time. They set prices that
reflect the supplier’s true economics for each process, part, compo-
nent, and system. These prices include a reasonable profit margin
for the supplier as well as incentives for lowering costs, improving
quality, expanding innovation, and making design changes in subse-
quent years.
     Contrast this with the alternative ingrained in many purchasing
departments: price-based sourcing. Essentially, this approach pits
the interests of the supplier against those of the manufacturer. Each
side reveals as little information as possible, for fear of giving the
opposing side an edge. Components, parts, raw materials, and fin-
ished goods are purchased through a competitive bidding process,
with specific volumes and deadlines spelled out in advance (hence
those agonizing negotiations).
     The primary cost-cutting option available to manufacturers in
a price-based sourcing approach is squeezing every possible cent out
of procurement contracts. Purchasing managers focus exclusively
on attaining cost savings greater than those of the previous year;
their compensation hinges on it. Suppliers, in turn, focus on calcu-




28   strategy+business Reader
lating bids that will win them the jobs. Once they have made a suc-
cessful bid, suppliers are stuck with its terms. They have no reason
to speak openly about their true costs, because they believe that
their customers won’t pay a penny more. They have no incentive to
improve their product, its design, or its manufacturing processes.
They often feel they have no recourse except to game the system
by overstating their expenses or charging exorbitantly for design
changes. Both sides lose, and mutual suspicion and resentment
are rooted so deeply in the system that they are almost impossible
to overcome. This all-too-common story ends with rising costs,
increased time-to-market, a loss of any shared innovation practice,
Exhibit 1: Sourcing Philosophies
and, in the worst of cases, supplier bankruptcies.
     Indeed, many suppliers today are in serious trouble. With raw
material prices rising, margins cut to the bone, and purchasing
departments struggling to meet corporate expectations for cost




The perspective associated with each type of sourcing can be deeply ingrained. Managers may take
them for granted — until they switch their approach.
reductions, suppliers are under pressure from all directions. In the
motor vehicle industry, many suppliers, including Collins &




                            Price-Based Customer                           Knowledge-Based Customer
Aikman, Dana, Delphi, Dura, Federal Mogul, and Tower
Automotive, have filed for bankruptcy. Even suppliers with a long
record of success have been squeezed, with profit margins often




View of the         A market of competitive, independent               An integral part of the business network,
falling below the cost of capital. These financial crises, in turn, are




supply base         providers bidding against one another              essential for competitive advantage
presenting a huge cost to buyers. The expenses associated with the




Cost management    • Seeks leverage on suppliers for price and       • Sets targets with suppliers that are based on
                     product improvements                              cost and performance
bankruptcy of major suppliers can easily swamp contract savings.




                   • Will switch suppliers to gain improvement       • Increases efficiency through sharing knowledge
                     or a slightly lower price                         and making a long-term commitment to
     No wonder knowledge-based procurement models, and the




                                                                       suppliers
                   • Constantly monitors market for new suppliers
                     to drive competition primarily on price         • Encourages suppliers to achieve an
management philosophy underlying them, are becoming more




                                                                       advantage over the market through continuous
                                                                       improvement
attractive to many manufacturers. (See Exhibit 1.) Although they




                                                                     • Promotes competition through dual sourcing
                                                                       and being the buyer of choice


The relationship   • High level of mistrust — relationship hinges    • High level of cooperation — relationship is
with suppliers       on leverage                                       focused on improvement

                   • Customer does not want to be too dependent      • Creates integrated relationships based on
                     on one supplier (for fear of losing leverage)     mutual learning, teaching, and quality-related
                                                                       efforts
                   • Often ends up combative or antagonistic
                                                                     • Demands operational excellence and relentless
                                                                       improvement




Source: Booz & Company



                                                                                            Win-Win Sourcing            29
are not perfect, the Toyota and Honda sourcing models consis-
tently earn high marks from suppliers — along with favorable terms.
As one automobile manufacturing executive put it recently, “Honda
cost estimators can tell suppliers their own costs within 1 percent
accuracy.” That’s meaningful because suppliers are often unable to
identify their own manufacturing expenses with anything near this
degree of certainty and, thus, often suffer cost overruns. Backed by
accurate cost information, automakers and suppliers can jointly
develop a performance improvement plan to reach their cost goals.
     Manufacturers are equally rewarded. For companies that adopt
the Toyota/Honda approach, the acquisition costs for parts such as
pistons, exhaust manifolds, and cylinder heads are 35 to 55 percent
lower than for those using traditional procurement models. Several
factors account for this. First, product and part designs can be deliv-
ered at lower costs. Second, productivity and quality improve as
suppliers practice joint process coordination and improvement.
Third, manufacturers’ purchasing departments can be quite small
because they work with fewer, more strategically chosen suppliers.
Fourth, warranty costs drop as much as 3 percentage points. Finally,
fewer components need to be reengineered after launch, and as a
result, both the manufacturer and the supplier avoid the added




30   strategy+business Reader
costs of changing product designs at the most expensive time —
during production.
     For all these reasons, in everyday practice, knowledge-based
sourcing consistently outperforms the traditional bid-based model.
This is true for companies in a variety of industries, and particular-
ly for repeat purchases of anything that is not a true commodity.
     In most cases, even taking into account annual price cuts of
approximately 5 percent, the quoted price under competitive bid-
ding doesn’t approach the agreed-to cost under knowledge-based
sourcing for the life of the contract. (See Exhibit 2.) More impor-
tant, this form of win-win sourcing ensures that the knowledge
Exhibit 2: Two Pricing Models

Price-Based Sourcing:                                                   –5%
A Recipe for Mediocrity
Customers pressure suppliers to reduce prices, often                                  –5%
demanding annual price cuts of, say, 5 percent. Although
this approach appears advantaged because of the significant
year-over-year savings, customers actually pay more as                                                  –5%
suppliers inflate their initial price in expectation of future
                                                                                                               Agreed-to cost


demands for price cuts.




Knowledge-Based Sourcing:
A Win-Win Approach                                                                         Ideal
                                                                                                               Agreed-to cost


Customer and supplier work together to achieve the lowest                                   cost
cost design up front. They agree on a price that is close to                     Update
but higher than ideal cost; this price reflects the supplier’s                    cost             Supplier
true costs plus a reasonable margin for the supplier. Over                     standards            quote
time, the price is further reduced to reflect productivity
improvements. This approach consistently outperforms
traditional price-based sourcing on an absolute basis.
                                                                                Supplier
                                                                              improvement          Agreed-to


Source: Booz & Company
                                                                                program               cost

                                                                 Time
Price




gained and improvements made on one program or product will be
transferred to the next. Meanwhile, the improvement plan contin-
ues to achieve new levels of success each year, until productivity
gains draw the supplier ever nearer to ideal cost expectations, which
reflect more closely the supply and demand realities.
     Yet as advantageous — and profitably innovative — as
knowledge-based sourcing can be, many companies, particularly
Western ones, have had a hard time adopting it. Some executives




                                                                                                   Win-Win Sourcing      31
find it difficult to accept the idea that knowledge-based purchasing
savings of 3 percent per year could be more profitable than the 5
percent annual savings mandated under the price-based system.
“Impossible,” one chief financial officer protested. But it’s not im-
possible. It merely requires a company to overcome its ingrained
habits and internal obstacles. The path to knowledge-based sourcing
includes reframing supplier relationships, building and sharing
knowledge along the supply chain, and instituting new employee
training in factory processes, product development, and industry
operations so that employees can accurately gauge ideal costs and
potential cost improvements.
Don’t Copy Toyota
For executives and procurement managers who want to adopt
knowledge-based sourcing, but who have not grown up with Asian
purchasing techniques, a framework can translate these techniques
into more familiar Western-style rubrics. American and European
businesses that adopt knowledge-based sourcing often need a new
set of formal cost and performance metrics and new employee
incentives. These standards replace old price-based sourcing metrics,
which were most likely aimed at attaining those old-fashioned an-
nual procurement cost savings. The new metrics are designed to
help managers work closely with suppliers, in an atmosphere of
mutual trust, to achieve the ideal cost for each item. They incorpo-
rate improved supplier measurement techniques, worker evaluation
programs, and a system of salaries and bonuses geared to meeting
performance goals — not to meeting narrowly defined purchase
price or cost objectives.
    Such metrics should not be direct copies of the Toyota or Honda
metrics. Indeed, the best knowledge-based sourcing practices are tai-
lored to each company’s situation. For example, Toyota typically
favors suppliers whose factories are in close proximity to the
automaker’s plants, and so does Honda; the automakers frequently




32   strategy+business Reader
acquire an ownership stake in the businesses. Although at times this
leads to somewhat higher costs because suppliers are located in more
developed and expensive regions, both Toyota and Honda prefer this
system because it minimizes product lead times, eliminates quality
and disruption risks, affords them more control, and dovetails well
with just-in-time, lean manufacturing philosophies.
    But this approach overlooks the favorable economics found in
low-labor-cost nations like China, India, Vietnam, and the
Philippines, benefits that should be strongly considered — though
not necessarily as the dominant factor — in a procurement pro-
gram. Through carefully constructed strategic relationships with key
1. Establish suppliers as strategic long-term partners. Toyota invests
suppliers elsewhere around the world, Western companies can coun-
terbalance the advantages that Japanese companies gain from prox-
imity and ownership.
    Every company has internal strengths that can allow it to change
models. But for an organization to fully make the transition to
knowledge-based sourcing, it must take four critical actions:

directly in its suppliers — using a keiretsu model of interlocking
ownership — to manage its alliances. But that isn’t necessary. More
important is an alignment of goals and cultures.
    In fact, one of Toyota’s preferred suppliers is not part of its
keiretsu. Johnson Controls Inc., a U.S.-based company that makes
automotive interior and battery products, has been cited by Toyota
for perfectly matching the automaker’s standards of quality, on-time
delivery, diversity, and performance excellence. By sharing opera-
tions, knowledge, and expertise, Toyota and Johnson Controls have
developed a mutual learning and development pact buoyed by a
steady rate of manufacturing improvement.
    The same is true for most other Toyota suppliers. They often
describe the automaker as both their best customer (providing pre-
dictable volumes and profitable margins) and their most demanding




                                                         Win-Win Sourcing   33
customer (requiring excellence in performance, continuous
improvement, and the highest quality at the lowest total cost).
    For suppliers to become willing partners, they must be con-
vinced that the new knowledge-based practices — setting cost,
quality, and delivery targets, and then more ambitious ideal cost and
performance levels — will not be used against them. It must be clear
that suppliers who meet the required standards and consistently
improve performance will benefit from more consistent business,
which in turn will allow them to operate more efficiently and enjoy
higher profit margins in the future.
    Long-term partnership does not mean exclusivity. At times,
2. Set up an ongoing system to eliminate waste through collaboration
across the supply chain.
when these relationships are not producing the expected returns,




Exhibit 3: Supplier Support Model
manufacturers choose a second supply source as a backup. Chiefly,
this creates competition that encourages the original supplier to
meet its targets and protects the manufacturer from receiving parts
that are lower in quality, more expensive, or delayed. If a supplier is
continually unable to raise its performance to agreed-on levels, man-




Manufacturers who follow a knowledge-based sourcing model must often educate their suppliers.
As suppliers gain proficiency, their role changes — from novice to full-fledged partner in a lean
ufacturers should transfer some volume to the secondary source,




production network.
always in hopes of eventually improving the initial supplier’s opera-
tions so that it can take on more business again.




                                                           Stable suppliers
                       One facet of knowledge-based sourcing that




                                                     ers
                                                 pli                                   Ma
                                                                                         tur
                                            up
many manufacturers readily embrace is the drive for transparency in




                                      ces                                                   es
                                                                                                 up
                                 Novi                                                               plie
        SUPPLIER                                                                                         rs
costs. Suppliers are asked to reveal their ideal cost performance, or




           STAGE
the cost to produce components under perfect circumstances. In a
true collaboration, this knowledge would then lead to a mutual




             Objective      Achieve stability              Improve production        Operate in a lean
                                                                                     network
effort between suppliers and manufacturers to improve production




                 Focus      Reactive; address              Proactive; concentrate    Forward looking;
                            quality issues and             on continuous             seek even greater
throughput, quality, and delivery, with the ideal cost performance




                            capability gaps                improvement               sophistication

     Level of customer      Hands-on                       Facilitation              Very little; suppliers
           involvement                                                               are self-directed

        Customer role       Teaching, training,            Teaching, training,       Networking, showcase
                            problem solving                facilitating, strategic   benchmarking
                                                           partnering


Source: Booz & Company



34    strategy+business Reader
demonstrating the potential savings that suppliers could achieve. In
many current cases, however, the ideal cost performance becomes
yet another target, a new form of leverage that manufacturers use
to press suppliers to cut their margins. This defeats the entire
knowledge-based effort; rather than providing incentives to collabo-
rate, it gives suppliers every reason to obfuscate their true costs.
    Instead, deliberately design the costing approach as a self-
reinforcing learning process for both buyer and supplier. Establish
up front that the ideal performance levels in cost, quality, delivery,
and innovation are expected to continually change. For each compo-
nent, suppliers should submit a cost breakdown — that is, what they
believe it would cost at their current level of productivity to produce
the item. Working with suppliers, manufacturers then reset this
price on the basis of industry data, productivity benchmarks, and a
competitive analysis. Ultimately, this process is meant to produce an
“agreed-to cost” that is acceptable to both the manufacturer and the
supplier, providing competitive cost and performance for the manu-
facturer and profit margins and stable volume for the supplier.
    As they collaborate to achieve these continually changing per-
formance goals, manufacturer and supplier develop a manufacturing
improvement plan together. This plan lowers the supplier’s cost fur-




                                                       Win-Win Sourcing   35
ther over time while improving the quality of the output and the
performance of the factory. The extent of the manufacturer’s
involvement depends on the supplier’s capabilities and process
sophistication. (See Exhibit 3.) Although more hands-on assistance
may be required to address quality issues and build capabilities at
some suppliers, the most mature suppliers are largely self-directed in
their continuous improvement efforts. Even with the most sophisti-
cated suppliers, a consistent focus on open communication and
mutual assistance helps reduce waste along the supply chain.
    One fascinating example of this virtuous learning circle occurred
in the late 1990s, when Toyota asked the Exxon Mobil Corporation
3. Get it right the first time. Because the price-based system favors
to produce motor oil at 30 percent below its bid. At first, the oil giant
was convinced that this was impossible and told Toyota management
so, adding a few choice words about what the automaker knew — or
didn’t know — about motor oil. But six months later, after exploring
Toyota’s offer more closely, ExxonMobil had a change of heart. It
turned out that Toyota’s assignment was possible, and ExxonMobil
agreed to the deal and used the knowledge gained to improve its cost
structure for all its jobs. ExxonMobil likely would never have realized
this performance reward without the benefit of Toyota’s sourcing
model. It helped that Toyota’s executives were willing to challenge
established attitudes. Indeed, a capability for constructive challenge
will make more of a difference to a knowledge-based sourcing initia-
tive than any number of borrowed best practices.

cost reduction over quality, it often leads companies to launch prod-
ucts on deadline but with unresolved flaws — which must then be
corrected in subsequent releases, recalls, and updates. Engineers
often end up tinkering with aspects of the post-release product,
sometimes for months, trying to justify the additional retooling
costs by arguing that the changes will add product value. Some
manufacturers even demand from suppliers the option of reengi-




36   strategy+business Reader
neering products after launch, billing the requirement as a cost
reduction measure.
     But no matter how it is justified, the net effect of the price-based
system is to raise design and engineering costs — for three reasons.
First, it sanctions sloppy engineering; if suppliers know that
redesigns are likely, they may feel less pressure to insist on flawless
engineering the first time. Second, and more pragmatically, suppli-
ers figure out the game very quickly; they build in features that will
then be removed to give the appearance of saving costs. In a
moment of candor, one designer at an automotive company said, “I
always overdesign the product so I can hit my cost reduction targets
4. Respect and develop human capabilities. Underpinning knowl-
after launch.” Third, when overhead and marketing costs are fac-
tored in, engineers working on an already launched program create
only a third of the value of those involved in a new effort.
     With knowledge-based sourcing, a short time after product
launch, the engineers are pulled from the project and redirected
toward developing new products or new versions of existing prod-
ucts. The manufacturing function, meanwhile, can focus attention
on in-plant productivity improvements, not on retooling for prod-
uct redesigns. In other words, by creating a well-managed up-front
phase, manufacturers gain a long-term, significant, and often unex-
pected benefit. Suppliers are equally enthusiastic. “U.S. automakers
reinvent for each program,” said one supplier. “They make eight to
10 design changes for each program, while Toyota makes maybe
two. What’s more, [the Detroit manufacturers] continue to change
up to the last minute but don’t want to pay for the changes.”

edge-based sourcing is a significant degree of people development.
Toyota and Honda, as well as many other Japanese companies, work
to instill in their employees a profound sense of cooperation. They
also build a deep and company-specific well of product and process
knowledge, identifying and codifying their best practices and




                                                      Win-Win Sourcing   37
pursuing ideal performance levels with their supply base. Few
Western companies can claim this type of educated workforce, so
a major training effort is needed to improve overall procurement
performance.
     In companies that pursue knowledge-based sourcing successful-
ly, we see the following skills present among a wide range of employ-
ees, whether on the shop floor or in the purchasing department:
   • They can map the underlying processes, materials, and tech-
     nologies that lead to or promote competitive performance.
   • They can produce cost models that accurately reflect supplier
     and industry economics.
• They can identify world-class factory output.
     • They can help suppliers reach recognized top-of-the-line
       standards.




The Path to a New Model
    Shifting from a traditional manufacturing model to this new
knowledge paradigm is culturally difficult. Managers at many com-
panies change jobs often; this makes it virtually impossible to
acquire the depth of experience and information needed to work
closely with suppliers on continuous cost and performance improve-
ment. Moreover, compensation is usually based on straightforward
cost and revenue benchmarks, not on quality and performance
improvements. That is why one of the first steps for a company to
take is to design creative incentives that reward employees for suc-
cessful long-term supplier relationships and for improved commu-
nication among purchasing, engineering, and the executive suite.
These incentives can alter old-fashioned perceptions quickly. Other
forms of support include focused training — on topics such as sup-
plier relationship management and development, cost modeling,
and industry economics — and career tracks that allow people to
grow and develop without shifting positions. Some companies have
successfully developed and implemented a training and certification




38    strategy+business Reader
program for cost management that encompasses much of the engi-
neering organization and all of purchasing.



The practice of knowledge-based sourcing is still evolving; a “next-
generation” approach is emerging now as more companies in a vari-
ety of industries adopt Japanese techniques and incorporate them
into their own corporate cultures. The most effective manufacturers
will build up supply chain management teams with differentiated
capabilities, balancing commercial, technological, and managerial
skills. They will align their values, incentives, and key performance
tain of reaching the end. +
indicators with the relationship-based system, focusing on perfor-
mance management and support instead of by-the-book cost reduc-
tions. They will build networks of suppliers who will work together
more regularly and effectively across the value chain, ensuring com-
patibility among components and seamlessness among their pro-
cesses. Finally, they will adopt more modular approaches, in which
components are distinctive when necessary but standardized when
distinction matters little to customers. In short, careful attention to
sourcing quality and logic will finally be seen as the strategic capa-
bility it deserves to be, positioned with a top management mandate.
     To be sure, a knowledge-based sourcing model is not appropri-
ate for every situation. If a company is buying a part or component
just once and is unlikely to require the supplier in the future, there
is little need to spend resources on improving operational and sys-
temic output. However, any company’s most important supplier




Editor’s Note
agreements involve the most essential components. In those cases,
manufacturing productivity improvements are critical in maintain-
ing high quality, reliability, and a continuously advantageous cost
base. The move to knowledge-based sourcing may not be easy, but
by implementing the four steps outlined here, most companies will
find themselves on the road to making the transition, relatively cer-




                                                       Win-Win Sourcing   39
First published in strategy+business, Summer 2007.
The New CPO
by Simon Harper and Fabrice Saporito




PURCHASING USED TO     be a boring function that most companies took
for granted; it involved a lot of transactional work and tedious rep-
etition — important activities for day-to-day or even moment-to-
moment operations, but not critical to the organization’s overall
planning and financial performance.
     Anyone with basic negotiating skills could manage procure-
ment, it was often said; deeper strategic thinking and serious deal
making took place elsewhere. For a nine-to-fiver, it wasn’t a bad way
to eke out a living. For an ambitious businessperson, however, pur-
chasing was nothing but a dead end.
     But that’s all changed. The growth in outsourcing, the drive for




40   strategy+business Reader
efficiency, and the dramatic cost savings that can be delivered by
well-managed supply chains and pricing analytics have transformed
purchasing into a strategic function in many companies. The best of
them now view procurement as a potential asset, one that is as
important as research, product design, finance, and marketing.
These companies realize that many of the questions that executives
must answer correctly to succeed in today’s commercial environ-
ment are intimately and directly linked to purchasing: What work
should we farm out? What work should we keep? With what com-
panies should we partner? How many suppliers should we have?
What should our relationship be with our suppliers? All of these
strategic questions now fall squarely on the desk of the chief pro-
curement officer.
    Of course, recognizing that the procurement department is not
the career backwater it was once considered and capturing the sig-
nificant strategic and financial value embedded in this function are
two different things. Indeed, to profit from an elevated respect for
procurement, many companies will have to undo decades of bad
habits in the recruitment, training, and development of their pur-
chasing professionals. No longer can they afford to place competent
but unimaginative people in these jobs. Nor can they afford to
ignore their current procurement staffers by offering them few
chances of advancement and neglecting their skills.
    Hiring the merely good is not enough for organizations that
want to build world-class purchasing departments. Instead, they
must make stellar appointments — filling the senior procurement
jobs with people who can become tomorrow’s top corporate leaders.
Managerial talent of this caliber doesn’t develop by accident.
Businesses hone executive abilities by identifying and encouraging
promising individuals and providing them with the right opportu-
nities over years, even decades.
    Slowly but inexorably, the programs that are needed to develop




                                                         The New CPO   41
top purchasing executives are being implemented at more and more
organizations. In fact, procurement managers themselves evince a
budding sense of optimism about their prospects, a sharp change
from prior, gloomier assessments. In a recent Booz & Company
survey of 100 CPOs and supply chain management leaders, 66 per-
cent of respondents said the CPO will play a larger role in setting
business strategy in the next five to 10 years, and 44 percent of
respondents said activities in the purchasing department will be a
top priority. (See Exhibit 1.) The general conviction in the executive
suite seems to be, as one respondent put it, “Procurement needs to
be more strategic — closer to the CEO agenda.”
Exhibit 1: CPO Role in Business Strategy

     What is the role of the CPO in defining the      How important will CPO involvement in
       business strategy of the company?            defining business strategy be in 5–10 years?




     Major role   7%                               Top priority   44%


                                                         More     22%
Important role    27%

                                                         Same     29%

  Limited role    27%
                                                          Less     3%


       No role    39%                                     N/A      2%



Source: Booz & Company survey



     This suggests that although it will continue to be important for




     1. Recruit from top schools. The bad news is that, by and large,
the purchasing professional to have functional expertise enabling
him or her to get the best deal on paper clips (as well as to leverage
more value from the entire supply base), strategic capabilities, polit-
ical savvy, and leadership talent are increasingly important priorities
and prerequisites for CPOs. In fact, our survey revealed that 46 per-
cent of senior purchasing executives believe that strategic under-
standing and overall business sense will be the most important traits




42     strategy+business Reader
for purchasing managers in the future. Meanwhile, two traditional
measures of purchasing professionals’ functional expertise — their
ability to manage supplier networks and their understanding of the
products or services they are buying — weren’t rated as the top pri-
ority by even 5 percent of respondents. (See Exhibit 2.) The chal-
lenge for tomorrow’s procurement officers, noted one CPO, will be
“setting the strategic agenda through growth and innovation.”
     Companies determined to develop a new generation of corpo-
rate procurement leaders — while maintaining a competitive supply
chain — should take five steps in particular:
2. Pay a competitive salary. The growing corporate realization of
companies have not bothered to seek out the best and the brightest
for purchasing; most recruiting has historically been internal. The
result, of course, was a self-fulfilling prophecy: Second-tier candi-




Exhibit 2: The Importance of Future Capabilities
dates couldn’t raise purchasing to a strategic competence, and their
underperformance seemed to justify the function’s relegation to a
supporting role. If procurement is to achieve its promise, companies
must seek out top performers to fill these jobs.
     The good news is that the level and quality of purchasing talent
is rising. Responding to the new demand, some top business and
industrial management schools have added purchasing to their cur-




                       Which two of the following capabilities do you believe will be most
                             important for purchasing professionals in the future?
riculum. For example, Helsinki University of Technology, a for-
ward-thinking business school whose students consistently beat
their European and American peers in international business case




   Strategic understanding and overall business sense     46%                                          13%
competitions, recently added a purchasing and supply management




Cross-functional supply and value chain understanding     15%                       21%
curriculum within its industrial management major. The university




                              Supplier cost modeling      4%            24%
developed the innovative course of study with the support of lead-




                                   Risk management        18%                 4%
ing Finnish corporations.




              Ability to manage supplier relationships    9%           10%                Most important

            Deep technical understanding of category      3%     13%                      Second most important
the enormous business impact that procurement can create has stim-




                   Ability to manage network supplier     3%    10%




Source: Booz & Company survey
                                                         0%                   20%         40%                 60%




                                                                                              The New CPO         43
3. Rotate functional assignments. It is essential to the development
ulated healthy increases in the earnings of procurement and supply
chain professionals. The magazine Purchasing reported in December
2007 that on average, U.S. purchasing professionals earned
US$84,611, up from $64,300 in 2002 — a 30 percent increase in
five years. In the United Kingdom, purchasing directors’ compensa-
tion rose steeply as well — to £76,000 ($157,000) in 2007, up a full
14 percent from the year before, according to a survey conducted by
the Chartered Institute of Purchasing and Supply and compensation
experts the Croner Company.
     Underpaying for purchasing executives in such an environment
is a penny-wise, pound-foolish strategy. Worse, an insistence on
clinging to old pay scales — that is, not paying purchasing execu-
tives on par with other top managers — will simply ensure that the
company hires the same old kinds of individuals, only worse.

of future purchasing leaders that they obtain the widest possible
training and experience within the organization. Leading corpora-
tions already routinely move executive candidates from one job to
another to broaden their knowledge of overall operations. At IBM,
for example, the most promising purchasing employees may spend
a few years in finance, market intelligence, or even global services




44   strategy+business Reader
before being shifted back to supplier management. Similarly,
Nokia’s procurement rotation plan gives its purchasing staff a taste
of what it’s like to deal with different types of expenditures or cate-
gories of supplies and services.
     Rotation programs not only create new opportunities for the
individual procurement executives but also benefit the company.
Two- to three-year rotations infuse fresh blood and new ideas into
the top purchasing ranks, prevent the development of counterpro-
ductive personal relationships between buyers and suppliers, and
reduce the risk that bottlenecks will arise from relying on a limited
number of experts who specialize in buying an even smaller number
4. Revise and expand training.
of products and services.
                                   The training required to function
effectively as a purchasing officer is much more complex than it was
just a few years ago, because it must include both traditional pur-
chasing expertise and broader financial and managerial skills.
     Procurement professionals still need such core skills as negotia-
tion techniques, supplier market analysis, and cost modeling, but
training programs involving these once-basic skills often require revi-
sion as the field of purchasing becomes more advanced and challeng-
ing. For example, traditional cost modeling involved little more than
short-term analysis of commodities markets to lock in prices over
perhaps a three- to 12-month period. But these days that’s only the
beginning. CPOs now must be adept at macroeconomics and have
wider corporate finance skills to manage futures, puts and calls, fixed




     5. Create career paths for purchasing talent. Ironically, although
contracts, and other strategies and instruments that are designed to
cover purchases over many years. CPOs increasingly need the finan-
cial acuity to accurately forecast supplier prices 24 months out or
more so they can make better decisions about long-term contracts
for oil and other commodities or the raw materials that should be
used in their company’s manufacturing processes and products.
     In some industries, such as the airline industry, the last few years




                                                            The New CPO   45
have demonstrated that the cost management of a key commodity
like fuel oil can sometimes be the key not just to profitability but
also to corporate survival. For example, with long-term hedging
of more than 80 percent of its energy costs, Southwest Airlines
avoided the turbulence many airlines suffered when jet fuel prices
nearly tripled between 2002 and 2005.
     To help develop the broad areas of expertise that procurement
officers need to thrive in the new purchasing environment, compa-
nies should turn again to top business schools for general manage-
ment training.
capabilities training is an investment that yields a higher return in
the short term, it’s also one that carries a greater risk to the depart-
ment. Equipped with a wider array of skills and more expertise,
purchasing professionals will find it easier than ever to leave their
companies for better opportunities — and high industry turnover
rates suggest that these budding executives aren’t shy about taking
advantage of new offers.
     To prevent such a brain drain and ensure that companies and
individuals are capturing the full potential of their purchasing tal-
ent, it is essential that companies offer concrete and compelling
career paths for procurement professionals. To determine which
procurement executives deserve special treatment, human resources
departments should build into performance appraisals and measure-
ment the new set of skills needed by purchasing managers, such as a
higher degree of financial acumen and finely honed strategic think-
ing. Moreover, the company must reward procurement officers who
meet certain cost and delivery targets with greater compensation.
     The purchasing department should be viewed as a training
ground for senior corporate positions. If the anecdotal evidence is
any indication, the best senior purchasing officers are fully capable
of filling those spots. For instance, Richard Purcell, former




46   strategy+business Reader
Microsoft CPO, is now chief executive officer of the Corporate Pri-
vacy Group, a consultancy on business privacy practices. And Pekka
Ojanpää, after only a year as CPO at Kemira Oyj, the leading chem-
ical supplier to the pulp and paper industry, was named president of
its Kemira Specialty division. In February 2008, he was named pres-
ident of Kemira Water.
     Some might argue that thinking of well-trained and innovative
purchasing managers as indispensable talent assets is a short-term
phenomenon that will generate only a modicum of real change
within most organizations before it disappears. But we see the rising
need and desire for highly skilled purchasing professionals as a lag-
smart purchasing professionals to adopt a new perspective. +
ging indicator in the long-term trend of supply chain revolution.
Over the past 30 years, business thinkers have become increasingly
aware of the crucial role that the supply chain plays in corporate suc-
cess. Yet even as they realized that the supply chain was a profit
engine, executives and purchasing professionals alike remained
oddly unaware of the purchasing department’s contribution to the
efficiency of that engine. It is time for both smart companies and




                                                          The New CPO   47
Getting Creative:
Efficient Sourcing in Marketing
by Harald Dutzler and Martha D. Turner




THE LARGE RETAIL   bank’s approach to buying marketing-related ser-
vices and materials was typical. On direct marketing efforts, decen-
tralized business units worked with advertising agencies of their
choice — agencies usually chosen on the basis of demonstrated
capabilities, their understanding of the nuances of the individual
businesses, and the personal relationships they had built over time.
The relative cost was hard to compare, as each of the bank’s business
units negotiated its own agreements with its marketing partners.
Pricing was usually project-based, with no standardization from one
business unit to another, even when it involved universally used
items, such as envelopes, mailing inserts, and postcards, or when




48   strategy+business Reader
units shared the same vendors.
     This sadly common scenario speaks volumes about the sourcing
side of marketing at large companies. Although creative develop-
ment is met with great attention to detail — no marketer would let
poorly written direct mail copy or artwork go out to half a million
customers or approve a point-of-sale placard that was off-message —
the sourcing of marketing materials or services rarely gets the same
scrutiny.
     In a way, this is understandable. A marketer’s first currency is
image — what people see, hear, or touch that draws them to a prod-
uct or service. But to focus on marketing’s end product at the
Leaving Money on the Table
expense of the sourcing process is to miss a very large opportunity
both corporation-wide and for marketers themselves. After all, mar-
keting materials and services can represent upwards of a quarter of
many companies’ total purchasing costs.



If marketing provides such a tangible opportunity for cost savings,
why have so few companies found a way to increase the function’s
purchasing efficiency? For one thing, when companies give their
local marketing departments an undue amount of autonomy to
work their magic, including allowing them to select vendors and
make buying decisions independently, the result is a wide and
uncontrolled proliferation of specification and service levels, along
with a fragmented vendor base.
    One consequence is a lack of consistency in the bidding process.
A provider to one business unit may get the job because it offers the
lowest price, but a similar supplier to another business unit may win
a contract simply because it has been the go-to vendor for many
years and the local marketing manager can’t imagine switching sup-
pliers. The results of narrow, relationship-based vendor selection can
be extremely damaging, both to the company and to the suppliers




                                                        Getting Creative   49
that are ostensibly benefiting. For example, a restaurant chain was
recently forced to end its relationship with a fulfillment vendor
because the growth of the chain’s footprint and associated marketing
needs outstripped the vendor’s capacity and capabilities. With the
overwhelming majority of its revenue gone, the fulfillment house
unfortunately went out of business.
    Another reason that marketing spending lacks controls and is
often wasteful lies in the limited interaction, at least historically,
between marketing and purchasing departments. Even at companies
that are trying to change that dynamic, purchasing directors often
do not have enough direct experience working with creative agencies
and media buyers — marketing’s primary cost centers — to know
how to implement more advantageous contracts.
     The results of companies with which we have worked demon-
strate that the benefits of addressing this disconnect can be substan-
tial. The cost savings from bringing marketing and procurement
together in a dedicated program to raise the efficiency of marketing
procurement start at 5 percent and can climb as high as 40 percent
across spending categories. That can mean tens of millions of dollars
in savings at companies that depend heavily on marketing, such as
those in the consumer packaged goods, pharmaceutical, and auto
industries. And although some marketers have harbored concerns
that any efficiency gains would be achieved at the expense of mar-
keting creativity, those fears, by and large, have not been justified.
     On the contrary, what chief marketing officers (CMOs) of some
leading-edge companies have discovered is that more efficient sourc-
ing actually leads to greater marketing effectiveness and a stronger
emphasis on creativity. This is true because one by-product of
greater procurement efficiency — say, in the form of designating
certain suppliers as strategic vendors — is less time spent on man-
aging processes and more time spent on developing core marketing
programs and activities. Further, when the CMO allows marketers




50   strategy+business Reader
to reinvest a portion of the savings generated from sourcing, they
can use the money to fund new creative efforts and invest more in
successful campaigns. In short, in this era of cost cutting, efficient
sourcing can enable marketing to do more with less.
     To gain the maximum benefit to their bottom lines and market-
ing efforts, companies will have to ensure that marketing and pro-
curement departments collaborate to an unprecedented degree. This
is not an indirect way of saying that marketing should be prepared
to relinquish control of its budget. Rather, it’s a prescription for a
new paradigm, in which purchasing can bring a fresh rigor to the
effectiveness of marketing expenditures.
1. Analyze Marketing Spending in Detail
    This tighter collaboration between marketing and procurement
won’t come naturally; it is a change that requires careful planning
and oversight. And although there is no silver bullet for achieving
this task, there are steps that companies can take to begin the process
of managing their marketing dollars more efficiently.



It is hard to buy marketing products and services efficiently without
knowing where and how the money is currently being spent. Yet this
is precisely the situation in which most CMOs of large companies
find themselves: They don’t have a detailed understanding of the
composition of their marketing expenditures or a comprehensive
profile of their supply base.
     This is because most marketing budgets are complicated, di-
vided between “above the line” items such as advertising and creative
services, meant to build brand awareness, and “below the line”
spending in targeted areas such as promotion, direct mail, and
point-of-sale, as well as prepress, printing, and fulfillment services.
Further, most marketers manage against budgets and campaigns
rather than focusing on the compliance of individual vendors to
contractual terms. Also, because brands tend to operate in silos,




                                                        Getting Creative   51
many CMOs cannot get a clear picture of spending across brands.
No wonder it’s so hard to keep it all straight: Marketing spending
isn’t a line item; it’s a scattergram.
     Nevertheless, setting a clear baseline by establishing where the
money is being spent is crucial to a CMO’s ability to identify
opportunities and develop insights for improvement. In the large
retail bank described above, the CMO was able to gain critical
knowledge of variations in prices and service-level agreements, as
well as the financial institution’s multiple internal points of contact
with suppliers, by conducting a thorough baseline diagnostic that
encompassed all of the bank’s marketing activities. That, in turn,
2. Adopt a More Rigorous Approach to Spending




     Supply levers. Supply levers offer a broad opportunity to become
allowed the CMO to drive toward more efficient sourcing by delin-
eating points of synergy and opportunities for greater collaboration
across brands.



Marketing can become more disciplined about controlling costs in
two ways. The first is attacking supply levers by rebidding and con-
solidating the vendor base, a process that marketing and procure-
ment can and should undertake together. The second is through the
manipulation of demand and process levers, the requirements
placed on suppliers by the marketing staffers themselves.

more efficient. This is partly because upwards of 70 percent of the
marketing budget lends itself to definition by a standard set of spec-
ifications — e.g., trim size, paper weight, color, finish, and binding
for printed materials. Companies that want to become efficient
about marketing sourcing must be willing to adhere to rigorous
pricing levels for standard products and services. They should also
establish and maintain enterprise-wide rate cards or pricing grids
for services such as graphics work, so that an individual business
unit knows what it can expect to pay for different design elements




52   strategy+business Reader
and for agency resources, such as the services of a copywriter or cre-
ative director.
     This discipline should extend to special situations in which the
marketing concept requires unusual purchases (think of a totem
pole, or a branded mobile that might hang in a store), creating
unique specifications so complex that it is not possible or does not
make sense to establish a rate card. In such cases, it is best to use a
“market basket” approach, meaning that the company asks for prices
for a representative set of services and uses those estimates to deter-
mine a preferred set of vendors. As the need for special items arises,
only these preferred vendors are asked to bid on the work.
Demand and process levers. On the creative side, demand and
    For companies in which print runs are a major component of
marketing costs, disaggregating fixed print costs from variable ones
is a good approach. Here, the relatively high fixed costs of print
setup are amortized over longer print runs. So if a marketer knows
she needs 200,000 print pieces in August and another 100,000 in
November, she orders a whole print run of 300,000 at once. Or, if
this is impossible, marketers might identify suppliers that are inher-
ently better — and hence less expensive — at running jobs of the
particular sizes needed.

process levers — which include the job’s complexity and deadlines;
the composition in terms of number of colors, trim size, paper
grade, and use of colors; the number of revisions and changes;
the extent of quality control; and the type of technology employed
— can be even more fruitful than pricing levers when brought
under control.
    Marketing should take the lead in managing the company’s
demand levers, with purchasing playing a facilitating role. As is the
case with the supply levers, improvements won’t happen until mar-
keting managers clearly understand the specifications of each job.
Only then can marketing take steps — harmonizing the size of




                                                        Getting Creative   53
posters, ruling out special colors that require the interruption of a
print run, and the like — to address what it buys, and how.
    On the process side, one change that marketing and procure-
ment may jointly pursue is handling more creative and production
work either in-house or offshore. This is the classic make-versus-buy
question, made more relevant in an era of cost-effective digital tech-
nology, which enables companies to do high-quality, low-cost pro-
duction work internally, possibly through independent contractors.
Another increasingly common tactic is to use one vendor to oversee
a larger fragmented supplier base, as part of an effort to minimize
internal administrative work.
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Sourcing reloaded

  • 1. Sourcing Reloaded: Targeting Procurement’s New Strategic Agenda A strategy+business Reader
  • 2. Sourcing Reloaded: Targeting Procurement’s New Strategic Agenda A strategy+business Reader Edited by Jeffrey Rothfeder and Georgina Grenon With an introduction by Patrick W. Houston, Detlef Schwarting, Robert Spieker, and Martha D. Turner In today’s risky global business environment, supplier networks are the ulti- mate lifeline for many companies — delivering the far-flung materials, goods, and services that drive worldwide commerce. The sourcing function has thus become an indispensable contributor to strategic goals and competi- tiveness in every industry. But charting a course that positions the corporate purchasing department as a catalyst for growth is no easy matter. This strategy+business Reader, Sourcing Reloaded: Targeting Procurement’s New Strategic Agenda, is packed with insights and prescriptive advice that senior leaders and purchasing executives can use to navigate today’s most vexing sourcing problems. Its main theme: how to balance traditional sourcing strategies with the new, collaborative approaches needed to drive sourcing’s effectiveness and help it attain its full potential in the face of the demands of globalization, resilience, sustainability, complexity, and customization. The Reader’s 14 chapters, written by Booz & Company’s foremost sourcing experts, cover the latest ideas and trends, including the next wave of sourcing excellence, the new role of the CPO, green sourcing, collaborative supplier relationships, improved strategies for commodities procurement and supply chain resilience, and global and low-cost-country sourcing. Sourcing Reloaded is aimed directly at companies that are determined to build fresh purchasing capabilities that leave behind old, unprofitable sourcing routines forever. For them, this Reader will be a helpful guide to a revolution in the making.
  • 4. Sourcing Reloaded: Targeting Procurement’s New Strategic Agenda A strategy+business Reader Edited by Jeffrey Rothfeder and Georgina Grenon With an introduction by Patrick W. Houston, Detlef Schwarting, Robert Spieker, and Martha D. Turner
  • 5. A strategy+business Reader Published by strategy+business Books Copyright © 2008 by Booz & Company Inc. All rights reserved. No reproduction is permitted in whole or part without written permission from Booz & Company. For permission requests, contact Virginia Brosnan by e-mail at brosnan_virginia@strategy-business.com. Visit Booz & Company online at www.booz.com Visit strategy+business online at www.strategy-business.com Increase your intellectual capital by subscribing to strategy+business. To subscribe for one year (four issues), visit www.strategy-business.com or call toll-free 877 829 9108. (Outside the U.S., call 850 682 7644.) Design: Opto Design Cover art: Pelato, Duarte, Lopez Pereyra strategy+business Books Publisher: Jonathan Gage Editor-in-Chief: Art Kleiner Executive Editor: Rob Norton Managing Editor: Elizabeth Johnson Deputy Managing Editors: Laura W. Geller, Debaney Shepard Senior Editors: Theodore Kinni, Melissa Master Cavanaugh
  • 6. Contents Introduction: Sourcing Transformation Sourcing’s New Frontier Reinventing Procurement to Drive Growth and Profitability 7 Win-Win Sourcing 18 The New CPO Getting Creative: Efficient Sourcing in Marketing 27 Green Sourcing: Seeking the Payoff in Environmentalism 40 The Building Blocks of a New Sourcing Approach 48 The Collaboration Game: Building Value in the Retail Supply Chain 59 Procurement’s New Operating Model by Patrick W. Houston, Detlef Schwarting, Robert Spieker, and Martha D. Turner 78 by Harald Dutzler, Peter-John Liberoth, Detlef Schwarting, 86 and Robert Spieker by Bill Jackson and Michael Pfitzmann by Simon Harper and Fabrice Saporito by Harald Dutzler and Martha D. Turner by Patrick W. Houston and Martha D. Turner by Simon Harper, Pertti Heinonen, Amit Kapoor, and Marco Kesteloo by Patrick W. Houston, Robert Hutchens, and Alan S. Pincus
  • 7. Contents, continued Coping with Record-setting Commodity Prices and Volatility Be Prepared to Bounce Back Sourcing Basics That Enable Success 96 Smoothing the Path for Procure-to-Pay: A New IT Approach 109 Make or Buy: Three Pillars of Sound Decision Making Buy Globally, Think Globally 122 Lessons from China: The Importance of Knowledge-based 132 Sourcing in Low-cost Countries 145 Off the Table, Into the Pocket: Capturing Procurement Savings 150 About the Authors 162 by Patrick W. Houston, Matthias Mueller, and Martha D. Turner 172 by Rich Kauffeld, Dermot Shorten, and Robert Spieker by Jeffrey Barta, Bernhard Rieder, and James Weinberg by Simon Harper, Michael Pfitzmann, and Dermot Shorten by Simon Harper and Laura Thompson by Ronald Haddock, Michael Pfitzmann, and Reid Wilk by Harry Hawkes, Patrick W. Houston, and Martha D. Turner
  • 8. Introduction: Sourcing Transformation by Patrick W. Houston, Detlef Schwarting, Robert Spieker, and Martha D. Turner IN TODAY ’ S RISKY global business environment, supplier networks are the ultimate lifeline for many companies — delivering the far- flung materials, goods, and services that drive worldwide commerce. The sourcing function has thus become an indispensable contribu- tor to the strategic goals and overall competitiveness of companies in every industry. This is quite a turnabout. Not long ago, procurement was little more than a back-office function, responsible for the down- stream process of negotiating price-based contracts and extracting scale benefits from increasingly unyielding groups of suppliers. Year- over-year price improvements and day-to-day supply assurance Introduction 7 often represented the extent of purchasing executives’ involvement in corporate activities. Today that antiquated notion of sourcing is scarcely recogniz- able in leading purchasing departments. Inexorably, these depart- ments and their leaders have extended their sphere of influence within the organization by proving that, given the opportunity, they can generate substantial value. This value comes in many forms. For instance, procurement departments have taken a leading role in driving cross-functional collaboration at several large companies. They are breaking down the silos that have isolated R&D, marketing, sales, and other corporate
  • 9. Sourcing’s Challenge departments from suppliers, because such isolation significantly inhibits cost savings and other performance improvements. They are using their newfound muscle to great effect — facilitating inte- grated sourcing processes, acting as liaisons between internal depart- ments and suppliers, and coordinating projects that are aimed at developing innovative products and minimizing sourcing and life- cycle costs. Leading purchasing departments have also demonstrated their importance by elevating their activities to new heights, to a strategic level far above mere cost cutting. Procurement executives can be found at the center of critical aspects of organizational performance, such as maximizing supply chain efficiency, reducing product devel- opment and manufacturing cycles from design to delivery, building operational resilience, enhancing marketing effectiveness and effi- ciency, and collaborating with suppliers to leverage capabilities throughout the supply chain. Given this wide-ranging set of activities, it is scant surprise that in many industries, purchasing departments now influence half of the annual operational budget. And that figure rises to 80 percent in such sectors as manufacturing and retail. 8 strategy+business Reader Despite sourcing’s promise and power, many companies have not yet successfully charted a course that positions their purchasing departments to become a catalyst for creating and capturing value, including profitability and growth. Even as chief procurement offi- cers (CPOs) relish the notion that they may finally earn spots on the senior leadership teams of their companies, they must also under- stand that only superlative performers will retain this privileged position. Indeed, in a recent Booz & Company survey, 46 percent of senior purchasing executives recognized that a high level of lead- ership ability, a strong business sense, and strategic savvy are the
  • 10. Globalization. Rich opportunities for profitability and product most important traits CPOs need for the future. Conversely — and clearly representing a sign of the times — the more traditional skills of purchasing executives, such as tactical supply management and Resilience. As supply chains extend ever further into regions that category experience, did not rank as priorities in the eyes of 95 per- cent of the respondents. The opportunity to raise purchasing to the level of other critical corporate functions also means that its leaders must shoulder their share of the responsibility for addressing the increasingly challeng- ing business landscape. When purchasing is managed well, compa- nies can gain a competitive edge because they are able to overcome the obstacles on which their competitors founder, such as: and service supply lie in the expanding economies and growing Complexity/Customization. The proliferation of products and ser- markets of India, China, and many other emerging nations; the vast new supply alternatives driven by low-cost labor pools and new factories opening in these countries; and the rising demand for essential commodities. But so do difficult challenges. The com- panies that most adeptly develop, manage, and optimize their sup- ply networks to serve end markets around the world will have a clear advantage. Introduction 9 were nearly untouched just a few decades ago, their exposure to nat- ural disasters, computer network attacks and failures, and political upheaval is increasing. There are many ways that companies can protect their supply chains from disruption, but few companies have actually done so. In fact, a recent Booz & Company survey of lead- ing supply chain executives found that 68 percent believe the great- est risks they face are interruptions in the flow of products and services from key suppliers, but only 46 percent of their companies have developed well-thought-out plans to avoid such calamities. vices that has been enabled by digital and other innovations has
  • 11. Sustainability. Concerns among all stakeholders — from custom- Four Rules for Approaching Sourcing Excellence been a boon to growth for most companies. This is an era of mass customization in which marketing efforts as well as products and services can be tailored to individual customers. However, as any good operations leader knows, this level of variation comes at a cost — increased complexity. Those companies that can balance the value of variety with the incremental costs of supply will be best positioned for significant profitability. The trick for sourcing is to work collaboratively across the company and with suppliers to provide what customers truly value in a way that minimizes sup- ply costs. Honda Motor Company has developed a no-nonsense way to ers to investors to governments and increasingly to end consumers — about global warming, large carbon footprints, and increased waste are compelling companies to link green initiatives closely to overall strategy. Much like quality, sustainability is evolving into an integral part of the supply equation, and its dictates must be recog- nized in the way companies produce and design their products and services. Sourcing’s role in facing this challenge is especially impor- tant because, for most companies, nearly two-thirds of green oppor- tunities reside externally, in the supply chain. 10 strategy+business Reader Simply put, in no other period has sourcing had so much power to make a significant impact in support of a company’s strategic direc- tion and overall competitiveness. And those organizations that are striving to achieve sourcing excellence will enjoy the competitive advantages it yields. For example: eliminate the enmity that typically paralyzes purchasing’s relation- ships with suppliers, replacing strident negotiations with open collaboration. Ideas for collaboration are often displayed openly on whiteboards during joint meetings, and then agreed upon by the
  • 12. Procter & Gamble Company has begun a comprehensive analysis to Vodafone Group PLC has shifted from purely transactional procure- end of the session. In the process, the automaker has lowered its costs and raised overall performance. determine how its supply chain must be transformed in the next decade. Through this study, the company plans to develop ways to reduce product size, create green packaging, and predict consumer demand so that it can place its factories and distribution points nearer its key sales markets. ment to a much more strategic approach that includes a comprehen- sive range of demand-side and supply-side levers and that is focused on creating value and optimizing the total cost of equipment own- ership in its global mobile telephony business. This transformation has enabled the company to better utilize supplier capabilities, to develop systematic measurement and insight into supplier perfor- mance, and to create extensive cross-functional collaboration inter- nally and with suppliers. These three examples are leading companies in the sourcing arena, but in our view, no single organization has yet achieved all the benefits of sourcing transformation. And no matter the stage of development at which its sourcing function stands, any company Introduction 11 can gain in the short and long term by “reloading” its sourcing func- tion if it closely aligns procurement with the overall business agenda and continuously challenges the function to enhance its capabilities. Further, more companies should do what the best do: improve their sourcing skills in those areas that are organizational priorities — a tactic that begins, of course, with precisely identify- ing those areas. From there, the path to purchasing improvement is an incremental activity that ultimately creates a full-fledged and fun- damental transformation. As sourcing leaders undertake this transformational process, they can benefit from these four rules of the road:
  • 13. 1. Pick your spots. 2. Create total transparency in purchasing costs and trade-offs. 3. Collaborate fully with internal and external stakeholders. A more Companies should start their sourcing trans- formation by redesigning procurement procedures in simple, con- 4. Become an influential corporate leader. Successful CPOs build crete ways that can produce measurable and significant value. These initial successes will build momentum within the organization for greater levels of change. A Source of Best Practices Whether it be the costs, savings, and benefits of environmentally friendly product options; the weighing of whether to buy or make a product; or the design of a more resilient manufacturing foot- print, the issues, implications, and ramifications of sourcing changes should be clearly articulated and openly shared throughout the organization. robust sourcing process depends on participation throughout the product life cycle, from the concept stage in R&D to the disposal or salvage of spent products by a recycler. This requires the combined efforts of key company departments and suppliers in the quest to deliver innovation, reduced costs, supply chain efficiency, improved product launches, and the reduction of silos. their confidence and power by leveraging their position in the exec- 12 strategy+business Reader utive suite. They ensure that purchasing plays a greater role in devel- oping and defining the company’s strategic direction. And they create a road map for sourcing transformation, as well as building the skills and capabilities required to support business partners. To help your company chart a winning course through today’s sourcing demands, priorities, and opportunities, this strategy+ business Reader, Sourcing Reloaded, offers a compendium of best practices culled from our experiences with purchasing executives in companies that have successfully undertaken this work. Sourcing
  • 14. Sourcing’s New Frontier. The five chapters in this section are Reloaded shows that businesses have many ways to achieve the highest level of procurement excellence. Whether companies are concerned with getting the basics right or elevating the sourcing function to new heights, this Reader includes the perspectives and insights they need to begin the difficult but ultimately lucrative effort to transform sourcing into a wellspring of significant added value. Toward that goal, this Reader is divided into three sections: devoted to exploring the newest sourcing ideas and trends. In “Re- inventing Procurement to Drive Growth and Profitability,” the fresh challenges and responsibilities of purchasing departments are plumbed through descriptions of some of the best companies’ strate- gies for staying ahead of the revolution in procurement’s potential to add value. “Win-Win Sourcing” explains how the conventional rules of procurement are being rewritten by a knowledge-based sourcing approach that allows manufacturers and suppliers to establish a long-term commitment aimed at improving each other’s capabilities and performance. “The New CPO” examines the job of today’s chief procurement Introduction 13 officer and finds that, far from being a career backwater, sourcing leadership now involves delivering significant strategic and finan- cial value. “Getting Creative: Efficient Sourcing in Marketing” explores sourcing’s often neglected role in the purchase of marketing prod- ucts and services, often a very sizable portion of a company’s spend- ing that should be managed with the same rigor as other critical functions. Indeed, all strategic services in a company, including legal counsel, back-office operations, and retail partnerships, can apply the lessons in this chapter. The final chapter in this section, “Green Sourcing: Seeking the
  • 15. The Building Blocks of a New Sourcing Approach. The four chapters of Payoff in Environmentalism,” describes how sourcing, supported by its growing credibility in the C-suite and the ability to encourage collaboration among corporate functions and business units, is in a perfect position to enable a holistic, multifunctional strategy for reducing environmental impact while cutting costs and building better relationships with suppliers and communities. the second section of this Reader examine the tools and techniques that enable a strategic sourcing program. “The Collaboration Game: Building Value in the Retail Supply Chain” details how building holistic, cross-functional, and collabo- rative relationships with selected suppliers across the value chain helps drive benefits in both revenue and cost far beyond the outdated and ineffective tradition of haggling over the terms of sup- ply contracts. “Procurement’s New Operating Model” points out the ways in which flawed and otherwise incomplete operating models cost most companies 5 to 10 percent of their total purchasing spend in unre- alized savings. The primary causes: End-users do not have the tools and processes to optimize procurement strategy, decision-making roles are not clearly delineated, and information systems fail to pro- 14 strategy+business Reader vide the data needed to ensure compliance with procurement poli- cies and objectives. “Coping with Record-setting Commodity Prices and Volatility” examines how to reduce the tremendous pressure that escalating commodity and material costs are bringing to bear on companies and on traditional procurement strategies. It offers fresh approaches to older methods that create more transparency and a detailed understanding of key cost drivers that can help reduce near-term cost variability as well as achieve supply, price, quality, and sustain- ability objectives. “Be Prepared to Bounce Back” explores how to combat the new
  • 16. Sourcing Basics That Enable Success. The third section of this fragility of supply chains caused by the rapid growth in outsourcing to geographically remote partners, the increase in sole sourcing, and the potential loss of data integrity due to the outsourcing of noncore services such as IT. Reader revisits perennial sourcing issues, offering insights and pre- scriptions that CPOs can use to reload in their efforts to deal with a globalized procurement landscape and ensure that a company’s extended supply chain and its technology dovetail perfectly with the needs and strategies of the organization. “Smoothing the Path for Procure-to-Pay: A New IT Approach” introduces procure-to-pay, an IT strategy that eliminates the need for one-size-fits-all purchasing systems and replaces them with highly efficient individual modular applications, each of which addresses a specific area of the procurement process. “Make or Buy: Three Pillars of Sound Decision Making” revis- its a classic sourcing decision and offers CPOs a rigorous process for making more objective and informed “in-house or outsource” decisions. “Buy Globally, Think Globally” explores how a more robust understanding of the economic and geopolitical dynamics of the Introduction 15 markets in which their companies participate enables CPOs to help their organizations take advantage of opportunities that have been overlooked by their competitors as well as create a competitive edge where it seemed none was available. “Lessons from China: The Importance of Knowledge-based Sourcing in Low-cost Countries” examines the fast-changing con- siderations in dealing with suppliers in low-cost nations. This chap- ter describes how companies can use knowledge-based sourcing to develop strong relationships with such suppliers that extend beyond supplier costs into a careful assessment of manufacturing and transportation economics, lead-time requirements, schedule sta-
  • 17. this revolution in the making. + bility, product design changes, and the technical skills of suppliers. Finally, “Off the Table, Into the Pocket: Capturing Procurement Savings” offers companies a way to identify and capture a large por- tion of procurement initiative savings and drive these savings to the bottom line. Sourcing Reloaded is intended to provide foresight and insight into how companies can tackle some of today’s most vexing sourc- ing problems. It emphasizes that successful sourcing transformations depend on carefully balancing traditional sourcing approaches with new approaches, earmarking a portion of the gains from new pro- curement strategies for building fresh capabilities that can drive profit and growth in the future, and building superior purchasing capabilities over time, in much the same way that Toyota, Honda, and Procter & Gamble developed their sourcing functions. To achieve similar levels of success, companies must encourage substan- tially more proactive and radical behavior in their CPOs and ensure that their organizations leave behind old, unprofitable sourcing rou- tines. We hope that Sourcing Reloaded will serve as a helpful guide to 16 strategy+business Reader
  • 19. Reinventing Procurement to Drive Growth and Profitability by Harald Dutzler, Peter-John Liberoth, Detlef Schwarting, and Robert Spieker Also contributing to this article were Simon Harper and Marco Kesteloo OVER THE PAST 10 years, company procurement departments have done well, on the whole, in meeting a series of new challenges. Whether it meant working with an increasingly global vendor base or managing partnerships with back-office service providers, pro- curement generally accomplished the task at hand. With each suc- cess, the visibility and importance of the function in the overall organization grew — so much so that procurement now controls half of the annual budget in many industries and up to 80 percent in sectors such as manufacturing and retail. As confidence in procurement departments soared, companies counted on them to take on even more challenging projects. Now, 18 strategy+business Reader procurement chiefs are being asked to undertake a host of new responsibilities: decrease supply chain complexity, speed products to market, stimulate supplier innovation, enhance operational security, and even consider the social and environmental impact of the sup- plier in sourcing decisions. Addressing issues like these requires a higher level of talent and commercial acumen than anything procurement departments have tackled before. Indeed, these aims demand a reach beyond that of the organizational supply nexus: They require a transformation in the way we traditionally think of sourcing. In leading companies, sourcing is evolving from a stand-alone function that ensures
  • 20. that materials move through the supply chain at the lowest possible cost to a nerve center that monitors, anticipates, and responds to a variety of needs throughout the company — and even those of its suppliers. More cross-functional integration. Many companies covet the potential rewards of this kind of holistic, integrated approach to sourcing, but few are prepared to implement the organizational changes such an approach demands. Often, the sheer scope of the challenge can overwhelm manage- ment’s ability to visualize the steps necessary to tackle it. To learn how some leading companies plan to meet this trans- formational sourcing challenge, Booz & Company interviewed chief procurement officers at more than 100 global companies with a reputation for procurement excellence. Through these conversa- tions, we discovered that companies will need to make four key organizational adjustments to stay in front of the next wave of change in sourcing: • More cross-functional integration • Better supply networks • More collaborative supplier relationships • Greater supply chain resilience and risk management Reinventing Procurement to Drive Growth and Profitability 19 At present, the silos and borders that separate functions often limit opportunities for cost savings and value achievement. For example, the walls that separate R&D, mar- keting, and suppliers inhibit jointly executed and coordinated proj- ects aimed at such goals as developing new products and services or driving down sourcing and life-cycle costs. Breaking down these barriers can have a substantial impact. Two-thirds of the survey’s respondents told us they believe that procurement has a crucial role to play in integrating departments within their organizations. And 73 percent saw a need for similar procurement-led, cross-functional integration with
  • 21. external suppliers and partners. The procurement function is well positioned to serve as the cat- alyst for bringing internal departments and external suppliers closer to each other: After all, the function often serves as the communica- tion link between them. Many procurement leaders point to better management of specifications as a key catalytic mechanism in this effort. One CPO told us he wanted his department to learn to take an “active role in challenging the core value” by questioning engi- neers on their product specifications. This, the CPO believed, Better supply networks. Today, most supplier interaction happens would encourage the procurement team to move from simply iden- tifying unnecessary design elements to better defining the product’s absolute needs. The advantages of this kind of dialogue are not limited to the CPO’s organization. Large global retailers, such as Wal-Mart and Gap, have discovered that closer contact with their suppliers allows the suppliers themselves to integrate logistics and returns- management solutions, as well as to adopt new supply chain tech- nologies such as RFID more rapidly. Greater integration, and the looser boundaries that may come with it, should not be confused with less discipline. On the contrary, many CPOs complain that buying procedures must become both 20 strategy+business Reader more rigorous and more widely applied. “There is still too much maverick buying,” declared one CPO. A vast majority of respon- dents — 86 percent — believe that creating global purchasing processes and systems will be increasingly important over the next five to 10 years. within a point-to-point relationship — procurement to supplier. This relationship has evolved in some industries, such as the automotive sector, where it is standard practice for companies to manage deeper into their supply chains, down to Tier Two and Tier Three suppliers. But soon, even this extended management
  • 22. will not be enough. As we interview leading executives, increasing numbers are telling us that the ability to orchestrate a vast network of supply relationships will become more important. Such networks will look at the supplier not just as a source of a material or a component, but as a partner that will help improve delivery systems and design More collaborative supplier relationships. Many unrealized opportu- products. These executives anticipate using a variety of strategies to improve their ability to manage supply networks. Fully three- quarters of respondents believe supplier cost modeling will become more important over the next five to 10 years, as buyers seek a greater understanding of their suppliers’ underlying expenses. And 81 percent of respondents see low-cost-country source modeling as a crucial emerging skill. Another important opportunity, CPOs believe, is joint action with suppliers in the continuous reduction of waste: 47 percent see the challenge to reduce waste as a top pri- ority, and an additional 30 percent say they will be focusing more intently on waste reduction in the future. All these tools speak to the growing need of companies to gain a deeper, more differentiated understanding of their supply net- works. “How to manage strategic partnerships will become key,” Reinventing Procurement to Drive Growth and Profitability 21 one CPO told us. Another agreed, but warned that, at present, “there is a lack of clear approach and tools to manage this.” nities for value arise within a company’s supplier network in areas that neither the buyer nor individual suppliers can identify on their own. Collaboration is needed to optimize cost, to drive top-line growth, and, sometimes, to develop breakthrough concepts. CPOs still see a tremendous untapped potential in collabora- tion. Although 86 percent of the procurement leaders we surveyed said they have worked hard to develop collaborative partnerships over the last three to five years, most believe their work is nowhere
  • 23. Linking Functions for Improved Results The experiences of a global toy company requirements generated, a practice exac- demonstrate the potential inherent in erbated by lax procurement compliance cross-functional process improvements. rules. Over years of incremental “scope Over time, this maker of construction creep,” the company lost its scale advan- kits had evolved from making a relatively tage as a major resin buyer and added a limited product line requiring parts in tremendous amount of waste and ineffi- a few primary colors and basic shapes ciency to the supply chain. to offering an extended line of kits The solution to the problem was requiring parts in hundreds of colors and found in rewriting the purchasing shapes. In the process, a low-cost product road map and adding a step that ensured based on molded resin blocks had grown regular communication between the into something complex and expensive engineers and procurement. This cross- to produce. functional link led to a reduction in This had occurred because the compa- the number of unique resins and ny’s engineers were encouraged to create colors needed by manufacturing, lower- innovative products without regard to ing the costs of materials and also cost of supply. As a result, few engineers simplifying production. Interestingly, thought much about the real price of reducing the number of resins also stim- materials or the additional costs — such ulated innovation, as engineers discov- as inventory expense and the capital ered new ways to make do with fewer required to maintain it — that their material options. near complete. In fact, 44 percent still see the development of these partnerships as a top priority over the next five to 10 years, and even those who don’t see such partnerships as a top priority say they 22 strategy+business Reader intend to pursue a greater level of collaboration (38 percent). Typically, collaboration with suppliers occurs in the areas of new product development, order delivery and fulfillment, and manufac- turing. In a recent example, a northern European airline uncovered valuable synergies while working with a private airport to improve its luggage handling and check-in facilities. By ignoring organiza- tional boundaries, the two were able to design a jointly executed check-in process that was much more cost-effective for each partner — and more convenient for passengers. In this new collaborative world, competitiveness will be based on a detailed understanding of the suppliers’ costs, not the back-
  • 24. Greater supply chain resilience and risk management. Many CPOs and-forth of negotiations. Companies will gain an advantage over their competitors not by squeezing an extra nickel out of their suppliers’ margins, but by working with suppliers to boost the level of efficiency in the supply network or to develop new cutting- edge products. The benefits of supplier collaboration are becoming well recog- nized. One study by the Toyota Motor Corporation found that whereas negotiations can reduce costs by about 5 percent, collabo- rative practices can yield as much as a 38 percent cost reduction. Toyota analysts estimate that the benefits of collaboration stack up this way: 5 to 10 percent in cost reduction from engineering improvements, 5 to 8 percent in lower inventory levels through just- in-time shipping, and, most productive of all, 15 to 20 percent in sourcing raw materials and finding low-cost sourcing strategies for the supplier. believe they will need to focus more on risk and resilience than they have in the past, because they fear that today’s extended supply chains have made their companies vulnerable to new kinds of dangers. A total of 68 percent of respondents believe their greatest risk is the interruption of deliveries from key suppliers. (By compar- Reinventing Procurement to Drive Growth and Profitability 23 ison, less than half as many, 31 percent, fear physical damage to company-owned facilities or breakdowns in information security.) “Risk management becomes more important as a larger part of production and development is done by partners,” said one CPO. In fact, this heightened dependence on external partners has exposed companies to new problems that are falling under the purview of procurement. Issues such as a contractor’s level of social responsibility in its labor practices are fast becoming an important part of due diligence. One new kind of resilience many CPOs say they must develop is the ability to work with their suppliers to create products that are
  • 25. Meeting the Next Wave Challenge manufactured and distributed with less carbon. And as environmen- tal sustainability or “green” business practices become more and more popular with customers and even become a regulatory neces- sity in some markets, such an ability will become a greater priority. To build resilience and manage risk, one CPO told us, “we need to be broader in our understanding and have people working in dif- ferent functions across the disciplines.” Consequently, nearly half of respondents — 45 percent — say they will be hiring professionals with the strategic knowledge and business sense that would enable them to tackle as-yet-unidentified social, regulatory, and environ- mental roadblocks. Risk management is a much-needed capability as well, according to 18 percent of the CPOs. (For a detailed examination of green practices, see “Green Sourcing: Seeking the Payoff in Environmentalism,” by Patrick W. Houston and Martha D. Turner, page 59. For more on supply chain resilience and risk management, including how to protect the sup- ply chain, see “Be Prepared to Bounce Back,” by Rich Kauffeld, Dermot Shorten, and Robert Spieker, page 109.) The last wave in sourcing’s evolution was based on disaggregation — 24 strategy+business Reader that is, evaluating the potential value of each supplier and then mak- ing sourcing choices based on that more granular understanding. The next wave of sourcing will build on that foundation and extend it in a holistic sense, propelling companies still further beyond the old zero-sum approach to purchasing. First, the purchasing department will encourage cross-functional integration to develop greater insight into the needs of the business. Next, it will work more closely with suppliers to help them address these insights in ways that go beyond simple price cutting. To do this, procurement will build networks of suppliers who work togeth- er to optimize the efficiency of the entire supply chain and engineer
  • 26. innovative new ways to create value. Finally, purchasing will apply these new capabilities to find ways to better manage the business risks their companies face and to boost resilience. (See Exhibit 1.) Exhibit 1: “Next Wave Sourcing” Key Themes Better knowledge management will be essential in meeting the next wave challenge. At minimum, purchasing needs to understand the cost drivers of its suppliers. But that’s just the beginning. In the future, a much deeper understanding will be necessary in all direc- tions — among suppliers, between suppliers and procurement, and between procurement and other departments within the company. This requires a complex and systematic web of cross-reporting and continual dialogue to ensure that the supply network learns and keeps on learning as needs continue to evolve. Value Creation (From price to cost and value focus, i.e., Finally, an elevated organizational commitment will be required. growth, profit, return on capital employed) For example, to release sourcing’s potential to drive growth and Cross- Supply networks Collaborative Business risk functional supplier and resilience profitability, the procurement department will need a strong board- integration relationships level presence: This will ensure that the company’s purchasing From silo to From one-to-one From transaction From risk to cross-functional supplier manage- to collaboration and resilience value perspective ment to managing capability leverage management and strategy incorporates and is aligned with its long-term goals. supply networks sustainability More critically, it will help the company realize important changes, such as arranging the sourcing footprint in a way that reflects People Supplier Organization Institutionalize Knowledge and Learning Source: Booz & Company Reinventing Procurement to Drive Growth and Profitability 25 Successful leadership strategies Changing business environment
  • 27. next wave of procurement strategies and opportunities. + the expected growth of the market or anticipates future require- ments for limiting carbon output. But board support — or, for that matter, senior management support — should not be a blank check. It must be given only if procurement’s values, processes, and key performance indicators are aligned with corporate projections and tactical plans. To accomplish this, CPOs will need to develop a culture of continuous learning within their departments, ensuring that the procurement team is able to adapt to changing business conditions. At the same time, they will need to build an infrastructure to continually raise the level of performance management and controls. As one CPO told us, “We need to professionalize the total procurement organization.” Sourcing is at an important juncture. Many companies are ready for a procurement transformation; others are not. But simple aware- ness is a first step. Companies that recognize the importance of holistic sourcing practices are on their way toward implementing the 26 strategy+business Reader
  • 28. Win-Win Sourcing by Bill Jackson and Michael Pfitzmann IT ’ S AN INTRIGUINGway to create a contract. At Honda Motor Company, during meetings with suppliers, the executives write their proposed actions and agreements on a whiteboard. When all the items have been discussed, the meeting is over. The contents of the whiteboard are then typed up, two copies are printed, the supplier and the automaker sign them, and the contract is complete. Thereafter, both sides focus on executing the plan. Honda and its suppliers thus avoid the drawn-out, querulous negotiation process that is common at other automakers, a process that can last months and even then sometimes blows up without a resolution. This is one of many methods by which innovative manufac- Win-Win Sourcing 27 turers like Honda and the Toyota Motor Corporation rewrite the conventional rules of procurement. Their unorthodox techniques add up to a form of procurement based on shared information and insight: We call it knowledge-based sourcing. In this approach, manufacturers and suppliers share a long-term commitment to improving each other’s capabilities, starting by working together to eliminate wasted effort and other inefficiencies. Instead of being at odds, the two sides collaborate openly to lower costs and raise overall performance, with the expectation that this mutual effort will continue over many years and benefit both companies. Businesses pursuing knowledge-based sourcing use sophisticated
  • 29. costing tools and industry data, as well as discussions with other suppliers, equipment manufacturers, and competitors, to produce realistic cost targets that change over time. They set prices that reflect the supplier’s true economics for each process, part, compo- nent, and system. These prices include a reasonable profit margin for the supplier as well as incentives for lowering costs, improving quality, expanding innovation, and making design changes in subse- quent years. Contrast this with the alternative ingrained in many purchasing departments: price-based sourcing. Essentially, this approach pits the interests of the supplier against those of the manufacturer. Each side reveals as little information as possible, for fear of giving the opposing side an edge. Components, parts, raw materials, and fin- ished goods are purchased through a competitive bidding process, with specific volumes and deadlines spelled out in advance (hence those agonizing negotiations). The primary cost-cutting option available to manufacturers in a price-based sourcing approach is squeezing every possible cent out of procurement contracts. Purchasing managers focus exclusively on attaining cost savings greater than those of the previous year; their compensation hinges on it. Suppliers, in turn, focus on calcu- 28 strategy+business Reader lating bids that will win them the jobs. Once they have made a suc- cessful bid, suppliers are stuck with its terms. They have no reason to speak openly about their true costs, because they believe that their customers won’t pay a penny more. They have no incentive to improve their product, its design, or its manufacturing processes. They often feel they have no recourse except to game the system by overstating their expenses or charging exorbitantly for design changes. Both sides lose, and mutual suspicion and resentment are rooted so deeply in the system that they are almost impossible to overcome. This all-too-common story ends with rising costs, increased time-to-market, a loss of any shared innovation practice,
  • 30. Exhibit 1: Sourcing Philosophies and, in the worst of cases, supplier bankruptcies. Indeed, many suppliers today are in serious trouble. With raw material prices rising, margins cut to the bone, and purchasing departments struggling to meet corporate expectations for cost The perspective associated with each type of sourcing can be deeply ingrained. Managers may take them for granted — until they switch their approach. reductions, suppliers are under pressure from all directions. In the motor vehicle industry, many suppliers, including Collins & Price-Based Customer Knowledge-Based Customer Aikman, Dana, Delphi, Dura, Federal Mogul, and Tower Automotive, have filed for bankruptcy. Even suppliers with a long record of success have been squeezed, with profit margins often View of the A market of competitive, independent An integral part of the business network, falling below the cost of capital. These financial crises, in turn, are supply base providers bidding against one another essential for competitive advantage presenting a huge cost to buyers. The expenses associated with the Cost management • Seeks leverage on suppliers for price and • Sets targets with suppliers that are based on product improvements cost and performance bankruptcy of major suppliers can easily swamp contract savings. • Will switch suppliers to gain improvement • Increases efficiency through sharing knowledge or a slightly lower price and making a long-term commitment to No wonder knowledge-based procurement models, and the suppliers • Constantly monitors market for new suppliers to drive competition primarily on price • Encourages suppliers to achieve an management philosophy underlying them, are becoming more advantage over the market through continuous improvement attractive to many manufacturers. (See Exhibit 1.) Although they • Promotes competition through dual sourcing and being the buyer of choice The relationship • High level of mistrust — relationship hinges • High level of cooperation — relationship is with suppliers on leverage focused on improvement • Customer does not want to be too dependent • Creates integrated relationships based on on one supplier (for fear of losing leverage) mutual learning, teaching, and quality-related efforts • Often ends up combative or antagonistic • Demands operational excellence and relentless improvement Source: Booz & Company Win-Win Sourcing 29
  • 31. are not perfect, the Toyota and Honda sourcing models consis- tently earn high marks from suppliers — along with favorable terms. As one automobile manufacturing executive put it recently, “Honda cost estimators can tell suppliers their own costs within 1 percent accuracy.” That’s meaningful because suppliers are often unable to identify their own manufacturing expenses with anything near this degree of certainty and, thus, often suffer cost overruns. Backed by accurate cost information, automakers and suppliers can jointly develop a performance improvement plan to reach their cost goals. Manufacturers are equally rewarded. For companies that adopt the Toyota/Honda approach, the acquisition costs for parts such as pistons, exhaust manifolds, and cylinder heads are 35 to 55 percent lower than for those using traditional procurement models. Several factors account for this. First, product and part designs can be deliv- ered at lower costs. Second, productivity and quality improve as suppliers practice joint process coordination and improvement. Third, manufacturers’ purchasing departments can be quite small because they work with fewer, more strategically chosen suppliers. Fourth, warranty costs drop as much as 3 percentage points. Finally, fewer components need to be reengineered after launch, and as a result, both the manufacturer and the supplier avoid the added 30 strategy+business Reader costs of changing product designs at the most expensive time — during production. For all these reasons, in everyday practice, knowledge-based sourcing consistently outperforms the traditional bid-based model. This is true for companies in a variety of industries, and particular- ly for repeat purchases of anything that is not a true commodity. In most cases, even taking into account annual price cuts of approximately 5 percent, the quoted price under competitive bid- ding doesn’t approach the agreed-to cost under knowledge-based sourcing for the life of the contract. (See Exhibit 2.) More impor- tant, this form of win-win sourcing ensures that the knowledge
  • 32. Exhibit 2: Two Pricing Models Price-Based Sourcing: –5% A Recipe for Mediocrity Customers pressure suppliers to reduce prices, often –5% demanding annual price cuts of, say, 5 percent. Although this approach appears advantaged because of the significant year-over-year savings, customers actually pay more as –5% suppliers inflate their initial price in expectation of future Agreed-to cost demands for price cuts. Knowledge-Based Sourcing: A Win-Win Approach Ideal Agreed-to cost Customer and supplier work together to achieve the lowest cost cost design up front. They agree on a price that is close to Update but higher than ideal cost; this price reflects the supplier’s cost Supplier true costs plus a reasonable margin for the supplier. Over standards quote time, the price is further reduced to reflect productivity improvements. This approach consistently outperforms traditional price-based sourcing on an absolute basis. Supplier improvement Agreed-to Source: Booz & Company program cost Time Price gained and improvements made on one program or product will be transferred to the next. Meanwhile, the improvement plan contin- ues to achieve new levels of success each year, until productivity gains draw the supplier ever nearer to ideal cost expectations, which reflect more closely the supply and demand realities. Yet as advantageous — and profitably innovative — as knowledge-based sourcing can be, many companies, particularly Western ones, have had a hard time adopting it. Some executives Win-Win Sourcing 31 find it difficult to accept the idea that knowledge-based purchasing savings of 3 percent per year could be more profitable than the 5 percent annual savings mandated under the price-based system. “Impossible,” one chief financial officer protested. But it’s not im- possible. It merely requires a company to overcome its ingrained habits and internal obstacles. The path to knowledge-based sourcing includes reframing supplier relationships, building and sharing knowledge along the supply chain, and instituting new employee training in factory processes, product development, and industry operations so that employees can accurately gauge ideal costs and potential cost improvements.
  • 33. Don’t Copy Toyota For executives and procurement managers who want to adopt knowledge-based sourcing, but who have not grown up with Asian purchasing techniques, a framework can translate these techniques into more familiar Western-style rubrics. American and European businesses that adopt knowledge-based sourcing often need a new set of formal cost and performance metrics and new employee incentives. These standards replace old price-based sourcing metrics, which were most likely aimed at attaining those old-fashioned an- nual procurement cost savings. The new metrics are designed to help managers work closely with suppliers, in an atmosphere of mutual trust, to achieve the ideal cost for each item. They incorpo- rate improved supplier measurement techniques, worker evaluation programs, and a system of salaries and bonuses geared to meeting performance goals — not to meeting narrowly defined purchase price or cost objectives. Such metrics should not be direct copies of the Toyota or Honda metrics. Indeed, the best knowledge-based sourcing practices are tai- lored to each company’s situation. For example, Toyota typically favors suppliers whose factories are in close proximity to the automaker’s plants, and so does Honda; the automakers frequently 32 strategy+business Reader acquire an ownership stake in the businesses. Although at times this leads to somewhat higher costs because suppliers are located in more developed and expensive regions, both Toyota and Honda prefer this system because it minimizes product lead times, eliminates quality and disruption risks, affords them more control, and dovetails well with just-in-time, lean manufacturing philosophies. But this approach overlooks the favorable economics found in low-labor-cost nations like China, India, Vietnam, and the Philippines, benefits that should be strongly considered — though not necessarily as the dominant factor — in a procurement pro- gram. Through carefully constructed strategic relationships with key
  • 34. 1. Establish suppliers as strategic long-term partners. Toyota invests suppliers elsewhere around the world, Western companies can coun- terbalance the advantages that Japanese companies gain from prox- imity and ownership. Every company has internal strengths that can allow it to change models. But for an organization to fully make the transition to knowledge-based sourcing, it must take four critical actions: directly in its suppliers — using a keiretsu model of interlocking ownership — to manage its alliances. But that isn’t necessary. More important is an alignment of goals and cultures. In fact, one of Toyota’s preferred suppliers is not part of its keiretsu. Johnson Controls Inc., a U.S.-based company that makes automotive interior and battery products, has been cited by Toyota for perfectly matching the automaker’s standards of quality, on-time delivery, diversity, and performance excellence. By sharing opera- tions, knowledge, and expertise, Toyota and Johnson Controls have developed a mutual learning and development pact buoyed by a steady rate of manufacturing improvement. The same is true for most other Toyota suppliers. They often describe the automaker as both their best customer (providing pre- dictable volumes and profitable margins) and their most demanding Win-Win Sourcing 33 customer (requiring excellence in performance, continuous improvement, and the highest quality at the lowest total cost). For suppliers to become willing partners, they must be con- vinced that the new knowledge-based practices — setting cost, quality, and delivery targets, and then more ambitious ideal cost and performance levels — will not be used against them. It must be clear that suppliers who meet the required standards and consistently improve performance will benefit from more consistent business, which in turn will allow them to operate more efficiently and enjoy higher profit margins in the future. Long-term partnership does not mean exclusivity. At times,
  • 35. 2. Set up an ongoing system to eliminate waste through collaboration across the supply chain. when these relationships are not producing the expected returns, Exhibit 3: Supplier Support Model manufacturers choose a second supply source as a backup. Chiefly, this creates competition that encourages the original supplier to meet its targets and protects the manufacturer from receiving parts that are lower in quality, more expensive, or delayed. If a supplier is continually unable to raise its performance to agreed-on levels, man- Manufacturers who follow a knowledge-based sourcing model must often educate their suppliers. As suppliers gain proficiency, their role changes — from novice to full-fledged partner in a lean ufacturers should transfer some volume to the secondary source, production network. always in hopes of eventually improving the initial supplier’s opera- tions so that it can take on more business again. Stable suppliers One facet of knowledge-based sourcing that ers pli Ma tur up many manufacturers readily embrace is the drive for transparency in ces es up Novi plie SUPPLIER rs costs. Suppliers are asked to reveal their ideal cost performance, or STAGE the cost to produce components under perfect circumstances. In a true collaboration, this knowledge would then lead to a mutual Objective Achieve stability Improve production Operate in a lean network effort between suppliers and manufacturers to improve production Focus Reactive; address Proactive; concentrate Forward looking; quality issues and on continuous seek even greater throughput, quality, and delivery, with the ideal cost performance capability gaps improvement sophistication Level of customer Hands-on Facilitation Very little; suppliers involvement are self-directed Customer role Teaching, training, Teaching, training, Networking, showcase problem solving facilitating, strategic benchmarking partnering Source: Booz & Company 34 strategy+business Reader
  • 36. demonstrating the potential savings that suppliers could achieve. In many current cases, however, the ideal cost performance becomes yet another target, a new form of leverage that manufacturers use to press suppliers to cut their margins. This defeats the entire knowledge-based effort; rather than providing incentives to collabo- rate, it gives suppliers every reason to obfuscate their true costs. Instead, deliberately design the costing approach as a self- reinforcing learning process for both buyer and supplier. Establish up front that the ideal performance levels in cost, quality, delivery, and innovation are expected to continually change. For each compo- nent, suppliers should submit a cost breakdown — that is, what they believe it would cost at their current level of productivity to produce the item. Working with suppliers, manufacturers then reset this price on the basis of industry data, productivity benchmarks, and a competitive analysis. Ultimately, this process is meant to produce an “agreed-to cost” that is acceptable to both the manufacturer and the supplier, providing competitive cost and performance for the manu- facturer and profit margins and stable volume for the supplier. As they collaborate to achieve these continually changing per- formance goals, manufacturer and supplier develop a manufacturing improvement plan together. This plan lowers the supplier’s cost fur- Win-Win Sourcing 35 ther over time while improving the quality of the output and the performance of the factory. The extent of the manufacturer’s involvement depends on the supplier’s capabilities and process sophistication. (See Exhibit 3.) Although more hands-on assistance may be required to address quality issues and build capabilities at some suppliers, the most mature suppliers are largely self-directed in their continuous improvement efforts. Even with the most sophisti- cated suppliers, a consistent focus on open communication and mutual assistance helps reduce waste along the supply chain. One fascinating example of this virtuous learning circle occurred in the late 1990s, when Toyota asked the Exxon Mobil Corporation
  • 37. 3. Get it right the first time. Because the price-based system favors to produce motor oil at 30 percent below its bid. At first, the oil giant was convinced that this was impossible and told Toyota management so, adding a few choice words about what the automaker knew — or didn’t know — about motor oil. But six months later, after exploring Toyota’s offer more closely, ExxonMobil had a change of heart. It turned out that Toyota’s assignment was possible, and ExxonMobil agreed to the deal and used the knowledge gained to improve its cost structure for all its jobs. ExxonMobil likely would never have realized this performance reward without the benefit of Toyota’s sourcing model. It helped that Toyota’s executives were willing to challenge established attitudes. Indeed, a capability for constructive challenge will make more of a difference to a knowledge-based sourcing initia- tive than any number of borrowed best practices. cost reduction over quality, it often leads companies to launch prod- ucts on deadline but with unresolved flaws — which must then be corrected in subsequent releases, recalls, and updates. Engineers often end up tinkering with aspects of the post-release product, sometimes for months, trying to justify the additional retooling costs by arguing that the changes will add product value. Some manufacturers even demand from suppliers the option of reengi- 36 strategy+business Reader neering products after launch, billing the requirement as a cost reduction measure. But no matter how it is justified, the net effect of the price-based system is to raise design and engineering costs — for three reasons. First, it sanctions sloppy engineering; if suppliers know that redesigns are likely, they may feel less pressure to insist on flawless engineering the first time. Second, and more pragmatically, suppli- ers figure out the game very quickly; they build in features that will then be removed to give the appearance of saving costs. In a moment of candor, one designer at an automotive company said, “I always overdesign the product so I can hit my cost reduction targets
  • 38. 4. Respect and develop human capabilities. Underpinning knowl- after launch.” Third, when overhead and marketing costs are fac- tored in, engineers working on an already launched program create only a third of the value of those involved in a new effort. With knowledge-based sourcing, a short time after product launch, the engineers are pulled from the project and redirected toward developing new products or new versions of existing prod- ucts. The manufacturing function, meanwhile, can focus attention on in-plant productivity improvements, not on retooling for prod- uct redesigns. In other words, by creating a well-managed up-front phase, manufacturers gain a long-term, significant, and often unex- pected benefit. Suppliers are equally enthusiastic. “U.S. automakers reinvent for each program,” said one supplier. “They make eight to 10 design changes for each program, while Toyota makes maybe two. What’s more, [the Detroit manufacturers] continue to change up to the last minute but don’t want to pay for the changes.” edge-based sourcing is a significant degree of people development. Toyota and Honda, as well as many other Japanese companies, work to instill in their employees a profound sense of cooperation. They also build a deep and company-specific well of product and process knowledge, identifying and codifying their best practices and Win-Win Sourcing 37 pursuing ideal performance levels with their supply base. Few Western companies can claim this type of educated workforce, so a major training effort is needed to improve overall procurement performance. In companies that pursue knowledge-based sourcing successful- ly, we see the following skills present among a wide range of employ- ees, whether on the shop floor or in the purchasing department: • They can map the underlying processes, materials, and tech- nologies that lead to or promote competitive performance. • They can produce cost models that accurately reflect supplier and industry economics.
  • 39. • They can identify world-class factory output. • They can help suppliers reach recognized top-of-the-line standards. The Path to a New Model Shifting from a traditional manufacturing model to this new knowledge paradigm is culturally difficult. Managers at many com- panies change jobs often; this makes it virtually impossible to acquire the depth of experience and information needed to work closely with suppliers on continuous cost and performance improve- ment. Moreover, compensation is usually based on straightforward cost and revenue benchmarks, not on quality and performance improvements. That is why one of the first steps for a company to take is to design creative incentives that reward employees for suc- cessful long-term supplier relationships and for improved commu- nication among purchasing, engineering, and the executive suite. These incentives can alter old-fashioned perceptions quickly. Other forms of support include focused training — on topics such as sup- plier relationship management and development, cost modeling, and industry economics — and career tracks that allow people to grow and develop without shifting positions. Some companies have successfully developed and implemented a training and certification 38 strategy+business Reader program for cost management that encompasses much of the engi- neering organization and all of purchasing. The practice of knowledge-based sourcing is still evolving; a “next- generation” approach is emerging now as more companies in a vari- ety of industries adopt Japanese techniques and incorporate them into their own corporate cultures. The most effective manufacturers will build up supply chain management teams with differentiated capabilities, balancing commercial, technological, and managerial skills. They will align their values, incentives, and key performance
  • 40. tain of reaching the end. + indicators with the relationship-based system, focusing on perfor- mance management and support instead of by-the-book cost reduc- tions. They will build networks of suppliers who will work together more regularly and effectively across the value chain, ensuring com- patibility among components and seamlessness among their pro- cesses. Finally, they will adopt more modular approaches, in which components are distinctive when necessary but standardized when distinction matters little to customers. In short, careful attention to sourcing quality and logic will finally be seen as the strategic capa- bility it deserves to be, positioned with a top management mandate. To be sure, a knowledge-based sourcing model is not appropri- ate for every situation. If a company is buying a part or component just once and is unlikely to require the supplier in the future, there is little need to spend resources on improving operational and sys- temic output. However, any company’s most important supplier Editor’s Note agreements involve the most essential components. In those cases, manufacturing productivity improvements are critical in maintain- ing high quality, reliability, and a continuously advantageous cost base. The move to knowledge-based sourcing may not be easy, but by implementing the four steps outlined here, most companies will find themselves on the road to making the transition, relatively cer- Win-Win Sourcing 39 First published in strategy+business, Summer 2007.
  • 41. The New CPO by Simon Harper and Fabrice Saporito PURCHASING USED TO be a boring function that most companies took for granted; it involved a lot of transactional work and tedious rep- etition — important activities for day-to-day or even moment-to- moment operations, but not critical to the organization’s overall planning and financial performance. Anyone with basic negotiating skills could manage procure- ment, it was often said; deeper strategic thinking and serious deal making took place elsewhere. For a nine-to-fiver, it wasn’t a bad way to eke out a living. For an ambitious businessperson, however, pur- chasing was nothing but a dead end. But that’s all changed. The growth in outsourcing, the drive for 40 strategy+business Reader efficiency, and the dramatic cost savings that can be delivered by well-managed supply chains and pricing analytics have transformed purchasing into a strategic function in many companies. The best of them now view procurement as a potential asset, one that is as important as research, product design, finance, and marketing. These companies realize that many of the questions that executives must answer correctly to succeed in today’s commercial environ- ment are intimately and directly linked to purchasing: What work should we farm out? What work should we keep? With what com- panies should we partner? How many suppliers should we have? What should our relationship be with our suppliers? All of these
  • 42. strategic questions now fall squarely on the desk of the chief pro- curement officer. Of course, recognizing that the procurement department is not the career backwater it was once considered and capturing the sig- nificant strategic and financial value embedded in this function are two different things. Indeed, to profit from an elevated respect for procurement, many companies will have to undo decades of bad habits in the recruitment, training, and development of their pur- chasing professionals. No longer can they afford to place competent but unimaginative people in these jobs. Nor can they afford to ignore their current procurement staffers by offering them few chances of advancement and neglecting their skills. Hiring the merely good is not enough for organizations that want to build world-class purchasing departments. Instead, they must make stellar appointments — filling the senior procurement jobs with people who can become tomorrow’s top corporate leaders. Managerial talent of this caliber doesn’t develop by accident. Businesses hone executive abilities by identifying and encouraging promising individuals and providing them with the right opportu- nities over years, even decades. Slowly but inexorably, the programs that are needed to develop The New CPO 41 top purchasing executives are being implemented at more and more organizations. In fact, procurement managers themselves evince a budding sense of optimism about their prospects, a sharp change from prior, gloomier assessments. In a recent Booz & Company survey of 100 CPOs and supply chain management leaders, 66 per- cent of respondents said the CPO will play a larger role in setting business strategy in the next five to 10 years, and 44 percent of respondents said activities in the purchasing department will be a top priority. (See Exhibit 1.) The general conviction in the executive suite seems to be, as one respondent put it, “Procurement needs to be more strategic — closer to the CEO agenda.”
  • 43. Exhibit 1: CPO Role in Business Strategy What is the role of the CPO in defining the How important will CPO involvement in business strategy of the company? defining business strategy be in 5–10 years? Major role 7% Top priority 44% More 22% Important role 27% Same 29% Limited role 27% Less 3% No role 39% N/A 2% Source: Booz & Company survey This suggests that although it will continue to be important for 1. Recruit from top schools. The bad news is that, by and large, the purchasing professional to have functional expertise enabling him or her to get the best deal on paper clips (as well as to leverage more value from the entire supply base), strategic capabilities, polit- ical savvy, and leadership talent are increasingly important priorities and prerequisites for CPOs. In fact, our survey revealed that 46 per- cent of senior purchasing executives believe that strategic under- standing and overall business sense will be the most important traits 42 strategy+business Reader for purchasing managers in the future. Meanwhile, two traditional measures of purchasing professionals’ functional expertise — their ability to manage supplier networks and their understanding of the products or services they are buying — weren’t rated as the top pri- ority by even 5 percent of respondents. (See Exhibit 2.) The chal- lenge for tomorrow’s procurement officers, noted one CPO, will be “setting the strategic agenda through growth and innovation.” Companies determined to develop a new generation of corpo- rate procurement leaders — while maintaining a competitive supply chain — should take five steps in particular:
  • 44. 2. Pay a competitive salary. The growing corporate realization of companies have not bothered to seek out the best and the brightest for purchasing; most recruiting has historically been internal. The result, of course, was a self-fulfilling prophecy: Second-tier candi- Exhibit 2: The Importance of Future Capabilities dates couldn’t raise purchasing to a strategic competence, and their underperformance seemed to justify the function’s relegation to a supporting role. If procurement is to achieve its promise, companies must seek out top performers to fill these jobs. The good news is that the level and quality of purchasing talent is rising. Responding to the new demand, some top business and industrial management schools have added purchasing to their cur- Which two of the following capabilities do you believe will be most important for purchasing professionals in the future? riculum. For example, Helsinki University of Technology, a for- ward-thinking business school whose students consistently beat their European and American peers in international business case Strategic understanding and overall business sense 46% 13% competitions, recently added a purchasing and supply management Cross-functional supply and value chain understanding 15% 21% curriculum within its industrial management major. The university Supplier cost modeling 4% 24% developed the innovative course of study with the support of lead- Risk management 18% 4% ing Finnish corporations. Ability to manage supplier relationships 9% 10% Most important Deep technical understanding of category 3% 13% Second most important the enormous business impact that procurement can create has stim- Ability to manage network supplier 3% 10% Source: Booz & Company survey 0% 20% 40% 60% The New CPO 43
  • 45. 3. Rotate functional assignments. It is essential to the development ulated healthy increases in the earnings of procurement and supply chain professionals. The magazine Purchasing reported in December 2007 that on average, U.S. purchasing professionals earned US$84,611, up from $64,300 in 2002 — a 30 percent increase in five years. In the United Kingdom, purchasing directors’ compensa- tion rose steeply as well — to £76,000 ($157,000) in 2007, up a full 14 percent from the year before, according to a survey conducted by the Chartered Institute of Purchasing and Supply and compensation experts the Croner Company. Underpaying for purchasing executives in such an environment is a penny-wise, pound-foolish strategy. Worse, an insistence on clinging to old pay scales — that is, not paying purchasing execu- tives on par with other top managers — will simply ensure that the company hires the same old kinds of individuals, only worse. of future purchasing leaders that they obtain the widest possible training and experience within the organization. Leading corpora- tions already routinely move executive candidates from one job to another to broaden their knowledge of overall operations. At IBM, for example, the most promising purchasing employees may spend a few years in finance, market intelligence, or even global services 44 strategy+business Reader before being shifted back to supplier management. Similarly, Nokia’s procurement rotation plan gives its purchasing staff a taste of what it’s like to deal with different types of expenditures or cate- gories of supplies and services. Rotation programs not only create new opportunities for the individual procurement executives but also benefit the company. Two- to three-year rotations infuse fresh blood and new ideas into the top purchasing ranks, prevent the development of counterpro- ductive personal relationships between buyers and suppliers, and reduce the risk that bottlenecks will arise from relying on a limited number of experts who specialize in buying an even smaller number
  • 46. 4. Revise and expand training. of products and services. The training required to function effectively as a purchasing officer is much more complex than it was just a few years ago, because it must include both traditional pur- chasing expertise and broader financial and managerial skills. Procurement professionals still need such core skills as negotia- tion techniques, supplier market analysis, and cost modeling, but training programs involving these once-basic skills often require revi- sion as the field of purchasing becomes more advanced and challeng- ing. For example, traditional cost modeling involved little more than short-term analysis of commodities markets to lock in prices over perhaps a three- to 12-month period. But these days that’s only the beginning. CPOs now must be adept at macroeconomics and have wider corporate finance skills to manage futures, puts and calls, fixed 5. Create career paths for purchasing talent. Ironically, although contracts, and other strategies and instruments that are designed to cover purchases over many years. CPOs increasingly need the finan- cial acuity to accurately forecast supplier prices 24 months out or more so they can make better decisions about long-term contracts for oil and other commodities or the raw materials that should be used in their company’s manufacturing processes and products. In some industries, such as the airline industry, the last few years The New CPO 45 have demonstrated that the cost management of a key commodity like fuel oil can sometimes be the key not just to profitability but also to corporate survival. For example, with long-term hedging of more than 80 percent of its energy costs, Southwest Airlines avoided the turbulence many airlines suffered when jet fuel prices nearly tripled between 2002 and 2005. To help develop the broad areas of expertise that procurement officers need to thrive in the new purchasing environment, compa- nies should turn again to top business schools for general manage- ment training.
  • 47. capabilities training is an investment that yields a higher return in the short term, it’s also one that carries a greater risk to the depart- ment. Equipped with a wider array of skills and more expertise, purchasing professionals will find it easier than ever to leave their companies for better opportunities — and high industry turnover rates suggest that these budding executives aren’t shy about taking advantage of new offers. To prevent such a brain drain and ensure that companies and individuals are capturing the full potential of their purchasing tal- ent, it is essential that companies offer concrete and compelling career paths for procurement professionals. To determine which procurement executives deserve special treatment, human resources departments should build into performance appraisals and measure- ment the new set of skills needed by purchasing managers, such as a higher degree of financial acumen and finely honed strategic think- ing. Moreover, the company must reward procurement officers who meet certain cost and delivery targets with greater compensation. The purchasing department should be viewed as a training ground for senior corporate positions. If the anecdotal evidence is any indication, the best senior purchasing officers are fully capable of filling those spots. For instance, Richard Purcell, former 46 strategy+business Reader Microsoft CPO, is now chief executive officer of the Corporate Pri- vacy Group, a consultancy on business privacy practices. And Pekka Ojanpää, after only a year as CPO at Kemira Oyj, the leading chem- ical supplier to the pulp and paper industry, was named president of its Kemira Specialty division. In February 2008, he was named pres- ident of Kemira Water. Some might argue that thinking of well-trained and innovative purchasing managers as indispensable talent assets is a short-term phenomenon that will generate only a modicum of real change within most organizations before it disappears. But we see the rising need and desire for highly skilled purchasing professionals as a lag-
  • 48. smart purchasing professionals to adopt a new perspective. + ging indicator in the long-term trend of supply chain revolution. Over the past 30 years, business thinkers have become increasingly aware of the crucial role that the supply chain plays in corporate suc- cess. Yet even as they realized that the supply chain was a profit engine, executives and purchasing professionals alike remained oddly unaware of the purchasing department’s contribution to the efficiency of that engine. It is time for both smart companies and The New CPO 47
  • 49. Getting Creative: Efficient Sourcing in Marketing by Harald Dutzler and Martha D. Turner THE LARGE RETAIL bank’s approach to buying marketing-related ser- vices and materials was typical. On direct marketing efforts, decen- tralized business units worked with advertising agencies of their choice — agencies usually chosen on the basis of demonstrated capabilities, their understanding of the nuances of the individual businesses, and the personal relationships they had built over time. The relative cost was hard to compare, as each of the bank’s business units negotiated its own agreements with its marketing partners. Pricing was usually project-based, with no standardization from one business unit to another, even when it involved universally used items, such as envelopes, mailing inserts, and postcards, or when 48 strategy+business Reader units shared the same vendors. This sadly common scenario speaks volumes about the sourcing side of marketing at large companies. Although creative develop- ment is met with great attention to detail — no marketer would let poorly written direct mail copy or artwork go out to half a million customers or approve a point-of-sale placard that was off-message — the sourcing of marketing materials or services rarely gets the same scrutiny. In a way, this is understandable. A marketer’s first currency is image — what people see, hear, or touch that draws them to a prod- uct or service. But to focus on marketing’s end product at the
  • 50. Leaving Money on the Table expense of the sourcing process is to miss a very large opportunity both corporation-wide and for marketers themselves. After all, mar- keting materials and services can represent upwards of a quarter of many companies’ total purchasing costs. If marketing provides such a tangible opportunity for cost savings, why have so few companies found a way to increase the function’s purchasing efficiency? For one thing, when companies give their local marketing departments an undue amount of autonomy to work their magic, including allowing them to select vendors and make buying decisions independently, the result is a wide and uncontrolled proliferation of specification and service levels, along with a fragmented vendor base. One consequence is a lack of consistency in the bidding process. A provider to one business unit may get the job because it offers the lowest price, but a similar supplier to another business unit may win a contract simply because it has been the go-to vendor for many years and the local marketing manager can’t imagine switching sup- pliers. The results of narrow, relationship-based vendor selection can be extremely damaging, both to the company and to the suppliers Getting Creative 49 that are ostensibly benefiting. For example, a restaurant chain was recently forced to end its relationship with a fulfillment vendor because the growth of the chain’s footprint and associated marketing needs outstripped the vendor’s capacity and capabilities. With the overwhelming majority of its revenue gone, the fulfillment house unfortunately went out of business. Another reason that marketing spending lacks controls and is often wasteful lies in the limited interaction, at least historically, between marketing and purchasing departments. Even at companies that are trying to change that dynamic, purchasing directors often do not have enough direct experience working with creative agencies
  • 51. and media buyers — marketing’s primary cost centers — to know how to implement more advantageous contracts. The results of companies with which we have worked demon- strate that the benefits of addressing this disconnect can be substan- tial. The cost savings from bringing marketing and procurement together in a dedicated program to raise the efficiency of marketing procurement start at 5 percent and can climb as high as 40 percent across spending categories. That can mean tens of millions of dollars in savings at companies that depend heavily on marketing, such as those in the consumer packaged goods, pharmaceutical, and auto industries. And although some marketers have harbored concerns that any efficiency gains would be achieved at the expense of mar- keting creativity, those fears, by and large, have not been justified. On the contrary, what chief marketing officers (CMOs) of some leading-edge companies have discovered is that more efficient sourc- ing actually leads to greater marketing effectiveness and a stronger emphasis on creativity. This is true because one by-product of greater procurement efficiency — say, in the form of designating certain suppliers as strategic vendors — is less time spent on man- aging processes and more time spent on developing core marketing programs and activities. Further, when the CMO allows marketers 50 strategy+business Reader to reinvest a portion of the savings generated from sourcing, they can use the money to fund new creative efforts and invest more in successful campaigns. In short, in this era of cost cutting, efficient sourcing can enable marketing to do more with less. To gain the maximum benefit to their bottom lines and market- ing efforts, companies will have to ensure that marketing and pro- curement departments collaborate to an unprecedented degree. This is not an indirect way of saying that marketing should be prepared to relinquish control of its budget. Rather, it’s a prescription for a new paradigm, in which purchasing can bring a fresh rigor to the effectiveness of marketing expenditures.
  • 52. 1. Analyze Marketing Spending in Detail This tighter collaboration between marketing and procurement won’t come naturally; it is a change that requires careful planning and oversight. And although there is no silver bullet for achieving this task, there are steps that companies can take to begin the process of managing their marketing dollars more efficiently. It is hard to buy marketing products and services efficiently without knowing where and how the money is currently being spent. Yet this is precisely the situation in which most CMOs of large companies find themselves: They don’t have a detailed understanding of the composition of their marketing expenditures or a comprehensive profile of their supply base. This is because most marketing budgets are complicated, di- vided between “above the line” items such as advertising and creative services, meant to build brand awareness, and “below the line” spending in targeted areas such as promotion, direct mail, and point-of-sale, as well as prepress, printing, and fulfillment services. Further, most marketers manage against budgets and campaigns rather than focusing on the compliance of individual vendors to contractual terms. Also, because brands tend to operate in silos, Getting Creative 51 many CMOs cannot get a clear picture of spending across brands. No wonder it’s so hard to keep it all straight: Marketing spending isn’t a line item; it’s a scattergram. Nevertheless, setting a clear baseline by establishing where the money is being spent is crucial to a CMO’s ability to identify opportunities and develop insights for improvement. In the large retail bank described above, the CMO was able to gain critical knowledge of variations in prices and service-level agreements, as well as the financial institution’s multiple internal points of contact with suppliers, by conducting a thorough baseline diagnostic that encompassed all of the bank’s marketing activities. That, in turn,
  • 53. 2. Adopt a More Rigorous Approach to Spending Supply levers. Supply levers offer a broad opportunity to become allowed the CMO to drive toward more efficient sourcing by delin- eating points of synergy and opportunities for greater collaboration across brands. Marketing can become more disciplined about controlling costs in two ways. The first is attacking supply levers by rebidding and con- solidating the vendor base, a process that marketing and procure- ment can and should undertake together. The second is through the manipulation of demand and process levers, the requirements placed on suppliers by the marketing staffers themselves. more efficient. This is partly because upwards of 70 percent of the marketing budget lends itself to definition by a standard set of spec- ifications — e.g., trim size, paper weight, color, finish, and binding for printed materials. Companies that want to become efficient about marketing sourcing must be willing to adhere to rigorous pricing levels for standard products and services. They should also establish and maintain enterprise-wide rate cards or pricing grids for services such as graphics work, so that an individual business unit knows what it can expect to pay for different design elements 52 strategy+business Reader and for agency resources, such as the services of a copywriter or cre- ative director. This discipline should extend to special situations in which the marketing concept requires unusual purchases (think of a totem pole, or a branded mobile that might hang in a store), creating unique specifications so complex that it is not possible or does not make sense to establish a rate card. In such cases, it is best to use a “market basket” approach, meaning that the company asks for prices for a representative set of services and uses those estimates to deter- mine a preferred set of vendors. As the need for special items arises, only these preferred vendors are asked to bid on the work.
  • 54. Demand and process levers. On the creative side, demand and For companies in which print runs are a major component of marketing costs, disaggregating fixed print costs from variable ones is a good approach. Here, the relatively high fixed costs of print setup are amortized over longer print runs. So if a marketer knows she needs 200,000 print pieces in August and another 100,000 in November, she orders a whole print run of 300,000 at once. Or, if this is impossible, marketers might identify suppliers that are inher- ently better — and hence less expensive — at running jobs of the particular sizes needed. process levers — which include the job’s complexity and deadlines; the composition in terms of number of colors, trim size, paper grade, and use of colors; the number of revisions and changes; the extent of quality control; and the type of technology employed — can be even more fruitful than pricing levers when brought under control. Marketing should take the lead in managing the company’s demand levers, with purchasing playing a facilitating role. As is the case with the supply levers, improvements won’t happen until mar- keting managers clearly understand the specifications of each job. Only then can marketing take steps — harmonizing the size of Getting Creative 53 posters, ruling out special colors that require the interruption of a print run, and the like — to address what it buys, and how. On the process side, one change that marketing and procure- ment may jointly pursue is handling more creative and production work either in-house or offshore. This is the classic make-versus-buy question, made more relevant in an era of cost-effective digital tech- nology, which enables companies to do high-quality, low-cost pro- duction work internally, possibly through independent contractors. Another increasingly common tactic is to use one vendor to oversee a larger fragmented supplier base, as part of an effort to minimize internal administrative work.