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
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.