How Do RFPs Factor into an Effective Sourcing Strategy?
One of the biggest mistakes procurement managers can make is insisting on a one-size-fits-all sourcing strategy. This may come about as the result of a strict procurement policy designed to add structure to an ad hoc purchasing process or even in attempts to curb fraud and corruption.
These one-size-fits-all sourcing strategies often focus on tactical purchases and aim to ensure large purchases are bought through a competitive bidding process. This type of strategy, for example, may dictate that all purchases above a certain threshold have to go to tender with bids received from a minimum of three suppliers, regardless of the market situation. Public organizations may have to adhere to rules such as these due to legal restrictions; however, private organizations have more flexibility and should develop a dynamic sourcing strategy that fits the market and specific needs of the stakeholders.
Consequences of an Inadequate Sourcing Strategy
Savings left on the table: By failing to run RFPs in highly competitive markets, you could be leaving savings on the table. Furthermore, purchases under the typical RFP threshold may be ripe for savings if put to tender, depending on the market.
Missing out on market insight: Requests for either information or proposals can provide valuable insight into the current market situation. Suppliers know their market inside and out, and asking the right questions can give you information you may not have been able to find out otherwise. Later on this information can give you a stronger hand during negotiations.
Damage supplier relationships: By automatically running requests regardless of the market situation, you could be inadvertently harming your relationships with preferred suppliers. Putting together a competitive proposal is a time-consuming process. Forcing suppliers to do so every year just as a formality could reduce their desire to do business with you. On the other hand, if your suppliers have gotten too comfortable, then they have little impetus to provide you with the best service possible.
Supply Power vs. Demand Power Matrix
To get a better understanding of how to develop a sourcing strategy, take a look at this supply power vs. demand power matrix. A simplified version of A.T. Kearney’s Purchasing Chessboard, you can see where RFPs will give you the best results — the lower right quadrant — and where they’re least likely to work — the top left quadrant.
The bottom right quadrant, when supply power is low but demand power is high, is where you’ll want to leverage competition among suppliers. To some extent, you can also use RFPs to your advantage if you find yourself in the top right quadrant. While lower supplier competition will mean that you won’t be able to use RFQs to drive costs down, you can still use requests to open up lines of communication with suppliers and evaluate proposals.
If you find yourself on the left side of this matrix, an RFx won’t serve you well as a sourcing strategy. Either you are facing a sole supplier situation or you simply don’t have the volume to demand increased savings. In situations such as these, you may be better off focusing on other ways to manage spend or change the nature of demand at your organization.
Example category placement for a typical manufacturing company
The yellow fields indicate where the suppliers have a lot of power, but the buyers don’t have much. This is where we would find supplier monopolies. RFPs, especially with the three-bid rule, do not work well in these categories.
Examples: specific component suppliers, city water provider, big-name brands
The top right of the board is where you have high buyer power, but there’s also high supplier power and not much competition. The best strategy here would be to create a partnership with your chosen supplier and find ways to build a mutually beneficial relationship. While a highly-competitive RFQ, wouldn’t work here, you might be able to use RFIs or RFPs to compare suppliers and their proposals.
Examples: direct materials
The bottom right corner is where most of the savings potential is hidden. This is where buyers dictate the purchasing process. There is a high competition on the market, and buyers should make an effort to achieve maximum competition, obtain lower bids and squeeze supplier profit margins.
Examples: transportation, raw materials
The lower left corner indicates low demand and low supplier power. Buyers should not waste their time running RFPs here since the potential for savings is low. The only exception might be when you’re looking to establish a framework agreement. In this case, the volume would have to be significant over the term of the contract and there would have to be enough suppliers on the market to justify competitive bidding.
Examples: office supplies, bulk items
The proper RFP mindset
The buyers should seek to boost their power and look for competition among suppliers, but only if it makes sense in the current market situation. Increasing competition may require looking for alternative components or sourcing from international suppliers. However, precautions should be taken to ensure quality levels remain the same and considerations are made for total cost of ownership, especially considering transportation costs when sourcing overseas.
In many organizations, an inadequate sourcing strategy and rote RFP process limit the potential for savings and the ability to find and partner with optimum suppliers. Such is the case for the commonly used three-bid rule, which forces buyers to spend a lot of time buying items regardless of the market situation. As a result, less time is spent on properly running RFPs in categories where potential savings are the highest.
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The RFP Process: A Buyer’s Guide to Best Practices
- What role do RFPs play in an effective sourcing strategy?
- What are RFIs and how can they be used for supplier qualification?
- How do I prepare RFPs for services and transportation procurement?
- What can I do to maximize cost savings during the RFQ process?
- How do I manage the RFP evaluation process?
- How can I use RFPs to encourage supplier innovation?
- What’s the best way to negotiate during the RFP process?