Chapter 4: Strategic Sourcing Methodology
Chapters 1-3 covered all of the preparation needed before you can decide on a strategy to get the most out of the savings opportunities you’ve identified. By now you’ve analyzed your spend and established your strategic suppliers and also explored possible alternate suppliers. You are almost to the strategy selection stage of the strategic sourcing cycle, but before you dive into it, you will need a better understanding of the methods we’ll be applying.
Our guiding question for this chapter: How do I build up a sourcing strategy?
Chapter 4 is a brief overview of strategic sourcing methodology. In it, we will take a look at two common strategic methods that can be used as a base for preparing your sourcing strategies.
Michael Porter’s Five Forces method helps us to understand and evaluate competitive forces within our industry and the supplier’s industry. Every company has customers, suppliers, and competitors in the industry. Understanding your position and the power relationship between these forces gives you valuable knowledge about how to implement your strategy.
Michael Porter described five competitive forces: supplier bargaining power, buyer bargaining power, industry internal rivalry, threat of new entrants, and threat of substitutes. The procurement function is most interested in supplier power and buyer power.
Let’s take a closer look at these powers. A typical high supplier power situation occurs when the supplier can increase prices, and the buyer can do nothing about it. On the other hand, buyer power is high when the buyer has multiple alternative sources and can push purchase prices down.
Imagine your company at the center of these five forces and analyze your position. Your company is sustainable if it can find a balance between these forces. However, sustainability is not always enough. In order to be successful, you also need to have the power to push the system out of balance, but only if you can do it for your own benefit.
Next, think of your supplier in the middle of these forces and weigh your power against his. You’ll have to consider several of the factors I mentioned in the previous chapters, namely how much of your spend accounts for what part of the supplier’s revenue and how dependent you are on an individual supplier for certain manufactured components or specific services. I suggest you use Porter’s method to think about and understand these competing forces every time you are preparing a strategy to use with your key suppliers.
Competitive power can change at any point in time, especially when there are changes in the market. During boom times, the supplier usually has the stronger bargaining power, but during a recession, the opposite occurs and customer bargaining power increases.
If you are interested in learning more about Porter’s Five Forces, I suggest you check out the Five Forces tool from MindTools. This tool can be used in a variety of business situations, but you can also use it as a guide during your sourcing analysis.
Porter’s Five Forces is great for a high-level, theoretical analysis. It’s important to carry out this analysis first in order to give you an idea of where you stand, which can be especially helpful when it comes to negotiations. However, while it does provide you with a broad understanding of your market power, it doesn’t outline the actions you should take once you have this knowledge. That is where A.T. Kearney’s Purchasing Chessboard® comes in. It’s a practical tool designed specifically for procurement.
The Purchasing Chessboard® is another matrix but one with 64 fields, like a regular chessboard. Buyer bargaining power is located along the horizontal axis, and on the vertical axis, supplier bargaining power.
The Purchasing Chessboard® is made up of three layers. The first layer is divided into four general purchasing strategies: manage your spend, change nature of your demand, seek joint advantage with supplier, and leverage competition among suppliers. These are the proposed main strategies for the large product categories as introduced by Kraljic in his matrix and that we also touched on in Chapter 1 “Internal Research.”
The second layer has four approaches for each high-level strategy, coming to a total of 16 strategy approaches. These approaches give you a better focus going into the next level of methods. The second layer helps you clarify the purpose and the long-term goals of the methods below each approach.
The third and bottom layer has four methods for each approach, for a total of 64 strategy implementation methods. There are quite a few methods, so you have a lot to choose from if you have to find the proper method at once. Drilling down from layer one to three helps you find your way to the strategy that best fits your situation.
In the next chapter, I will describe how exactly to use the Purchasing Chessboard® and go through a practical exercise. In the mean time, you can go to their website to explore this method more in depth. They even have a Purchasing Chessboard® LinkedIn group if you want to ask questions of experienced practitioners.
I am a mechanical engineer, and I like structure. I had a eureka moment the first time I saw the Purchasing Chessboard®. It was so logical and self-explanatory. Like most of you, I found several of those methods to feel quite familiar. But at the time, I felt lost as to what methods to use when and what should the next step be after one method has already been carried out. Then I said, “Eureka!” when I saw for the first time a system behind the approach and methods that can be used one after another. The main idea of the Purchasing Chessboard® is to increase your bargaining power. The goal is to move step-by-step towards the bottom right quadrant. In Chapter 4, I will try to explain how I use this great tool from A.T. Kearney to find and execute a comprehensive sourcing strategy.
Don’t forget to share this guide with your colleagues!
Written by Peep Tomingas