Today’s guest post is from Torey Guingrich, a Project Manager at Source One Management Services, who focuses on helping global companies drive greater value from their expenditures.
Part of good category management is ensuring that the sourcing strategy in place for the products/services is intentional and logical based on the market and commercial aspects of your company. Consider how you are determining sourcing, contract management, and vendor management strategies for different categories of spend: what are the guiding factors that push you towards a long term versus a short term contract, or a consolidated versus a segmented supply base? If you are applying the same strategy for every category, e.g. consolidate suppliers and sign a three-year contract, you may need to reconsider the variances in the categories and how these differences should affect the chosen strategy.
In 1983, Peter Kraljic published his ideas around how Procurement can transition from purchasing to supply management in a still-relevant 1983 article. These ideas were introduced to me when I first began my career in Procurement. I’ve kept these ideas in mind throughout my career to understand at a high-level how the inputs being sourced relate to the business at hand and how to best position a category management strategy given the market conditions associated. We’ll walk through a simplified version of Kraljic’s original ideas and how they can be applied to Procurement at any company.
Complexity of Supply Market/Supply Availability:
To simplify the original idea around “Complexity of the Supply Market” that Kraljic introduced, I want to focus on the availability of supply within the market. Across categories, there are certainly areas where suppliers or additional production are more available than others. In the manufacturing world, I’ve worked with companies that pursued long-term contracts with key suppliers, e.g. over 10 years, and even shared in the capital investment of building plants or production facilities in order to secure supply. Certainly a decision that large would be made with many stakeholders and C-suite folks involved, but it serves as an example of understanding the availability of supply in a given market and strategically responding to scarcity.
Scarce goods or services have rigid supply curves; there are limitations that prevent supply from meeting demand by simply increasing production/output. I use availability to mean more than just physically scarce resources; low availability can be brought on by high barriers to entry, complexity in extracting or moving the materials, a rapid increase in demand, or a rapid decrease in supply. Consider a manufacturing company; an example of a relatively scarce service in that market would be railroad transportation. For railroad capacity, we see high barriers to entry (e.g. we don’t see new railroad companies popping up every year) and an inability to ramp up to changes in demand (e.g. new railroad lines can’t be quickly added). When in Procurement, it is crucial need to look at the supply markets of different categories related to your business – are you being approached by suppliers frequently; are you able to easily find new suppliers to include in sourcing events; have there been any large-scale events that impact supply? Additionally, you can research the number of suppliers in the market, limitations on delivering the product/service, alternatives/substitutions available, and any other limiting factors that can affect supply to determine the relative scale of availability.
Importance of Purchasing/Criticality to the Business:
Availability of supply works hand-in-hand with criticality of that category to the business. Kraljic calls this component “Importance of Purchasing;” I position this aspect as “Criticality to the Business” to refer to the level of spend for a category and the overall impact on profit or production. To be able to measure this, Procurement needs to understand the business perspective and what drives production (either physical production of goods or sale of services). When I was taught these concepts at a steel company, one of the key materials to production was coke to fuel the furnace to smelt iron ore. Consider the core elements of your business and the drivers of production/sales as well as high volume/high price goods; this will help to gauge how critical a given product/service is your business. It should be noted that when looking at criticality, that the quality of that supply can be just as important as actually guaranteeing the volume needed. If key quality specs do not meet acceptable levels for production, there is the risk that the material may not be usable at all.
Based on availability and criticality, you can begin fitting Procurement’s spend categories into different quadrants to develop a sourcing strategy around each.
We will dive into details in Part II.