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.
In Part I, we noted that 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. We also noted that, over 30 years ago, Peter Kraljic published his ideas around how Procurement can transition from purchasing to supply management in a still-relevant 1983 article, and that if you look at the complexity of the supply market and contrast that with the criticality to the business, you can fit Procurement’s spend categories into different quadrants and develop a sourcing strategy around each.
Before we discuss what type of strategy generally works in each bucket, we want to make it clear that it is important to track changes and moves in the degree of availability/criticality and adjust your strategy when and where it makes sense. Each classification is examined below; remember that a given product/category can change classifications based on your company and the market conditions; the examples given below should encourage you to think of a comparable product for your company:
Highly Critical, Low Availability [Strategic]:
These are the areas that will stop production or service to customers and are also the hardest products or services to secure and source. To guarantee supply, you will likely need to establish long-term contracts and high quality standards. Due to the criticality, ideally, you would have an alternate supplier pre-qualified for failover or shortages with your preferred supplier. If the market is extremely scarce, you may even need to supplement your supply with multiple long-term suppliers to meet the demand you require. Depending on the products or service, companies can examine the make vs. buy decision and consider vertically integrating the supply into your own company.
Take iron ore for a steel company as an example. If quantities and quality are not met, it can severely impact or even halt production; there are very few suppliers in the market and high barriers to entry. Many steel companies have long term contracts and their own mining divisions to lower the supply risk.
Highly Critical, High Availability [Leverage]:
These categories of spend are still very important to the business, but the products/services are much easier to secure. Due to criticality, you will typically need to establish quality standards, but you can make changes in suppliers more easily and the market should be able to absorb increases in demand. This is one category where other market conditions will likely play a major role in determining sourcing strategy, i.e. how is the market evolving and how are vendors differentiating themselves? Because there is high availability of supply, Procurement should look to leverage spend and focus on cost and quality.
IT products and services are a prime example of this. They are highly available in the market and these can be critical to keep core processes or systems running. For many software and hardware products, there are multiple options to get the same end product by going direct to an OEM, utilizing a reseller, leveraging a VAR relationship, or even one-off buys from local or online suppliers if necessary.
Less Critical, High Availability [Non-critical]:
These products and services are still necessary to run the business, but do not have a significant impact on the end product and results should not be drastic if there is a lapse in supply or an alternate product or service is used in its place. This is where you may cherry pick among suppliers to achieve the lowest cost, introduce alternates/replacements, and use regular RFx efforts to drive down cost. Procurement should look to streamline purchasing and not invest their time heavily on non-critical items.
Office supplies could fall under this category. While office supplies are needed, there are certainly options and alternatives if they are not available, e.g. if pens aren’t available, pencils can be used. Essentially, you can continue to push production without office supplies and the supply base for these items is rather abundant.
Less Critical, Low Availability [Bottleneck]:
Similar to the items above, these categories of products and services are less crucial to running the business and do not add much value to the end product, but because the supply is limited, there is increased risk of scarcity. Procurement will need to secure supply by fostering the supplier relationship to ensure supply, while simultaneously qualifying additional suppliers, considering alternatives, and creating a cushion of inventory where able.
For example: electricity – the market is limited and electricity doesn’t add value as an input into an end product. For many companies, electricity is a utility and necessary to continuing day to day business, so it is crucial to ensure there is a supplier in place. The strategy for something like electricity may lean towards assurance of supply as opposed to finding alternates, but that strategy could adjust depending on presence in deregulated vs regulated energy markets.
These classifications are a starting point that Procurement should use to begin looking at categories and sourcing strategies in a more deliberate manner (or validate the strategies in place today). Determining where a category or even a specific product fits on the scales of criticality and availability will take heavy partnership with business stakeholders. By partnering with end users, Procurement can transform itself from a “buying” department to a “business-enablement” partner and gain inherent knowledge of the business you are supporting each day. The onus is on Procurement to understand how categories being sourced affect and fit into the core business to ensure alignment to overall company goals and business plans. By understanding and tracking the changes in criticality and availability of different inputs to your business, Procurement can ensure the sourcing strategy, category management, and vendor management are aligned to both the supply market and the company goals.