Coase laid the original foundations … Kraljic gave us fundamentals … and now the Busch-Lamoureux Exact Purchasing Framework is building on that to give you a guide to modern Procurement!
The Kraljic matrix is broken. A big problem, as we have regularly explained, is that you can’t compress two independent dimensions (risk and complexity) into one. A little problem is people don’t understand how to qualify the importance of a purchase. It has nothing to do with cost or volume but everything to do with the organizational impact if the product or service being purchased suddenly becomes unavailable. Similarly, it has nothing to do with how much you buy from the supplier, but how critical it is they don’t go out of business. It might be a critical component, but if there are ten other suppliers who can meet that demand for you tomorrow, the supplier is not critical to your organization.
But the biggest problem is that people regularly misunderstand the purpose of the matrix — it was a tool, and the first of it’s kind, designed to get us thinking critically about purchasing and point us in the right direction. It wasn’t the be-all and end-all. It was the first formal methodology an organization had to segment purchases and suppliers, think about them critically, and approach sourcing and supply assurance methodologically. And it was created in a time when global sourcing was more predictable (because natural disasters were a fifth of what they are today, war’s didn’t breakout overnight without warning on the whims of a mad man stuck in a macho cold war colonial mindset), risk was primarily complexity, and if you used the methodology, you probably had a success rate of 90%, which was phenomenal.
Kraljic gave us a way to structure our critical thinking and improve the profession, and all most consultants did was water it down, create a one-size-fits-none methodology, and sell it like it was the next panacea, creating a consulting snake oil from a masterpiece of thought.
A masterpiece of thought you only understand if you understand the framework in which it was built, and those were foundations laid four and a half decades earlier by Ronald Coase in his 1937 essay “The Nature of the Firm“.
The framework was that of organizing the supply management operations of a firm, where the definition of the firm was the one put forward by Coase, which is essentially that the firm was the mechanism by which transaction costs were minimized. (Otherwise, there would be no need for a firm!)
Transaction costs are the result of the price mechanism of the open market, and include:
- the cost of the negotiation and contract
- the cost of the individual transactions the contract covers
- the costs associated with production
and include all of the factors (people, equipment, technology, etc.) included in these prices.
This tells us that the fundamental purpose of a firm is … PURCHASING! And the only way a firm can grow is if it can continue to PURCHASE cost effectively (because as soon as the cost of subsequent transactions and / or production exceed the market costs, the firm is dead).
However, as most firms grew, they reached a point of inefficiency (due to management overhead, process inefficiency, and/or paperwork and/or communication point overload), and growth stopped. Also, as they grew, they became more brittle and sensitive to even tiny disruptions.
Kraljic recognized this and introduced the matrix so that firms could approach their purchasing in a more structured manner that would reduce the brittleness, simplify the management, and allow for additional growth and resiliency. And it was a great start.
But simply classifying items into non-critical, leverage, bottleneck, and strategic misses they key point of the firm’s existence. And that’s to ensure that the costs related to the category are not only always lower than the market cost, but remain low as the company scales.
When you classify an item as non-critical, it becomes ignored tail spend, and we’ve seen time and time again that the average overspend in this category is at least 15% in most companies, with many products and services being bought 30% more over market price.
When you classify an item as bottleneck, you focus on assurance of supply, and don’t dive into determining whether an item is a bottleneck because it can only be supplied by a rather limited supply base or because absence would shut down a production line. (Just because only a few suppliers produce the item to your specs doesn’t mean that only a few can, there might be a few dozen that could, and would, produce it to your specs [at a higher quality at the same price] for a guaranteed mid-to-long contractual commitment.)
When you classify an item as leverage, you double down on price (and exploitation of the price mechanism), and this can often come at the expense of quality and dependability, which can result in higher costs later if warranties come into effect or you have to replace products faster than normal (which always incurs a replacement cost in manpower and opportunity that is never factored into the “we can afford 4 of these per decade vs 3” equation).
When you classify an item as strategic, you triple (or more) the amount of effort you put into the management of that item (or category), and there is a point where the excess time investment not only fails to keep to the associated contract and transaction costs below market, but leads to no additional return on cost investment.
This is because the profiles don’t take into account the separate dimensions of risk and complexity or ensure that “importance” is defined as true “impact”, or provide any mechanisms for determining the impact (or risk or complexity).
This is why you need to go back to the foundations and build up a framework that is capable of capturing what the firm really needs!
That’s what the Busch-Lamoureux framework is intending to do.
By organizing categories based on complexity, risk, and impact
- the cost of the negotiation and contract is based on the complexity, risk, and impact — where all are low, the whole process can be automated and costs minimized
- the cost of the individual transactions the contract covers are minimized to verification of only what is important, and humans are only involved when automation can’t do that or finds a discrepancy
- the costs associated with production are minimized as you are selecting a supplier that meets all of the necessary requirements at the minimum cost subject to an acceptable risk factor!
Furthermore, you’re making your contracts for durations appropriate to the category such that you’re adequately accounting for complexity and risk without locking yourself into long term deals that are not beneficial to your organization!
But most important, because the categorization helps you determine how much manpower you actually need to spend on each sourcing event, contract, and transaction, your organization is much less likely to experience decreasing returns as it grows, allowing it the funds it needs to ensure Procurement is appropriately staffed and resourced with the right systems.
Coase gave us the definition of a firm (PURCHASING)! Kraljic helped us understand the fundamentals we need to consider in our modern world. Now we’re giving you a framework to apply those fundamentals in a manner that will let you scale without fear of unnecessary waste. Go forth and transact! (The market depends on it!)
