Leverage Not Always Perfect Procurement Plan

By Guest Editor

January 03, 2017 at 7:52 AM

By Jaime Mora 

In strategic sourcing, as procurement teams know, some categories of goods and services are “complex;” others not so much. Usually categories of “low technology” goods provided by many suppliers fall into this latter group. For them, procurement usually works to leverage the purchasing power of the organization as much as possible to create a competitive price advantage.  

Some strategies “from the book” are: Consolidate suppliers, renegotiate prices, model “should costs,” volume price points and rebates, develop new suppliers and unbundling pricing. Which strategy is more successful, and whether it is classified as leverage or routine, will depend on the impact on the business. Although the category influences the strategy selected, it is common that materials related to low technology either on the product side or the material itself, often are subject to commoditization (to gain more leverage to pressure price down making volume the relevant variable, often resulting in the reduction of suppliers when the strategy is implemented.)

Nothing wrong there, as the strategy delivers results from the moment it is executed. Everybody wins: The selected suppliers see business and profit value grow, despite a possible reduction in profitability by unit; the organization wins, as its costs base is reduced and the procurement manager wins, as the results make it possible to gain the strategic position it seeks (increased scope, closeness to management, etc.).

Is then the continuous commoditizing of materials the bulletproof strategy?

The answer is: No

The procurement manager, as a professional with long-term vision and a strategic mindset should be careful not to rely too much on this strategy in the long term when one or more of these conditions is/are present:

  • Too much: Consolidating volumes in exchange for low price has been done so much and for so long that it has actually changed the complexity of the supply market. The suppliers have identified the “modus operandi” of the buyers and have adapted accordingly, “moving” the market to their convenience and bidding not the best possible cost, but the price that the buyer is more likely to pay.
  • Limited transparency on raw material costs of suppliers: How does market complexity look when you analyze one level before? In case there is no information accessible regarding the input price of suppliers and the organization is being supplied by a reduced number of suppliers this will affect the negotiation position of the buyer in the mid-term, with the risk of increased costs. It is always possible to change suppliers, but keep in mind that this has hidden costs as well (e.g. the learning curve of working with a new partner).  
  • Suppliers in the same location/circumstances: The supply chain risk increases when all or the majority of selected suppliers are located in the same region, or are subject to the same circumstances (e.g. regulation, exchange rate) as one change or force majeure event will affect directly supply and will leave procurement with limited options.

leverage table one.jpg

 

 

 

 

 

 

 

 

 

 

 

 

Please click on image to enlarge for viewing. 

Then, for the case when the one level before supply market is complex and no information is available, how best to manage this type of materials? 

First it is important to point out that the procurement manager should be critic enough regarding the temptation of initially achieving low prices, and the pressure and/or explanation that will have to be provided for so. Therefore it is important to make the organization conscious that the in short-term the only attractive decision is not being chosen in the benefit of a secure supply strategy more appropriate for the long-term. 

Next to that, the best strategy will depend on the business impact of the category:

Leverage. Even though leverage to the lowest offered price is to be avoided, the leverage factor is still relevant; however, the leverage has to be limited to the exact point where the volume starts to be attractive to the supplier. This might result in the “counterintuitive” strategy of increasing the number of suppliers (useful when the business impact is high). The suppliers might pressure as they will be supplying less than they want or could, however, it is unlikely they leave the business, as it is still good for them.

The benefits of having more suppliers is that overall the risk of the supply chain is reduced, as it becomes easier to overcome disruptions of supply, quality events, etc. by simply relying on the rest of the supply base. In addition, price risk is also reduced, as in case the lack of price transparency in the chain is used as a tool to request higher prices, there are different information points in each supplier for the buyer to obtain information on the matter and negotiate appropriately.

Routine. In the case of routine categories, it is assumed that the volume is low also for suppliers. In this case, the option is to have an appropriate number of suppliers qualified but they have to be small or medium-sized. The allocations should be 0% or 100%, giving incentives to the suppliers to compete as much as possible, as having no business affects their results. It is important to be aware that having only one supplier at the time makes the supply chain more risky. To mitigate that, the procurement manager should be fully aware of delivery times, capabilities and restrictions of suppliers to provide product in case of emergencies having pre-defined actions to implement when required (Tip: in RFXs and business reviews never forget to ask about current installed and free capacity, delivery times and critical route to supply a product.) 

For procurement manager it is important to be aware that there is seldom a perfect solution (which happens to be good news considering it opens the field for strategic procurement). In this case, the strategies presented above are appropriate, but it is always a good idea to have good access to substitute product, and constantly be in contact with new suppliers that could be included in the operation.

Many organizations have implemented strategic procurement which coupled with the recent volatility of markets requires procurement to evolve the function. Part of this is increasing the strategy and analysis to a wider scope of the supply chain to prepare the organization for today's challenges.

leverage image two.jpg  

 















Caption: Porter analysis of the low technology suitable for leverage category. Pay attention to the combination of supplier’s market complexity (second level in the chain of the buying organization) and leverage interest of the buying organization.

 

Jaime Mora is a purchasing manager, indirect, pursuing an MS degree in purchasing and supply chain management at Robert Gordon University (Aberdeen).

Also see Jaime Mora's article at My Purchasing Center: Is Procurement Achieving the Lowest Possible Price?

 



Tags: purchasing Supplier relationship management Supply chain management Negotiation Procurement Technology sourcing price costs SRM
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