This is the second installment in our series on how purchasing staffs at a variety of companies organize their strategic sourcing activities. The first installment, on "How to analyze the supply market," ran in the March 1, 2007 issue of Purchasing.

This series is more of a conversation than a tutorial, and we want to hear about your best practices too. You can send your comments to pteague@reedbusiness.com. Write Strategic Sourcing in the subject line.

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Know the suppliers' costs
Perhaps the most common mistake in selecting the right sourcing strategy is making the decision too early.
Billy Horne, corporate sourcing manager at AT&T South in Atlanta, says buyers too often get an offer for a small discount over their historical or current price from a supplier and take it. But in truth, by not researching the current market as well as their suppliers' cost structures, those buyers could wind up leaving money on the table—or conversely, driving their suppliers out of business—by focusing too much on historical pricing.
"Strategic sourcing is a dynamic process and you have to recognize that for the process to be successful," Horne tells Purchasing. He adds that one of the most important keys to success is making sure that you have all of the internal stakeholders involved in the decision-making process before selecting a sourcing strategy.
Horne says AT&T South has broken the selection of the sourcing strategy into five basic points, the first of which involves assessing your own bargaining position in that specific spend area. You have to determine how much your company depends on that commodity or the supplier(s) providing the commodity. "For example," he says, "if you've been relying on an incumbent supplier a long time, you have to weigh the pros and cons of bringing that contract out to bid and possibly bring in a new supplier. And you have to establish what you are willing to spend in this area."

“Buyers need to research the suppliers’ history and get as much information as possible from existing clients.” —Billy Horne

The next step is to assess the suppliers' bargaining position for the specific spend area. Suppliers need to make a profit, Horne says, but not too much of a profit. The key to assessing their bargaining position is getting a true understanding of the suppliers' cost structures. This includes not only suppliers' material costs but also their labor costs in the various regions around the world, if the bidders are global.
"Buyers have to research the suppliers' history and get as much information from that supplier's existing clients as they can," Horne says.

The third phase of preparation focuses on the establishment of benchmarks that will guide the buyer's sourcing strategy. The benchmarks established may vary depending on the spend category, but, again having all the stakeholders involved helps set realistic, meaningful parameters. For example, setting benchmarks around risk management can be tricky, but very helpful in selecting a sourcing strategy.

With the benchmarks set, buyers can build a list of plausible sourcing strategies and begin to review them. For example, Horne says there can be "a lot of positives and negatives about an RFP process—you have to have your specifications and requirements very clear to make an RFP effective." There are times, Horne says, when individual negotiations with suppliers can produce the best benefits, and that really "puts the buyer in the hot seat. The buyer really needs to know the suppliers' costing structures and the market they work in."
Horne is a proponent of reverse auctions and e-sourcing tools, but emphasizes that sourcing professionals "have to make sure their supply stream is conducive to them. They create a very competitive atmosphere."
—David Hannon

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Rank the suppliers' importance

For the MRO and packaging commodity team at AB Volvo, it's not the dollar value of the spend that determines the team's decision in selecting a sourcing strategy, it's the criticality and visibility of the spend to the team's internal customers.

“One of the first things they taught us is we have to define requirements of our customers.” —Randy Clark

At AB Volvo, everyone in the purchasing operation participates in a project-management training program.
"One of the first things they taught us is that we have to define requirements of our customers," says Randy Clark, senior strategic buyer, in nonautomotive purchasing in Greensboro, N.C.

The team has responsibility for sourcing MRO and packaging for all AB Volvo facilities worldwide.
Clark is the only buyer from North America on the team. Other team members are based in Gothenburg, Sweden and Lyon, France.

AB Volvo has a formal strategic sourcing process that looks to customers for input at every step. The process is gated, with approvals needed for purchasing to progress to the next step. Approvals may be from different levels of purchasing or nonpurchasing management, as well as that of internal customers for whom purchasing is sourcing goods and services.

When an internal customer needs, for example, a better quality screwdriver than the one he's currently using, purchasing will gather all available data on screwdrivers.

This would include responses to such questions as: How many locations are using screwdrivers? What is Volvo paying? Who is the company buying them from? How many distributors is it using? What manufacturers are out there?

"From the data, we can determine whether undertaking a new sourcing strategy will result in higher quality, lower price or improved service levels," says Clark. "They set the stage for the strategy we will adopt."
Based on input of internal customers, the MRO and packaging team has developed a three-pronged purchasing strategy that encompasses cost reduction, supplier consolidation and payment terms improvement. It has selected an integrator approach that incorporates global agreements the company has in place to maximize its leverage and influence. Under this model, outside integrators handle such administrative aspects of the MRO purchasing process as ordering while Volvo personnel manage such storeroom duties as receiving. The buy includes industrial consumption materials, hand tools and supplies

Purchasing named Clark to its All-Star MRO Buying Team for 2006 for his "common and consistent approach to managing the MRO and packaging spend for Volvo's North American sites."

His efforts have been wide ranging and have included extensive work on managing the company's inventory through VMI processes, and improving payment terms that have resulted in documented savings for the company of 12% on a $32 million spend.
—Susan Avery

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Seek long-term relationships

It's not uncommon for many electronics OEMs to buy the bulk of their production material needs from distributors. However, in some cases a small OEM must also purchase directly from suppliers. Exerra, a small OEM based in Rosh Haayin, Israel that makes equipment used in printed circuit board production, has that dual sourcing model.

“We need to work closely with suppliers so they understand our equipment and what we need from them.” —Hezi Eini

The company splits its $10 million spend evenly between distributors and direct manufacturers, relying on the latter for customized products, such as x86 computers and cameras. Exerra's basic sourcing strategy: "We work closely with suppliers so they understand our equipment and what we need from them," says Hezi Eini, general manager of production, who is also responsible for purchasing. The company values long-term relationships with its suppliers. "We have been working with them for several years and haven't changed them yet," Eini says.

Exerra has a very diverse bill of materials. Eini buys machine parts, electronic components, including passives and semiconductors, and those computers and cameras. In addition, the company also purchases EMS services to build some of the boards used in the printers, though the company retains the purchasing for the components and other materials used on the boards.

Because Exerra's purchasing volumes are low, it purchases most of its electronic components from about 10 distributors, including Arrow, Avnet and Future.

A key challenge for Exerra is getting competitive prices from suppliers, and the company is working to make sure it has qualified second sources for all strategic materials.

—Jim Carbone

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Become a commodity specialist

Determining which materials, parts and components require critical attention from the buying team and the suppliers is as easy as A, B, C and D at Monroe Truck Equipment Co. in Monroe, Wis.

“The nature of our product line does not allow for forecasting models that other companies may enjoy.” —Roger Schultz

The company produces a wide variety of large- and small-truck bodies, mounted hydraulics, pickup accessories, snowplows, spreaders, utility bodies for pickups, small fire trucks, snow and ice control equipment, and other commercial vehicles. Production materials cost an average $23 million annually for the privately held company.

"The nature of our product line does not allow for forecasting models that other companies may enjoy," says Purchasing Manager Roger Schulz. "Our in-house inventory of raw materials is extremely lean, and the lack of forecasts requires our response time to be shorter than one might imagine. The result is a heavy reliance on suppliers that can respond quickly and reliably, with a competitive price." And that discourages him and his small buying team from repeatedly shopping for best price.

In working to winnow out noncritical materials, the Monroe buyers first categorize purchased parts and components into groups that are required or designed exclusively for the company's manufacturing division (A and B) vs. those that are commercially available (C) or can become part of a vendor-managed inventory system (D).

The A group is the $10 million worth of carbon and stainless steel flat-rolled products sourced by Schulz from a small cadre of primary and secondary service centers. The B group is made up of pre-designed and fabricated—usually laser cut or plasma cut—steel parts and steel angles, channels, beams and rods. The C group of commercially standard components typically includes bearings, hoses and filters. The D group of VMI products—with the entire contract monitored in total by a buyer on a continuing basis—includes fasteners, switches, circuit breakers and other generic parts.

"Organizing the purchases in this manner allows our buyers to become specialists in their individual commodities and product lines, and further, allows them to become more knowledgeable about the capabilities of the various individual suppliers," Schulz says.

He also believes that this approach "has led to the development of closer relationships with our suppliers of custom-made products than many other companies might experience, and a concentration of purchase dollars with generic product suppliers to maximize buying power and minimize leadtimes."

—Tom Stundza

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Concentrate on the critical materials

Sustainability of supply is the highest priority for critical-material sourcing at St. Paul, Minn.-based H.B. Fuller, says Latin America sourcing manager Roy Calderón. Direct materials are classified as critical or noncritical depending on their overall impact to the company's revenue as well as potential for growth.
"For example, a material specific to a top seller will be on a list of critical materials," he says. "However, a material we use a lot but only in one product that is not a top contributor to company revenue still might not be critical."

“Sometimes I’m willing to pay more if we have delivery and quality of product guaranteed, and disruption is minimized.” —Roy calderÓn

Calderón says he will go to whatever lengths needed to find the lowest cost source for critical materials, as well as the lowest transportation and delivery cost.

"In those critical materials, I'm willing to invest the time and effort to coordinate logistics, getting it right," he says.

"If I get freight down, reliability up, quality good and consistent, I will work around soft areas in the sourcing strategy for the lowest cost material, lowest cost for transportation and will source anywhere and make the logistics work," he says.

In addition to shorter leadtimes and less required inventory, there's less chance of a supply disruption if the material comes from a geographically close source, so what Calderón might lose in cost per kilogram for a raw material, he makes up for in overall TCO in sourcing from closer and more reliable locations. "A material sourced in Houston might have a lower TCO even though the cost per kilo is lower in Russia," he adds.
If a material is noncritical, Calderón makes reliability, and not necessarily raw material cost, his largest concern, even if this means a higher total cost of ownership. It's a matter of time and convenience. He wants to put the time into the sourcing of the critical materials.

"For a noncritical material, I'm willing to have more TCO if it's available locally," he says. For Calderón, minimizing the time and effort needed to track a low-cost, noncritical material globally is well worth it.

—Maria Varmazis