Procurement Strategies and

structures

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◦ Introduction
◦ Sourcing Strategies
◦ Supply structure and Design
◦ Supplier Development Strategies

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 3.1. Introduction

Sourcing decisions are high-level, often

strategic decisions that address:
What will use resources within the project
What will be provided by supply chain partners

 Insourcing –
The use of resources within the firm
to provide products or services
Make-or-Buy
 Outsourcing – Decision
The use of supply chain partners
to provide products or services

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 Once the decision has been made to outsource
a product or service, firms will typically use a
process known as strategic sourcing to decide
to whom to outsource the product or service,
as well as the structure and type of
relationship that should be established.

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 A sourcing strategy is typically focused on a
category of products or services, and for that
reason, the strategy is sometimes called a
category strategy.
 A category strategy is a decision process
used to identify which suppliers should
provide a group of products or services, the
form of the contract, the performance
measures used to measure supplier
performance, and the appropriate level of
price, quality, and delivery arrangements that
should be negotiated.

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 A typical category may include many smaller
subcategories. For example, a category
around information technology may include
subcategories such as laptops, desktops,
servers, and keyboards.
 If a firm outsources accounting services, the
category strategy may include tax
accountants and managerial accountants.
 The strategic sourcing decision is typically
made by a cross-functional team, composed
of sourcing professionals, operations
managers, finance, or other stakeholders for
the product or service.

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◦ Reduce the costs of goods and services
◦ Capture resulting savings
◦ Create contractual alliances with
suppliers to support the long-term
goals of the project.
◦ Maintain and improve product quality
◦ Improve business functions
◦ Optimize the total purchasing process

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 Once the team have educated themselves to the
point that they feel they know enough about the
supply market conditions, the forecasted spend,
and the user stakeholder requirements, they are
faced with a different challenge. The team must
convert all of this data into meaningful
knowledge and apply some meaningful tools to
structure the information so that it will render an
effective decision.
 Two tools are most often used in this process: a
portfolio analysis matrix (sometimes called the
strategic sourcing matrix), and the supplier
evaluation scorecard.

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 A firm can organise its supply process using a
variety of sourcing strategies.
 The choice of these different approaches is
contingent upon a variety of factors, such as
the importance of a good or service to the
project and the competitiveness of the supply
marketplace. Project Organizations must also
consider the technical complexity of the
product.

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 To help Buyers formulate appropriate
sourcing and competitive strategies, Kraljic
(1983) developed a simple positioning matrix
based on these factors.
 Virtually every Purchasing department and
consultancy firm uses this matrix today and it
is the main strategic positioning tool for
thinking about supply management
decisions.

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 Kraljic identified four key procurement
approaches or strategies (see fig below).

 He suggested that selecting the best supply

strategy is a function of the level of supply
exposure, technical risk and the strategic
nature of the product or service (i.e. its value
or cost to the buying firm).

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 Portfolio analysis is a tool to structure and
segment the supply base, and is used as a means
of classifying suppliers into one of four types.
The objective is to categorize every purchase or
family of purchases into one of four categories.
The premise of portfolio analysis is that every
purchase or family of purchases can be classified
into one of four categories or quadrants: (1)
Critical, (2) Routine, (3) Leverage, and (4)
Bottleneck

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 By effectively classifying the goods and
services being purchased into one of these
categories, those responsible for proposing a
strategy are able to comprehend the strategic
importance of the item to the business.
 The results of this analysis can then be
compared to the current sourcing strategy for
the category group, and tactics and actions
defined for moving forward.

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 High Leverage : Best Deal Critical: Cooperation
(high profit impact, low supply risk) (high profit impact, high supply risk)
•Unit cost management is important •Customer design or unique
Impact of Business (internal

because of volume usage. specification

•Substitution possible •Supplier technology important
•Competitive supply market with •Changing source of supply difficult
several capable suppliers or costly
•Substitution difficult
issue)

Routine: Efficiency Bottleneck: supply Continuity

(lower profit impact, lower supply (low profit impact, high supply risk)
risk) •Unique specification
•Standard specification or •Supplier’s technology important
“commodity” type items •Production based scarcity due to
•Substitute products readily low demand and/or few sources of
available supply
•Competitive supply market with •Usage fluctuation not routinely
many suppliers. predictable
Low •Potential storage risk

Low Supply risk/supply market complexity (external issues) High

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 Strategy Tactics Actions
Ensure •Decrease •Widen specification
Supply uniquenes •Increase
Continuity s of competition
suppliers •Develop new
•Manage suppliers
supply •Medium-term
contracts
•Attempt competitive
bidding

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Strategy Tactics Actions
Form Increase role •Heavy negotiation
Partnerships of selected •Supplier process
with suppliers management
Suppliers •Prepare contingency
plans
•Analyze
market/competition
•Use functional
specifications

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Strategy Tactics Actions
Maximize •Concentra •Promote competitive
Commerci te business bidding
al •Maintain •Exploit market
Advantag competitio cycles/trends
e n •Procurement
coordination
•Use industry
standards
•Active sourcing

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Strategy Tactics Actions
•Simplify •Increase role •Rationalize supplier
Acquisition of systems base
Process •Reduce •Automate
buying effort requisitioning, e.g., EDI,
credit cards
•Stockless procurement
•Minimize administrative
costs
•Little negotiating

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 The horizontal axis is concerned with the
supply-side risk that occurs due to external
supply market issues and the complexity of
the market.
 Supply Strategists should consider factors
such as power relations, the availability of
supply and substitution possibilities that will
have a fundamental effect on risk.

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 The vertical axis of Kraljic’s matrix is fundamentally
concerned with the impact on profit or the value
obtained from the sourcing group. Whereas the
horizontal axis shows market exposure risks that are
‘external’ to the firm, the impact on business factors
can be thought of as ‘internal’ to the firm.
 Determining what product and service categories fall
into this group is reasonably difficult, owing to the
contradictory nature of the terms on this axis; for
example, a product could be low cost, but high value.

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 The matrix itself forces firms to consider
categories of spend based on their level of
supply market exposure and internal risk and
cost.
 It is worth emphasising at this point that the
matrix does not allow for the positioning of
companies, but rather spend categories. These
categories may well be spread across a range of
suppliers. The model offers buyer firms four
distinct strategies that they can follow:

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 Thisstrategy is aimed at a spend
category known as routine items.
The recommended approach here
is to follow a strategy based on
efficiency.
 This quadrant contains products
or services of low value or cost
and low technical or supply risk.

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 The recommendation is that these should be
sourced from the most efficient suppliers.
 The objective is to pay the most competitive
price for the product, whilst maintaining
delivery and quality standards.
 As switching costs are low and the market is
highly competitive, buyers would negotiate
on price.

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 This strategy is aimed at the spend category
known as bottleneck items. These are items
that can seriously affect the delivery of the
buyer firm’s product or service.
 They tend to be relatively low value but are
relatively rare in terms of the supply market.
A good example of this may be computer
chips.

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 These don’t cost a great deal compared to the
total unit price, but they are essential to the
running of the product.
 Here the strategy is to maintain supply continuity
by, for example, establishing long-term
contracts containing liquidated damages clauses.
 The buyer will tend to focus on total cost rather
than simply on purchase price.

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 This strategy is aimed at the spend category known
as leverage. The focus of this strategy is to obtain the
best deal possible.
 This strategy occurs when the buyer perceives market
exposure to be low yet the cost or value of the item is
high (e.g. foam for car seats at an automotive
assembler).
 The buyer can obtain the best deal by using
‘leverage’ strategies (Porter, 1980) where the buyer
power is high and the supplier power is low.

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 Leveraging involves pulling together a range of
similar products – sometimes the same product
bought at different locations throughout the firm – to
increase contract size and therefore buyer bargaining
power.
 An automotive manufacturer might source two
models of car seat using a single supplier rather than
multiple suppliers.
 This may achieve economies of scale for the buyer,
providing a stronger negotiation position. Firms
pursuing a cost reduction strategy consistently follow
this strategy.

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 This strategy is aimed at the spending category
known as critical. The suggested strategy for
buyers in this quadrant is ‘cooperation’, because
these suppliers are both high risk and can have a
high impact on the buyer firm’s profitability.
 Suppliers that fall into this segment of the model
provide products or services which are
characterised by high supply risk and having a
high impact on the business in terms of value or
cost.

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 Not all project procurements are created
equal. Some purchases are big, others small.
Some are complex, while most are routine.
Some procurements carry high risks, while
others have only minimal or perhaps no risks
at all.
 Some procurements require a major long-
term commitment from both the buyer and
the seller, while other commodities are
immediately available for purchase in the
open market.

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 Question: why might it be a good practice to
place all procurements into generic
categories?
 Answer: because you manage project
procurements differently, according to their
complexity, their risks, their unique
characteristics. Sometimes you must form
project teams to manage the critical buys.

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  One such grouping of project procurements would
create three generic categories, plus two special
relationships as follows:
1. Major (high risk) complexity procurements, the
purchase of something which does not exist,
tailored to the project's unique specification.
These would be considered critical sub-projects.
2. Minor (low risk) complexity procurements, will
often represent large monetary values, but the
commodities exist and will conform to the sellers
existing product specification.

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3. Routine buys of COTS (Commercial Off-The
Shelf) commodities or purchased services.
4. Special procurements: done under corporate
teaming arrangements.
5. Special procurements: to other segments of
the project's company, typically called
interdivisional work.

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(I) Major (high-risk) Complexity Procurements
... to the Buyer's Specification
These procurements are the most
challenging buys for any project to manage.

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 By their natures they typically represent
high risks to the project's technical, quality,
costs, and schedule. They often require the
creation of something new by a seller,
something that doesn't already exist.
 In order to be managed properly these
items require that the project specify
precisely what it needs, typically taking the
form of specifications, drawings, and often
includes a comprehensive statement of
work.

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 Typical characteristics for purchased items in
this category might be:
 a new product or a system, a major new
component, a major structural element, a
design to a performance requirement, project
interface documents, high risks to the overall
project, and often, significant senior
management and even customer oversight.

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 Each quadrant of the Kraljic matrix suggests a
sourcing strategy which in turn dictates a related
sourcing or supply structure.
 It is important to choose the structure that is
suitable for the strategy and the sourcing
category.
 There are four primary sourcing structures that
can be used (with some amount of variation):
single, multiple, delegated and parallel.

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 The complexity of the various sourcing approaches
ranges from the simplest structure, single or sole
sourcing, to the more complex structures of
delegated and parallel sourcing.
 It is the role of the Supply Strategist to decide when
and where to apply each of these structures.
 This decision will be dependent upon the needs and
wants of the firm, the type of relationship desired,
the acceptable level of dependency for both buyer
and supplier and the nature of market-based
competition.

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 This structure characterises a buyer with only one
source of supply for a particular good or service.
It may be the result of a deliberate choice by the
Buyer, perhaps because of the high cost of the
item or its strategic importance to the end
product.
 Alternatively it may occur because the final
customer has explicitly required the firm to work
with a particular sub-supplier’s product in the
completed product.

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 By definition these relationships tend to be
much more long term in focus, allowing firms
to spend time focusing on the development
of the relationship, i.e. a feeling that they are
both committed.

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 Single sourcing

Buyer Supplier 1

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 Multiple sourcing describes securing multiple supply
sources to supply the product or service. The Buyer
will have a range of suppliers to choose from, and will
carefully balance capacity constraints with individual
supplier performance when placing orders.
 The old adage, ‘don’t put all your eggs in one
basket’, is often used to describe this supply
structure. Buyers will also frequently use so-called
‘Dutch auctions’ to play suppliers off against each
other to achieve the best price.

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 This is often viewed as an adversarial approach
and prevails in marketplaces where there are a
high degree of competition, low switching costs
and low levels of technological competence.
 This structure would tend to appear in the
‘Routine’ quadrant of the strategic positioning
matrix and applies to the low-level type of
purchase. Buyers using this structure will tend to
focus on purchase price rather than total cost.

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 Multiple Sourcing
S1
S2

Buyer

S3

S4

S6 S5

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 Delegated sourcing strategies have grown in
popularity since the mid-1990s, across a wide range
of industries.
 This sourcing configuration involves making one
supplier responsible for the delivery of an entire sub-
assembly as opposed to an individual part. The
customer delegates authority to a key supplier who
becomes known as a first-tier supplier.
 The customer’s objective is to work with one
supplier; the supplier in turn works with all other
suppliers that provide parts to complete the product.

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 Delegated sourcing has a number of advantages
for customer and supplier.
 Focusing on one supplier enables the Buyer to
work closely with that one supply source to
reduce day-to-day transaction costs.
 The increased dependence on one supplier
results in the buyer and supplier exchanging
more detailed information, particularly around
cost issues.

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 The process of delegated sourcing tends to create
‘mega’ suppliers that may evolve into a potential
threat. Suppliers can become very powerful and exert
their power over the buyer, usually in the form of
price increases.
 It is vitally important for the buyer to understand and
manage all the dependencies when these
arrangements are put in place. This strategy is often
found initially in the ‘leverage’ quadrant of the
matrix, moving to ‘critical’ quadrant in the medium
term due to the high dependency and high switching
costs.

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 Delegated Sourcing: Buyer

S3

S4
S1

S2

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 The concept of parallel sourcing is a little more
complex. Richardson (1993) developed the concept
using game theory to optimise supply for the buyer.
 Richardson suggests that the supply structure
provides the buyer with the advantages of sole and
multiple sourcing whilst excluding the disadvantages
of these strategies.
 Parallel sourcing allows the buying firm to work on a
single or sole-sourced basis with each component
supplier within a product group while maintaining a
multiple-sourced relationship across product groups.

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 Sourcing structures provide the means for
implementing supply strategy. As such, they
must be aligned to the requirements of the
organisation.
 For these strategies to work effectively they
need to sit within an appropriate
organisational structure and be measured in
the correct manner.

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 Model 1
Model 2 Buyer

S2
CA
S1
CA
S4 S3
CB C
B
 CA- component A, CB- component B

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 Fig.
Leverage Critical
Delegated All except Multiple
Structure structure
 The detail Read more ,,,,,,,,,,,,,,

Routine Bottleneck
Multiple Structure Single Structure

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 Read : supplier Development processes and
strategies ….from Cousins Paul etal….from
page 75-88.
 NB all specific readings would be included in
the final exam.

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