Focus on Costs: Day 5 – Strategic Procurement

Yesterday we looked at realising Tactical Longer- Term savings from third party costs using a spend segmentation framework called the Kraljic Matrix (see Fig.1 below), a four-box matrix defined by Supply Risk and Size of Spend.

The source of Tactical Longer- Term savings is from spend categories allocated to the Tactical Profit box (lower right in Figure 1.)  We explained why Tactical Longer-Term savings make a significant impact upon costs, but require more effort, skill & experience than Quick Wins, since the spend categories typically must fit in with other functions & processes in your business. 

Strategic Security vs Strategic Critical

Today the focus is upon Strategic Procurement and our focus is on the top two boxes in the matrix, Strategic Security and Strategic Critical. 

These strategic boxes in the matrix contain spend categories which provide significant risk to the ability of a business to conduct its operations should the supply arrangement fail or be withdrawn. These spend categories can irreparably interrupt an organisation’s sales and harpoon its reputation.  They should be treated with utmost care and attention, cost is not the key criteria for judging supply and therefore it is highly unlikely that Quick Wins will be found here… unless of course there is a shock to the operating environment and ‘all bets are off’…. (sound familiar!)

The nature of risk in these boxes takes two forms:

1. A lack of alternative options in the market which reduces or eliminates supplier choice and thus competition.  This is the case for products and services which are “niche” or protected by a patent or license.  Even in conditions where the Size of Spend is low, spend categories which are niche or based on Intellectual Property (IP) e.g. software, carry high Supply Risk.
2. High switching costs for products or services.  High switching costs include the volume of effort required at any one point in time and the duration of applying that effort.  These costs can land across many functions in an organisation.  They also include the cost of investments in capital or new process required to enable use of alternatives.  The quality of expertise and skill to shift from existing supply arrangements to new ones tends to be high as well.

Procurement Strategy for Strategic Spend Categories

Wherever possible organisations should adopt a dynamic approach to de-risk their supply chains by moving spend categories from Strategic to Tactical. In particular, from top right (see Fig.2), in the matrix towards bottom left (Tactical Acquisition) perhaps via bottom right (Tactical Profit) as a staging post.  

This is an Enlightened Procurement approach enabling the simultaneous benefits of lower costs, lower Supply Risk, higher value.  Once repositioned in the matrix and a ‘steady state’ or ‘business as usual’ position is adopted then spend categories must be managed accordingly for the medium and longer terms.  Re-positioning spend categories will be a function of increasing competition and standardisation of specification as discussed yesterday.  

The short-term potential for repositioning from the Strategic boxes can be quite limited but should not be dismissed as ‘being too difficult’.  ‘The nettle needs to be grasped!’ in these spend categories and if the journey looks like a long one, so be it, as ‘Illustration 1’ below shows. The strategies to be adopted over time must always carry the strategic intent set out above.

There are a few recognised strategic approaches to spend categories to handle ‘steady state’ or ‘business as usual’.

High Supply Risk, Low Size of Spend (Top Left Box Fig.1)

Spend categories exhibiting these characteristics tend to involve niche products and services or IP heavy products and services or just ‘Know How’ rich products and services.  If the supplier is strategically aware, they will be exploiting this situation from a price perspective.  In relation to the specific products and services the supplier has a monopoly or near monopoly.

The strategy ‘to keep friends close and your enemies even closer’ applies.  If it is not possible in the medium or longer term (5 years+) to reposition towards the bottom left, then a strategic acquisition or merger or joint venture should be considered to secure access to the goods and services.  

A long-term supply agreement with options to acquire may also suffice if the supplier is prepared to do so.  The goal here will be to achieve security of supply.  If the Size of Spend is sufficiently low, it may be worthwhile considering building a strategic stock such that the supplier’s short-term power to threaten your supply is eroded.

High Risk, High Size of Spend (Top Right Box Fig.1)

Spend categories exhibiting these categories are frequently associated with some level of lock-in whereby the cost of change is too onerous, even in the longer term.

The high Size of Spend is reflective of the importance of the spend category to the ability of an organisation to conduct its business; these spend categories are business critical. This often results from rapid growth and use of a proprietary product or service to help during this period.  It often occurs in regulated industries which are vertically integrated with R&D through to manufacturing and marketing.    

The recognised strategy for dealing with these spend categories, should it not be possible to commoditise them, is Partnership.  Partnership is a much-maligned term, too glibly sprayed around by suppliers looking to establish the perception at least that their future, as a key supplier to your organisation, is secure.  We will deal with the concept of Supplier Perception in more detail later in this series of articles.  

The essence of Partnership though is some level of shared risk such as longer-term supply agreements and collaborative objectives to focus on cost reduction with shared benefits are crucial.  This type of initiative can be extremely rewarding financially but are rarely short term and can involve substantial investment by both parties.  The prevailing conditions and rewards must put skin in the game for both parties.

It’s apt then that we examine this last point in more detail in our next article in which we’ll turn our attention to Power Regimes and Supplier Perception.