MAASTRICHT SCHOOL OF MANAGEMENT. Application of Kraljic s Purchasing Portfolio Matrix in an Undeveloped Logistics Infrastructure

Transcription

1 MAASTRICHT SCHOOL OF MANAGEMENT Application of Kraljic s Purchasing Portfolio Matrix in an Undeveloped Logistics Infrastructure - The Staatsolie Suriname Case - By Dennis R. Mac Donald (Suriname) This paper was submitted in partial fulfillment of the requirements for the Masters of Business Administration (MBA) degree at the Maastricht School of Management (MSM), Maastricht, the Netherlands, November 2006.

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3 ACKNOWLEDGEMENTS This research was done with the support of some individuals to whom I am very grateful. First of all, I want to express my deepest gratitude to my thesis supervisor, dr. Cees J. Gelderman who helped me through the study with his valuable remarks, encouragement and inspiration. Thank you Cees it was an honor to have you as my supervisor and for always being available to listen to me and to guide me to the right direction. Secondly, special thanks go to all my MBA-intake-II fellow students, especially my thesis team members Dynaida, Juliette, Meryl and Clifton for their stimulation, valuable remarks and instructions during the several stages of my research. Furthermore, I would like to express my gratitude to the research team members at Staatsolie for their substantial support to this research project. In particular, I would like to thank Peter, Robbin and Kenneth, also many thanks to my colleague, Duncan for his inspiration and useful instructions. Thanks to Hans Lim A Po and Ollye Chin A Sen and their administrative supporting team at the FHR Lim A Po Institute for making this all possible and manageable. I would also like to thank Iwan Kortram, Finance Director of Staatsolie, for giving me the opportunity to follow the program for my future career development. Last but not least, I would like to thank my family, Hortence, Arusha, Xavaira and Silvio for their inspiration and patience during this process. Dennis R. Mac Donald Paramaribo, November 2006 i

4 ABSTRACT Portfolio models in purchasing have received large-scale recognition and have gained an increased degree of adoption, especially in Western Europe (Gelderman, 2003). Kraljic (1983) introduced the first comprehensive portfolio approach for purchasing and supply management. This approach includes the construction of a portfolio matrix that classifies products on the basis of two dimensions: profit impact and supply risk. Purchasing portfolio models, including Kraljic s, have been developed from a point of view of a well-developed industrialized logistics infrastructure. The buyer-supplier relationships of companies situated in remote areas with an undeveloped logistics infrastructure, however, are subject to, and often defined by, those (poor) logistics infrastructures. A poor logistics infrastructure will have an impact on the supply risk, but the Kraljic approach does not explicitly deal with issues of logistics and (a poor) infrastructure. This led to the following problem statement, How may Kraljic s purchasing portfolio model be used under conditions of remote suppliers and an undeveloped logistics infrastructure?. To deal with this problem statement the following four research questions were formulated: 1. Which characteristics of remoteness should be considered when adapting the Kraljic model for use in remote areas? 2. Which adaptations to the dimensions of the Kraljic matrix are required, when using the Kraljic approach under conditions of remote suppliers and an undeveloped logistics infrastructure? 3. Which adaptations to the categories of the Kraljic matrix are required when using the Kraljic approach under conditions of remote suppliers and an undeveloped logistics infrastructure? 4. Which adaptations to the strategic recommendations of the Kraljic matrix are required when using the Kraljic approach under conditions of remote suppliers and an undeveloped logistics infrastructure? The research method started with a literature review that included the research of many subject areas that are related to purchasing, such as, ABC-analysis, commodity analysis, purchasing portfolio models, and logistics as well as literature review on the characteristics of remote environments. The information gained from the literature review formed a framework for the adaptation of the Kraljic purchasing portfolio matrix for remote environments. In this study remoteness or a remote environment is assumed to be geographically distant suppliers where the buyer is located in an environment of poor or undeveloped logistics infrastructure, often ii

5 developing countries (Caddick and Dale, 1987 and Fawcett, 2000). The characteristics to consider for a remote environment are mainly linked to logistical problems and a lack of understanding of the importance of logistics for the supply chain. The answer to the second research question reveals that the dimension of profit impact is less dependent on the location of the business; therefore this dimension does not need to be adapted for a remote environment, while for the supply risk several factors have been identified that could have an impact on the supply risk dimension. With respect to adaptations to the categories of the Kraljic matrix, no need was found to adapt these for remote environments. Therefore, the original four categories, bottleneck, non-critical, leverage, and strategic quadrants, can be used for remote environments. This study resulted in the addition of two strategic recommendations to the Kraljic matrix: one strategy is the use of remote purchasing agents and the other is the use of an advanced logistics management system between buyer and supplier. Both these strategies are aimed at reducing the supply risk for remote environments. In conjunction with the result from the literature study an action research method was used to apply the adapted Kraljic matrix for the State Oil Company of Suriname, Staatsolie, a company that has to do business within a remote environment. In order to fill in the matrix and to arrive at the strategic recommendations, a five-step approach as outlined by Gelderman (2003) was used. The use of this methodology upon a sample of 44 materials or classes of materials at Staatsolie resulted in a current purchasing portfolio matrix with three main clusters in respectively the non-critical, the leverage and the strategic quadrant. The portfolio matrix demonstrates that Staatsolie is facing an extreme supply risk with a substantial part of its items that have a high profit impact, as a result of which it depends only on one or a limited amount of suppliers for these materials. Through application of differentiated purchasing strategies, the supply risk can be reduced, resulting in a much better negotiating position for Staatsolie. The reduced supply risk will protect Staatsolie against disastrous supply interruptions and unplanned shutdowns of its operations. Due to the stronger negotiating position Staatsolie can make the most of their potential buying power. This study made clear that for remote environments adaptations have to be made to the Kraljic matrix at the supply risk dimension and to the strategic recommendations. Further research is recommended to gain a deeper understanding of the impact of remote aspects on the Kraljic matrix. iii

6 ABBREVIATIONS BCG E&P HRM HSE ISO LDC MCC MMBLS MW PEP PPP Boston Consulting Group Exploration & Production Human Resources Management Health Safety and Environment International Organization for Standardization Less Developed Countries Maintenance Control Center Million Barrels Mega Watt Production Expansion Program Purchasing Policy and Procedures iv

7 CONTENT ACKNOWLEDGEMENTS...i ABSTRACT...ii ABBREVIATIONS...iv CHAPTER 1. INTRODUCTION...1 Section 1.1. General...1 Section 1.2. Problem Statement and research questions...2 Section 1.3. Research methods...3 Section 1.4. Scope and Limitations...4 Section 1.5. Chapter Overview...4 Section 1.6. Summary...4 CHAPTER 2. LITERATURE REVIEW...5 Section 2.1. From Pareto to Kraljic...5 Section 2.2. The Kraljic Purchasing Portfolio Matrix...8 Section 2.3. Criticisms and Support of the Kraljic Matrix...16 Section 2.4. Remoteness...19 Section 2.5. Summary...21 CHAPTER 3. THE KRALJIC MATRIX ADAPTED TO REMOTENESS...22 Section 3.1. Adaptations to the Dimensions...22 Section 3.2. Adaptations to the Categories...24 Section 3.3. Impact on the strategic recommendations...25 Section 3.4. Summary...27 CHAPTER 4. PORTFOLIO ANALYSIS WITH THE KRALJIC MATRIX...28 Section 4.1. Methodology...28 Section 4.2. Summary...31 CHAPTER 5. BUSINESS CONTEXT...33 Section 5.1. Company description...33 Section 5.2. Purchasing Function within Staatsolie...34 Section 5.3. Inventory Management...35 Section 5.4. Summary...36 CHAPTER 6. RESEARCH RESULTS...38 Section 6.1. Preparation...38 Section 6.2. Designing and filling in the matrix...38 Section 6.3. Interpretation of the results...41 Section 6.4. Defining strategic directions...44 Section 6.5. Summary...49 v

8 CHAPTER 7. CONCLUSIONS AND RECOMMENDATIONS...50 Section 7.1. Conclusions...50 Section 7.2. Recommendations...52 APPENDIX 1: Stages of Purchasing Sophistication, Kraljic APPENDIX 2: The Purchasing Portfolio Matrix, Kraljic APPENDIX 3: Organization Structure Staatsolie...55 APPENDIX 4: Organization Structure Procurement Division Staatsolie...56 APPENDIX 5: Customer Classes for Materials...57 APPENDIX 6: Commodity Groups (short list)...58 APPENDIX 7: Material Classes and Products for Supply Risk...59 APPENDIX 8: Staatsolie s Purchasing Portfolio Matrix (Linear Scale)...60 APPENDIX 9: Staatsolie s Purchasing Portfolio Matrix (Logarithmic Scale)...61 APPENDIX 10: Strategic Recommendation for Staatsolie Purchasing Portfolio...62 APPENDIX 11: Staatsolie s Improved Purchasing Portfolio Matrix...63 BIBLIOGRAPHY:...64 vi

9 CHAPTER 1. INTRODUCTION Section 1.1. General Portfolio models have been used in strategic planning and marketing, but their application to the field of purchasing has been limited. This, however, appears to be changing as procurement management is viewed more and more as being of strategic importance (Nellore and Söderquist, 2000). According to Kraljic (1983), instead of simply monitoring current developments, management must learn to use these developments to its own advantage. This calls for nothing less than a total change of perspective: from purchasing which is an operational function, to supply management which is strategic. The introduction of the Kraljic portfolio approach can be considered a major breakthrough in the development of professional purchasing (Gelderman and Van Weele, 2003). Kraljic s approach has inspired many academics to undertake further research into purchasing portfolio models (Caniëls and Gelderman, 2005). Obviously, not all products and not all buyer-supplier relationships are to be managed in the same manner. In general, purchasing portfolio models aim at developing differentiated purchasing and supplier strategies. Kraljic (1983) introduced the first comprehensive portfolio approach for purchasing and supply management. Shortly after the oil crisis in 1973, he posited that purchasing must become supply management, advising companies to progress toward more effective supply management. Kraljic accompanied this advice with a practical portfolio tool for shaping the supply strategy. Kraljic s categories and strategies recommendations matrix was developed for BASF, a European chemical multinational, in the early seventies, around 1973, Kraljic (1983) made a reasonable case for the usefulness of his portfolio approach by describing the experiences of four large industrial companies. More recent empirical studies have corroborated the usefulness of the matrix in practice (e.g. Carter, 1997; Lilliecreutz and Ydreskog, 1999; Gelderman and Van Weele, 2003 and 2005; Johnson and Wagner, 2004). However, all of these studies have been carried out in companies that are located in developed countries under conditions of a well-developed infrastructure. 1

10 In many developing and former state-regulated countries the logistic infrastructure is poor, customs and regulations unclear and inefficient, the logistics supply market underdeveloped, and the risk for crime high (Andersson and Norrman, 2002). These conditions result in relatively high supply risks, as the number of trustworthy or capable partners is low and the few existing ones enjoy a better negotiating position. Obviously, for companies located in these environments it is more difficult and more costly to develop close, productive relationships with their geographically distant suppliers. The challenge begins with identifying and qualifying capable suppliers in regions of the world where buyers have little experience (Fawcett, 2000). However, it remains unclear whether the Kraljic matrix could be applied under such remote conditions. The concept remote conditions within this study refers to a situation where a company is operating in a country or region where the logistics infrastructure for the procurement of materials is limited or not well developed. Section 1.2. Problem Statement and research questions Purchasing portfolio models, including Kraljic s, have been developed from a point of view of welldeveloped industrialized logistics infrastructures. The buyer-supplier relationships of companies situated in remote areas with an undeveloped logistics infrastructure, however, are subject to, and often defined by, those (poor) logistics infrastructures. Poor logistics infrastructures will influence lead times and therefore will impact the supply risk. It is clear that an undeveloped logistics infrastructure should play a significant part in the Kraljic approach. However, the Kraljic approach does not explicitly deal with issues of logistics and (a poor) infrastructure. This gave rise to the problem statement for this study: How may Kraljic s purchasing portfolio model be used under conditions of remote suppliers and an undeveloped logistics infrastructure? In order to deal with the problem statement, the following research questions were answered by this study: 1. Which characteristics of remoteness should be considered when adapting the Kraljic model for use in remote areas? 2. Which adaptations to the dimensions of the Kraljic matrix are required, when using the Kraljic approach under conditions of remote suppliers and an undeveloped logistics infrastructure? 2

11 3. Which adaptations to the categories of the Kraljic matrix are required when using the Kraljic approach under conditions of remote suppliers and an undeveloped logistics infrastructure? 4. Which adaptations to the strategic recommendations of the Kraljic matrix are required when using the Kraljic approach under conditions of remote suppliers and an undeveloped logistics infrastructure? Section 1.3. Research methods The main objective of this research paper was to identify and describe the application of the Kraljic purchasing portfolio model to remote areas. To establish a theoretical framework a literature research was conducted. Based on the literature study, a revised version of the Kraljic approach was developed, including adjusted dimensions (factors), and strategic recommendations. This new purchasing portfolio model was tested and refined by means of action research in which the new model was used in practice. The model was tested and evaluated in a location where the logistics infrastructure is relatively poor, namely at the State Oil Company of Suriname, Staatsolie. Figure 1.1 provides an overview of the research model. Purchasing Portfolio Theory Expert Interviews Logistics Management Theory Analysis Adaptation to Kraljic Model for Remote Areas Case Study Conclusions and Recommendations Supply Management Remote Areas Figure 1.1. Research Model 3

12 Section 1.4. Scope and Limitations The application of the adjusted Kraljic model for remote areas was validated for only one company. Within the scope of this research paper no attempt was made to validate the framework through a broader audience. The results of the study should not, therefore, be extrapolated to other companies and other industries. Section 1.5. Chapter Overview This research paper is organized as follows: Chapter one is an introduction of the research subject regarding purchasing portfolio models and the characteristics of remote areas. Chapter two provides an overview of the literature research pertaining to purchasing portfolio models. In this chapter a detailed overview is given of the use of purchasing portfolio models to define the different strategies in buyer supplier relations. In addition, the Kraljic purchasing portfolio matrix is discussed in detail and some logistics constraints for remote areas are outlined. Chapter three supplies an overview of the adaptations of the Kraljic matrix to remote environments Chapter four supplies an overview of the research methodology used. Chapter five describes the business context within which the study was carried out. Chapter six expounds upon the findings and the analysis Chapter seven provides the conclusion and recommendations. Section 1.6. Summary The present chapter demonstrated the need for adaptation of the Kraljic purchasing portfolio model for use under conditions of remote suppliers and an undeveloped logistics infrastructure. The process through which this paper attempted to arrive at such a model was laid down. 4

13 CHAPTER 2. LITERATURE REVIEW Section 2.1. From Pareto to Kraljic Pareto Analysis For a long while the ABC-analysis or Pareto-analysis was the only tool available for differentiating between important and less important purchases (Gelderman, 2005). In a Pareto curve items are placed into one of three classes according to the cumulative number of purchasing orders and their cumulative value. The A-category contains 20% of the number of orders, which typically accounts for 80% of the total value. The B-category contains 30% of the items accounting for less than 20% of the spending. The remaining 50% of the items accounts for less then 2% of the total spending of the C-category. ABC-analysis is considered to be helpful in situations where the majority of purchases spend is generated by a limited number of material categories. ABC-analysis is usually applied to the financial value of the purchasing portfolio, essentially a volume characteristic. Another volume characteristic is the number of parts, especially important in discrete production. Instead of a volume dimension, it is also possible to use the cumulative number of supplies. This classification differentiates suppliers with significant spend from the mass suppliers with only small purchase volumes (Hartmann et al., 2002). ABC-analysis concentrates on the financial value of items and ignores the cost of poor quality (Burt, 1989), performance risk, social risk and other components (Hartmann et al., 2002). In addition, the ABC-analysis fails to discriminate between the methods which should be used to obtain different item categories (Steel and Court, 1996). ABC-analysis does not recommend specific strategies for each category, it merely provides information on the concentration of purchase spend. It is a classification tool, not a portfolio model, since it does not provide (differentiated) purchasing and supplier strategies Commodity Analysis Commodity analysis is another example of a classification tool in purchasing (Gelderman, 2005). This type of analysis divides the total purchasing volume in percentages for all combinations of 5

14 product groups and principal users. It reveals key users and the commodities that are most important to them (Bauer, 1977). Commodity analysis identifies critical procurement areas, is helpful for setting priorities, and provides recommendations with respect to the organization of purchasing (assignment of responsibilities and centralized or decentralized purchasing). Just as in ABC-analysis, commodity analysis should be classified as a classification tool, since it too does not provide (differentiated) purchasing and supplier strategies. They are both examples of a spend analysis which is limited to the classification of the items and suppliers according to their financial value Portfolio Analysis A portfolio refers to a collection of related items. The portfolio concept stresses the importance of the whole rather than the parts. It reflects the importance for balance in a collection on individual elements. As a consequence it allows for differentiation and diversification, in our aim for balance and an optimal use of limited resources. The portfolio concept has it roots in financial investments in the 1950s. For business purposes, portfolio approaches haven been developed for applications in investment theory, strategic management, marketing, and purchasing management. In general, the portfolio concept focuses on the interdependencies among management decisions and emphasizes an integrated approach (Turnbull, 1990). According to Ellram and Olson (1997), portfolio models have primarily been used in strategic decision-making to support resource allocation decisions among strategic business units. Perhaps the most used, misused and discussed portfolio model is the Boston Consulting Group s (BCG) growth/share matrix. Portfolio models have been used in strategic planning and marketing, but their application to the field of purchasing has been limited. This seems to be changing, however, as procurement management has become more strategic (Nellore and Söderquist, 2000). 6

15 Kraljic s Comprehensive Portfolio Approach Kraljic (1983) introduced the first comprehensive portfolio approach for purchasing and supply management. This approach includes the construction of a portfolio matrix that classifies products on the basis of two dimensions: profit impact and supply risk with both a low and high end. The result is a 2x2 matrix and a classification in four categories, figure 2.1 below. With the help of this matrix, professional purchasers can differentiate between the various items and supplier relations and choose strategies that are appropriate for each category, thereby effectively managing suppliers (Nellore and Söderquist, 2000). Quite a number of scholars have introduced variations on the original Kraljic matrix (e.g. Elliot-Shircore and Steele, 1985; Syson, 1992; Evans and Hadeler, 1994; Ellram and Olsen, 1997; Gelderman, 2000; Van Weele, 2002). However, the proposed matrices are very similar to the Kraljic matrix; the models employ practically the same dimensions, the same categories and the same recommendations (Gelderman and Van Weele, 2005). Exploit Balance Profit Impact Low High Leverage Non-Critical Strategic Bottleneck Diversify Low Supply Risk High Figure 2.1. Kraljic s categories and strategic recommendations matrix, source Kraljic (1983) It is fair to conclude that the Kraljic matrix has become the standard in the field of purchasing portfolio models (Gelderman, 2003). 7

16 In the course of time the Kraljic approach entered many textbooks on purchasing and supply management. Purchasing portfolio models have gained ground in both research and practice (Nellore and Söderquist, 2000). The Kraljic portfolio approach can be considered an important breakthrough in the development of theory in the field of purchasing and supply management. Syson (1992) characterized it as a powerful tool to be used for diagnostic and prescriptive purposes and that goes far beyond the wellknown, rather simplistic ABC-analysis. Commenting on purchasing management Ellram and Olson (1997), stated that portfolio models could be used to improve the allocation of scarce resources by being one method of identifying which groups of products, suppliers or relationships warrant greater attention than others. Section 2.2. The Kraljic Purchasing Portfolio Matrix Section General Kraljic (1983) advised managers to guard their firms against damaging supply interruptions and to deal with continuous technological change and economic growth. In his seminal paper he advised companies to establish more effective supply management. He proclaimed, purchasing must become supply management (Kraljic 1983, p. 109). He presented a figure as Exhibit I (see Appendix 1) that classified the stages of purchasing sophistication within companies. This figure identified four stages: (1) purchasing management, (2) materials management, (3) sourcing management, and (4) supply management. Kraljic (1983, p. 111) further argued that supply management is particularly relevant when the supply market is complex and the importance of purchasing is high. Specifically for the fourth stage of purchasing sophistication, supply management, Kraljic (1983) proposed a four-phase framework for developing supply strategies for single products or product groups. In the first phase, a company is to classify all its purchased products depending on the associated profit impact and supply risk into one of four categories: Strategic, Bottleneck, Non- Critical, and Leverage. Subsequently, the company should weigh the bargaining power of its suppliers against its own power. At the third phase, the company should position the products that 8

17 were identified in the first phase as strategic (high profit impact and high supply risk), in a portfolio matrix. Finally, depending on the company s own strength and the strength of the supply market, the company is to develop purchasing strategies and action plans for products labeled strategic. Three general purchasing strategies are recommended: exploitation, in the case of buyer dominance; balance, in the case of a balanced relationship; and diversification, in the case of supplier dominance. In his 1983 article Kraljic introduced a nine-block Purchasing Portfolio Matrix to be used for strategic items as Exhibit IV (see Appendix 2). It should be noted that Kraljic focuses on strategic products; for the other item categories, bottleneck, non-critical, and leverage, Kraljic merely formulated a number of main tasks. Other scholars have filled this gap (e.g. Van Weele, 2002; Syson, 1992; Elliott-Shircore and Steele, 1985). They refined the matrix and elaborated on the 'main tasks' for bottleneck, non-critical and leverage items. In addition, they formulated strategic recommendations, resulting in an overall purchasing strategy recommendation for each portfolio quadrant (see figure 2.2). This refined matrix is commonly referred to as Kraljic s Purchasing Portfolio Matrix (e.g. Ellram and Olsen, 1997; Lilliecreutz and Ydreskog, 1999; Van Weele, 2002; Gelderman, 2003), not to be confused with his original nine-block model. With the help of the refined Kraljic Purchasing Portfolio Matrix, professional purchasers can differentiate between the various supplier relations and choose strategies that are appropriate for each category and thereby effectively manage suppliers (Nellore and Söderquist, 2000). Profit Impact Exploit purchasing power Ensure Efficient processing Low High Leverage Non-Critical Strategic Bottleneck Form partnerships Assure supply Low Supply Risk High Figure 2.2: The Kraljic Purchasing Portfolio Matrix (modified from Kraljic, 1983, p. 111) 9

18 Gelderman (2003), has discussed and evaluated Kraljic approach on: dimensions; categories; and strategic recommendations. This is described in the following sections Dimensions a. Theoretical foundations of the Kraljic Purchasing Portfolio Matrix A generally accepted view on the purchasing function is that it should prevent disruptions in production of other activities. Some authors describe the general objectives of purchasing and supply management in terms of the five rights which professional purchasing should achieve in the acquisition of materials: the right quality, from the right supplier, in the right quantity, at the right time, and at the right place (Dobler and Burt, 1996). The right supply, the right time and the right place refer to logistics aspects of supply management. Products should be bought for the right price, which refers to the commercial and financial aspects of purchasing. An attractive feature of the portfolio approach is that it encompasses two key variables with respect to these crucial aspects: profit impact is linked to the commercial requirements, supply risk is related to logistics issues, amongst others. However, it is not clear why only these particular dimensions are selected for use in Kraljic s portfolio approach. Gelderman (2003) concluded that Kraljic s article does not provide any reference to a theoretical foundation or comprehensive perspective. In his article Kraljic offers a basic tool for purchasing management, although it is without any reference to literature or documented evidence. The tool is developed for practical use. The combination of the two dimensions is to minimize supply vulnerability and make the most of potential buying power (Kraljic, 1983: 112). b. Measurement issues In general, decisions based on portfolio models are proven to be sensitive to the choice of dimensions, factors and weights. There is a demarcation problem with respect to the measurement of key variables. What is the exact distinction between high and low supply risk. Ellram and Olson (1997) emphasized that the weighting of each factor is the most important of the implementation process, but at the same time very subjective. De Boer (1997) suggested a fully customized approach: organizations should determine their own criteria as well as their own specific threshold values. Nellore and Söderquist (2000) pointed out that there is a risk that the variables used in portfolio analysis might not be accurate proxies for the dimensions they are suppose to measure. 10

19 c. Confusion with the first matrix dimensions According to Gelderman (2003) many authors refer to the Kraljic approach as being a single portfolio matrix, based on the dimensions strategic importance (or just importance ) and complexity of the supply market, see for instance Kamann (2000), Ellram and Olson (1997), and Lilliecreutz and Ydreskog (1999). Kraljic himself is partly responsible for this confusion over the names of the dimensions Gelderman (2003). Before introducing the portfolio approach, Kraljic (1983: 111) presented a figure in as Exhibit 1 (see Appendix 1) that uses importance of purchasing and complexity of supply market as dimensions. However, this figure is not part of the portfolio approach, it does not classify product categories, nor does it provide strategic recommendations. The name of the picture clarifies the purpose of the matrix; the stages of purchasing sophistication Categories a. The focus on one category Kraljic is concerned about disastrous supply disruptions of vital materials. From this perspective it is logical that Kraljic should focus on strategic items with a high profit impact and a high supply risk. The second matrix, presented by Kraljic as Exhibit IV (see Appendix 2), only applies to strategic items. For the other categories a list is provided merely of main tasks, the required information and the advised decision level. The conclusion is that these categories are disregarded. An elaboration for strategies for bottleneck, leverage and non-critical items was offered by Van Weele in b. The role of power and dependence The fundamental assumption of portfolio models seems to be that differences in power and dependence between buyer and supplier exist (Caniëls and Gelderman, 2005). However, Kraljic s approach does not explicitly deal with issues of power and dependence. Some of the strategic recommendations obviously refer to prevailing power structure ( exploitation of power ), others do not. In Kraljic s first matrix it is not clear in what way profit impact and supply risk are related to the relative power position of the buying company. Presumably, the buyer is more powerful than the supplier in the case of leverage items, while the opposite might be true for bottleneck items. In the second matrix, for the strategic item categories, the role of power is more clearly defined; a buyer-supplier relationship can be balanced, buyer-dominated or supplier-dominated. The Kraljic 11

20 approach deals in a rather implicit way with issues of power and dependence. The application implies dealing with two matrices without being clear about the role of power and dependence Strategic Recommendations (a) The Suppliers side The Kraljic approach does not explicitly take into account the possible strategies and reactions of suppliers (Kamann, 2000). Nellore and Söderquist (2000) confirmed that it is imperative for any portfolio used to indicate the characteristics of the supplier with regard to the specification generation, the required relationship and required type of specification for a given component. Unquestionably, the supplier s side should be included in any strategic thinking in the field of purchasing and supply management. Different solutions have been proposed for this issue, although it should be said that the Kraljic approach does not imply the neglect on the supplier s side. The impression might be nourished by Kraljic s focus on supply vulnerability, threats of material scarcity and the situation on supply markets (Kraljic, 1983:109). Lilliecreutz and Ydreskog (1999) proposed an additional evaluation of suppliers according to three dimensions: performance assessment, relation characteristics and network position. The most appropriate approach to adopt with each supplier can be determined by combining the assessment of the supplier s view with the own purchasing Kraljic matrix. For example, a product could be termed a strategic or bottleneck item from a purchasing perspective, but the account categorized by the supplier as nuisance or exploitable; any aggressive or confrontational behaviour could result in the supplier withdrawing from the situation, leaving the buying company with a serious problem. Alternatively, should a product be strategic in the Kraljic matrix and also be core for the supplier, there will be possibilities in forming close relationships and a partnership. (b) Influencing the power balance: dynamics in the matrix Lilliecreutz and Ydreskog (1999) stated: strategies that are based solely on Kraljic s matrix lack the dynamics of the power that the suppliers can obtain. They too stressed the importance of taking the supplier s situation into account. Kempeners and van Weele (1997) pointed at the natural conflict of interests in buyer-supplier relationships. Both are likely to prefer a dominant power position due to the attached benefits. As a result, positions in the Kraljic matrix will always be amendable to the dynamics of buyer-seller relationships. Parties are inclined to seek possibilities for influencing their relatively powerful position. 12

21 (c) The nature of strategic recommendations Gelderman (2003) argued that the strategic recommendations in the Kraljic matrix are quite reactive in nature. They react and adapt to the prevailing structure of power in buyer-supplier relationships. It is not clear if and how other positions in the matrix are to be pursued through the implementation of the recommended main tasks. However, Kraljic s Exhibit IV Purchasing Portfolio Matrix for strategic items is especially designed to develop counter-strategies vis-à-vis key suppliers (Kraljic, 1983). By plotting the buying strengths against the strengths of the supply market, three basic power positions are identified and associated with three different supplier s strategies: balance, exploit and diversify. It should be noted, however, that the strategies are rather generic by nature, providing only rough indications for the most appropriate suppliers strategies. Discussing Kraljic, most publications are limited to his figure with stages of purchasing sophistication shown in his article as Exhibit I in Appendix 1 with the well-known categories: strategic, leverage, noncritical and bottleneck. It might be assumed that all strategic products are to be managed by means of (strategic) partnership. Looking at Kraljic s Purchasing Portfolio Matrix for strategic items in Appendix 2, we must conclude that this was certainly not Kraljic s intention. Section The Kraljic Matrix with its Strategic Directions A recent study by Gelderman and Van Weele (2003) paid attention to the experience of purchasing professionals with the use of the portfolio matrix in practice. On the basis of three in-depth case studies they found that practitioners distinguish between several separate purchasing strategies within each portfolio quadrant. Some of these strategies focused on keeping the current position in the quadrant, while other strategies were directed towards moving to another position. The case studies revealed that, in addition to Kraljic's theory, experienced practitioners were very aware of the different choices within each quadrant. Based on the interviews and the overview of selected strategies, it was concluded that for each category two different kinds of strategic directions could be distinguished: 1. actions to hold the same positions in the matrix, and 2. actions to pursue other positions in the matrix. Holding on to a position implicitly means that current circumstances are taken for granted. Gelderman and Van Weele (2003) observed that a position in the matrix could be accepted for different reasons, sometimes positive, sometimes referring to a negative choice. A position might be preferred because a firm is convinced that it is the best position for a certain item. In other cases a 13

22 position might be accepted, because there are no realistic possibilities for change. The first type of strategy is of a more active, radical nature. When possible and desirable, other positions in the matrix are identified and pursued. Figure 2.3 gives an overview of strategic directions for all categories. If we take a look at the bottleneck and strategic quadrant at the right side of the matrix, those movements that reduce the supply risk are pursued. In terms of the matrix, this means moving to the left. Non-critical items are moved upwards; leverage items could be exchanged for strategic positions. Exploit buying power ( partner of convenience ) Develop a strategic partnership Terminate partnership, find new supplier Accept the locked-in partnership Maintain strategic partnership Profit Impact Low High 3 4 Leverage Strategic Non-critical Bottleneck Low Supply Risk Individual ordering, pursue Efficient processing Pooling of requirements High Reduce dependence and risk, Find other solutions Accept the dependence, reduce the negative consequences Fig The Kraljic Purchasing Portfolio Matrix with Strategic Directions for all categories Source: Gelderman and Van Weele (2003) The strategic positions and directions as illustrated in figure 1 can, according to Gelderman and van Weele (2003), be elaborated as follows: 14

23 Bottleneck items (1) Moving to another position: decomplex the product, find a new supplier Bottleneck items are by definition of low value and high risk. It should be interesting enough, especially from an economic point of view, to search for other solutions. The solutions must lead to a lower level of supply risk and a lower level of dependency on a supplier. This means shift towards the non-critical quadrant. (2) Holding the position: accept the dependency on a supplier, assurance of supply If no other options are feasible, the position remains the same. Non-critical items (3) Moving to another position: pooling of requirements Preferably, non-critical items are put together in large quantities, increasing the buying power of the firm. If necessary, a process of standardization is pursued. The strategic direction is in all cases towards the leverage quadrant, resulting in lower direct and indirect purchasing costs. (4) Holding the position: individual ordering efficient processing Whenever it is not possible to combine the purchasing requirements, the only remaining option is some type of individual ordering. The purchasing strategy is aimed at reducing the administrative costs which are connected to administrative activities. Leverage items (5) Holding position: exploit buying power, maintain a partnership of convenience This generally preferred leverage position can be used for a rather aggressive supplier management. Competitive bidding and short-term contracts are feasible options to exploit the leverage position. (6) Moving to another position: develop a strategic partnership Exceptionally, the leverage position is abandoned in search for a more strategic partnership with a supplier. A cooperative strategy is only pursued, if the supplier involved is willing and capable of contributing to the competitive advantage of the firm. Such a role is only feasible for technologically advanced suppliers. 15

24 Strategic items (7) Holding the position: maintain a strategic partnership Long-term relationships with key suppliers should always contribute to the competitive advantage of the firm. Such relationships include mutual trust, mutual commitment, and an open exchange of information. A successful partnership can be very valuable for both parties. (8) Holding the position: accept a locked-in partnership A position in the strategic quadrant may be due to not chosen, unfavorable conditions (e.g. patents, monopoly, high switching costs). These circumstances produce an involuntary stay at the strategic quadrant. (9) Moving to another position: terminate a partnership, find a new supplier A supplier s performance may become unacceptable and incorrigible. The firm will have to search, develop and contract another supplier, while bringing the relationship with the non-performing supplier to an end. Section 2.3. Criticisms and Support of the Kraljic Matrix In contrast to the growing acceptance and usage, purchasing portfolio models have become the target of severe criticism (Gelderman and Van Weele 2005). Some argue that the complexity of business decisions does not allow for just simple recommendations. Kraljic (1983) made a reasonable case for the usefulness of the portfolio approach by describing the experiences of four large industrial companies. Section Support of the Kraljic Matrix Some case studies indicted that a purchasing portfolio model is a powerful tool for: Coordinating the sourcing patterns of fairly autonomous strategic business units within companies, resulting in leverage and synergy (Gelderman and Van Weele 2002). Differentiating the overall purchasing strategy, with different strategies for different supplier groups (Lilliecreutz and Ydreskog 1999) 16

25 Discussing, visualizing and illustrating the possibilities of the development of differentiated purchasing strategies (Gelderman and Van Weele 2002) Some other case studies indicated that: Portfolio approaches can be used to improve the allocation of scarce resources (Olsen and Ellram 1997) A portfolio model provides a framework to understand and to focus a company s supply strategy (Evans and Hadeler 1994) A portfolio approach can make the difference between an unfocussed, ineffective purchasing organization and a focused, effective one (Evans and Hadeler 1994), especially for those companies that have never thought systematically about their procurement expenditure (Cox 1997) The utilization of this purchasing methodology may lift the purchasing activity out of the tactical, firefighting mode into a strategic role (Elliot-Shircore and Steele 1985) It convinces top management of the effective role that purchasing can play in contributing to a company s profit and success (Carter 1997) Section Criticism of the Kraljic Matrix Purchasing portfolio models have been severely criticized too and there are doubts and questions with respect to the following measurement issues: The selection of variables: How could one know whether the most appropriate variables are being used? (Nellore and Söderquist 2000) The supplier s side: Why is the supplier s side disregarded in most portfolio models? (Homburg 1995, Kamann 2000) The operationalization of dimensions: What is exactly meant by profit impact and supply risk? (Ramsay 1996) The measurement of variables: How should the weighting of factors take place? (Olsen and Ellram 1997) The line of demarcation: What is the exact difference between high and low supply risk? (Homburg 1995) The simplicity of recommendations: How could one deduce strategies from an analysis that is based on just two dimensions? (Dubois and Pedersen 2002) 17

26 Other criticisms relate to more fundamental issues and objections: Portfolio models have a tendency to result in strategies that are independent of each other (Coat, 1983) Portfolio models do not depict the interdependencies between two or more items in the matrix (Olsen and Ellram 1997) From a difference perspective, Cox (1997) condemned the portfolio methodology, because it does not provide any proactive thinking about what can be done to change the existing reality in the various supply chains in which companies are involved. Gelderman and van Weele (2003) reported that experienced users have found a reply to the critique of portfolio models, stressing that there is no simple, standardized blueprint for the application of portfolio models. It requires critical thinking and sophistication of the purchasing function. A more recent study by Gelderman and Van Weele (2005) attempted to provide new insights into the relationship between purchasing sophistication (or maturity) and the usage of purchasing portfolio models. Purchasing sophistication can be viewed as a key characteristic of the purchasing function. The sophistication level of the function determines the extent to which the purchasing function will be included in strategic management decision process (Pearson and Gritzmacher 1990). In the study of Gelderman and Van Weele (2005), purchasing sophistication is defined as the level of professionalism of the purchasing function. Gelderman and Van Weele (2005) used the following characteristics for the development of a purchasing sophistication construct: Based on a survey of purchasing professionals by Gelderman and Van Weele (2005), the study provides evidence that purchasing portfolio usage is associated with purchasing sophistication. Users contrast in a positive way with nonusers of the portfolio, especially on their professionalism (skills) and their position within their companies. The results of the study imply that top managers discovering that portfolio management methods have not been endorsed by their purchasing organizations should question the relative sophistication of the purchasing function. These companies are probably lagging behind both in terms of professionalism and position of the purchasing organization in the overall company hierarchy. The application of purchasing portfolio management seems to have prerequisites both in terms of professionalism that needs to be present and the exposure, i.e., locus that the purchasing domain has within the overall company organization. The application of purchasing portfolio techniques requires skills extending beyond 18

27 traditional administrative competences. In addition, the purchasing function needs to have a clear presence and position within the organizational hierarchy. Section 2.4. Remoteness In this study remoteness is limited to geographically distant suppliers where the buyer is located in a developing country with an environment of poor or undeveloped logistics infrastructure (Caddick and Dale, 1987 and Fawcett, 2000). According to Fawcett (2000), it is simply more difficult and more costly to develop close, productive relationships with geographically distant suppliers. Logistics problems have been identified as the biggest obstacle in international sourcing. However, neither the purchasing nor the logistics literature contains much information on logistics considerations in global sourcing. As stated by Das and Handfield (1997), overseas transactions affect lead times and lead times variability and carry increase risks of supply interruptions. Other common problems in international sourcing include buyer-supplier time-zone lags, costs of obtaining post purchase supplier services and rectifying errors in quality, part count, billing, etc. Add to that the basic difficulty in forming a meaningful relationship with a supplier separated by oceans, customs, cultures and language. The challenges many less developed countries (LDCs) currently face in developing their logistics systems are legacies of the past (Razzaque, 1997). These are fundamental problems inherited not only from their embryonic trappings but also from lack of understanding of logistics role and importance. Furthermore, Razzaque stated that a rich and expanding literature on logistics systems and management in advanced nations is available, in contrast to which the literature on those in developing nations is only emerging. A survey of 532 publications on logistics management in major Western journals for the period January 1971 to June 1995 revealed less than 20 contributions on developing nations. According to Das and Handfield (1997), a number of studies have examined logistics in various countries and regions. Studies examining distribution systems in industrialized nations are most prevalent. Caddick and Dale (1987), Waters and Soman (1989) and Cook (1989) concentrate on 19

28 developing regions and remote areas. These studies provide useful information on a range of issues pertaining to international logistics. In many countries, e.g. developing or formerly state-regulated ones, the logistics infrastructure is bad, customs and regulations unclear and inefficient, the logistics supply market underdeveloped and the crime risks are high (Andersson and Norrman, 2002). All this makes the supply risk high, as the number of trustworthy or capable partners is low and the few existing ones enjoy a better negotiating position. Goonatilake (1990) provides useful insights into inventory management practices in developing countries and contrasts them with those in developed countries. In developing countries inventory control is lax and bureaucratic with little pressure to meet delivery dates and inventory costs; infrastructure is poor; many of supply sources are overseas; and there is a shortage of trained personnel. Thus inventories are used to buffer poor infrastructure and greater uncertainty. If a country does not have a good base network of dependable transportation, warehousing, communication and other related facilities, desired configuration of the network by the firm will be difficult. Literature reveals that many LDCs lack an environment conducive to the development of a good logistics system Das and Handfield (1997). According to Razzaque (1997), it is clear that problems of logistics systems and barriers to logistics development are unique to each country. The provision of links between productivity facilities and consuming units, which is the fundamental role of logistics, is affected by differences in various country specific factors such as geographical features, socio-economic and politico-legal systems, cultural realities, industrial development and resources endowments. As stated by Svensson (2000), disturbance in the supply chain may be mainly categorized as either quantitative or qualitative. The causes of quantitative disturbances are events that create a lack of components and materials for downstream activities in the supply chain, for example: breakdowns or delays in transportation (i.e. by road or sea) caused by unexpected conditions, bad weather. Causes of qualitative disturbance are events that lead to deficiencies in components and materials in the supply chain, for example measurement errors in components, non-functioning articles. Due to emerging situations suddenly affecting the supply chain, short-term disturbances appear often in the context of quantitative and qualitative disturbances. 20