HOW TO BUILD A STRATEGIC SOURCING ORGANIZATION November, 2014 Louis Berard, Senior Research Analyst Global Supply Chain, Complex Spend, HCM Report Highlights p3 p4 p6 p8 78% of respondents find strategic sourcing to be significantly important Setting up a successful strategic sourcing organization, by the numbers Companies that view strategic sourcing as a prominent or critical function retain a Median Budget of Spend Under Management between 71% to 80% Top strategic sourcing organizations report key benefit of increased cost savings by 73% This report will illustrate the requirements for developing a strategic sourcing organization today, and how to create a roadmap for success into the future. This analysis will be based on 120 respondents who are active in Strategic Sourcing at organizations that deployed the concept both in the short term (between one to five years) and longer (five years and greater).
2 Key Performance Metrics Total spend under management: o For 1-5 years-58% o 5+ years-69% Average yearly savings realized: o 1-5 years-7% o 5+ years-9% Average cycle time to create, negotiate, and approve contracts (in days): o 1-5 years-44 days o 5+ years-42 days In the beginning, traditional strategic sourcing approaches were largely manual. Today, strategic sourcing requires unique skills and tools to process this living and ever growing data stream. With the use of more advanced sourcing techniques, organizations have improved their ability to obtain in-depth and measureable supplier performance that directly relates to increased cost savings. This report will review the performance of organizations that have deployed strategic sourcing programs in the last one to five years, along with those that have had strategic sourcing programs deployed for five years and greater. As a whole, strategic sourcing can impact direct and indirect spend connections, so it s no surprise that Figure 1 below shows that 71% of respondents indicated that strategic sourcing plays either a prominent or a critical role within their organization. Figure 1: Importance of Strategic Sourcing Furthermore, when viewing this data based on the analysis criteria of one to five years, and five years and above, we see a
3 dramatic change between organization types. Figure 2 below shows how important strategic sourcing is for organizations that have a five plus year program in place, with 53% listing it as critical compared to 20% of organizations with a program for one to five years. We further see that these younger organizations (one to five years) understand the need to achieve a successful strategic sourcing program, with a combined 78% saying it is prominent or moderately significant. Some of these plaguing factors could be attributed to market uncertainty, internal direction, and the how to get there challenge, which we will discuss further in this paper. Figure 2: Importance of Strategic Sourcing compared with Years of Service
4 Understanding Strategic Sourcing Interesting Fact: According to Wikipedia: The 80/20 rule states that, for many events, roughly 80% of the effects come from 20% of the causes. Joseph M. Juran suggested the principle and named it after the Italian economist Vilfredo Pareto, who observed in 1906 that 80% of the land in Italy was owned by 20% of the population; Pareto developed the principle by observing that 20% of the pea pods in his garden contained 80% of the peas. Wikipedia 80/20 rule Strategic sourcing is very different from standard product sourcing. It s how your procurement group is attempting to gain the best cost, quality, and delivery times (or on-hand product) at the most competitive price. Strategic sourcing, in the simplest of forms, is the ability to adapt and adjust sourcing procedures, in an effective and efficient manner, which will reflect change for the overall organization in a continuously changing global market. It is this analyst s belief that the first steps to a successful strategic sourcing program are as follows. Aggregate the spends by understanding what is purchased, for how much, who owns it, and where it was procured. This allows you to perform analysis and target your spend categories across the organization. Standardization of this data will help develop a true understanding of your spend ranking and where you are compared to the market. Ranking: Analyze from top to bottom your supplier network. Where is the largest amount of spend occurring and with which suppliers? Generally, the 80/20 rule applies here, where the majority of your spend will be with a few key suppliers. Rationalize the suppliers: How many is too many? Define your supplier network by who offers the best total cost, highest quality, location, design options, value added services, finance terms, dynamic discounting, etc. This needs to be evaluated on what your operational efficiencies are.
5 Re-aggregate your supplier network based on the new structure. This will make it more competitive for your key suppliers to gain greater revenue from sourcing product to you, and provide you with significant savings from short orders. Also, it provides the ability to have yearover-year discounts based on efficiency gains. If a supplier wants to be a sole-source provider, understand that this allows both of you greater savings but with higher risk. This risk is generally addressed in the contract clauses, with fines and penalties for violating contracts terms and conditions. Generally, I would seldom recommend sole-sourcing as a standard business procedure, but in some situations, it works best all around. Continuous Improvement. Take advantage of savings and greater spend with the customer-supplier relationship and view ways to improve processes on both sides. Continuous improvement is a journey not a race. For every step taken there are opportunities, some tangible some less, but through the journey it s a winning solution for all involved. When an organization takes this journey, greater efficiencies are seen immediately in the process, from purchasing and payables (process efficiency), working with less people/less time on the phone (time efficiency), less PO s value added services (quality efficiency), better terms, consignment inventory, and VMI (cost efficiency). When speaking with our end users, the aggregation of data across sites is the largest difficulty. Once this task of data aggregation is accomplished, organizations are able to claim a 3% to 10% first-time implementation savings of total spend based on their strategic sourcing program. Also, once deployed,
6 Analysis Process Nominal Association by: Phi and Cramer s V. This was used to show the strengths of association as it refers to coefficients, which gauge the strength of the relationship. Coefficients in this section have been designed with nominal data. Phi and Cramer's V is based on adjusting chi-square significance to factor out the sample size. Phi and Cramer's V vary between 0 and 1%. continued savings occur depending on organizational focus and commitment, but on average, 2% to 3% yearly savings are gained in total spend. This is successfully achieved by maintaining documented baselines of total spend through your organizations journey and capturing your benefits. Benefit Analysis In learning about the creation of a strategic sourcing structure, it s clear that benefits must exist. In this report, I wanted to impress the importance of the benefit gains to our readers through the use of various analyses. Earlier in this paper I asked the question, Is strategic sourcing valuable to my business? By using Phi and Cramer s V for nominal association (as described in the sidebar), these are the three key findings related to this important question. - By comparing the length of time a strategic sourcing program was in place, to the importance of the role it plays in the organization, based on 120 respondents, it was determined that, overall, the longer the program has been implemented, the greater the perceived role of strategic sourcing is. - By comparing the role played by strategic sourcing and the percentage of budget spent under management for procurement organizations, based on 120 respondents, it was found that, for companies where strategic sourcing plays a prominent to critical role, the median percentage of budget spent under management is 71% to 80%. For those companies where strategic sourcing plays a moderate role, there is a median percentage of 61% to 70%. Overall, the greater the perceived role of strategic sourcing, the higher the spend under management. - By comparing the length of program implementation and the percentage of budget spent under management for procurement
7 organizations, based on 120 respondents, we learned that, for companies where the program has been implemented for three or more years, the median percentage of budget spent under management is 71% to 80%. For those companies where the program has been implemented for one to two years, they have a median percentage of 51% to 60%. Overall, the longer the program has been implemented, the higher the spend under management. Benefits From these essential baseline findings, let s now look at the top benefits that can be gained from a strategic sourcing program. With the majority of respondents reporting key benefits of strategic sourcing as an increased level of cost savings (by 73%), followed by more robust management of key spend categories (at 56%), and better alignment of sourcing and business objectives (at 50%), it becomes clear that strategic sourcing is not just a short-term solution, but a long-term plan. These initial benefits exhibit the gains that organizations long for in value added sourcing to their overall business objectives. With strategic sourcing, organizations have the capability to obtain a consolidated view of a commodity to determine the total cost before making a buy decision based on price alone. Organizations can now leverage this ability to gain greater visibility into spending and non-cost factors, and this is recognized as a key benefit by 38% of respondents, as they are able to capture leakage by 22%. As outlined above, this ongoing journey requires flexibility with the changing global economy and sourcing requirements of today s ever evolving world.
8 Figure 3: Top Five Benefits of Strategic Sourcing Top Strategic Sourcing Strategies The ability to provide timely information to executives is clearly based on the knowledge an organization has over its sourcing process. Looking at what key strategies are deployed by more senior organizations (five plus years) gives us better insight into where to focus our efforts. In examining Figure 4 below, it s clear that these more senior organizations have clear advantages in their use of advanced sourcing. In viewing this chart from payment terms to make, versus buy decisions, the average separation across all of these categories represents nearly a 20% separation for each unique category represented, except makes versus buy. Based on these results, the more senior organizations have the capability to collect and compare payment terms based both on terms, price, and non-price attributes. What this shows is that the leading organizations are able to prevent alienating potential suppliers in services, where suppliers may vary
9 considerably based on price or non-price factors such as quality, reliability and terms. Figure 4 below shows an increased ability to recognize unique opportunities when evaluating suppliers for projects based on strengths and total cost of ownership. This is most likely to be used with an advanced focus on non-price terms, with the largest gaps captured by a matrix or a tiered pricing model. By providing your organization with a broader, more intelligent view of your sourcing requirements, better strategies can be implemented, allowing for greater returns and significant savings opportunities. Figure 4: Strategies for Strategic Sourcing
10 Take Away Strategic Sourcing is a discipline which demonstrates the need to evolve in our ever changing global environment. The ability to link efficient processes to technology is essential. Having a holistic view across the organization and the sourcing processes is vital for driving down cost and growing customer/vendor relationships. For more information on this or other research topics, please visit. Treasury and Risk Management : Top Financial Risks and Tools to Manage Them; December 2013 Risk Management Through Effective Financial Planning, Budgeting, and Forecasting; May 2013 Related Research Risk Management for Travel: Policy and Mobility is a Must; April 2014 Improving Revenue Operations: Efficiencies and Innovation Lead the Way; May 2014 Author: Louis Berard, Senior Research Analyst, GSM, Complex Spend and VMS (louis.berard@aberdeen.com) About Aberdeen Group For 26 years, Aberdeen Group has published research that helps businesses worldwide improve performance. We identify Best-in-Class organizations by conducting primary research with industry practitioners. Our team of analysts derives fact-based, vendor-agnostic insights from a proprietary analytical framework independent of outside influence. The resulting research content is used by hundreds of thousands of business professionals to drive smarter decision making and improve business strategy. Aberdeen's content marketing solutions help B2B organizations take control of the Hidden Sales Cycle through content licensing, speaking engagements, custom research, and content creation services. Located in Boston, MA, Aberdeen Group is a Harte Hanks Company.