Transcription of Strategic Sourcing lecture by Dr. Tobias Schoenherr, PhD
Welcome to this class on Strategic Sourcing and Supply Management. I am Tobias Schoenherr and I’m a professor at the Broad Graduate School of Management at Michigan State University.
I’m looking forward to working with you and to introduce you to this exciting area of sourcing, purchasing, and procurement. This subject area is my passion which I’ve been focusing on over the last decade, in both my teaching and my research.
It is an exciting area and I hope to convey to you this motivation and this fascination that I have for this topic. It is an area of great potential and I look forward to introducing you to how strategic sourcing and supply management can make a difference.
Let’s go over the course overview. This course is all about the operational and strategic role played by supply management, both within the organization, and across the supply chain, so we look at purchasing’s role within the company and across the supply chain.
Topics covered include: the development and implementation of a procurements strategy; the selection, management, and development of suppliers; the importance of buyer/supplier relationships, global sourcing, negotiations, electronic procurement, cost/price considerations, green purchasing, and purchasing ethics.
What is important to recognize with all of these topics – they apply to both manufacturing and services companies.
Most people just recognize the applicability to manufacturing companies, but these concepts that we will be covering in this course equally apply to services companies; they are a supply chain as well.
The course objectives can be summarized as follows: at the end of the course you will be able to understand, recognize, and be able to assess key issues, principles, opportunities, strategies, techniques, and developments in strategic sourcing, as they’re being pursued by leading-edge organizations to achieve competitive advantage.
One of these aspects is, for example, the importance of achieving strategic alignment between sourcing and the firm’s overall competitive strategy.
You will also be addressing internal and external challenges that affect sourcing strategy. A major component of the course will also address criteria and techniques for selecting new suppliers and for assessing and evaluating existing suppliers. You will be able to understand how and when to build trust.
At the end of the course you will have an understanding of the issues involved in global sourcing, electronic procurement, the extended enterprise, negotiations, and ethics of how they pertain to procurement.
You will be introduced to decision-making frameworks and problem-solving skills to determine the best course of action pertaining to above strategy areas. When discussing these issues I will intersperse the discussion with real-life examples of exemplary companies whose purchasing practices can be considered among the best.
I will also introduce you to some of most recent research findings that my colleagues and I have been finding where we believe this area is to be headed, so we get a cutting-edge, up-to-date view of this field.
Let’s talk a little bit about the definition and the nomenclature that we will be using in this course.
The Institute for Supply Management, which is abbreviated as ISM, which is the premier professional association for procurement professionals, defines supply management as follows: supply management is the identification, acquisition, access, positioning, and management of resources the organization needs, or potentially needs, in the attainment of its strategic objectives.
Now, that is a mouthful. Let’s go into detail what all of these components of the definition mean.
Identification: this relates to the identification of opportunities in the marketplace and the opportunities could present themselves in terms of new materials, new suppliers, new technologies, but might be also different paradigms and also potentially different management approaches, which for example, can be learned from your suppliers.
Acquisition: acquisition is much more than buying. It’s also the acquisition of relationships. So you’re not only acquiring products or services, you’re also acquiring relationships.
Access pertains to the access or the permission to use of something of value, such as patents or other innovations. Again, this goes above and beyond the mere access to products and services, but the access of innovation, the access of capabilities.
Positioning: you can use your supply base to better position yourself for competitive advantage. What is implied here is that you look at it from the long-term perspective. You take a long-term orientation and focus, for example, on supply development. You not only take a short-term perspective, but look in the long-term of how your suppliers can help you become better.
It involves the management of resources. Resources are anything that are useful for competitive differentiation. You tap into the resources of your suppliers, so again, you not only look at your own internal company, but look at the external supply chain involving your suppliers and your customers.
The last part of the definition speaks to the importance of strategic alignment of supply management and its actions being strategically aligned with corporate strategy. This is very important.
You’ve probably heard me mention the terms of “sourcing,” “purchasing,” “procurement,” “supply management.” For the purposes of this course, let us use these terms interchangeably.
I’ve seen the whole range of terms used for the same concepts in different companies, across the board if you want to be picky, if you want to differentiate between these terms, then I’ve seen sourcing to be associated with more strategic aspects, and purchasing and procurement to be associated with more operational or more tactical aspects.
Procurement is also often used for referring to governmental purchasing, to governmental procurement. So some people when they hear “procurement,” they immediately think of the government, of how the government conducts purchasing.
The most encompassing term would probably be “supply management,” to which many companies have been switching, maybe also to avoid any ambiguity in terms of the nature of the tasks involved.
So while one can make such a fine-grained differentiation between the terms, and while they’re used quite differently in different companies, for our purposes let us use these terms interchangeably.
Why study supply management? Let me talk a little bit about the importance. Supply management is important for a variety of reasons. One of the most obvious ones lies in its potential to directly affect the bottom line of a company, through effective negotiations and other approaches that we will discuss in this course.
A firm can achieve price reductions from suppliers, for example, which almost directly translate into actual savings from an accounting standpoint, contributing to the financial performance of the firm. The impact is almost immediate.
Supply management also plays a crucial part in assuring the quality of the final product. Since the final product nowadays a firm sells consists of a large proportion of sub-assemblies or components that all purchased – that are purchased from suppliers. Therefore the reputation of a company also hinges directly on the quality of the components it purchases from suppliers.
If something goes wrong with the final products, the company selling the items will likely be associated with the fault, and not necessarily the supplier that delivered the faulty subcomponents in the first place.
Examples abound in the recent history: just think about an example of Mattel, the toy company, and their Mattel cars few years ago. The reputation of Mattel seriously suffered due to a supplier having provided paint including lead. This paint was used on toy cars and other products under the Fisher- Price brand especially, and this resulted in the company having to recall a total of 2 million products.
The public not necessarily associated that fault of those products with the supplier, but with Mattel. So this is an illustration of how the quality of your suppliers can directly impact your reputation although it might not have been your fault.
This is also emphasized by supply chains spanning greater distances with global sourcing especially. Consider the incident of Baxter, the pharmaceutical company. One of their drugs that they are producing is heparin for dialysis patients. The supply chain for heparin for Baxter includes over 50% foreign suppliers, so visibility in the supply chain is absolutely crucial in the assurance of quality.
With the help of supply chain management, you can also achieve a faster time to market. This is crucial especially in the involvement of suppliers early on in the new product development. Not only can such collaboration speed up the process to bring up the product to market, but it can also lead to significant improvements in material cost and in terms of savings.
A further major contributor to the importance of supply management is its ability to create competitive differentiation via, for example, to purchase components that become part of the final product.
This is especially prevalent for consumer products. Think about cereal and especially Raisin Bran – by the way, Raisin Bran is one of my favorite cereals – one of the producers of Raisin Bran is Post cereals.
When you look at the Post cereal packaging, Post advertises prominently on its packages the use of Sun Maid Raisins, which add brand equity and thus can raise the overall perception of the product in the market. This can differentiate the product from competitors and lead to competitive differentiation; this can lead to customers preferring your product over the competitors’ brand.
Other examples abound, such as the licensing of the Hershey brand for many of the products offered by General Mills, or the specific reference that Microsoft Sync technology is included in Ford vehicles; not any type of technology is included, but Microsoft technology.
This adds brand equity and might induce customers to purchase your product vs. the product of your competitors.
Supply chain management or supply management has also the potential to engage in relationships that can drive innovation. Think, for example, of the company Cargill. Cargill offers to its suppliers, to its farmers, field schools in which they learn how to optimize crops for high yield. So Cargill is actually helping its suppliers, developing its suppliers, to improve their product for the benefit of the entire supply chain. So they’re creating a win-win situation.
So relationships are very important in working with the supplier. This also illustrates a point that we will be covering in various instances through this course, it’s not only you demanding from the supplier improvements; you need to also be a good customer.
You need to help your supplier become better. And the example of Cargill is a nice illustration for that.
There are a few trends that are contributing to this increasing importance of purchasing.
Let’s go over some of them.
The most dominant one probably has been outsourcing and the practice of companies to focus on their core competencies, to focus on what I can do best. So companies outsource everything where other suppliers can do better at, so companies focus on what I can do best.
This led to the transfer of more and more responsibility to outside chain partners, to the suppliers. So suppliers have much more influence in determining the final product with their inputs, and this has influence on quality and reputation as we discussed before.
This trend away from vertical integration has also increased the risk associated with the supplier function; just remember the Mattel example I mentioned before. This increased risk has also further contributed to the raising importance of supply management and its role in managing and mitigating these risks.
At the same time, customer expectations are constantly rising, especially since the 1980s. Customers demand products faster, with a better quality, and a cheaper price. So companies have to follow that mantra: faster, better, cheaper.
It is virtually impossible for a company to keep up with these demands just by itself. It needs the help of outside supply chain partners to also maintain its flexibility and agility to accommodate change in customer demands. Customer demands are changing more and more quickly.
To conclude this first part of the introduction of supply management, let me illustrate the true financial – the direct financial impact that supply management can have on the bottom line, specifically on return on investment.
Consider the following profit model that calculates your return on investment. Let’s start on the top. At the top, at the beginning, you have your operating cost elements; these can be labor, materials, and overhead. All of these make up your COGs, your cost of goods sold.
You add your other costs to that and subtract that sum from sales, from your sales figures. You take your net income, divide it by the sales, and that yields your profit margin.
On the other hand, we have inventories. These – this is your assets side. We have inventories. We have accounts receivable. We have cash. All of this makes up our current assets. Add your fixed assets and this yields to your total assets.
Take your sales again, divide it by these total assets, and you get your asset turnover rate; multiplying the profit margin and asset turnover rate can give you your ROI or your return on investment.
And just plugged in here some example numbers to see how actual numbers would turn out here in an ROI of about 10%.
Now let’s look at the contribution of purchasing of supply management, of how we can make a difference, by for example, negotiating with suppliers by helping them reduce the cost of the purchase material.
Let’s say we are able to achieve a purchase price reduction of 5%, which is not unreasonable. This would be reflected on our operating cost element side in a reduction of the material costs, so our material costs would be reduced; so would be our cost of goods sold, so would be our net income, yielding a profit margin of 10.3%.
We also need the asset side, because now our inventories are worth less, 5% less, so that is reflected here. That translates into a lower number in terms of the current assets. That translates further into a lower number for our total assets and yields an asset turnover rate of 1.26.
Multiplying this asset turnover rate with your profit margin leads to a return of investment of 13%, which is 3 percentage points higher than before.
So here you see the direct profit potential, the direct return on investment potential, that we can have in purchasing. It is almost a very direct impact on the bottom line of the company. This is why purchasing is so important.
This concludes the first part of our introduction. The second part we will start out with a discussion of the evolution of purchasing, how its importance has increased over the years; we will talk about objectives and the responsibilities of purchasing, and we will go over some of the trends that impact purchasing in the present times.