Chapter-Three

Procurement Strategies and

structures

Temesgen Belayneh (PhD)

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 content
 Introduction
 Sourcing Strategies
 Supply structure and Design
 Supplier Development Strategies

Temesgen Belayneh (PhD)

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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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 Cont’d...

 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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 Cont’d....
 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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 Cont’d...
 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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Strategic Sourcing Primary Objectives

 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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3.2. The Sourcing Strategy Development

 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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 Cont’d....
 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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 Cont’d...

 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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 Cont’d...
 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
 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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 Cont’d...
 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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 Kraljic’s Portfolio Analysis
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
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
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)

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 Bottleneck

Strategy Tactics Actions

Ensure •Decrease •Widen specification
Supply uniqueness •Increase competition
Continuity of suppliers •Develop new suppliers
•Manage •Medium-term
supply contracts
•Attempt competitive
bidding

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 Critical

Strategy Tactics Actions

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

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 Leverage

Strategy Tactics Actions

Maximize •Concentrat •Promote competitive
Commerci e business bidding
al •Maintain •Exploit market
Advantage competition cycles/trends
•Procurement
coordination
•Use industry standards
•Active sourcing

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 Routine

Strategy Tactics Actions

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

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 Supply market complexity
 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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 Impact on business
 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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 Strategic directions for managing
category spends
 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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Strategy 1: Routine.

 This strategy 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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 cont’d...
 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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Strategy 2: Bottleneck.

 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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 Cont’d....

 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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Strategy 3: Leverage
 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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 Cont’d...
 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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Strategy 4: Critical

 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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 Specific project context…..
 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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 Cont’d…
 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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 Cont’d…
 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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 Cont’d…
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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 Cont’d…

(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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 Cont’d…
 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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 Cont’d…
 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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 3.3.Supply structure and design
 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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 Cont’d...
 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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 Single sourcing
 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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 Cont’d...

 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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 Cont’d...

 Single sourcing

Buyer Supplier 1

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Multiple sourcing
 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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 Cont’d...
 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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 Cont’d...

 Multiple Sourcing S1
S2

Buyer

S3

S4

S6 S5

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Delegated sourcing strategy
 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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 Cont’d...
 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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 Cont’d..
 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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 Cont’d..

 Delegated Sourcing: Buyer

S3

S4
S1

S2

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Parallel sourcing
 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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 Cont’d..

 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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 Cont’d...

 Model 1 Buyer
Model 2
S2
CA
S1
CA
S4 S
CB 3
C
B

 CA- component A, CB- component B

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Temesgen B.
Sourcing Strategy and Sourcing Structure

 Fig.
Critical
Leverage All except Multiple
Delegated Structure structure

 The detail Read more ,,,,,,,,,,,,,,

Routine Bottleneck
Multiple Structure Single Structure

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 Reading Assignment

 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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