Dec. 21, 2004
Strategic sourcing can improve suppliers' productivity, component and product quality-and the bottom line.

WHEN A HONDA OF America team of pur-chasing engineers spent 13 weeks visit-ing a TRW Inc. auto-parts plant in Juarez, Mexico, last year, they didn't get much of a recep-tion- at first. The Honda team was visiting TRW-one of its supplier part-ners- on a process-improvement mis-sion, assigned to help the plant solve some troubling quality problems. "There were all these young Mexican women working on the line, building automotive switches," remembers Dave Nelson, senior vice president of pur-chasing and corporate affairs for Honda of America Mfg. Inc., Marysville, Ohio. "They were very bashful with our people. Our team tried and tried to get them to give us improvement suggestions, but they were too shy. "We put a suggestion box out on the line. Every day, one of our engineers would make a big show of checking the box and looking disappointed when he didn't find any suggestions in it. He would get out his handkerchief and wipe his eyes as if he were crying. "The women would see this and smile, but still they wouldn't give us any suggestions. We'd been there more than a week, and we hadn't gotten one single suggestion. We were beginning to panic." Then one day a woman named Rosa called an engineer over to her station and told him that her testing board, which she used to check the quality of certain electronic parts, was set up so that she couldn't read the numbers. She had difficulty telling if a part should pass or fail. Rosa suggested that if the board were propped at a 45- degree angle, she could read the lights better and would be able to do her work more accurately. "Rosa went to lunch, and our engineers went to work," Nelson recalls. "They went out back to the scrap pile, found a magazine rack and used it to prop Rosa's board at an angle. When she came back from lunch, she saw what they had done, and she started to cry. She never thought anyone would pay attention to her ideas. After that, the ideas just flowed in, and it was one of our most successful trips." Honda's 13-week visit with TRW is part of the Japanese automaker's Best Partner program, which falls under the auspices of the company's strate-gic- sourcing effort. The goal of Best Partner is to help suppliers improve their productivity and efficiency by reducing waste. "Our purpose is not to save money on one line," Nelson ex-plains, "but to teach our suppliers' people how to make process improvements throughout their plant, so they can be strong and healthy." Usually, when a Honda purchasing/ engineering team goes to a supplier, the workers are apprehensive. "But we roll up our sleeves the minute we arrive," Nelson says. "We work hard to develop rapport with the work-ers. We wear whatever they wear. If they wear uniforms, we wear uniforms. We gain their confidence. Then we ask for their ideas. As soon as they start sharing, we implement their ideas with the speed of light. We can almost always find savings at a supplier." Honda's goal with these trips is to improve productivity on a certain line or area by 100%. "We want to double the output, and we're successful time after time," Nelson reports. "That's a powerful building block in our relationships with our suppliers." Why does Honda go to such lengths to help its suppliers? Because healthy suppliers ultimately translate into lower-cost, higher-quality products and services for the automaker. In fact, supplier welfare is vital to Honda's profitability. First, the company marries its suppliers for life. When Honda signs a contract with a supplier, it expects to maintain that relationship for 25 to 50 years. Second, the au-tomaker currently buys 80% of the cost of every car from outside suppliers-to the tune of $6 billion worth of goods from North American suppliers every year. From those purchased materials, Honda produces 620,000 vehicles and 900,000 engines. "Our 13,000 employ-ees only make about 20% of the cost of the car," Nelson says. "So it's critical that we purchase well." Because of its huge bottom-line im-pact, Honda's procurement group re-ports directly to the president of the company and occupies a strategic posi-tion at least equal to that of manufac-turing. "Our very best people work in purchasing," Nelson notes. Breaking old habits Historically, companies have not considered procurement a key busi-ness activity. Before New York-based Bristol-Myers Squibb Co. launched its strategic-sourcing initiatives two years ago, for example, purchasing was ranked in the "lowest quartile" of management functions in terms of or- That's where the concept of strategic sourcing comes in. "Strategic sourcing is about maximizing the value added through your external suppliers," Semaca explains. "It can include gathering a supplier base that represents the lowest-cost producers for key materials/ services, using key suppliers to help differentiate products in the marketplace, or using suppliers as part of an extended network/enterprise." Strategic sourcing involves apply-ing analytical methodology to develop-ing and implementing a sourcing strategy for specific groups of items. Let's say XYZ office supply company buys $200 million of paper clips a year. Using a strategic-sourcing approach, XYZ first analyzes the marketplace for ganizational stature. "Purchasing was not a higher calling in our company," reports Douglas Tunnell, senior vice president of planning, strategic sourcing, and productivity. Traditionally, purchasing involved getting the right quantity and quality of goods to the right place and time at a decent cost. It was transactionally focused. "Today," says Nick Semaca, vice president and leader of the North American Strategic Sourcing practice at Chicago-based consulting firm A.T. Kearney Inc., "it's not enough to buy the goods you need at the cheapest price." Competition, price pressure, and a host of other factors require a more strategic approach to buying goods and services. COMPANY Index paper clips, understands the economics of usage and manufacture, develops a procurement strategy, and finally negotiates and implements a relationship with suppliers . During this process, a company should ask such questions as: Why do we buy this product or service? What do we use it for? What are the dynamics of the supply market for this item? Is there a difference between manufacturers? What does the item cost to pro-duce? What kind of profit margin do the suppliers want/need? What is the total cost of buying a particular item from a particular vendor (i.e., pur-chase price plus cost of quality prob-lems, etc.)? How and where is the item manufactured? What does the production process look like? Know what you buy As noted, one of the first and most important steps in implementing strategic sourcing is to analyze what you buy. This means collecting data on all goods and services purchased corporate-wide, and assessing these buys with the goal of consolidating volumes with fewer vendors, standardizing the items procured as well as the procurement process, and buying on as large a scale as possible. Bristol-Myers Squibb launched its strategic-sourcing effort with just such an analysis. "We needed to understand what we were going to buy, where it is, and whether the buy can be consolidated geographically or on a worldwide basis," Tunnell says. "Once we'd done this analysis, we screened potential vendors and sent out a request for a proposal or information, depending on the nature of the buy. Those are very detailed-the specifications on quality, service, and price are all itemized. Vendors review these documents and either choose to play or not. Then we start a series of discussions with the interested vendors on our needs and how they can respond to them." Whenever possible, Bristol-Myers Squibb buys on a global basis. "Certain items, like computers and travel, are a natural for global purchasing," Tun-nell points out. "Every location in the world uses computers and travel. So we find out the users' needs and try to leverage the volume, either by conti-nent or worldwide." The idea is to standardize the purchase-buy one kind of computer instead of 20; use three air carriers instead of 10. Once the pharmaceutical company had analyzed its purchases, it renegotiated all of its procurement contracts with vendors. "We consolidated our vendor base and consolidated our buys at higher levels of our organization," explains Tunnell. "This makes us a much more important customer when we present a consolidated buy. Where before we were dealing with a regional sales rep, it's not uncommon to for us now to deal with the chairman of a company." Consolidating the corporate buy yields significant savings and is a major "early win" for a company transitioning to strategic sourcing. "Most companies have fractured their purchases so much that they've given up their buying power," says Paul Katz, vice president at Mercer Management Consulting, New York. "There's a huge opportunity for savings in simply consolidating buys for greater volumes. Companies should try to make themselves appear as large as possible to their vendors." Know what things cost A second foundation for strategic sourcing is knowing what things cost. Honda, for example, develops what it calls "target prices" for everything it buys. Together with suppliers, Honda procurement associates develop cost tables for every item purchased. From these tables, the procurement associates develop target prices that they communicate to the suppliers. "We have 15 to 20 people who study the cost of everything we purchase," Nelson explains. "We know what it costs for a supplier to make a part, including all the overhead and profit. So if a supplier comes in once we've given him a target price, and says, 'You guys are crazy,' we send one of our engineers to visit the company. They look at the supplier's production process to see if they can spot a problem that's causing the supplier's prices to be higher. If necessary, our engineer helps the supplier rearrange the pro-duction line to make it more efficient. "There are times when we'll discover we've made an error in our tar-get cost," Nelson acknowledges. "Then we adjust the price to something we can all agree on. Whatever the case, we end up with a specific nailed-down cost at the end of the process. And that cost always takes the vendor's profit margin into account." Bristol-Myers Squibb has adopted a similar practice. Tunnell says the pharmaceutical company's sourcing group has category experts who know a given product/service market intimately. "They know what things cost. They're physicians, lawyers, pharmacologists, computer experts, travel ex-perts, and the like, and it's their job to know what's going on in their area of spending-what the market forces are, who the key players are, who's a rising star, how technology is changing and much more." The new face of procurement Most companies find that, to truly implement strategic sourcing, they need to rid the company of its old ways. This often means totally revamping the procurement organization-something Bristol-Myers Squibb did. In fact, the pharmaceutical firm "cleaned house"- orchestrating a complete turnover of procurement personnel at all levels. In place of the old fragmented, divisionally based purchasing organization, the company created a centrally led procurement organization with management oversight across all divisions. This kind of massive organizational change is key to making strategic sourcing work, Semaca says. The procurement function, rather than re-main merely a purchaser of goods, must become a value generator and driver of business strategy, he argues. "Procurement's focus must shift from cost savings to value creation, taking into account product quality, total-life-cycle costs, and profitability. Instead of simply supporting new-product development, for example, strategic sourcing must lead that effort through the identification of new materials, technologies, production techniques, and competitor activities." Obviously, the procurement manager's role is no longer what it was. "We're evolving away from the old school of buying at the lowest possible price, trying to squeeze vendors for concessions, and using many sources under the divide-and-conquer theory, to a new approach that asks, 'How can I lever-age my suppliers' expertise to be more competitive in the final marketplace?'" says Robert Spekman, professor of business administration at the University of Virginia's Darden Graduate School of Business, Charlottesville, Va. Spekman outlines this new approach in "Purchasing's new role" (above). The grid derives from findings of a major study of 22 North American and European supply chains, con-ducted by consulting firm Ernst & Young of Cleveland, the University of Virginia, and the Western Business School of the University of Ontario. Another study by A.T. Kearney of best practices in procurement at 26 leading corporations found that, by adopting a more strategic approach to working with suppliers, companies have reduced total annual expenditures by an average of 12% between 1992 and 1995. This reduction amounted to savings of $4 billion. The study also found that: Procurement methodologies are not just applicable to the purchase of direct and indirect materials. Leading corporations are using these methodologies to direct all types of external expenditures, often yielding a greater percentage of cost improvement than "traditional areas." Outsourcing is growing rapidly- 86% of surveyed corporations reported outsourcing some production function in 1995 versus 58% in 1992. Supplier concentration is still being pursued aggressively, with corporations reducing their supply base by 28% between 1992 and 1995. Leading firms chopped their inventory levels by 41% using strategic sourc- ing. Half the firms expect inventory lev-els to fall another 40% by the year 2000. Product-development cycles con-tinue to shorten, with leading compa-nies trimming their development cycles by an average of 62%, to just over a year. Not yet walking the talk While some companies are adopting tenets of strategic sourcing, the ranks of converts still are relatively thin. Ac-cording to the Ernst & Young study, buyers in most companies are loathe to give up their old ways. The study found that, despite all the talk about partner-ing and the virtues of supply-chain management, significant tension still exists between buyers and sellers. "The data suggest that buyers still tend to focus more on the cost-reduc-tion aspects of supply-chain manage-ment and view securing a reliable source of supply, reduced leadtime, and lower cost as key drivers of supply-chain management," Spekman says. "Buyers are less likely to view the supplier as irreplaceable and essential to their future business. One senses a self-serving view of supply-chain man-agement among buyers, where buyers still look for economic gain at the ex-pense of their partners." Overall, buyers are less likely than sellers to embrace the notion of collab-oration, and appear to fear the close ties that are required for integrated supply-chain management. Strategic sourcing isn't just the latest business fad-it generates very real short- and long-term benefits. This year, for instance, Bristol-Myers Squibb expects to reap between $340 million and $350 million in savings from its sourcing effort. And while purchase-price savings are significant and make an immediate contribution, they're not strategic sourcing's only contribution. Strategic sourcing enables corporations to drive revenue growth by slashing develop-ment cost and time for new products through supplier alliances. Honda's Nelson reports that suppliers helped design the 1998 Accord and shaved 21.3 % off the cost of producing the car. "We got suggestions from every supplier as to how to improve the quality but make the parts more efficient," he says. "Our suppliers gave us hundreds of ideas. We analyzed and tested them and employed the best." Bristol-Myers Squibb's Tunnell asserts, "Our company is much better off today than we were two years ago. We have a more cost-conscious employee group. We're much more unified. And there's much greater alignment across corporate and divisional lines." And Semaca points out that "the good news is that it does not require a huge investment. In most cases, the savings more than adequately fund any required investment. So typically you can be cash-positive very quickly-within the first year."

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