Importance of Strategic Sourcing and its Process

Importance of Strategic Sourcing and its Process

Strategic sourcing is positioned at the top of the procurement model. It’s focused on finding and contracting with suppliers to meet an organization’s needs for materials and services. Once an organization identifies a need for new materials or services it must launch a process to identify an appropriate supplier to meet the requirements. The process begins with an opportunity assessment to determine specifically what needs to be purchased, how much needs to be acquired and when it needs to be acquired. 

The specifications and other critical elements associated with the new material or service are needed to help identify appropriate suppliers. Analyzing demand for an established finished product or service may be relatively straightforward. However, if the item is a new component being used for a new finished product it may be difficult to accurately determine how many finished products will be sold. Determining the lifecycle of the product and the needs for replacement parts would also pose a challenge. Hence, the procurement function may need to engage in demand analysis activities along with other functions within the organization. There’s also a need to build contingencies to handle unexpected variances in demand.

Let’s take a moment to analyse the challenges faced by a typical purchasing manager engaged in sourcing the parts of a new product. The manager must ensure that a quality affordable set of suppliers are in place to meet production requirements with an understanding of specifications and demand needs. So the strategic sourcing process begins with researching potential suppliers. The research takes place by reaching out to existing suppliers, conducting research, reviewing literature from trade magazines and professional societies and working with peer organizations in other corporate divisions.

Oftentimes corporations establish commodity councils to share knowledge regarding specific suppliers and commodities across geographies and divisions. Such councils help leverage spend and mitigate effort and risk when researching new suppliers. 

A formal proposal process is used to identify and evaluate potential suppliers fairly and transparently. Many organizations including government agencies often require formal proposal processes. 

Often, a request for information or RFI is issued to identify a set of suppliers who appear to be willing and able to engage in further discussion leading to a potential contract. The RFIs may contain a minimal amount of information about the needed product or service. While the requests for proposals or RFPs contain detailed documentation to convey the needs related to the product or service to be purchased. A formal process is followed in creating RFPs, soliciting vendors and evaluating RFP responses. Furthermore, criteria scores and weighted scorecards are often used to identify a shortlist of vendors for final discussion and selection. 

Typically a cross-functional team is involved in generating RFPs and evaluating vendors. With the emergence of internet-based tools, auctions have become popular for quickly communicating requirements to a broad range of potential suppliers who may bid on the need with minimal efforts. Auctions tend to be somewhat commodity-specific open markets for sharing requirements and evaluating potential vendors. Auctions are good for driving efficiency however they may not be a good fit for highly specialized needs that require a deep understanding of specific unique product requirements.

The final step in the strategic sourcing process is supplier selection and contracting. Regardless of how the supplier is identified, final negotiations need to take place leading to the creation of a contract. The pricing, service, legal terms and other aspects of the relationship are cleared from the very beginning. Hence, the completion of strategic sourcing for a given item is a signed contract with the supplier or suppliers to meet the needs of the organization. 

Some people have the view that procurement should focus solely on pressuring suppliers to get the lowest purchase price per unit. One way that this may be facilitated is by having the buying organization concentrate its purchasing spend on as few suppliers as possible and thus becoming a big part of their business. This serves the benefit of having the buying company deal with fewer complexities of dealing with a large number of suppliers and multiple contracts. However, there are risks relating to increased cost and quality issues in putting all of your spendings in one company which may go out of business.

Rather than making procurement decisions based solely on concentrating spend and getting the lowest possible per unit purchase price, it is better to consider the total cost of ownership approach (TCO). It is an estimation of the expenses associated with purchasing, deploying using and retiring a product or piece of equipment. This is designed to help procurement personnel make more informed financial decisions when purchasing products or services. 

Other costs expected to be incurred during the life of the product are that of service, repair, insurance, freight, costs from specific vendors, proposed inventory ownership policies and return policies as well as ease of interaction with the supplier and other intangible issues. All of these are real costs that need to be considered to get accurate data of total acquisition cost.

Takeaway

Strategic sourcing is a fact-based process for optimizing the organization’s supply base. The TOC considers the total expenditures associated with purchasing, deploying, using and retiring a product or piece of equipment. It is a continuous process beginning with opportunities, assessments and leading to the selection of and contracting with suppliers. The process continues after signing the contract with a supplier. It is essential to establish an effective way of benchmarking supplier performance. Over time, when discrepancies occur, SCM can follow up with such situations and allow the vendors to address the issue.

Learn more about: Why maintaining supplier relationships is important for any business.

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