Friday, July 27, 2012

Key Steps to Designing an Effective Supply Strategy

Identifying the key steps to designing an effective supply strategy

Developing a supply strategy is a process that when integrated with a firm’s other business processes, contributes to a firm’s overall goals of competitive advantage and profitability.  A simple, but effective purchasing portfolio model may be constructed using a supply segmentation technique that classifies products or services to be sourced in order to formulate distinctive supply strategies for each.  Although  the specific supply strategies, tactics, and supply management approaches developed will be balanced and  tailored to an individual firm’s needs, certain basic steps are common to their development.

The first step is to categorize the types products and/or services to be sourced.  Products are evaluated on the basis of the internal “risk” a company would encounter if the item were no longer available or of low quality, followed by an assessment of each item’s “value” (both monetary and intrinsic) to the company.  The value of a relatively low-cost item might be high when it adds significant value to the organization’s output.  This could be because it makes up a high proportion of the output (for example, raw fruit juice used by a fruit juice maker) or because it has a high impact on quality (for example, the cloth used by a high-end clothing manufacturer).  A detailed “spend analysis” that is aggregated across  divisions, strategic business units, and suppliers should also be developed for all sourced items.  This helps define key spend categories and assess impact on a firm’s profitability.

The next step is to graph each unit or group of units on a chart on the basis of two dimensions:  supply market complexity and the cost/value of each unit.  Each dimension has two possible values, “high” and “low.”  The horizontal (X) axis represents cost/value (measured as the total annual dollar amount spent on each) and the vertical (Y) axis represents market complexity.  Market complexity is determined, in part, by the number of suppliers, available capacity,  product specifications (unique or standard), and availability of substitutes.  An upscale specialty jeweler such as Tiffany’s would face a highly “complex” market with few suppliers, limited capacity, unique product specifications, and no available substitute products, whereas a mall-environment jewelry store would deal in a simple or low- complexity market with numerous suppliers and substitute products available. Market analysis helps a firm assess the current supply market structure and available purchasing options  and supply risks, as well as analyze trends and forecast future supply problems.

After completing the market analysis, the previously classified products/product groups can be segmented on a purchasing portfolio matrix consisting of four quadrants that represent distinctively different supply environments:

Quadrant I, “tactical” (low market complexity,  low cost/value);
Quadrant II, “leverage” (low market complexity,  high cost/value);
Quadrant III, “critical” (high market complexity, low cost/value); and
Quadrant IV, “strategic” (high market complexity, high cost/value).

 The items in each quadrant require development of specific supply management goals and strategies of varying complexity.  For example, the supply management focus on items in the strategic quadrant is on increasing competitive advantage through strong buyer-supplier relationships such as strategic alliances, joint ventures, and sole sourcing and through medium- to long-term supply contracts.  Mutual trust provides access to new technology that is important for developing value-ads that increase customer satisfaction and loyalty.  In contrast, the standardized, generic products in the high-volume leverage quadrant do not require long-term supply contracts or supplier partnering strategies because products and suppliers are interchangeable and supply risk is minimal.  With a goal of decreasing unit costs and increasing profit margins to contribute to corporate profitability, managers can utilize traditional supply strategies.  These include aggressively seeking lower-cost suppliers from a large supply base, finding substitute products,  and leveraging buying power to obtain volume discounts and competitive bids.

Distinctive differences may also be found in the supply market characteristics of the critical and tactical quadrants, with a corresponding adjustment of  supply management goals and supply strategies.   To illustrate, the supply risk of items in the low-value critical quadrant is high, so management’s goal is to minimize supply disruptions even if additional cost is required.  Strategies to assure supply may entail keeping extra stock and developing contingency plans to deal with  unexpected situations.  When possible, ways should be found to move critical items into the tactical quadrant to reduce their supply risk.  In the tactical quadrant, which consists of low-value, non-critical items, supply management’s emphasis is on reducing acquisition costs  that may consume up to 80 percent of a purchasing department’s time.  Strategies include utilizing integrated supplier relationships such as electronic data interchange and supplier-managed inventory systems to reduce transaction and logistics costs in this category.

Each stage of the supply segmentation technique is an important building block in the systematic process of constructing a purchasing portfolio analysis model based on the relationship between market complexity and cost/value.  The portfolio matrix forms a simple, but clearly focused framework for analyzing supply environments in order to develop feasible supply strategies for the sourcing of products in each quadrant.  This model presents a multi-stage process of developing supply strategies that minimize a firm’s supply risk and highlight opportunities to improve a firm’s overall buying position not only in the short term, but also in the long term.  As such, it encourages CEO’s to look at the “big picture,” and it changes the traditional operating perspective of “purchasing” to one of strategic supply management.

Copyright 2012.  James L. Alyea.  All Rights Reserved.

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