Strategic Sourcing

This weeks topic: Strategic Sourcing
Ideas were taken from:
Getting Offshoring Right by Ravi Aron and Jitendra V. Singh
Strategic Supplier Segmentation: THE New “BESTPRACTICE”IN SUPPLYCHAIN byJeffrey H. Dyer, Dong Sung Cho, Wujin Chu
Strategic Sourcing: To Make or Not To Make by Ravi Venkatesan

As global competition has increased during the past decade, managers have been under tremendous pressure to improve supply chain management as a vehicle through which their organizations can create a competitive advantage. In order for organizations to achieve this advantage, managers must utilize strategic thinking and planning. Strategic thinking is a process that encompasses every aspect of a firm and is critical to increasing firm revenues and value to the end customer. In order to accomplish this, managers must establish a value hierarchy for their corporation. This hierarchy of value allows managers to think strategically about the importance of processes, supplier segmentation, and organizational structure. Systematic review of these core elements will provide key information necessary for managers to make strategic decisions and establish competitive advantage.
In order to create this hierarchy of value, it is imperative that managers have an in-depth knowledge of their company. They must be familiar with the critical nature of their processes in order to make informed decisions. Therefore, managers should establish a standard methodology for differentiating between these internal processes. For example, these processes can be separated into strategic and non-strategic subsystems. First, managers evaluate all internal processes in order to identify “core processes”, “critical processes”, and “commodity processes”. Core processes are classified as strategic in that they are indispensible to the company’s competitive position in the future. Critical and commodity processes are classifiable as non-strategic subsystems. Through differentiating these processes, organizations are able to focus precious resources in developing strategic “core proprietary processes” that can, and must, become the source of competitive advantage. Evaluation of processes provides strategic information, which enables strategic decisions.
The classification of processes as strategic or non-strategic is the foundation of an organization’s value hierarchy. Using this foundation, organizations are then able to make strategic decisions concerning the outsourcing of “non-core” processes. For example, by differentiating processes into strategic and non-strategic subsystems, organizations can choose to subcontract commodity (non-strategic) processes to suppliers better qualified to produce them, while at the same time focusing on core processes and components pivotal to product differentiation. Cummins Engine is an excellent example of an organization that used the value hierarchy to make strategic decisions.
In the 1980’s, Cummins was faced with the need to develop much more advanced piston designs to meet emissions legislation. The investment required to upgrade these processes internally would have been substantial. Moreover, there were several suppliers able to provide better technology at economies of scale. Regardless, Cummins believed that pistons were the very “guts” of their engine; therefore, they were wary about outsourcing this component. To solve this problem, managers at Cummins used the value hierarchy. “Through this objective, data-based analysis, managers at Cummins concluded that pistons were not a core competence. By seeking the most cost-effective source for pistons worldwide, Cummins could now focus organizational energy on building leadership in electronics, ceramics, and alternate fuels-emerging technologies that will shape tomorrow’s competition.” Using the value hierarchy to identify core processes has provided great benefits to Cummins by way of competitive advantage in these emerging technologies.
Another key component required for effective decision making is the ability to identify and manage risk. After using the value hierarchy, organizations looking to outsource commodity processes face operational and structural risks. The ability to make strategic decisions concerning these risks provides an additional competitive advantage to corporations. Operational risk comes from the fact that many service providers will make more errors and execute tasks more slowly than the company’s in-house employees do. This often results in lower customer satisfaction. Structural risk is the risk that service providers may not perform as per original expectations. However, these risks can be mitigated through the organization’s metrics and ability to codify work.
The ability to codify work will decrease operational risk. “When companies document the work that employees do, describe the different situations they face, and stipulate what employees’ responses should be in each scenario, people anywhere in the world can do the job for them. “ Additionally, effective use of metrics reduces structural risk. Only firms that set tolerance limits for error, draw up completion times and productivity norms, and continuously measure employees performance are able to effectively capitalize on outsourcing. “What an organization doesn’t measure, it can’t outsource well.” By analyzing both operational and structural risk, organizations are able to further differentiate processes into: opaque, transparent, codifiable, and non-codifiable processes. This provides more strategic information that managers can use to make effective strategic decisions concerning organizational form and location.
When organizations identify risks of potentially outsourcing a process, they must use strategic planning to decide what location and organizational structure will provide the most value. In the past, managers have had the false impression that outsourcing is an all-or-nothing endeavor. However, there are many options that provide different levels of security for the firm. For example, organizations can: offshore, outsource to service providers, purchase from local suppliers, or enter into joint ventures. With each of these organizational forms, organizations weigh the potential trade-off between internal control and quality with respect to scale economies and gains from specialization offered by suppliers. Through the strategic process of identifying risk, mitigating risk through use of metrics, and weighing all possible options based on this information, organizations can make “better” strategic decisions.
After organizations have a clear understanding of their core processes, inherent risks, and organizational structure; they must use strategic thinking to manage supplier relationships within that structure. In order to manage supplier relations, each supplier should be analyzed strategically to determine the extent to which the supplier’s products contribute to the core competencies and comparative advantage of the buying firm. Based on this information, organizations can use either an arm’s length or partner model to maximize value in their given industry. The arm’s length model is effective in that it minimizes dependence on suppliers and maximizes the bargaining power of the firm. The partner model exhibits better information sharing, coordination, and long term trust based relationships. While both of these models can be effective, firms must think more strategically about supplier management. There is not a one-size-fits-all approach to relationship management. “A company’s ability to strategically segment suppliers in a way as to realize the benefits of both the arm’s length and partner models provides the key to future competitive advantage in supply chain management.”
To achieve the advantages of the arm’s length and partner models, organizations need to manage each supplier relationship irrespective to others. Differentiating between groups of suppliers that provide strategic and non-strategic inputs is critical to managing relationships. For example, supplier that provides strategic inputs must be managed differently from independent suppliers. “Organizations should maintain high levels of communication with these strategic suppliers, provide managerial assistance, exchange personnel, make relation-specific investments, and make every effort to ensure that these suppliers have world-class capabilities.” The best example of effective supplier segmentation is Japanese Automakers. The Japanese utilize a mixture of partners and independent suppliers in order to maximize value and create economies of scale. Each supplier is managed in a way that provides the most value to the home firm.
Strategic thinking is a process that will lead to great success for organizations in the increasingly competitive global market. In order for organizations to gain the full benefits of strategic thinking they must first acquire strategic information. Strategic information comes from evaluation and differentiation of processes, risk management, and organizational form. Strategic information in these areas enables managers to make strategic decisions concerning outsourcing and supplier segmentation management. It is through implementation of strategic decisions that organizations establish competitive advantage and increase value. In order to ensure success, managers must utilize strategic thinking throughout every aspect of the organization.