2020 is a crucible year that has put every strategy, every technology, and every supply chain to the test. In many cases, it revealed vulnerabilities and outdated processes that took the form of supply shortages, product delays, and extended impacts across the value chain. It also revealed which organizations are prepared for a drastic shift in the market, and which ones are not. In a time where many manufacturers are rethinking every aspect of their strategic sourcing, supply management, and procurement processes, there’s an opportunity to recall the strategies and the lessons of the past.
To this end, we look back to Peter Kraljic’s 1983 article, “Purchasing Must Become Supply Management,” published in Harvard Business Review. Almost forty years later, much of what Kraljic shares in his article is still relevant to strategic sourcing, and useful into the ”next normal.”
5 Key Questions to Inform Modern Sourcing Strategies
The goal of any sound purchasing and supply strategy is twofold: enhance purchasing power with important suppliers, and reduce risk to an established minimum. The benefits of formulating a strategy like this include the realization of new sourcing strategies, revealing potential weaknesses in your existing processes, improving negotiation outcomes, and more.
It all starts by presenting the kinds of questions that invite relevant discussion and insight. Consider these five questions proposed by Kraljic in 1983:
- Is the organization making use of opportunities to collaborate between different divisions or subsidiaries? (Are there opportunities to consolidate or combine purchases to enhance bargaining power?)
- Can the organization avoid potential bottlenecks and interruptions in supply? (Are your current suppliers potential risks when it comes to geopolitical issues, forces of nature, or known shortages? More importantly, do you have alternate sources?)
- How much risk are you willing to accept? (Mitigating risk with a goal in mind allows you to separate acceptable risk from unacceptable issues)
- What make-or-buy policies offer the best balance between cost and flexibility? (If your organization sources from suppliers it owns, you’re in a better position to negotiate for the remaining outside requirements. In other cases, it could be more profitable to source outside if suppliers face an overcapacity issue.
- How would cooperation with competitors or suppliers benefit the organization? (In some cases, shared resources across competitors can yield beneficial outcomes for everyone involved. Collaboration with suppliers can also open up opportunities for a closer integration with the design process that results in higher quality and lower costs overall.
With these questions in mind, we turn our focus towards the basis of Kraljic’s proposed solution, and how it affects both past and present strategies.
From Pareto to Kraljic: Deals vs Strategy in Procurement and Supply
Prior to the concepts Kraljic introduced in his seminal article, procurement was primarily a clerical process focused on making deals. Many organizations looked to Pareto Analysis, sometimes known as the “80/20 rule,” to inform their decisions.
A typical spend portfolio in this time had a small number of categories that made up the vast majority of spend. Pareto Analysis, applied in this regard, offered a prioritization tool, not a strategic one. People paid attention to only a few categories and disregarded the lower priority items.
This led to significant issues over time, as some of those categories that received less focus could snowball into larger issues. As part of his article, Kraljic introduced the idea that a purchasing strategy should go beyond “making deals.” Procurement decisions should be made while considering risk, spend, cost, and value in equal measure.
Furthermore, organizations must look beyond the supplier and consider the supply market itself. All of this, of course, should be considered through a strategic lens. This led to the creation of a portfolio analysis model that easily segments categories:
The Kraljic Portfolio Purchasing Model
In creating this model, Kraljic merged the concepts of Pareto Analysis with a deeper grasp of supply market complexity to create something that offered strategy over prioritization. The approach provides insight into the inherent value of each proposed category, and quickly identifies their importance based on both profitability and overall risk and complexity.
“Kraljic made us think about what we are doing when spending someone else’s money. The abiding challenge is that we have to more than simply save it.”
– Dick Russill
Let’s take a look at each category in more detail:
The items that fall into this category are both low risk and low profit impact, making them the lowest in terms of priority, but still necessary to the business. These usually include things like office supplies that aren’t difficult to source.
Conversely, items that fall into the bottleneck category are low in terms of overall profit impact, but much higher in risk and complexity. These can be anything from legal fees, to the battery for a laptop. The common denominator is, of course, the limited source of supply.
This category focuses on critical products and represents the core focus for the procurement team. Both high risk and high profit impact are a factor here. Given that this segment represents a complex market and a high impact for the business, it is here where strategic behavior stands to offer the most benefit.
Cost leadership and differentiation will play a key role in this aspect of the overall procurement strategy.
Many existing strategies treat every category like it’s leverage, which of course, is not the right approach. These items allow you to utilize your purchasing power to place high-volume orders and utilize alternate items or suppliers in the pursuit of cost savings.
A major challenge here is the scenario where the buyer does not have market power, which takes away their ability to truly utilize this category in their favor. Changing the market dynamics is the answer here, but short term tactics won’t offer that outcome.
Leadership should step in at this point and facilitate a cooperative relationship with the supplier, or position them in a leverage category by inviting another supplier into the market, in exchange for a guaranteed share.
Peter Kraljic’s model for elevating purchasing to procurement has four categories, but the focus is on three components: people, process, and technology. You need the right people in leadership influencing decisions both inside and outside of the organization. You need flexible processes that allow for collaboration and strategy. Finally, you need the technology and intelligence to properly take action and achieve your desired result.
These are strategic sourcing lessons that ring true almost 40 years after Kraljic’s article was published, and they offer valuable insights into how we can adjust our strategies into 2021 and the years to come. Global manufacturers should reexamine their current approach to segmenting spend, suppliers, and new forms of risk to align their supply management to the new realities of today’s market dynamics.