Strategic Supply Management

A company’s purchasing or procurement organization once had a simple enough task: buy what the company needed while spending as little money as possible. Today the function is typically called “supply management,” and it faces a more complex set of challenges. Corporate leaders expect supply managers to ensure an uninterrupted flow of goods and services (often on a just-in-time basis), help improve product quality, reduce cycle time or time-to-market, and increase the rate of innovation.

The surprise is that some companies’ supply-management functions actually achieve these demanding objectives. We recently conducted a detailed survey of procurement practices at 156 U.S. companies. About 60% of respondents were executives within the procurement function; the rest were either in charge of procurement or had an in-depth understanding of their organizations’ practices. The companies themselves came from a wide range of industries, with roughly half reporting sales greater than $1 billion.

Thirty-four of the companies, or 22%, stood significantly above the rest. These leaders were growing at more than 20% a year. Supply managers at these companies generated significantly more incremental revenue than their counterparts at lower-performing companies. They were responsible for a greater reduction in cycle time and were far more likely to bring innovation to the company. Overall, more than half of the cost reductions these organizations had effected were attributable to supply-management activities.

Exactly how did these supply-management organizations achieve their results? What do their executives know that others don’t? Our reading of the results, together with our case experience and a review of relevant literature, suggests some answers.

First, leading companies tend to pursue cost reduction in a variety of innovative ways. They create new competition by continually searching for new suppliers and developing alternatives, including “insourcing.” They perform independent analyses of the market and of suppliers’ cost structures and returns, simulating the impact of greater volume on per-unit costs. These measures allow them to transform negotiations by establishing analytically robust target prices in advance. Leading supply-management organizations also rely on their industry’s experience curve to project (and demand) continuing cost reductions year after year.

An example is Bayer AG, which set up strategic-sourcing teams to coordinate its buys. In key procurement areas such as chemicals, it has moved increasingly toward sole sourcing, with a goal of achieving “producer economics,” or better-than-market price, wherever possible. Over one two-year period, cost-reduction initiatives in the U.S., Canada and Mexico saved more than $125 million, equal to 8.3% of the company’s total spend on chemicals.

But the supply-management leaders do not focus on price alone. Depending on their company’s strategy and the materials sourced, they may emphasize speed, quality, flexibility or assured supply. That requires charting costs and delivery times for single parts, subassemblies and major assemblies, along with making accurate projections of warehouse time, inventory buildup and potential lost sales due to supply disruptions. It also requires modeling supplier-industry dynamics in critical categories, along with the position of the various suppliers within the industry. The companies’ objective is not necessarily to find the lowest price but to determine which supplier is likely to be the strongest horse in the race.

Leading supply-management organizations also view procurement as an agent of innovation. One approach is to design products to cost. (In some industries, as much as 80% of the total cost of a product is determined during the design phase.) A Swiss precision manufacturer, for instance, gets a cross-functional team involved in new-product design at an early stage, researching what features and capabilities customers really want and what they are willing to pay.

A second approach is to tap supplier knowledge for new and improved products. Procter & Gamble Co., for example, relied on the chemical expertise of BASF Aktiengesellschaft to help develop the melamine foam that is the active ingredient in the company’s Mr. Clean Magic Eraser; its Mr. Clean AutoDry Carwash detergent utilizes a polymer developed by Rhodia Inc. Yet a third approach is to expand the supplier universe in search of innovation. Thus, a Raytheon Integrated Defense Systems unit recently hosted a gathering of some 100 local companies; it was looking for innovative ideas in fuel cells, optics, software development and radiation-resistant electronics.

Today, supply management is critical to business success, and its key metric is not only cost savings, but also increased shareholder value.