Procurement Management and Global Sourcing

Topic 8 – Purchasing and Commodity Strategy Development

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Topic 8 – Purchasing and Commodity Strategy Development i

Contents

Contents ii

Introduction 1
Learning objectives 1

Origin of Strategy 1

The Type of Business Strategies and Linkage to Procurement 2

Linking Procurement and Corporate Strategy 3

Types of Procurement Strategies 3

The Procurement Strategy Development Process (Bringing

goals and objective together) 4

Spend Analysis 4

Insourcing and Outsourcing: 5

Summary 5

ii Procurement Management and Global Sourcing

Introduction
As procurement is the major contributor to a firm’s competitive advantage,
procurement goals drive both strategic procurement processes and
commodity strategies. It provides a step-by-step process to translate
corporate strategy objectives into procurement strategies. Key questions
we will address here are what is strategy? Why strategy is important? And
what are the linkages between strategy, procurement and supply chain
management?

Learning objectives
At the conclusion of this topic you should be able to:
• Elucidate the key questions related to procurement and commodity
strategy development
• Assess levels of strategy (corporate/business)
• Conduct integrative strategy development
• Devise procurement strategies

Reading
Prescribed Text: Monczka, R.M., Handfield, R.B., Giunipero, L.C. and
Patterson, James L. (2014), Purchasing and Supply Chain
Management, South-Western, Cengage Learning. 6th Edition. Chapter
6

Origin of Strategy
The word strategy is derived from the Greek word – strategia or
generalship. It is about command and control structures of a military
organisation. Strategy is the determination of the basic long term goals and
objectives of an enterprise and the adoption of courses of action and the
allocation of resources necessary for carrying out these goals. Strategy is
about plan, ploy, pattern, position and perspective. Plan means the
strategy is about leaders who provide organisational direction and
predetermined course of action. Ploy refers to the strategy is about
intended ways to outwit competitors and pattern refers to a stream of
actions demonstrating consistency in action. Strategy is about choice that
deals: where are we now? Where do we want to go? And how do we get
there?
Corporate level strategy is concerned with determination of the types of

Topic 8 – Purchasing and Commodity Strategy Development 1

 businesses the firm should be in to maximise profitability. It also decides
‘strategies’ – growth strategies (forward, backward horizontal integration,
diversification, mergers and acquisitions.
Business level strategy on the other hand, the strategies developed within
the strategic business unit – SBU. SBU deals with coordinating and
integrating unit strategies so that they are consonant with corporate
strategies, developing the distinctive competences and competitive
advantages of each unit, identifying product market niches and developing
strategies for competing market and monitoring products and markets so
that strategies conform to the needs markets and products.

The Type of Business Strategies and Linkage to

Procurement
Companies depending on its situation may adopt a number of business
strategies. These are withdrawal, consolidation, market penetration,
product development, market development, diversification, cost
leadership, differentiation and focus. For each of these strategies
procurement may play certain roles which are listed below:
• Running down/disposal of stock, negotiating contract cancellations
• Moving to standard/generic materials/components. Negotiation of limited
period contracts
• Providing competitor information, price volatility, and unused capacity in
supplier market. Negotiation of contracts with options to increase.
• Liaison with design and production. Partnership sourcing, Negotiation
of ownership of tools. Timing of deliveries.

• Liaison with marketing. Partnership sourcing specifying packing

and shipping instructions etc.

• Supply considerations. Effect on set-up costs and production runs.

Purchasing quantity considerations.

• Lower purchase costs through consolidation of purchases, single sourcing,

global procurement. Reduction in costs of purchasing systems and
administration. Value for money spent. Logistical contributions to
competitive advantage. Buying in of sub-assemblies in lieu of components
etc
• Involvement of suppliers in product design and development, value
analysis, total quality management, alternative materials, stimulation of
technological developments in one-supplier markets etc.
• Location of specialist suppliers, make or buy decision for specialist
components, subcontracting, outsourcing etc.

2 Procurement Management and Global Sourcing

Linking Procurement and Corporate Strategy
An organisation must take in more revenues than it spends on operating
costs in the long term to grow and increase profits. Corporate strategy
addresses long-term survival and a company’s ability to compete in a
changing competitive environment. Strategic alignment occurs when
purchasing activities are consistent with the nature of the business
strategy. Therefore, in order to align with corporate strategy, corporate
objectives are required to be translated into procurement goals.
Goals and objectives differ across four major dimensions:
1. Time frame: Objectives are open ended; goals are time based.
2. Measurement: Objectives are stated in relative terms; goals are more
specific.
3. Specificity: Objectives are stated in broad, general terms; goals are
in terms of a particular result.
4. Focus: Objectives are externally focused; goals are internally focused.
Procurement must couple each objective with a specific goal that it can
measure and act upon. Following are few examples of coupled objectives
and goals:
• Objective: Low cost producer within our industry.
• Goal: Reduce material costs by 15% in one year.
• Examples of coupled objectives and goals:
• Objective: Reduce product development time.
• Goal: Develop formal supplier integration process manual by end of
fiscal year.
• Objective: Reduce number of suppliers used.
• Goal: Reduce supply base by 30% over 6 months.
• Examples of procurement goal setting:
Business Goals Increase volume and market share
(SBU): through pricing reduction.
Product Goals: Reduce cost of goods by 20%
System/Component Reduce purchase prices (with
Goals: redesign) by 25% in 12 months’
develop lower cost production
processes or modify design resulting
in 25% lower prices

Types of Procurement Strategies

a. Supply base optimisation: determining the appropriate number and
mix of suppliers to maintain.
b. Total quality management of suppliers: working with suppliers to
initiate quality processes and procedures to attain zero defect quality
while endorsing continuous improvement.
Topic 8 – Purchasing and Commodity Strategy Development 3
 c. Global sourcing: requires purchasing to view the world as a potential
source for products.
d. Longer-term supplier relationships: the selection of and continuous
involvement with suppliers.
e. Early supplier design involvement: participation of suppliers at the
concept or predesign phase of new-product development.
f. Supplier development: working directly with a supplier to facilitate
improvement in a designated functional or activity area.

The Procurement Strategy Development Process

(Bringing goals and objective together)
a. Define business unit requirements;
b. Define strategic importance of commodity via spend analysis (describe
din next section);
c. Determine business and purchasing requirements and conduct supply
market research;
d. Set goals and conduct gap analysis;
e. Develop sourcing strategy and objectives;
f. Execute the strategy;
g. Monitor Results and review performance.

Spend Analysis
Spend analysis is the process of collecting, cleansing, classifying and
analyzing expenditure data from all sources within the organisation (i.e.
purchasing card, eProcurement systems, etc.). The process analyses the
current, past and forecasted expenditures to allow visibility of data by
supplier, by commodity or service, and by department within the
organisation. Spend analysis can be used to make future management
decisions by providing answers to such questions as: what was bought; when
was it bought; where was it purchased; how many suppliers were used and
how much was spent with each; how much was paid for the item. (ref:
http://www.globalpublicprocurement.org/Documents/Resources/public-
procurement-practices/SOPSpend-Analysis.pdf )
For further information on spend analysis refer to page no 198-200 of your
textbook (Monczka, Handfield, Giunipero & Patterson, 2011). However, if
you are using a different textbook refer to spend analysis section (you may
find by searching end-of-text “index” of topic). However, in order to fully
understand and apply your knowledge in this case read further detail of
portfolio analysis and strategy development from your text (page 215-218).
If you are using a different textbook, refer to Portfolio Matrix section (you
may find by searching end-of-text “index” of topic. You may find some
textbooks or articles used this mode in slightly different manner. For

4 Procurement Management and Global Sourcing

 example you may visit UN Procurement Practitioner’s Handbook spend
analysis section (https://www.ungm.org/pph/ch02s03.html) wherein they
have used Kraljic, 1983. The discussion there will be helpful for you to
apply; however, you will use Exhibit 6.12 of your textbook for this course.

Insourcing and Outsourcing:

It is critical for a manufacturing organisation whether to produce internally,
or procure externally. This decision now is being applied to every process
and process within the organisation. The primary driver has been cost
reduction. This requires following a three step process which are briefly
discussed below:
i. Company Strategy Formulation: This step requires an assessment of
how sourcing decision aligns with organisation’s strategic long-term
plans, a determination of an organization’s core competency and an
assessment of the maturity of the process technology used to make
an item or accomplish a process.
ii. Conduct Total Cost Analysis of All Alternatives: Besides the obvious
costs, costs such as idle equipment, loss of jobs, potential union
grievances, and other factors must be considered.
• Implementation. Successful implementation is driven by three
critical activities such as effective supplier selection,
information sharing arrangement and buying company resource
allocation.
The following summarizes the key factors to consider in this analysis.
• Insourcing Factors:
Direct Labour, Direct Material, Inbound Freight, Facilities,
Depreciation, Overhead, Direct Management Costs, Cost of
Inventories, Working Capital Costs
• Outsourcing Factors:
Purchase Costs, Inbound Freight/Delivery, Administrative Costs of
Control, Contact with Supplier, Continuing Investment, Costs of
Inventories, Working Capital Costs.
• Conduct Total Cost Analysis of all Alternatives: Analyse total variable
costs, total factory costs, full operating costs, and determination of
transfer price.

Summary
This topic addressed key questions related to procurement and
commodity Strategy development. It has outlined levels of strategy
(corporate/business), integrative strategy development and related
procurement strategies. The companies need to have a careful approach,
particularly in spend analysis to understand their position and take
measures to move forward.

Topic 8 – Purchasing and Commodity Strategy Development 5

 In the next topic we will discuss three interrelated issues for procurement
which are quality, supplier quality and supply base management.

Online Discussion Activity

Theme: Spend Analysis/Portfolio Analysis/Strategy Development
Company A is a specialty chemicals company located in Singapore
which supplies its products to its customers in the Asia Pacific. Jason,
the Procurement Manager has been tasked by his boss to perform a
strategic procurement review of the company’s suppliers of goods and
services. Jason started by analyzing the procurement data and
information that was available in his company’s SAP system. After
some time, he was able to extract the total spend for 2012 in detail
which allowed him to do a Spend Analysis. He collated and simplified
the data, which are given in Table 1 in next page.
After Jason presented his findings to his boss, he was then asked to
categorize these suppliers using the Portfolio Analysis Approach and
then to formulate a strategy for each category of suppliers.
Spend Analysis is the process of collecting, cleansing, classifying and
analyzing expenditure data from all sources within the organization
(i.e. purchasing card, eProcurement systems, etc.). The process
analyzes the current, past and forecasted expenditures to allow
visibility of data by supplier, by commodity or service, and by
department within the organization. Spend analysis can be used to
make future management decisions by providing answers to such
questions as: what was bought; when was it bought; where was it
purchased; how many suppliers were used and how much was spent
with each; how much was paid for the item. (ref:
http://www.globalpublicprocurement.org/Documents/Resources/pub
lic-procurement-practices/SOPSpend-Analysis.pdf ).
For further information on spend analysis refer to page no 198-200 of
your textbook (Monczka, Handfield, Giunipero & Patterson, 2011).
However, if you are using a different textbook refer to spend analysis
section (you may find by searching end-of-text “index” of topic.
1 Enclosing Exhibit 6.12 of your textbook (page 216) on Portfolio
Matrix for your convenience. However, in order to fully understand
and apply your knowledge in this case read further detail of portfolio
analysis and strategy development from your text (page 215-218). If
you are using a different textbook, refer to Portfolio Matrix section
(you may find by searching end-of-text “index” of topic. You may find
some textbooks or articles used this mode in slightly different
manner. For example you may visit UN Procurement Practitioner’s
Handbook spend analysis section
(https://www.ungm.org/pph/ch02s03.html) wherein they have used
Kraljic, 1983.

1. Categorise the suppliers into each of the 4 quadrants of this

portfolio matrix. List your reasons for doing so.
2. Formulate a strategy to deal with each category of suppliers. For
the high risk group, please state how you might take actions to
reduce the risks.

6 Procurement Management and Global Sourcing

Online Discussion Activity cont’d
Products or Expenditur Supplie Supply Extra
services e (S$000) r market information
procured characteristi
cs
Drums, pails 2,000 Supplier Quite a few For use as
A qualified product
suppliers packaging
available in
the market
Office 7 Supplier Many qualified
stationery B suppliers
available
Esters 800 Supplier Quite a few A family of
C, D, E qualified chemicals used
suppliers as a raw
available in material in the
the market manufacture of
finished products
Photocopy 10 Supplier Many qualified
services F suppliers
available
5L, 1L plastic 1,500 Supplier Quite a few For use as
bottles G, H qualified product
suppliers packaging
available in
the market
Amines 1,100 Supplier Quite a few A family of
I,J,K qualified chemicals used
suppliers as a raw
available in material in the
the market manufacture of
finished products
Utilities 25K Singapor Only 1 supplier Water &
e Power in the market electricity used
by the office and
the plant
Wooden 600K Supplier Quite a few To palletize the
pallets, L qualified finished products
string wrap suppliers
available in
the market
Laboratory 30K Supplier Quite a few Things like test
consumable M qualified tubes, cotton
suppliers swabs, chemical
available in reagents used in
the market the laboratory
for quality
checks
Office 60K Supplier Many qualified
cleaning N suppliers
services available
Security 30K Supplier Many qualified Security guards
services O suppliers
available
Chemical A 150K Supplier Very, very few Unique chemical
P suppliers used as a raw
available material in a few
critical &
important
finished products
Chemical 4,500K Supplier Very, very few Unique patented
B,C,D Q suppliers chemicals used
available as a raw
material in the
company’s
flagship
products.
Topic 8 – Purchasing and Commodity Strategy Development 7
 Online Discussion Activity cont’d
Reading
Prescribed Text: Monczka, R.M., Handfield, R.B., Giunipero, L.C. and
Patterson, James L. (2011), Purchasing and Supply Chain
Management, South-Western, Cengage Learning. 5th Edition. Chapter
6

8 Procurement Management and Global Sourcing

References
CIPS and NIGP (2012). Public Procurement Practice,
http://www.globalpublicprocurement.org/Documents/Resources/
public-procurement-practices/SOPSpend-Analysis.pdf accessed 3
September 2013.
Interagency Procurement Working Group (IAPWG) of United Nations
(2012). UN Procurement Handbook,
https://www.ungm.org/pph/ch02s03.html, accessed 2 September
2013.
Kraljic, P. (1983). "Purchasing Must Become Supply Management,"
Harvard Business Review, (61), September-October, pp. 109-117.
Monczka, R M., Handfield, R. B., Giunipero, L. C and Patterson, James
L. (2014), Purchasing and Supply Chain Management, South-Western,
Cengage Leaming, 6th Edition, pp 1998-200 and 215-218.

Topic 8 – Purchasing and Commodity Strategy Development 9