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The Purchasing Chessboard

Buying in turbulent times

Recent turbulent months have caught many buyers off guard. Their procurement strategies were geared to a specific market condition lacking the flexibility to act upon the radical changes we are currently experiencing. While 12 months ago companies had their focus on rising raw material prices and scarce resources, the current economic crisis has now led to a shift towards cost containment. Although market volatility is likely to continue over the next year, one trend is destined to remain: Supplier markets will become more differentiated. What does this mean for companies and industries worldwide? That a "one size fits all" strategy no longer applies.

TM

For years, most procurement organisations have operated in supply markets that could be addressed using relatively simple tools and techniques-- RFIs (requests for information) and RFPs (requests for proposals), bundled products and services and multi-year contracts, among others. Today's supply markets, however, are heterogeneous and require vastly different methods in order to yield benefits from material costs. To cope with these challenges, A.T. Kearney developed The Purchasing ChessboardTM, a framework to address every supply and demand market condition (see sidebar: Applying the Purchasing Chessboard: Five Steps to Success on the next page).

today's often consolidating and more volatile supply markets. In a recent A.T. Kearney survey, we discussed the impact of differentiated markets with more than 200 CPOs and managing directors of major companies. One of the most frequent remarks among survey participants was that procurement departments are not up to the challenge. "We have a deficit in know-how among our procurement professionals," explains one survey respondent. "There is also a lack of knowledge about how to use analytic tools to improve the process."

In turbulent times, buyers must adopt new tools and strategies to compete effectively on a new playing field.

The A.T. Kearney Purchasing Chessboard

To help procurement professionals master the tools of their trade, we developed The Purchasing Chessboard-- a compilation of insights and experience from more than 500 purchasing projects performed worldwide over the past three years, and thousands performed

Differentiated Approaches for Differentiated Markets

The "old" purchasing strategies of pitting suppliers against each other, or simply requesting price reductions, are no longer sufficient to address

over the past three decades. The Purchasing Chessboard constitutes 64 methods, each representing a stand-alone, differentiating way to work with suppliers to reduce costs and increase value. These methods are derived from 16 approaches and four purchasing strategies (see figure 1). The following offers a brief discussion of the four major strategies. Leverage competition among suppliers. The most celebrated and perhaps most frequently employed procurement strategy is competitive tendering or commercial negotiations with a strong focus on price. This is particularly popular when buying in a

high-demand, low-supply market, for example component parts. There are four main procurement levers: tendering, leveraging global supplier markets, reviewing suppliers' prices, and enforcing target prices. Experience shows that most procurement organizations readily employ the first two levers, but only a few companies focus on pricing and enforcing target prices. With this in mind, we have included a cost regression analysis as a key component of The Purchasing Chessboard. The analysis is performed via a statistical methodology that determines target prices based on the technical characteristics of a

Applying the Purchasing Chessboard: Five Steps to Success

1 Place specific categories on the Purchasing Chessboard depending on their unique demand or supply conditions 2 Make sure you are applying relevant purchasing strategies to categories. Are you conducting cost regression analysis to identify the target price of packaging material? Have you considered a supplier fitness program for molded plastic parts? Would it be financially beneficial to outsource purchasing of indirect materials? When performing a specification assessment wouldn't it make sense to also perform a functionality assessment? 3 Review the competencies of the purchasing function. Can your team play on all relevant fields of the Purchasing Chessboard? In what areas should you broaden your skill sets? 4 Do you have the right composition of cross-functional team members involved when working with categories? Purchasing strategies that fall in the left top corner of the chessboard (innovation breakthroughs) will require deep involvement of engineers whereas the right top corner of the chessboard (value partnership) will require corporate strategy experts. 5 Review and update the position of categories on the Purchasing Chessboard regularly and adjust purchasing strategies accordingly. The world is not static. For example, the supply power of key raw materials such as steel, metals and chemicals has significantly decreased in the past year.

FIGURE 1: The Purchasing ChessboardTM

Change nature of demand

Seek joint advantage with supplier

4 purchasing strategies

Manage spend Leverage competition among suppliers

Innovation breakthrough Risk management Co-sourcing Demand management

Respecification Technical data mining Commercial data mining Volume bundling

Value chain management Integrated operations planning Tendering

Value partnership Cost partnership Supplier pricing review Target pricing

16 levers

Globalization

Invention on demand Core cost analysis Vertical integration

Leverage innovation network Design for sourcing

Functionality assessment Product teardown Composite benchmark

Specification assessment Design for manufacture

Value chain reconfiguration Supplier tiering

Revenue sharing Sustainability management

Profit sharing Project based partnership Total lifecycle concept

Strategic alliance Value based sourcing Collaborative cost reduction

Intelligent deal structure Political framework management Buying consortia

Process benchmark Complexity reduction Standardization

Collaborative capacity management

Virtual inventory management

64 methods

Bottleneck management Sourcing community Procurement outsourcing Compliance management Demand reduction

Product benchmark Cost data mining

Visible process Vendor managed Supplier organization inventory development RFI/RFP process Expressive bidding Reverse auctions Best shoring LCC sourcing Total cost of ownership Price benchmark Cost regression analysis Cost based price modeling

Supplier fitness program Leverage market imbalances Unbundled prices

Mega supplier strategy Closed loop spend management

Master data management Supplier consolidation

Spend transparency Bundling across generations

Supplier market intelligence Make or buy Global sourcing

Contract management

Bundling across product lines

Bundling across sites

Factor cost analysis Linear performance pricing

Source: A.T. Kearney

module. Once identified, the target price becomes the fact base for renegotiating with existing suppliers. In the past three years, this analysis has proved successful for procurement professionals in the automotive industry (OEMs and suppliers), mechanical engineering firms, financial institutions and consumer goods, especially for commodities such as castings, hydraulic components, forgings, and also for indirect categories such as IT equipment. Seek joint advantage with suppliers. When buyers and suppliers in a transaction have equal market power, the first strategy will not be sufficient

to achieve sustainable cost or value advantages. For example, the automotive industry procures numerous unique modules (for example, engine controls) so simply putting suppliers into competition will not suffice. In these situations, companies must strive to find common advantages with their suppliers. The goal is to build joint cost-value partnerships, an integrated and transparent operations planning process, and joint management along the entire value chain. Such partnerships can reduce costs while also generating value. Suppliers and buyers work together to spawn ideas for optimizing costs and

FIGURE 2: The Chessboard constitutes 64 stand-alone methods

High 8

Invention on demand Core cost analysis

Leverage Functionality innovation assessnetwork ment Design for sourcing Product teardown

Specification assessment Design for manufacture Process benchmark

Value chain reconfiguration Supplier tiering Collaborative capacity management

Revenue sharing Sustainability management Virtual inventory management Vendor managed inventory

Profit sharing Project based partnership Total lifecycle concept Supplier development

Strategic alliance

7

Value based sourcing Collaborative cost reduction Supplier fitness program

6

Vertical Intelligent Composite deal benchintegration structure mark Political Bottleneck framework manage- management ment Sourcing Buying community consortia Product benchmark

Supply power

5

Visible Complexity process reduction organization Standardization RFI/RFP process

4

Cost data mining Master data management

Total Leverage Expressive cost of market bidding ownership imbalances Price benchmark Cost regression analysis Cost based price modeling

3

ProcureMega ment supplier outsourcing strategy Closed Compliance loop spend manage- management ment Demand reduction Contract management

Spend Supplier Reverse transmarket parency intelligence auctions

Unbundled prices

2

Supplier Bundling consoliacross dation generations Bundling across product lines Bundling across sites

Make or buy

Best shoring

Factor cost analysis Linear performance pricing

1 Low

Global sourcing

LCC sourcing

A Low

Source: A.T. Kearney

B

C

D

E

F

G

H High

Demand power

then agree to share in the respective benefits. What begins as an ad-hoc program could eventually turn into a longer-term strategic alliance between buyer and supplier. Change the nature of demand. In low-demand, high-supply markets--where suppliers are in monopolistic or quasi-monopolistic positions due to their technical expertise-- companies must change the nature of demand. Low-demand markets stem from companies developing long-term partnerships with key suppliers; these suppliers soon become indispensable, particularly in terms of research and development (R&D) or technological expertise. Companies expand the problem by not wanting to endure the time and costs associated with shifting to new suppliers. In such markets, the objective is to change the nature of demand. This is done by re-specifications of components, data mining, developing new technical options, and risk management. In The Purchasing Chessboard, we call this "invention on demand" (see figure 2), whereby a company systematically challenges the basic elements of a technical system and searches for alternatives throughout the field of science--essentially replacing technical options for modules delivered by suppliers. This approach is particularly relevant for industries where patent-protected components or systems are already successfully employed, for instance, in aviation, engineering and automotive. Manage spend. The fourth strategy, managing spend, is particularly useful in low-demand, low-supply markets. For example, for most indirect material categories such as office

supplies or MRO (maintenance, repair and operations). In these situations, the focus should be on volume bundling, commercial data mining, co-sourcing and demand management. Apart from defining and monitoring guidelines, transparency in spend behavior (for example, through IT-based spend-cube solutions) is a

concrete approach to reducing costs and increasing value.

Outlook to a New Purchasing Era

The Purchasing Chessboard is a holistic framework for companies to map each market situation that takes place between their purchasing orga-

nizations and suppliers. It is flexible enough to adapt to changing market conditions, and strategic enough to address the challenges in a new age of purchasing--where purchasing contributes to the company's success. To learn more, please visit www.purchasingchessboard.com

Authors Christian Schuh is based in the Vienna office and can be reached at [email protected] Robert Kromoser is based in the Vienna office and can be reached at [email protected] Michael F. Strohmer is based in the Vienna office and can be reached at [email protected] Ramón Romero Pérez is based in the Berlin office and can be reached at [email protected] Alenka Triplat is based in the Vienna office and can be reached at [email protected]

A.T. Kearney is a global strategic management consulting firm known for helping clients gain lasting results through a unique combination of strategic insight and collaborative working style. The firm was established in 1926 to provide management advice concerning issues on the CEO's agenda. Today, we serve the largest global clients in all major industries. A.T. Kearney's offices are located in major business centers in 34 countries.

If you have any questions or would like to discuss this topic further please contact Wolfgang Steck A.T. Kearney Ltd, Lansdowne House, Berkeley Square, London W1J 6ER [email protected] or visit www.atkearney.co.uk

Copyright 2008, A.T. Kearney, Inc. All rights reserved. No part of this work may be reproduced in any form without written permission from the copyright holder. A.T. Kearney® is a registered mark of A.T. Kearney Ltd. A.T. Kearney Ltd. is an equal opportunity employer. 3-08

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