Today’s guest post is from Torey Guingrich, a Project Manager at Source One Management Services, who focuses on helping global companies drive greater value from their expenditures.

In Part I, we noted that if you are applying the same strategy for every category, e.g. consolidate suppliers and sign a three-year contract, you may need to reconsider the variances in the categories and how these differences should affect the chosen strategy. We also noted that, over 30 years ago, Peter Kraljic published his ideas around how Procurement can transition from purchasing to supply management in a still-relevant 1983 article, and that if you look at the complexity of the supply market and contrast that with the criticality to the business, you can fit Procurement’s spend categories into different quadrants and develop a sourcing strategy around each.

Before we discuss what type of strategy generally works in each bucket, we want to make it clear that it is important to track changes and moves in the degree of availability/criticality and adjust your strategy when and where it makes sense. Each classification is examined below; remember that a given product/category can change classifications based on your company and the market conditions; the examples given below should encourage you to think of a comparable product for your company:

Highly Critical, Low Availability [Strategic]:
These are the areas that will stop production or service to customers and are also the hardest products or services to secure and source. To guarantee supply, you will likely need to establish long-term contracts and high quality standards. Due to the criticality, ideally, you would have an alternate supplier pre-qualified for failover or shortages with your preferred supplier. If the market is extremely scarce, you may even need to supplement your supply with multiple long-term suppliers to meet the demand you require. Depending on the products or service, companies can examine the make vs. buy decision and consider vertically integrating the supply into your own company.

Take iron ore for a steel company as an example. If quantities and quality are not met, it can severely impact or even halt production; there are very few suppliers in the market and high barriers to entry. Many steel companies have long term contracts and their own mining divisions to lower the supply risk.

Highly Critical, High Availability [Leverage]:
These categories of spend are still very important to the business, but the products/services are much easier to secure. Due to criticality, you will typically need to establish quality standards, but you can make changes in suppliers more easily and the market should be able to absorb increases in demand. This is one category where other market conditions will likely play a major role in determining sourcing strategy, i.e. how is the market evolving and how are vendors differentiating themselves? Because there is high availability of supply, Procurement should look to leverage spend and focus on cost and quality.

IT products and services are a prime example of this. They are highly available in the market and these can be critical to keep core processes or systems running. For many software and hardware products, there are multiple options to get the same end product by going direct to an OEM, utilizing a reseller, leveraging a VAR relationship, or even one-off buys from local or online suppliers if necessary.

Less Critical, High Availability [Non-critical]:
These products and services are still necessary to run the business, but do not have a significant impact on the end product and results should not be drastic if there is a lapse in supply or an alternate product or service is used in its place. This is where you may cherry pick among suppliers to achieve the lowest cost, introduce alternates/replacements, and use regular RFx efforts to drive down cost. Procurement should look to streamline purchasing and not invest their time heavily on non-critical items.

Office supplies could fall under this category. While office supplies are needed, there are certainly options and alternatives if they are not available, e.g. if pens aren’t available, pencils can be used. Essentially, you can continue to push production without office supplies and the supply base for these items is rather abundant.

Less Critical, Low Availability [Bottleneck]:
Similar to the items above, these categories of products and services are less crucial to running the business and do not add much value to the end product, but because the supply is limited, there is increased risk of scarcity. Procurement will need to secure supply by fostering the supplier relationship to ensure supply, while simultaneously qualifying additional suppliers, considering alternatives, and creating a cushion of inventory where able.

For example: electricity – the market is limited and electricity doesn’t add value as an input into an end product. For many companies, electricity is a utility and necessary to continuing day to day business, so it is crucial to ensure there is a supplier in place. The strategy for something like electricity may lean towards assurance of supply as opposed to finding alternates, but that strategy could adjust depending on presence in deregulated vs regulated energy markets.

These classifications are a starting point that Procurement should use to begin looking at categories and sourcing strategies in a more deliberate manner (or validate the strategies in place today). Determining where a category or even a specific product fits on the scales of criticality and availability will take heavy partnership with business stakeholders. By partnering with end users, Procurement can transform itself from a “buying” department to a “business-enablement” partner and gain inherent knowledge of the business you are supporting each day. The onus is on Procurement to understand how categories being sourced affect and fit into the core business to ensure alignment to overall company goals and business plans. By understanding and tracking the changes in criticality and availability of different inputs to your business, Procurement can ensure the sourcing strategy, category management, and vendor management are aligned to both the supply market and the company goals.

Thanks, Torey.

Today’s guest post is from Torey Guingrich, a Project Manager at Source One Management Services, who focuses on helping global companies drive greater value from their expenditures.

Part of good category management is ensuring that the sourcing strategy in place for the products/services is intentional and logical based on the market and commercial aspects of your company. Consider how you are determining sourcing, contract management, and vendor management strategies for different categories of spend: what are the guiding factors that push you towards a long term versus a short term contract, or a consolidated versus a segmented supply base? If you are applying the same strategy for every category, e.g. consolidate suppliers and sign a three-year contract, you may need to reconsider the variances in the categories and how these differences should affect the chosen strategy.

In 1983, Peter Kraljic published his ideas around how Procurement can transition from purchasing to supply management in a still-relevant 1983 article. These ideas were introduced to me when I first began my career in Procurement. I’ve kept these ideas in mind throughout my career to understand at a high-level how the inputs being sourced relate to the business at hand and how to best position a category management strategy given the market conditions associated. We’ll walk through a simplified version of Kraljic’s original ideas and how they can be applied to Procurement at any company.

Complexity of Supply Market/Supply Availability:

To simplify the original idea around “Complexity of the Supply Market” that Kraljic introduced, I want to focus on the availability of supply within the market. Across categories, there are certainly areas where suppliers or additional production are more available than others. In the manufacturing world, I’ve worked with companies that pursued long-term contracts with key suppliers, e.g. over 10 years, and even shared in the capital investment of building plants or production facilities in order to secure supply. Certainly a decision that large would be made with many stakeholders and C-suite folks involved, but it serves as an example of understanding the availability of supply in a given market and strategically responding to scarcity.

Scarce goods or services have rigid supply curves; there are limitations that prevent supply from meeting demand by simply increasing production/output. I use availability to mean more than just physically scarce resources; low availability can be brought on by high barriers to entry, complexity in extracting or moving the materials, a rapid increase in demand, or a rapid decrease in supply. Consider a manufacturing company; an example of a relatively scarce service in that market would be railroad transportation. For railroad capacity, we see high barriers to entry (e.g. we don’t see new railroad companies popping up every year) and an inability to ramp up to changes in demand (e.g. new railroad lines can’t be quickly added). When in Procurement, it is crucial need to look at the supply markets of different categories related to your business – are you being approached by suppliers frequently; are you able to easily find new suppliers to include in sourcing events; have there been any large-scale events that impact supply? Additionally, you can research the number of suppliers in the market, limitations on delivering the product/service, alternatives/substitutions available, and any other limiting factors that can affect supply to determine the relative scale of availability.

Importance of Purchasing/Criticality to the Business:

Availability of supply works hand-in-hand with criticality of that category to the business. Kraljic calls this component “Importance of Purchasing;” I position this aspect as “Criticality to the Business” to refer to the level of spend for a category and the overall impact on profit or production. To be able to measure this, Procurement needs to understand the business perspective and what drives production (either physical production of goods or sale of services). When I was taught these concepts at a steel company, one of the key materials to production was coke to fuel the furnace to smelt iron ore. Consider the core elements of your business and the drivers of production/sales as well as high volume/high price goods; this will help to gauge how critical a given product/service is your business. It should be noted that when looking at criticality, that the quality of that supply can be just as important as actually guaranteeing the volume needed. If key quality specs do not meet acceptable levels for production, there is the risk that the material may not be usable at all.

Based on availability and criticality, you can begin fitting Procurement’s spend categories into different quadrants to develop a sourcing strategy around each.

We will dive into details in Part II.

Thanks, Torey.