STRATEGIC PROCUREMENT

THEORY AND PRACTICE

MSCSCM 628
LESSON – TRANSITION FROM
SERVICE FUNCTION TO
STRATEGIC FUNCTION
 INTRODUCTION
• Over the recent years procurement is transforming from a service function to one
of the most critical functions or departments in every sector (Nawi, Deraman,
Bamgbade, Zulhumadi, & Riazi, 2017, p. 209).
• This has placed procurement at the strategic level.
• With procurement transiting from a service to a strategic function, McConnell,
(2009, p. 19) described the function as the “back water” of the organisation
which is often considered as the “Cinderella” activity.
 IS PROCUREMENT A SERVICE ACTIVITY?
• The thinking prevalent before was that procurement was a service function,
often subordinated to production or engineering in the manufacturing sector,
or to finance in the service or public sectors.
• The idea was that specialist supplies staff could do the bidding of the more
strategic elements of the organisation, and employ their skills at a secondary
‘support’ level.
• Thinking moved on, and there came a more general realisation that
procurement might contribute more effectively at a strategic as well as at an
operational level.
• The idea that procurement and supply was merely a support activity is
somewhat being discredited, with a developing recognition that procurement
involvement in issues such as the ‘make or buy’ decision or strategic
commercial relationship which is giving the function a central and strategic
role in the competitive organisation.
 IS PROCUREMENT A SERVICE ACTIVITY?

• Procurement has been transformed from a service function whose

aims were expressed in the price, quality and delivery equation to one
that makes a contribution to sustainable competitive advantage by
reducing the cost of ownership, cycle-time reduction and improving
time to market.
• Simply to improve service levels or to cut costs is no longer enough.
 THE CHANGING ROLE OF PROCUREMENT AND
SUPPLY
• As we have indicated, procurement is seen by many of today’s successful
organisations as an activity of considerable strategic importance.
• The fact that the strategic role and contribution of procurement and supply is
well recognised in many leading commercial concerns has meant that the
strategic procurement decisions may be taken by procurement’s involvement at
board level, rather than by a departmental manager.  
• There are a number of reasons for this shift in importance and recognition, and
the main ones can be summarised as follows:
 EXTERNAL ORGANISATIONAL FACTORS

Leading edge concepts

• Organisations employing leading-edge approaches to the management of materials
are putting into practice integrative ideas, which are, at least in part, based on a
strategic and integrated role for procurement.
•  Approaches and concepts which might be considered under this heading are:
1. Total quality management;
2. Just-in-time philosophies and lean production;
3. Supply chain concepts;
4. Tiering and empowerment of suppliers;
5. Relationship management;
6. Customer focus.
• The expression ‘world-class concepts’ is sometimes employed to describe these, and
in order to achieve such concepts, procurement needs to be well developed and
proactive.
 EXTERNAL ORGANISATIONAL FACTORS
Increasing environmental awareness
• The recognition has dawned, perhaps belatedly, that it is good business sense to
be ‘green’, and to be seen to be responsible in this respect.
• Recycling, the specification of renewable raw materials, a greater concern with
the effects of waste and by-products, wider concern for the use of returnable
packaging and many other related concerns all have implications for procurement
and are affecting perceptions of the function.
 EXTERNAL ORGANISATIONAL FACTORS
The Chartered Institute of procurement and Supply (CIPS) and the contribution of
procurement
• In the early 1990s, the Institute of procurement and Supply was granted a Royal
Charter.
• This was a landmark in the development of the procurement and supply function,
and it is now more widely regarded as a truly professional activity.
• The Institute has spent considerable time and effort at a national level demonstrating
the importance and contribution of effective procurement in both the public and
private sectors.
• Its examination scheme and courses have done much to enhance the status of the
procurement function, and the CIPS is now represented on many government
committees where procurement issues are discussed.
• The change of the status of purchasing and its evolution into procurement is further
reflected in the imminent change of name from the Chartered Institute of purchasing
and Supply to the Chartered Institute of Procurement and Supply (2014)
 EXTERNAL ORGANISATIONAL FACTORS
Increasing proportion of revenue spent externally
• Organisations are spending a greater proportion of their income externally
and less on internal costs such as wages and overheads.
• With the increased share of the expenditure comes an increasing
responsibility for procurement.
 INTERNAL ORGANISATIONAL FACTORS

• Although there is considerable pressure from outside to develop the

procurement function, it is often internal influences that initiate the changes.
• These internal influences include the following factors:
 INTERNAL ORGANISATIONAL FACTORS

The level and percentage of purchased goods and services

• Normally, as the external expenditure increases as a proportion of the
total, greater attention is paid to the input activities.
 INTERNAL ORGANISATIONAL FACTORS

Structural changes
• Moves towards materials management, logistics and supply chain concepts have
in turn helped to develop the procurement and supply function.
• In almost all cases, the amount of attention paid to procurement and supply has
risen.
 INTERNAL ORGANISATIONAL FACTORS

Performance measurement
• There has been more emphasis in recent years on measurement.
• Within organisations that measure the contribution of the procurement and
supply function, its status is usually affected in a positive way.
• Senior management have become aware of its contribution to cost reduction and
its strategic capabilities, and in consequence are far more likely to promote its
development.
 PROACTIVE PROCUREMENT
Reactive buying
• procurement is a cost centre
• procurement receives specifications
• procurement rejects defective material
• procurement reports to finance or production
• Buyers respond to market conditions
• Problems are supplier’s responsibility
• Price is key variable
• Emphasis on today
• Systems independent of suppliers
• Users or designers specify
• Negotiations win/lose
• Plenty of stock = security
• Plenty of suppliers = security
• Information is power
Proactive buying
• procurement can add value
• procurement ( and suppliers) contribute to specification
• procurement avoids defective suppliers
• procurement is a main management function
• procurement contributes to making markets
• Problems are a shared responsibility
• Total cost and value are key variables
• Emphasis strategic
• Systems may be integrated with suppliers’ system
• Buyers and suppliers contribute to specification
• Negotiations win-win (or better)
• Plenty of stock = waste
• Plenty of suppliers = lost opportunities
• Information is valuable
 THE CHANGING NATURE OF RELATIONSHIPS

• A simplistic view of procurement activity is that it is merely buying; that is in

essence it consists of finding a supplier who is willing to exchange the goods or
services required for an agreed sum of money.
• This perception of procurement has become known as the ‘transactional’ view,
and is based on the idea that procurement is concerned with simple exchanges,
with buyer and seller interacting with each other on an arm’s-length basis.
THE CHANGING NATURE OF
RELATIONSHIPS
• The underlying interest of the buyer in this rather simple scenario is
to acquire as much resource as possible for as little money as
possible.
• It is true to say that this transactional view is not obsolete; it is still an
appropriate way of looking at the process whereby low-cost items, for
which there are plenty of competing suppliers, might be purchased.
THE CHANGING NATURE OF
RELATIONSHIPS
• Much more attention has been paid in recent years to the
development of ‘mutual’ supplier–buyer relationships, where the
benefits of doing business together arise from ideas of sharing as well
as exchanging.
• In a mutual relationship the emphasis is on building a satisfactory
outcome together.
• Confidence and support are invested by both sides with the intention
of adding value, a process not possible with a simple transaction.
• The organisations concerned seek to come closer together and to
identify overlapping interests.
PROCUREMENT
POSITIONING/TARGETING
• Of course, it is not the case that any organisation will wish to develop
mutual or partnership relationships with all of its suppliers.
• Pareto’s principle applies: it will generally be found that 80 per cent of
expenditure will be with 20 per cent of suppliers, and it is likely to be
the suppliers with whom large sums of money are spent that will be
the ones with whom closer relationships are sought.
PROCUREMENT
POSITIONING/TARGETING
• A useful tool in determining those suppliers with whom close
relationships might best be sought is the ‘procurement positioning’
tool, based on the work of Kraljic (1983).
• The vertical axis, labelled ‘Risk’, is concerned with the degree of
difficulty associated with sourcing a product or service, or the
vulnerability of the client organisation to a failure of the supplier to
provide the product or service on time, or to the failure ‘in service’ of
a supply.
PROCUREMENT
POSITIONING/TARGETING
• The horizontal axis, ‘Profit potential’, is used to indicate the extent of
the potential of the supply to contribute to the profitability (or
efficiency) of the buying concern.
• This profit potential might be realised by achieving lower costs,
either by paying a lower price for a good or service or by introducing
more efficient buying methods.
• The foundation of procurement positioning is the division of key items
procured into four categories on the basis of their associated risks and
Profit potential.
PROCUREMENT POSITIONING TOOL
Bottle neck (e.g. Critical (e.g. key sub
proprietary spares or assemblies for car
a specialized maker or engine for a
consultancy need) plane)
risk

Routine (e.g. Leverage (e.g. paper

stationery) supplies for printing
firm)

• Profit potential
 RISK
Risk consists of:
• supply risk – risks of vulnerability of the business to unreliability of supply;
• technical risk – risks arising during and after installation.
 
The principal factors determining risk are:
• the reliability of the sources of supply;
• the availability of the commodity or service required;
• the degree of response by suppliers to the company’s requirements;
• the quality of the product in relation to the role which it is required to fulfil.
 RISK
• Supply risk measures both the likelihood of a commodity or service
not being available when it is required and the costs resulting from its
non-availability.
• ‘Non-availability’ does not simply mean that an item is not physically
present but also includes failure to be effectively present, due to, for
example, a quality failure.
 EXAMPLES OF FACTORS
DETERMINING RISK
Factor High risk Low risk
Experience with the First-time purchase Frequent purchase
Product
Supply/demand Demand exceeds Excess capacity
balance supply exists
Supply chain Many parties Direct purchase
complexity
Financial risks High cost Low
Design maturity New, innovative Proven design
design
Manufacturing Complex Simple
complexity
 PROFIT POTENTIAL
• Profit potential is the degree of opportunity that exists for the process of
procuring the commodity or service under consideration to contribute to
company profitability.
• It is a measure of the benefits that can be achieved by using an
appropriate procurement strategy, as opposed to the unquestioning,
mechanistic placement of orders.
• The benefits potentially include: 
1. reducing the total cost of ownership (TCO);
2. improving the quality of the procurement process;
3. improving the efficiency of the procurement process;
 EXAMPLES OF FACTORS
DETERMINING – PROFIT POTENTIAL
Factor High potential Low potential
Structure of the Many competing Monopoly or
market sources oligopoly
Value of spend High value Low value
Efficiency of the Identical process Contract types and
procurement applied to all procedures promote
process Purchases continuous
improvement
 THE FOUR CATEGORIES
• The key commodities or services for which a company wishes to develop tailored
procurement strategies can be ranked as high or low in terms both of risk exposure
and of Profit potential.
• The score of an item in respect of each of these criteria determines the positioning
of the commodity or service on the procurement positioning/targeting matrix.
• The quadrants of the matrix represent the four categories, which are:
1. Critical
2. Leverage
3. Bottleneck
4. Routine
 THE FOUR CATEGORIES
• The factors to be taken into account when determining risk and Profit
potential will vary according to the circumstances of the company
carrying out the assessment.
• Successful application of the tool depends upon a co-ordinated, cross-
functional team effort resulting in a common view of the relevant
factors shared by everyone involved in the procurement process.
 THE FOUR CATEGORIES
• The same commodity may fall into different categories depending on
use, location and other factors and some commodities are far too
broad to fit into a single category.
• It is important to be aware that the category for a given item may
change over time due to changes in the market or the procurement
organisation.
 CRITICAL ITEMS
• Critical items are those with high risk and high Profit potential.
• All companies have certain commodities and services that are vital to
their operation.
• In many cases these are also high in value and therefore provide a
significant opportunity for increasing profit through the application of
appropriate procurement strategies.
• Such items are categorised as critical.
• Typically, essential considerations include supply continuity, quality,
company image and total cost.
 BOTTLENECK ITEMS
• Bottleneck items are those with high risk and low Profit potential.
• This category, like the critical category, covers items that will stop or
severely impair company operations if they are not available.
• Unlike critical items, however, a common characteristic of items in the
bottleneck category is that there are a small number of potential
sources resulting in limited opportunities for negotiation.
 LEVERAGE ITEMS
• Leverage items are those with low risk and high Profit potential.
• Typically, items in this category are standard items purchased in
volume which are readily available from a range of sources, and so
the company is likely to be in a strong negotiating position due to the
combination of a high spend value and competing suitable suppliers.
• It is important to aggregate volumes in order to maximise leverage.
 ROUTINE ITEMS
• Routine items are those with low risk and low Profit potential.
• Typically, these are low-value, homogenous items; therefore, detailed
negotiations and detailed attention are not cost justified.
• The procurement process therefore needs to be simple and efficient.
 PROCUREMENT STRATEGIES/TACTICS
FOR EACH QUADRANT
• Each quadrant of the procurement targeting matrix requires a different strategic
and tactical approach to procurement.

Critical items
• For critical items, the recommended strategy is to establish close relationships
or partnerships with trustworthy, reliable suppliers in order to minimise the risk
of non-availability and maximise the Profit potential. Possible tactics include:
1. direct negotiation;
2. involvement in supplier quality management;
3. developing close collaborative relationships.
 PROCUREMENT STRATEGIES/TACTICS
FOR EACH QUADRANT
Bottleneck items
• For bottleneck items, for which the risk of non-availability is the principal
consideration, the strategic aim should be to ensure continuity of supply.
• The supply risk can be reduced through a combination of:
1. maintaining a detailed knowledge of the market;
2. accurately forecasting requirements and planning procurement;
3. using medium-term contracts;
4. carefully managing relationships with existing suppliers;
5. value analysis in order to simplify the specification and open up more
competition.
PROCUREMENT STRATEGIES/TACTICS
FOR EACH QUADRANT
Leverage items
• For leverage items, the principal consideration is the Profit potential offered
by the procurement process and therefore the strategic aim is to maximise
the company’s commercial advantage.
• Multiple sourcing and competitive tendering may be used in order to
encourage suppliers to price competitively.
• Ideally, contracts should allow the flexibility to change suppliers at short
notice.
• It may be practical to arrange for supplier stockholding and just-in-time
delivery arrangements. In addition, it is likely to be beneficial to encourage:
1. standardisation;
2. switching to industry standards where possible;
3. co-ordination between business units and companies in order to
strengthen the negotiating position.
PROCUREMENT STRATEGIES/TACTICS
FOR EACH QUADRANT
Routine items
•  Risks associated with routine items are minimal and,
as such, the strategy for these items should be to
adopt simple, cost-effective procurement techniques.
Possible techniques are:
1. E-procurement/fully automated ordering (for stock
items);
2. Outsourcing;
3. Vendor-managed inventory (VMI).
 SUPPLIER PREFERENCING
• Each potential supplier will also have a view of the market and of the
potential customer.
• Therefore, before finalising the procurement strategy and tactics it is
essential to consider the chosen supplier’s view of the purchaser.
• This is known as supplier preferencing.
• One way in which the supplier may view the customer is on the basis of
the relative value (i.e. what proportion of company profits the customer
generates) and the other factors that make a particular customer more or
less attractive, for example, the quality of the relationship and the
prestige of the account.
• It is advisable to check a potential supplier’s view before entering into
negotiations as it will indicate whether the supplier’s and customer’s
views are compatible..
Market Analysis
Supplier Preferencing - the supplier’s view

The Supplier’s View:

Hi

DEVELOPMENT CORE
Nurture customer Defend vigorously
Expand business Manage closely
Seek new opportunities High service and response

Attractiveness
of Account NUISANCE EXPLOITABLE
Low attention Premium price
Little interest Short-term advantage
Withdraw in easiest manner Risk losing customer

Lo
Lo Hi
1% of turnover
Relative Value
of Business
 SUPPLIER PREFERENCING
Nuisance customers
• These customers are neither attractive nor valuable to do
business with.
• Suppliers practising customer relation management will regularly
review their customer base and downgrade or cease service to
unprofitable customers – or raise their prices in such a way to
turn them into exploitable customers
 
Exploitable customers
• The customers offer large volume of business, which
compensates for lack of attractiveness.
• The supplier will fulfil the terms of the supply contract – but will
not go out of its way to provide extras
 SUPPLIER PREFERENCING
Development
• Customers are attractive, despite currently low levels.
• The supplier may see potential to grow the account and may go an
extra mile in fulfilling contracts.
• If all goes well, the customer may be converted to ‘core’ status

Core
• Customers are highly desirable and valuable for suppliers, who will
want to establish long term mutual profitable relationships