The low-hanging fruit has been picked. Now what?

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JonathanHughes.jpgKraljic helped us pick the low hanging fruit, but the model is unlikely to drive the next wave of value, says Jonathan Hughes, Strategic Sourcing & Supply Chain Management Practice Leader at Vantage Partners, in this month's SmartProcurement.

Strategic sourcing rests largely upon a set of concepts and principles laid out by Peter Kraljic in his classic Harvard Business Review article "Purchasing must become supply management”, which was published in September 1983.

While still relevant, Kraljic’s original sourcing matrix is no longer sufficient for the contemporary service-oriented and innovation-powered economy, argues Hughes.

Kraljic's matrix is implicitly based on markets for physical goods and the traditional relationship between supply, demand, power and pricing in such markets: it classifies categories of supply and suppliers by focusing primarily on zero-sum power dynamics between a company and suppliers, encouraging an unhelpful over-emphasis on bargaining power and an under-emphasis on the power of engaging suppliers in the joint exploration of ways to work together that deliver mutual benefits.

As Kraljic put it: “The purchasing portfolio matrix plots company buying strength against the strengths of the supply market and can be used to develop counterstrategies [in relation to] key suppliers.”

So, Kraljic viewed procurement through the lens of a manufacturing economy, but, interestingly, even in 1984 services were already approximately 55% of US GDP; today that number is approximately 70%.

Traditional ways of thinking about supply markets and suppliers, rooted in an industrial past, fail to guide effective thinking about the fairly different risks and opportunities that arise in working with suppliers of services, and suppliers whose primary value derives from their intangible assets.

Companies may have intangible assets worth more than $8-trillion, according to Leonard Nakamura, an economist at the Federal Reserve Bank of Philadelphia, US. That figure is almost half of the $18-trillion market capitalisation of all the companies comprising the S&P 500 index.

Moreover, according to research conducted by economist Carol Corrado and reported in the Wall Street Journal, in 2014, companies invested the equivalent of 14% of the private sector’s share of GDP in intangibles (such as their brand and data assets) versus approximately 10% in physical assets (such as factories).

Clearly, the world economy has changed, and procurement needs to catch up—quickly.

A service-oriented economy requires procurement to develop new strategies and competencies.

Companies are not simply in competition for customers and revenue. They are also in competition with one another for preferred access to supplier innovation, ideas, “A-team” talent, and investment of various kinds.

Procurement is increasingly charged with developing and implementing strategies to become a “customer of choice.”

Insufficient, not obsolete

Despite its insufficiencies, Kraljic’s original sourcing matrix remains relevant. His 1983 article is full of many useful examples and case studies that remain relevant, as do many of the principles and methodologies of strategic sourcing that developed later.

At the outset of his article, for instance, Kraljic asks how a company can “…guard against disastrous supply interruptions and cope with the changing economics and new opportunities brought on by new technologies? What capabilities will a profitable international business need to sustain itself in the face of strong protectionist pressures? Almost every kind of manufacturer will have to answer these questions.”

Such questions remain top-of-mind to business leaders who are grappling with disruptions from natural disasters, rapidly changing technologies, the digitisation of business and shifting geo-political alliances.

Furthermore, the physical economy and associated supply chains still exist. Capacity constraints will continue to arise in many markets and lead to cost increases and/or supply shortages that lead to lost revenue.

So, it would seem that a critical function for procurement in the future will be the capability to strike the right strategic balance with different suppliers between competitive pressure and associated uncertainty (which helps guard against supplier complacency, but also acts as a powerful disincentive to supplier investment), and deeper collaboration and longer-term commitments to suppliers (which act as a positive incentive to supplier investments).

Furthermore, procurement will need to be the torch bearer for “the drivers of past success will not drive future success”.

Jonathan Hughes will be taking this topic further in the 2016 issue of Smart Procurement Review

 

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