Strategic Sourcing – Need for a disciplined approach
26 June 2008:
In order to make their value chains more elastic and their organizations more flexible, successful companies are re-looking closely at their core capabilities and redefining how and where to source every single key activity in the value chain. Outsourcing has become strategic in the sense that core functions like design, manufacturing, HR, R&D, marketing, logistics are moved offshore so that companies achieve competitive edge in the market place. Strategic sourcing helps a business enterprise to achieve process improvements, faster-to-market, and create long term value to its customers, thereby dramatically improving its competitive position in the market place.
Globalization and challenges before modern business enterprises
We live today in a hyper-competitive world. Globalization is inextricably linking the world’s major economies. Today’s goal of business excellence is not just best-in-class but best-in-world. In this global economy, every enterprise must compete against customer choices that are available from anywhere and everywhere. Barriers to the market place are vanishing rapidly with newer and newer competitors entering the field all the time.
The single most visible result of this hyper-competitive environment is rapid commoditization. In this age of intense competition, even the most innovative products / services are fast turning into commodities, thereby seriously curtailing the ability of the producers to command higher prices for their offerings.
At the same time, stakeholders’ expectations for profitability and growth are mounting. Increased shareholder value is the common demand. Disappointments on any of these fronts are severely punished in the capital markets, making it difficult for the enterprises to raise funding for their future operations.
In this backdrop of hyper-competition and increasing pressure for performance, the very structural integrity of organizations is beginning to break down. The classical view was that organizations should be, by design, vertically integrated and self- sufficient: vertically integrated through a hierarchical, command and control structure; self-sufficient in terms of setting out to own, manage, and control as many of the factors of production as possible.
This classical model is no more a prescription of success. There are two main reasons: the first is the fact that accelerating pace of change dramatically compresses investment cycles. The competitive advantage from an organization’s internal investments lasts for a shorter and shorter period of time. This leads to ever increasing demands of new investments across the entire firm which, for obvious reasons, is not feasible.
The second reason for the failure of classical approach to organizational structure is that all the operational activities across an organization are becoming increasingly specialized and knowledge driven. Rapid advancement in every field makes it a practical impossibility for any organization to develop and sustain best-in-world expertise in every facet of its operation. Yet, whenever even a single part of the business is operating below that standard of excellence, the result can be disastrous in terms of reduced capacity, below par performance, operational inefficiency, higher costs, and competitive disadvantage.
Companies are therefore moving away, even being forced away, from this classical structure toward a structure that is more flexible. It is no longer a company’s ownership of capabilities that matters, but rather its ability to control and make the most of critical capabilities, whether or not they reside within the organization, or outside its physical boundaries. Doing the right thing is becoming far more important than doing everything on your own. Expertise is rivaling size as a competitive differentiator in today’s business scenario.
To respond to this hyper competitive and performance driven environment, organizations are becoming more focused and specialized. They are critically evaluating each activity in the value chain to determine, if and how, it provides a unique competitive advantage. Those areas that provide an advantage are likely to receive more attention and increased
internal investments. Those areas, that do not, are either eliminated or considered for outsourcing from specialist service providers in respective fields.
In this changed business environment, with the decline of the vertically integrated business model, the decision whether to outsource or in-source a capability or activity has become critical , which is being termed by some authors as the new discipline of ’capability sourcing’.
The term ’core competence’, the areas of a business’s operation that provide its unique competitive differentiation, was first introduced by C K Prahalad and Gary Hamel in 1990 (HBR). In 1994, James Brian Quinn and Fred Hilmer (MIT Sloan Management Review) identified the seven characteristics of core competencies as: skills and knowledge sets, not products or functions; flexible, long term platforms capable of adaptation or evolution; limited in number with no more than two or three per organization; unique sources of leverage in the value chain; areas where the company can dominate; elements important to customers in the long run and capabilities embedded in the organization’s systems. Tom Peter’s oft quoted remark ‘Do what you do best and outsource the rest’ aptly describes the connection between core competencies and outsourcing. Chrysler and Microsoft are classic cases of how sourcing ‘strategically’ from outside competent sources enables forward thinking organizations to leverage the capabilities of outside ’partners’ and simultaneously increase the focus on their core competencies, thereby gaining a distinct competitive advantage.
Sourcing as strategy
Over the years, ‘sourcing’ primarily meant procurement, a peripheral corporate function with less strategic importance. Given the rapidly shifting contours of the global competition and with the decline of classical and vertically integrated business model, sourcing has moved from periphery to the core. In the process, it has become a top level corporate activity of high strategic importance that gives directions to the business as to what and where to source core competencies that will generate long term value for customers and a sustainable competitive advantage for the organization.
Traditionally, organizations have seen only one source of competitive advantage: their internal operations. However, strategic sourcing opens up brand new sources of competitive advantage. Some of these new competitive advantages come directly from the outside partners, others come from the competition-driven continuous improvement that outsourced activities generate in the organization’s support functions and still others are found in the unique ways the organization blends its inside and outside operations to create new solutions for its customers. All of this can happen however, if and only if, sourcing is elevated to a level of importance where it becomes part of the organization’s overall strategic planning process.
Sourcing is no longer optional, and a strategic approach has become a precondition for business success and in some industries, a prerequisite for survival. The challenge of modern organizations, however, is to integrate sourcing as an integral part of the business strategy. Decisions on how and when to source business activities are often not getting the importance and attention they deserve from the top management , or are based on the wrong sourcing scenario and are addressed too late. A pro-active and systematic, structured approach strengthens the competitive position of the organization in the market through reduction of costs, increase in quality of service or product and the ability to concentrate on the primary processes and core activities. Over the years, many organizations have experienced the benefits as well as the pains of outsourcing and insourcing of business processes. Traditionally, the reduction of costs was the primary or sole driver to consider different sourcing possibilities. This has changed now. Many forward- looking enterprises today outsource activities in order to excel. Another strong motivator is the opportunity to get access to new and specialized expertise and services. The services and skills of specialized firms are added to improve the overall service levels of the organization, in terms of increased innovation and business continuity.
Strategic Sourcing – Definition
Conceptually, strategic sourcing can be described best through its main characteristics which are:
- It is a systematic and on-going activity
- It is a corporate level strategy
- It concerns all activities and services in the organization, including the core activities.
- Its focus is to identify activities that are sourced within the organization and activities that can be sourced outside the boundaries of the organization.
Strategic Sourcing can therefore be defined as: ‘the disciplined and on-going evaluation whether to source organizational processes and activities internally or externally, guided by maximizing the achievement of the business strategy and business goals’
Strategic sourcing therefore requires an in-depth and continual assessment of the value of internal and external activities, services and knowledge and their relevance in the context of the business function, processes, and activities. Through this exercise, the business also gets the added benefit of critically examining its entire value chain, and identifying those value reducing activities or processes which can either be eliminated or put in the right hands to transform them over as value enhancing activity or process.
In the past, outsourcing focused on tactical, nonessential activities such as payroll processing or security services. But the focus is shifting. Outsourcing is becoming so sophisticated that today we see fast growing companies across various industry segments are moving outside some of their core functions, like engineering, manufacturing, design, R&D, HR, logistics, and marketing etc. The list goes on increasing. And, that, in turn, is changing the way firms think about their organizations, their value chains, and their competitive positions.
Sourcing variants
As said before, every process or activity in an organization needs to be sourced. The organization may use its own resources, external resources, or a mix of both. Though total insourcing or total outsourcing (where 80 per cent of activities or processes or more, are sourced internally or externally) is possible, most organizations go for selective sourcing where suppliers are selected for specific and carefully selected activities or processes. In the execution of a sourcing strategy for an organization, several of these sourcing variants can be executed alongside of each other. In order to determine the right sourcing variant, sourcing feasibility (source-ability) of the process or activity needs to be determined in the organizational context. This means not only the nature of the task will have to be assessed, but also the maturity and the strengths / weaknesses of the organization are to be looked into. Careful financial, situational and risk analyses need to be prepared to ground the sourcing decisions and propose sourcing scenarios.
Implementation of Strategic Sourcing
Implementing or optimizing strategic sourcing is done in a two phased approach. In the goal of the strategic decision phase is to determine the firm’s current situation against the background of the vision, mission, and ambition of the organization. This involves analyzing external developments of the environment in which the organization operates but at the same time this phase is used to identify the possibilities or opportunities in the context of the organizational competencies.
The strategy definition phase naturally evolves in the second phase in which the sourcing strategy and execution are started. The second phase is based on the results of the first phase and aims to develop and implement a suitable sourcing strategy. The implementation of strategic sourcing develops through three interrelated activities: Choice, Change, and Control.
Choice involves the identification and analysis of possible sourcing strategies and decides on the best sourcing strategy for the organization.
Change focuses on finding, rating and advising on best fit vendors, transforming the organization to fully embrace the new possibilities that sourcing offers.
Control is essential to ensure that the choices and changes continue to pay off for the organization. This implies that internal and external suppliers’ performance need to be monitored and improved where needed.
The result of placing sourcing as a strategic focus is that the organizations will no longer superficially allocate resources across its entire chain, leaving the sourcing decisions up to the downstream operational managers. Instead, the senior leadership would direct sourcing decisions as part of the organization’s overall strategy for competitive advantage in the markets it intends to serve.
This kind of strategic thrust can be seen in companies such as American Express and Ericsson. American Express has one of the most visible and admired brands in the world. When American Express examines its sources of competitive advantage, activities that directly strengthen the brand’s image and raise brand awareness get high importance for internal investment. At the same time, the company strategically invests in outside relationships that provide it highly valuable and complementary competitive advantages in selected market segments. Ericcson similarly has repositioned its internal source of competitive advantage away from its product design and manufacturing operations toward its service operations. There are other recent examples of success elsewhere.
Business Transformation Outsourcing
In this context, ‘Business Transformation Outsourcing’ needs a mention here. ‘Business Transformation’ can be vital for survival for many an enterprise in today’s highly volatile, competitive, and regulated business environment. Competitiveness, agility, innovation and customer service are the new benchmarks for this transformation. Transformational outsourcing involves outsourcing ongoing services that are critical to the performance of the business. It can be said that ‘Transformational Outsourcing’ is using outsourcing strategically to achieve a rapid, sustainable, step-change improvement in enterprise-level performance. However, this is a subject matter of its own and beyond the scope of this article.
Conclusion
In conclusion, it can be said that Strategic Sourcing has become pre requisite for continued business success. Corporate firms as well as government organizations need to think strategically about their processes and the different possibilities to source them. Several sourcing models can be applied, but only when an integrated strategy is developed, maximum benefits will accrue in terms of business excellence.
The management of the sourcing process and the parties that can provide their services has become complex, global and competitive. New suppliers are emerging, and new service offerings become available. A corporate sourcing strategy needs to provide a clear guideline for sourcing objectives to prevent piecemeal and sub-optimal solutions. The development and implementation of a corporate sourcing strategy requires specialists with a good understanding of the business, its mission and vision, market opportunities and possible threats in the medium and long term, sourcing possibilities and supplier / contract management. Most importantly, it requires complete harmony between corporate strategists and operational / functional specialists in any business enterprise which is often seen missing.
Source: Prof S N Mookherjee, Faculty Member in Marketing and International Business in ICFAI Business School, Kolkata
