The CPOs Guide to

The CPOs Guide to

Strategic Sourcing
Strategic
Sourcing
A 10-step guide to strategic sourcing
A 9-step guide
to strategic sourcing
implementation
implementation

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Chapter One
Internal Research

In the preparation phase, you will focus on gathering data from within your
company, analyzing it, and building up a framework for the subsequent steps. The
preparation phase requires analytical skill in order to handpick useful information
from the companys systems.

To review the strategic sourcing definition from CIPS, the purpose of strategic
sourcing is to satisfy business needs for predefined materials and services. Of
course, every business has many different needs, and you cannot do everything at
the same time. This is why in step one you will have to make choices and define your
list of priorities and scope of work.

There are six parts to internal data research:

1

Categorization

Category risk analysis

Scope selection

Spend analysis

Cost structure analysis

Total cost of ownership

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1. Categorization

Categorization in the supply chain is a key element when defining a category

managers scope of work. There are different ways to categorize spend in a
company. Some simple examples of high-level spend categorization are
direct/indirect, materials/services, domestic/import, critical/noncritical, ABC, etc.
However, these categories are simply too broad to draw meaningful conclusions,
and we have to go deeper into the details.

Fig.1 A sample spend categorization

Every company should have their own spend categorization structure, and it should
be maintained in the ERP material master. If the company has not created
categorization in the ERP material master, it should still have spend separated into
different cost accounts. Usually Accounting is responsible for separating spend into
different cost categories. If your company has no master data available, check with
Accounting first to see if you can use their spend data as a starting point.

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When building up a categorization structure from scratch, make sure you include
your entire team in the process. You may also find it helpful to team up with
Engineering and Design in order to find the answers to some of your more technical
questions. Build up a category tree by starting at the highest level and then moving
down to the details. How many levels you want to go down and how detailed you
want to go is up to the companys profile. In Fig.1 you will find an example of high level
categorization for a typical production company that produces machines.
Categorization should be done with the long view in mind; it should not be changed
often. Otherwise, if you change your categories frequently, you will not be able to
compare category spend between periods.

2. Category Risk Analysis

When you are done with categorization, you can start to analyze the data. Use the
Kraljic portfolio matrix (Fig. 2) to help you define a risk level for each category and its
impact on company performance. The Kraljic model is a four-quadrant (strategic,
bottleneck, leverage, and noncritical) matrix with one axis for supply risk and
another for profit impact.

Fig.2 Kraljic portfolio matrix

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Imagine each of your categories as a basket filled with products. One by one, take
each of those baskets and place it on the Kraljic matrix. This will help you define
which categories can be labelled strategic, bottleneck, leverage, and noncritical.
Later on in Step 2 we will drill into each category and evaluate the risk level of
suppliers in Category C.
If youre not familiar with the Kraljic matrix, there are lot of materials available online.
I recommended taking some time to learn about this matrix since the Kralijc model
will be used in several steps of strategic sourcing.

3. Scope Selection

It is important to select a feasible scope. Selecting a category level thats too high
may put you in a situation where very few or no suppliers can cover your category
need. In cases where you have one highly critical component, you can define this one
component as your scope of sourcing work. However, if you select a single product
as your category, you may spend a lot of time and energy executing your sourcing
strategy for every single product. The sweet spot lies somewhere in between.
It takes experience to select a proper categorization level. Work with your team on
scope selection; you should not define category scope alone.

Fig.2 Requisitions Management Dashboard

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4. Spend Analysis

A spend analysis requires working with historical consumption data. During the
spend analysis phase, the more detailed data, the better. This is where your
companys ERP comes in because this is where your purchase records are stored. If
your company is not using master data for making purchase transactions or the
master data it is not maintained, then the category managers work will be more
complicated.

Fig.3 Total spend by suppliers and categories

There are some workarounds for getting historical spend data, though. For example,
you can get the suppliers spend data from Accounting. If you are desperate enough,
you can even ask for your spend data from your suppliers. It may not look the best,
but at least you will get what you need.
Once you have the data, then you can analyze it. The category managers best friend
is Excels PivotTable. If you have a huge pile of data, no tool can beat it. PivotTable can
be used for spend analysis since it allows you to sort and filter data in many ways and
drill into the details. Ideally, PivotTable will be integrated with your companys ERP so
that you will always have access to your organizations most recent spend data.

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The spend analysis should enable you to look at the data in different ways:

Total spend by category and then by supplier

Total spend by supplier and then by category
Top suppliers with 80% of the total spend
Category spend by supplier and then by product
Category spend by product and then by supplier

Fig.4 Total spend divided by category and supplier

5. Cost Structure Analysis

Almost every company performs a cost analysis when calculating its own product
price, but not many try to do it for purchased items. It is not an easy thing to do, and it
does require some engineering skills.
First of all, try to figure out what cost elements make up the component price your
supplier offers you. Typically, for a physical product, one cost element would be raw
material.

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The second cost element would be machining. However, even machining can be split
into different operations: punching, bending, etc. (Its not necessary to go so deep.)
Then the next elements would be finishing, like painting and packing.

Fig.5 Sample cost structure template

6. Total Cost of Ownership

The total cost of ownership calculation is an advanced cost structure analysis where,
in addition to product cost elements, other cost elements, such as acquisition
(transportation, warehouse, financing cost) and lifecycle (usage period,
maintenance, repair), are taken into consideration.
Prepare a TCO template (Fig. 6) and start filling it in with the data you already know. If
youre missing some data, it is not a problem since we can put those gaps on the
action list.

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Fig.6 Sample total cost of ownership template

Both the CSA and TCO are powerful tools when negotiating with suppliers because
you as a buyer have an overview of different suppliers data when your negotiation
partner has only his own.
A cost structure elements template should be used when asking for quotations
through an RFQ.

Summary

Step one on the road to strategic sourcing is all about internal research. A category
manager must be familiar with each and every category, which is why it may take one
to two months before you can move on to the next step. The importance of this key
preparation phase should not be underestimated, as it is the foundation for all of the
other steps to strategic sourcing.

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About the author: Peep Tomingas

After graduating from Tallinn University of Technology with a degree in Mechanical Engineering, Peep received a
masters degree in International Business Administration from the Estonian Business School. Peep spent five years at
Ericsson Estonia as logistics manager, and then worked as a supply chain manager for the Baltic States at ABB until 2015.
Peep has been a board member for Estonia's Purchasing and Supply Chain Management Association Prolog since 2014,
and he is currently their CEO. He is also an advisor at DeltaBid, specializing in supply chain management, strategic
sourcing, and supplier relationship management.

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