Supply Chain Management: A Guide To Best Practice (Management Briefings Executive Series)

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Supply Chain Management

Prentice Hall FINANCIAL TIMES

In an increasingly competitive world, we believe it’s quality of thinking that will give you the edge – an idea that opens new doors, a technique that solves a problem, or an insight that simply makes sense of it all. The more you know, the smarter and faster you can go. That’s why we work with the best minds in business and finance to bring cutting-edge thinking and best learning practice to a global market. Under a range of leading imprints, including Financial Times Prentice Hall, we create world-class print publications and electronic products bringing our readers knowledge, skills and understanding which can be applied whether studying or at work. To find out more about our business publications, or tell us about the books you’d like to find, you can visit us at www.business-minds.com For other Pearson Education publications, visit www.pearsoned-ema.com

Supply Chain Management A guide to best practice

ANDREW COX, PAUL IRELAND, CHRIS LONSDALE, JOE SANDERSON AND GLYN WATSON

Prentice Hall FINANCIAL TIMES

An imprint of Pearson Education London ■ New York ■ Toronto ■ Sydney ■ Tokyo ■ Singapore ■ Hong Kong New Delhi ■ Madrid ■ Paris ■ Amsterdam ■ Munich ■ Milan ■ Stockholm

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Cape Town

PEARSON EDUCATION LIMITED Head Office: Edinburgh Gate Harlow CM20 2JE Tel: +44 (0)1279 623623 Fax: +44 (0)1279 431059 London Office: 128 Long Acre London WC2E 9AN Tel: +44 (0)20 7447 2000 Fax: +44 (0)20 7447 2170 Website: www.briefingzone.com

First published in Great Britain in 2003 © Andrew Cox, Paul Ireland, Chris Lonsdale, Joe Sanderson and Glyn Watson 2003 The right of Andrew Cox, Paul Ireland, Chris Lonsdale, Joe Sanderson and Glyn Watson to be identified as authors of this work has been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. ISBN 0 273 66270 8 British Library Cataloguing in Publication Data A CIP catalogue record for this book can be obtained from the British Library. All rights reserved; no part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without either the prior written permission of the Publishers or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published, without the prior consent of the Publishers. 10 9 8 7 6 5 4 3 2 1 Typeset by Monolith – www.monolith.uk.com Printed and bound in Great Britain by Ashford Colour Press Ltd, Gosport, Hants. The Publishers’ policy is to use paper manufactured from sustainable forests.

About the authors

Andrew Cox is Professor and Director of the Centre for Business Strategy and Procurement at Birmingham Business School, University of Birmingham in the UK. He is also Chairman and CEO of Robertson Cox Ltd a UK and US based consultancy. Andrew can be contacted at: [email protected] Paul Ireland is a research fellow in the Centre for Business Strategy and Procurement at Birmingham Business School, University of Birmingham in the UK. Paul can be contacted at: [email protected] Chris Lonsdale is a lecturer in Supply Chain Management in the Department of Commerce and the Centre for Business Strategy and Procurement at Birmingham Business School, University of Birmingham in the UK. Chris can be contacted at: [email protected] Joe Sanderson is a lecturer in Supply Chain Management in the Department of Commerce and the Centre for Business Strategy Land Procurement at Birmingham Business School, University of Birmingham in the UK. Joe can be contacted at: [email protected] Glyn Watson is a lecturer in Supply Chain Management in the Department of Commerce and the Centre for Business Strategy and Procurement at Birmingham Business School, University of Birmingham in the UK. Glyn can be contacted at: [email protected]

v

Contents

List of figures

ix

List of tables

x

Preface

xi

1

2

3

Supply chain management and ‘best practice’ sourcing

1

Introduction The four basic sourcing options Which of the options is ‘best practice’ for the buyer? The key enablers of SCM implementation Conclusions References

3 4 8 9 12 13

Is supply chain management the best strategic sourcing option?

15

Introduction Selecting the right sourcing strategy Internal investments and the make–buy decision External investments and the four generic sourcing strategies Selecting strategic sourcing options Conclusions References

17 18 19 24 27 34 35

Is supply chain management feasible operationally? 37 Introduction Internal success factors External success factors Conclusions References

39 40 51 62 63

vii

Contents

4

5

Implementing supply chain management initiatives

65

Introduction The three competitive market and SCM strategy options A framework for developing competitive market and SCM strategies Creating a physically efficient (lean) supply chain Creating an innovative and market-responsive (agile) supply chain Market differentiation and cost leadership with an innovative and process efficiency supply chain strategy Conclusions: the conundrum of knowledge and understanding References

67 67

Software and Internet tools for effective supply chain management Introduction The theoretical benefit of software and Internet tools for SCM initiative The major e-sourcing software applications The major Internet sourcing applications A framework for analyzing the utility of software and Internet-based tools and SCM initiatives Conclusions References

viii

71 75 89 94 97 99

101 103 103 107 110 116 119 120

Figures

1.1 The four sourcing options for buyers

5

1.2 The Power Matrix between buyers and suppliers

10

1.3 Internal opposition and support for SCM strategies

11

2.1 The 5-step model to proactive supply chain management

17

2.2 Calculating and allocating costs

27

2.3 Calculating post-contractual risk

31

2.4 Calculating the return

32

3.1 Customer portfolio framework: what type of customer is the buyer?

43

3.2 Knowing your enemies and your friends

50

3.3 The attributes of buyer and supplier power

54

3.4 The competence and congruence matrix

57

3.5 Hypothetical idealized power regimes in supply chains

59

3.6 The power regime for in-flight re-fuelling equipment

61

4.1 The three competitive market and supply chain strategy options

68

4.2 Functional and innovative demand profiles

72

4.3 Physically efficient and market-responsive supply chains

73

4.4 Matching supply chains with products/services

75

4.5 An example of big picture mapping

79

4.6 An example of process activity mapping

81

4.7 Strategies for cycle time reduction

92

4.8 Understanding the scope for successful implementation of market and SCM strategies

98

5.1 Internal and external enterprise process flows

108

5.2 The e-enabled internal and external enterprise process flows

111

5.3 The operational use value of software and Internet-based applications 116

ix

Tables

x

3.1 Actors involved in the organizational sourcing process

41

3.2 Key tools and techniques for SCM

42

3.3 Potential demand management problems

45

3.4 Rating the power of different functions involved in the sourcing process

49

Preface

The work that has supported the production of this short practitioner volume has been underway for a number of years. It began in the mid-1990s with the publication of a book that challenged much of the received orthodoxy in procurement and supply management in particular and business thinking in general. Since the publication of that book – Business Success (1997) – the work of the Centre for Business Strategy and Procurement in Birmingham Business School at the University of Birmingham has been devoted to testing empirically the theoretical arguments first outlined in that volume, and then latterly in two companion volumes – Power Regimes (2000) and Supply Chains, Markets and Power (2002). The latter two volumes were based on work that was generously supported by a research grant from the Engineering and Physical Sciences Research Council (EPSRC) (Project No: GR/L86395). This latest volume has been based on work into ‘Competitive Advantage through Supply Chain Management’ that has also been generously supported by the EPSRC (Project No: GR/N34161/01). We would like to express our gratitude to the EPSRC and also to the collaborating public and private sector organizations involved in these two research projects. This is because many of the findings outlined here could not have been made without the generous support – both financial and time – that has been provided to the research team. There will be a companion volume to this particular offering in the near future exploring the link between types of buyer and supplier power structures and alternative forms of relationship management. When this is completed we will have finished the current empirical testing of our original hypotheses about the ways practitioners can manage business-to-business relationships – whether they are buyers or suppliers. We hope that, if nothing else, this body of work will challenge our readers to think logically about how to manage their business relationships and, hopefully, provide them with some clues as to how they might maximize whatever valued outcomes they desire from their business interactions with others.

xi

Contents

List of figures

ix

List of tables

x

Preface

xi

1

2

3


1

Introduction The four basic sourcing options Which of the options is ‘best practice’ for the buyer? The key enablers of SCM implementation Conclusions References

3 4 8 9 12 13

Is supply chain management the best strategic sourcing option?

15

Introduction Selecting the right sourcing strategy Internal investments and the make–buy decision External investments and the four generic sourcing strategies Selecting strategic sourcing options Conclusions References

17 18 19 24 27 34 35

Is supply chain management feasible operationally? 37 Introduction Internal success factors External success factors Conclusions References

39 40 51 62 63

vii

Contents

4

5

Implementing supply chain management initiatives

65

Introduction The three competitive market and SCM strategy options A framework for developing competitive market and SCM strategies Creating a physically efficient (lean) supply chain Creating an innovative and market-responsive (agile) supply chain Market differentiation and cost leadership with an innovative and process efficiency supply chain strategy Conclusions: the conundrum of knowledge and understanding References

67 67

Software and Internet tools for effective supply chain management Introduction The theoretical benefit of software and Internet tools for SCM initiative The major e-sourcing software applications The major Internet sourcing applications A framework for analyzing the utility of software and Internet-based tools and SCM initiatives Conclusions References

viii

71 75 89 94 97 99

101 103 103 107 110 116 119 120

2 Is supply chain management the best strategic sourcing option?

■

Introduction

■

Selecting the right sourcing strategy

■

Internal investments and the make–buy decision

■

External investments and the four generic sourcing strategies 24

■

Selecting strategic sourcing options

■

Conclusions

■

References

17 18 19

27

34 35

15

Is SCM the best strategic sourcing option?

INTRODUCTION As we saw, the issue of whether to undertake SCM or to pursue alternative approaches to external relationship management has become a significant topic for most companies. This is because, faced with increased international competition, firms have come under intense pressure to cut costs in order to survive and sustain double-digit returns on investment. In seeking to achieve this, firms have looked for world-class practices wherever they can be found. One of the sources of inspiration has been proactive Japanese lean manufacturing and supply chain practice (Womack and Jones, 1996). This practice can be distilled into a simple 5-step model that companies should follow as shown in Figure 2.1. Fig. 2.1

The 5-step model to proactive supply chain management

1. Concentrate on core competencies. 2. Outsource all non-core competencies to suppliers. 3. Consolidate all supply inputs into categories of spend. 4. Concentrate internal resources on a limited number of long-term collaborative relationships with preferred suppliers. 5. Improve supplier and supply chain performance through proactive supply chain development activities.

As we noted in the preceding chapter, however, any firm has a choice of four generic supply strategies and not one. The strategic choice that a company has to make, therefore, is whether or not SCM (as summarized in the 5-step model in Figure 2.1) is the most strategically relevant approach, rather than supplier selection, supply chain sourcing or supplier development. Deciding on which of these approaches makes sense for any company depends on two major variables. First, practitioners must understand the constraints to be overcome when trying to implement any strategy. It makes little sense to develop a plan of action that has almost no hope of garnering support from either internal stakeholders or external suppliers. Consequently, a detailed account of the operational constraints facing managers follows in the next chapter. Second, prior to consideration of operational issues, it is necessary to understand whether there is a strategic case for the adoption of a SCM approach. Whether this approach should be developed depends largely on the strategic economic and commercial case that can be made. This is because sourcing decisions – like business management decisions more generally – require companies to pick the option that offers the greatest possible

17


pay-off (and/or imposes the smallest possible costs). This chapter is therefore divided into four sections that allow practitioners to understand whether a supply chain management approach offers a strategically viable choice for their company: ■

section 1 describes the basic principles behind make–buy selection and provides a decision-making framework;

■

section 2 explains when a firm should insource particular supply chain resources as a core competence;

■

section 3 outlines how SCM approaches are more ambitious investment decisions for the firm than the other three sourcing options because of the demands they make on managerial time;

■

section 4 concludes by showing how this basic framework can be operationalized through the use of three strategic sourcing decision-making templates.

SELECTING THE RIGHT SOURCING STRATEGY Management decisions are investments because they carry with them costs that are expected to yield returns. This is true even if the cost is the time that it takes to perform a task. Time, like everything else, is a scarce resource. If companies spend it pursuing unprofitable activities, then they lose the opportunity to do something more profitable. The return that a company receives from any investment is highly variable. It depends upon what the action is intended to achieve. The yield may take the form of the firm getting ‘the right man for the job’ in the case of a human resource manager properly chasing up references. Alternatively, it may take the form of reduced production downtime in the case of an operations manager putting in place a rigorous programme of repair and maintenance. For the sourcing manager adding-value means receiving the right products or services from vendors on time, or streamlining operational and logistical processes, or obtaining simple cost savings. It could also, of course, be a combination of all three of these potentially beneficial outcomes. As with all investments, however, the attainment of any of these goals is speculative because risk is involved in their achievement. Time spent trying to develop a supplier may take weeks or even months of effort but offer very little by way of tangible return. Consequently, strategic sourcing competence specifically requires that sourcing managers take the options that offer the firm the best investment return ratio – after risk has been factored into the equation.

18


INTERNAL INVESTMENTS AND THE MAKE–BUY DECISION When a firm insources it is using investor’s capital to develop productive capabilities within the organization that will offer the firm a return in the form of an increased revenue-generating capacity. Whether the investment actually pays-off in practice depends upon two major factors: ■

Does the firm’s enhanced internal resources lead to the creation of new (or enhanced) products and services for which there is a demand that leads to acceptable returns? Business history is replete with examples of new products that failed to find favour with the public, and up to 80 per cent of all new product offerings fail to either capture sufficient market share or sustain profitability over time.

■

Does the firm’s investment provoke a competitive reaction that squeezes margins? When new products and services come to market, if they are successful, the normal response by competitors is to develop copycat items. When this occurs the margins achieved by the first mover will be squeezed by competition.

Companies, therefore, have to think seriously about whether it is sensible to insource activities or whether they should discontinue them. If activities are essential to corporate strategy, and there is fierce competition, it may be necessary to find cheaper ways of delivering required (but currently internally unprofitable) activities by outsourcing these to external suppliers. Through outsourcing in this way a company may be able to achieve competitive advantage by finding lower cost or more efficient suppliers than its competitors. In this way the company may increase its own internal margins, as well as offering customers better value and/or lower cost products and services. In recent years many firms have assumed, therefore, that less is more. There is a widespread belief that there are significant competitive gains to be obtained from redrawing the boundary of the firm so that suppliers handle more of the production, with the outsourcing company focusing on strategy, marketing, sales and supplier contract management. One survey indicated that 73 per cent of respondent companies were contemplating outsourcing their printing services; over 63 per cent were considering outsourcing travel services; and nearly 60 per cent wanted to outsource pensions. More significantly, however, 26 per cent believed that marketing and research and development could be safely outsourced (3i, 1994). In a similar survey 12 per cent, 27 per cent and 34 per cent of respondents respectively felt that manufacturing, legal services and IT services would be outsourced by 2001(PA Consulting Group, 1996).

19


The motives behind these initiatives can be highly varied. Three key drivers behind the outsourcing phenomena have, however, been isolated (Lonsdale and Cox, 1998): 1. Cost reduction. Cost reductions are obtained from reducing internal headcount or through the vendor offering greater efficiency in its production or servicing techniques. A firm that specializes in a particular activity is often able to consolidate its clients’ spend to obtain significant economies of scale. 2. Converting fixed to variable costs. The move to quarterly results focused on double-digit returns has forced many companies to seek the approval of investors by outsourcing currently in-house competencies that are required only occasionally, or for which the company is not able to undertake the necessary internal investments to retain state-of-the-art capabilities. 3. Improve time to market/plug the competitive gap. In industries subject to rapid technological change, the ability to maintain a cutting-edge across the board can be problematic. As a result, delays in new product launches may occur that can undermine a firm’s competitiveness. The ability of a firm to outsource part of the innovation process to suppliers (who possess the complementary resources that it lacks) can plug this competitive gap. The first two drivers outlined often make short-term commercial sense for companies, assuming that they understand the contractual risks in outsourcing non-core activities. The third driver is more problematic because it touches on issues that go to the very heart of a company’s revenue-generating capabilities. Companies need to be concerned not just with the costs of ownership but also with the risks of non-ownership of key supply chain resources. Some resources are essential to wealth creation. Transferring ownership of these resources to a supplier not only threatens to de-skill the company but also imposes substantial sourcing costs on the firm in the long term. The scale of these risks can be illustrated by considering the case of IBM and Microsoft, quite possibly the biggest outsourcing mistake in contemporary business history (Case study 2:1). Case study 2.1

The IBM/Microsoft case IBM invented the PC and made the theoretical basis of the architecture transparent by publishing the basic details of how it worked. This allowed new entrants to develop competing products. The most successful of these was Apple, who were able to reverse engineer and produce a more customer-focused PC than IBM. The Apple PC had a monitor and a windows-style software operating system. This was preferred by customers to the cumbersome IBM system because, at that time, it did not have a monitor or a ‘click and move’ software operating system.

20


This forced IBM, who was taking considerable time to develop a customer-focused operating system, to find a quick-fix for its own products so that it could compete with Apple, who was winning large market shares. IBM believed that the operating system that it was perfecting (and that would become known as OS2) would eventually be superior to anything that currently existed in the marketplace and that it needed to find a competent supplier with a reasonable operating system until its own system was perfected. IBM firmly believed that once its operating system was available it would be state of the art and that everyone would switch to it. IBM then sourced its initial operating system from a small fledgling company called Microsoft but used a short-term royalty-based contract, under which Microsoft retained the intellectual property rights in the software, because IBM assumed that it would purchase a maximum of 100 000 units. The contract was not exclusive to IBM and Microsoft was allowed to sell the operating system to anybody else. Eventually, when IBM’s operating system was available, it discovered that nobody wanted to switch to its new OS2 system from the now industrial standard operating system owned by Microsoft. In effect IBM had outsourced the critical asset in the supply chain – the operating system – to one of its suppliers. The problem for IBM was that when it came to market, nobody would pay the switching costs of retraining their staff to the new OS2 system. This was because they were all standardized on the original IBM operating system that, unfortunately for IBM, did not belong to them but to one of their suppliers – Microsoft. The rest is history. Microsoft is now a much more profitable and successful company than IBM, which no longer makes double-digit returns, unlike its supplier – Microsoft.

The point of this case study is to demonstrate that companies must be very careful when they pursue SCM approaches that require them to focus on their core competencies. One key requirement is that they do not outsource the critical assets in their supply chains to their suppliers (Cox, 1997). Deciding what should be insourced and what can be safely outsourced is, therefore, no simple matter. This is a key strategic decision that requires a company to consider the following issues relating to the external commercial environment as it thinks about what its core competencies should be: ■

Is there a demand for the products and services that the firm is trying to develop? Is the product capable of satisfying a value proposition that customers want or need?

■

Is demand effective? Is there a constituency that will not only like the product but will also be prepared to pay for it (and in sufficient numbers and at the right price)?

■

Do other firms already offer similar, better or cheaper products? Is there a gap in the market that the firm can profitably fill or is the marketplace saturated with too many competitors?

21


Internally, the firm must also consider: ■

Of the resources and capabilities necessary to bring the product or service to market that are critical to the process of competitive differentiation and revenue creation, which must be insourced at all costs and which are noncritical and can be safely outsourced?

The answer to this question depends on what is the basic strategy of a company. Traditionally there has been a view that companies have only two basic choices about business strategy (Porter, 1985). We believe, however, that there are in fact three basic strategic options available that companies can attempt to pursue: ■

A firm can pursue a competitive strategy of product differentiation by creating products that perform better than those of its rivals. This could take the form of bread that is more white or brown, softer or more granular. In the IT market differentiation might take the form of computer chips that process data faster. Alternatively, in a pharmaceutical market, differentiation might focus on drugs that cure more people, more quickly and with fewer side effects.

■

On the other hand, if a market has become commoditized, and there is little scope for further product differentiation, it may be necessary to pursue a strategy of cost leadership. This involves a company seeking to increase its market share by producing more cheaply than its direct competitors.

■

A third option is to pass value to customers on a continuous basis by pursuing product differentiation and cost leadership at the same time. This is the general approach of Japanese car companies, like Toyota and Honda. These companies seek to provide greater use value to the customer and at a consistently lower cost and on a continuous basis. Dell is currently attempting to do the same in the PC marketplace.

The problem with this latter approach is that the company may win market share but with only relatively low profit margins. This problem also exists for those pursuing cost leadership strategies. It is only those able to differentiate that can normally achieve higher than normal profits because they are able to provide some mechanism by which competitors are not able to replicate their activities. It is interesting to note, however, that it is those companies that have historically pursued the strategy of passing value to the customers, and those that have to pursue cost leadership, that have been the most active in outsourcing and SCM approaches. Product differentiating companies do not necessarily have to pursue these strategies, although they may a still seek to maximize their profitability by retaining all the cost reductions that they can generate from their supply chains. Cisco is a company that has been able to achieve product differentiation while at

22


the same time pursuing SCM approaches, especially, in their case, by using the latest Internet and e-business technology. Regardless of whether a company is pursuing product differentiation, cost leadership or the passing of value to the customer it must at all costs retain in-house all those activities that set it apart from the competition. If a company’s advantage lies in R&D and marketing, then it may be safe to outsource manufacturing. If the firm’s advantage lies in the internal efficiency of its production capability, then it would not be safe to outsource this competence. Finally, when considering what is core or non-core to its business, a company must understand whether its differentiator(s) can be defended. Critical resources and capabilities should be sustainable. It is necessary, therefore, to consider the barriers to competitive imitation (Rumelt, 1997): ■

Information impactedness. This means that the knowledge on which an advantage is based remains largely tacit and uncodified. Unless key personnel within the organization opt to defect to a competitor, it is hard for the competitor to determine the causes of success.

■

Causal ambiguity. This arises when the processes leading to differentiation are especially complex and difficult to unravel by the differentiators themselves.

■

Reputation effects. This arises when products are difficult for the customer to evaluate prior to purchase, making them risk averse. In such circumstances customers often purchase on the basis of brand and reputation, regardless of whether the competition can provide better alternatives.

■

Buyer costs of switch. The reluctance of customers to switch from one supplier to another may go beyond a simple case of risk aversion. It may be because once a customer has bought into a supplier’s technologies it finds itself locked into them.

Clearly companies considering SCM approaches that require them to outsource non-core activities will need to be cognizant of the key issues outlined above. Key learning point 2.1 ■

The lesson from companies successfully pursuing SCM approaches is that they always understand which skills and capabilities (competencies) are critical assets for their own competitive advantage, and these are always retained in-house.

■

Only those skills and capabilities (competencies) that are not critical to competitive advantage should be outsourced and managed by external suppliers.

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EXTERNAL INVESTMENTS AND THE FOUR GENERIC SOURCING STRATEGIES Just as the question of what should be insourced and outsourced is an investment decision, the same can be said of the choice a company makes about which of the four generic external sourcing strategies – supplier selection, supply chain sourcing, supplier development and supply chain management – it should adopt. Clearly, a company must choose that approach which is the most profitable for it to adopt. Even the most reactive short-term strategy requires an investment. This can be as minimal as the time required to research and negotiate a contract and place an order. For some of the more ambitious proactive strategies available to the outsourcing company, however, the investments required can be substantial. These can cover internal administrative costs as well as any dedicated investments that must be made to mange suppliers effectively. Generally reactive strategies represent a cheaper option for the firm than proactive strategies because the up-front investments are largely administrative. By contrast, in proactive strategies the investment process involves the product development process as well. Reactive and proactive strategies also differ in respect to the benefits to be realized. With reactive strategies the return normally takes the form of the negotiation of better deals from suppliers. In the case of supplier selection these gains are confined to the first tier; while in supply chain sourcing they extend into the supply chain. Proactive approaches normally involve additional benefits such as continuous waste reduction and/or product development, either at the first tier or throughout the supply chain. As a result, when considering proactive strategies it is also necessary to think about the ownership of exploitable technologies. Sourcing strategy choices also carry with them an element of risk. For example, a manager might spend many hours researching a supply market in an attempt to obtain a better deal, only to find that the firm already receives the best possible price. Similarly, many proactive strategies can involve the outlay of considerable sums of money with no observable return. In the defence industry, governments often discover that weapons systems do not materialize, or are late and/or over budget, despite considerable efforts by the buyer to develop the supplier and their supply chains. There is an additional factor that must be considered when selecting one of the four sourcing strategies. Sourcing strategies are necessarily co-operative undertakings because they require two separate organizations (the buyer and the supplier) to interact. At the same time, because they involve two separate organizations that

24


normally seek to pursue their own corporate interests, an element of conflict must exist in any relationship, with each side attempting to maximize its potential gain. This insight leads us to conclude that power must impact on this process, because the relative power resources of the buyer and supplier will determine which side (if any) assumes the majority of the risk in any relationship and which side (if any) will obtain the majority of the subsequent gains. Generally speaking, in an ideal world, it is better to be powerful (in a position to assign risk and appropriate the maximum share of value) than to be weak and dependent in any sourcing exchange relationship. The basic framework that informs the strategic choice about sourcing strategies is outlined below: 1

Firms need to understand the cost-reward ratios associated with each strategic option if they are to make the right choice. The best strategy is the one that offers the greatest gain for the smallest investment.

2

In this context, the basic rule of thumb is that proactive strategies are more resource intensive than reactive strategies.

3

This is because they require not only administrative investments but may also require direct financial contributions in order to realize any prospective gains.

4

The potential gains may or may not be greater for proactive sourcing, it depends upon the particular case. However, the gains tend to be wider in their scope. They involve product development and process improvement as well as basic price reduction.

5

Complicating the decision-making process is the concept of risk. It may make more sense to pursue a low-cost strategy that has a high probability of delivering modest gains than to pursue a high-cost strategy that offers a potentially big pay-back, but with only a small probability of success.

6

Complicating the decision-making process is the question of power. This is because power determines which party will assume the risk and which party will appropriate the benefits. For example, an advantageous power position may enable a buyer to pass the risks to the supplier while disproportionately appropriating the benefits.

A simple hypothetical example can be used to illustrate this decision frame (see case study 2.2). Case study 2.2

Choosing between supplier selection and supplier development In this example a supply manager is asked to choose between Option A (Supplier Selection) and Option B (Supplier Development).

25


In the case of Option A, the buyer is operating in a weak power relationship with its supplier. In the case of Option B, the buyer starts from the same power position but understands that, as a result of investments that both parties must make in the relationship, both parties will move to a situation of interdependence. In Option A the firm believes that its supplier is padding costs. For this reason the company wishes to increase competition by bidding the business to force the incumbent supplier to reduce their costs. This approach requires an investment in management time costing £1000. Given the volume of business that the firm has with the supplier, it has been calculated that there is a reasonable probability that, through this initiative, the firm can save £4000. The expected pay-off for the firm can be calculated easily enough by multiplying the expected return and then subtracting the up-front cost. In this instance the expected pay-off would be £4000 less £1000 = £3000. Supplier selection is not, however, the only option available to the buyer because it can also pursue Option B (Supplier Development) with the incumbent supplier. What the firm needs to know is which of the two strategies offers the better return. Supplier Development is a more expensive alternative because it will require not only the administrative costs of £1000 but also an additional investment to augment the supplier’s manufacturing capability. This cost of dedicated investments in the relationship is estimated at £4000. It has been calculated that the subsequent gain will, however, generate savings of the order of £24 000. What is the pay-off in this instance? Under conditions of interdependence, buyers and sellers can be expected to share the risks and rewards of any initiative. Since the buyer’s administrative costs are £1000 and its share of the dedicated investments are £2000 (50 per cent of £4000), its exposure totals £3000. The costs for the supplier are the same at £3000 for administrative costs and dedicated investments. If the initiative works, it will deliver gains of £24 000 but the buyer and supplier will each have to find £3000 (= £6000) and share the net gains (£24 000 less £6000). This leaves both parties with a half share of £18 000 = £9000 each. Consequently, the case for a strategy of Supplier Development appears, in this situation, much stronger than that for Supplier Selection.

Key learning point 2.2 The attractiveness of particular sourcing options is likely to be highly sensitive to changes in four key variables. These are: ■

the level of investment required;

■

the returns anticipated;

■

the risks that may arise from adopting a particular option;

■

the power of the buyer and supplier to assign risk and reward on the other party.

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SELECTING STRATEGIC SOURCING OPTIONS In practice, selecting the appropriate sourcing strategy is an art rather than a science. Often it is not possible to obtain accurate data on the costs, returns and risks surrounding any sourcing investment. As a result, most managers have to fall back on collecting data that are indicative of what is likely to result from the adoption of a particular option. What follows is a series of templates designed to assist managers in making comparisons between the four sourcing options available. Figure 2.2 allows managers to understand the cost side of the equation. Figure 2.3 allows managers to analyze the risk elements and Figure 2.4 does the same for the returns/rewards. When considering any category of spend that it may be deciding to outsource to the supply market, it is essential that the buying company undertakes the following analysis for each of the four sourcing options that it might pursue.

Calculating and allocating costs

Calculating and allocating costs

Fig. 2.2

Phase I

Phase II

Nature of the investment

Relative demand that investment would make

Investment type

Buyer H/M/L

Cost

Supplier H/M/L

Phase III

Phase IV Allocation of cost

Structure of power

Upfront cost

Ultimate cost

Buyer Supplier Buyer Supplier

Administrative

Dedicated

Other

Phase I: The nature of the investment In Phase I it is necessary to identify and collect data on the various types of cost associated with the planned strategy. This includes data on the different

27


administrative tasks that the firm must perform, plus data on any dedicated investments that the initiative requires. The table calls for cash figures whenever possible. Consequently, if the initiative will take one full-administrator’s time for two months and the administrator’s salary is £2000 a month, then a figure of £4000 would be entered into the column. Similarly, if the initiative requires one or either of the two parties to invest in specialized investments in support of the relationship, then this combined total should also be recorded.

Phase II: The relative demands made by the investment required The methodology asks the company to calculate any necessary investments but it is important to remember that there are a number of other issues at stake. Any investment is relative to the resources that a firm has at its disposal. Companies in a cash-rich industry (like pharmaceuticals) can often afford to throw money at a problem. A small company working in the fourth-tier of an automotive supply chain may not have the personnel or time to consider a proactive initiative of any sort. Consequently, managers need to consider not just what the upfront cost is but also what extent the activity is likely to divert scarce resources away from more productive uses. Generally speaking, therefore, supplier development or supply chain management tend to be reserved for either major items of spend (i.e. areas that the firm spends a lot of money on) or commercially sensitive areas (i.e. areas that contribute to, but are not necessarily essential for, the maintenance of the firm’s core competencies). For this reason the template provides in Phase II the opportunity to record data pertaining to the relative demands of the investment on both the buyer and the supplier. If the firm wishes the initiative to work, it must be sensitive to the demands that it makes on its own and the supplier’s time and resources. If the supplier is overextended, they may not wish (or indeed be able) to deliver.

Phase III: The structure of power Phase III allows the company to record data relating to the structure of power that exists between the buyer and the supplier. For further details refer to the discussions in Chapters 1 and 3 where the Power Matrix (Figure 1.2) can be used to understand the current power situation. For the reasons already covered, different power structures will allow costs, risks and rewards to be divided in different ways. In the case where the supplier is dominant, for example, the buyer can expect to foot most of the bills up-front – regardless of the ultimate success of the relationship. In an interdependent relationship, both parties would expect to take a more equitable share of the risks and rewards.

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Phase IV: The overall allocation of costs Phase IV allows managers to allocate the expected division of cost between the buyer and the supplier. This includes the up-front as well as the final costs (regardless of whether or not the initiative is successful). However, managers also have to be able to calculate the costs to their organization should something go awry. Contingency planning, after all, is part and parcel of good management. It is possible, for example, that the administrative effort required has been under or overestimated. It is also possible that the commitment for dedicated investments has to be revised in the light of new developments in technology or because of a misunderstanding of the true costs of the initiative before project commencement. Whatever the reason, should the costs spiral the additional expenditures need to be allocated. Furthermore, how they are allocated will determine just how profitable the initiative proves to be in the long run.

Calculating post-contractual risk Firms have to be particularly careful because proactive strategies can expose them to significant contractual risk (what some analysts refer to as moral hazard). Sustaining the commitment of a supplier depends upon a firm’s ability to motivate them. Motivation can take the form of a carrot (bonuses for good performance) or a stick (the cancellation of the initiative or the whole contract if the performance is poor). In order for the incentive structure to work it must be credible. This means being able to monitor the supplier to see if they are complying with the terms of the deal and having the ability to punish the supplier (by invoking penalties or by threatening exit) if they are not. The buyer must, therefore, be able to spot those areas where there is significant scope for opportunism by the supplier (in this case in the form of trying to renegotiate the risk–reward allocation) and be able to craft safeguards against the risk. Where contractual safeguards cannot properly be introduced, then the firm is probably better to retain the competence within the organization rather than to outsource it. Moral hazard is frequently a problem in supply management because effective monitoring is always an issue. However, sometimes the risks are particularly acute. Contracting that takes place in a highly volatile or uncertain environment is difficult because it raises the issue of renegotiation. Buyers attempt to draft contracts in as complete a fashion as possible, but when an environment is particularly volatile, specifying all the terms of an agreement in advance is likely

29


to prove next to impossible. This in itself need not present a difficulty unless the firm becomes locked-in to its outsourced provider. If this happens, the supplier may choose to renegotiate on terms that benefit it rather than its customer. Contractual lock-in occurs if the contract requires the buyer to make some form of highly specialized investment in the relationship. The investment might take the form of time. An organization that has spent months negotiating and implementing an outsourced relationship might be reluctant to write-off all of this hard work – especially if re-sourcing means repeating the effort with no greater chance of success next time around. Alternatively, firms might have made substantial and non-fungible investments in specialized training or equipment (otherwise known as asset specific investments). Less creditably, though, firms are often reluctant to call time on a poorly performing supplier if the managers who negotiated the contract have a significant reputational investment in the deal. Calling a halt to the affair means admitting that they got it wrong, and nobody likes doing that. Whatever the form of the lock-in, the effect is the same: the firm loses its capacity to impose costs on the supplier and thus its ability to impose discipline. Of course, just because a contract presents the firm with a risk, it does not follow that the risk cannot be managed. For example, one strategy often pursued by buyers involves unbundling a contract. This means separating out those elements that pose a risk from those that do not. The highly risky elements are retained in-house and only the less risky elements are outsourced. The supplier may even be asked to post a bond, or share the costs of the dedicated investments, as a sign of its good faith (i.e. to show that its word of honour and commitment to the relationship is credible). The purpose of Figure 2.3 is to record and analyze the risks described above by dividing the issues into four broad phases of analysis.

Phase I: The pre-contractual power position Phase I simply records the pre-contractual power situation and this can be taken from the analysis shown in Figure 2.2.

Phase II: The risks of lock-in and dependency Phase II itself divides into four parts. The first allows the manager to describe the nature of the investment required to support the relationship. This description can be transferred from Phase I of Figure 2.2. It is then necessary to indicate the extent to which the investment required is asset specific (i.e. necessary to make this relationship work). If it is, then it is necessary to record which of the contracting parties (buyer and/or supplier) is commercially exposed.

30


Fig. 2.3 Phase I

Calculating post-contractual risk Phase II

Phase III

Phase IV

Confidence in Lock-in-risk PrePostinvestment plan contractual contractual structure structure Is this Is the Is of power Investment cost of power H/M/L Revise Revise firm vendor type up down sunk? locked-in? locked-in?

Net gainer/ loser from the revised investment plan

Phase III: The post-contractual power position If the investments on both sides are small, it is unlikely that the power relationship will have changed at all, however, if they are substantial and asymmetric, a shift may well have taken place. Phase III records the post-contractual power situation once the required investments have been made. Again the matrices linked to the Power Matrix in Chapters 1 and 3 can be used to ascertain whether the selected sourcing strategy is likely to lead to a power shift. This is most likely in proactive approaches because these relationships often require dedicated investments that do not always come with adequate safeguards against post-contractual lock-in.

Phase IV: Understanding contractual uncertainty Phase IV requires a consideration of contractual uncertainty. Companies need to indicate the level of confidence (high/medium/low) they have that their initial investment estimates will be valid. Should confidence be low, it will be necessary to indicate whether the costs will ultimately be revised downwards (or more importantly) upwards. If it is concluded that there is a significant risk that estimates regarding one of the more substantial areas of investment are soft, then it will be necessary to

31


allocate this exposure between the buyer and supplier. If it is likely that the initiative will lead to the company being locked into a relationship, and the cost figures are also considered soft, it may well be that the strategy does not make commercial sense. If the gains from the investment justify the initiative, it may make more sense to internalize (insource) the activity within the firm.

Calculating the return Figure 2.4 allows companies to think about the returns from any investment. How some of these gains may be calculated operationally is covered in Chapter 4, which deals with the operationalization of SCM techniques. Figure 2.4 is restricted to recording projected gains and losses. Fig. 2.4

Calculating the return Phase I

Generic nature of change in product offering

Phase II Value of change

Phase III Confidence in change

Type of change Positive Negative Neutral

H/M/L

Revise Revise up down

Projected gain/loss from initiative

Reactive Price and/or functionality change Proactive Price and/or functionality change Proactive Efficiency (total costs of ownership change Proactive Revenue generating opportunities

This is not straightforward because the concept of Value for Money (VFM) must be understood by linking functionality with cost options. Improving VFM can be achieved in the following obvious ways:

32

■

improving functionality while reducing cost;

■

improving functionality while maintaining cost;

■

maintaining functionality while reducing cost.


However, it can also be achieved in a number of less obvious ways: ■

improving functionality while increasing cost (where the functionality increase is greater than the cost increase);

■

reducing functionality while reducing cost (where the fall in functionality is less than the fall in cost).

It is not, therefore, necessary for all the elements of a deal to improve in order for the deal itself to improve. Figure 2.4 attempts to capture this through three phases of analysis.

Phase I: The expected changes in functionality and costs of ownership In Phase I the company must describe the changes that are expected to arise as a result of the adoption of the chosen strategy. These may conceivably fall into one of four broad options: ■

If the strategy is essentially reactive, then it is likely that changes in performance by the supplier will be linked either to the initial purchase price and/or to increases in functionality of the product or services offered to the buyer.

■

If the strategy is proactive, there are potentially three major changes possible. The first is a change in the initial purchase price and/or functionality. The second arises from a change in the total costs of ownership through supply chain efficiency gains (this is only possible when supply chain initiatives are being undertaken). The third is an increase in revenue generating capability, as a result of innovations from the initiative that generate isolating mechanisms that contribute to competitive advantages in market closure and/or sustainable increases in profit margins.

Phase II: The value of the change Phase II requires that the value of the change for the buyer is recorded. Three options are available: ■

Positive. The initiative either results in value for money benefits for the buyer such as reduced prices and margins from the supplier; improved efficiency; improved functionality, or delivers exploitable new technologies.

■

Negative. The initiative provides value for money benefits for the supplier and undermines the current value received by the buyer.

■

Neutral. There is no discernible change in value for money for the buyer.

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Phase III: Mapping uncertainty Phase III allows uncertainty to be mapped. First, it is necessary to indicate the degree to which the probability (high, medium or low) of the projected estimates of achievable outcomes will occur or not. If the probability is medium or low, it is then necessary to indicate whether the gains/losses estimated have been over- or under-stated. Following from this it will be necessary to record a revised projection of the anticipated reward structure.

CONCLUSIONS Having completed each of the figures for a specific category of sourcing requirement, and for each of the four sourcing options available, it should now be possible for companies to make a judgement about which of the four sourcing options available for this category of spend appears to be the most strategically beneficial. Key learning point 2.3 ■

Any of the sourcing options available is worth pursuing if the projected gains exceed the projected costs, after the pattern of risk has been factored into the equation.

■

The strategy that is optimal is, however, likely to be that approach which results in the greatest pay-off when all the four alternative sourcing approaches are compared against one another for a particular category of spend.

It is clear that this approach to sourcing strategy selection may well result in an answer that says a proactive SCM approach is simply not the most optimal solution for the buying company. In such circumstances our view is that the sensible company should opt to undertake the sourcing approach that is most conducive for its commercial success. Obviously, if the analysis leads to the conclusion that SCM is optimal, then the buying company should pursue this option vigorously. There is one additional caveat that must be addressed before such an approach is adopted. Identifying what may be the most commercially profitable sourcing option is not the same thing as identifying a strategy that will work operationally. Before embarking on any sourcing strategy it is necessary to understand, first, whether there are any major internal and external constraints that will so affect implementation that the strategy cannot be made to work in practice, despite the clear commercial benefits that may be achieved strategically. These issues are discussed in the next chapter in relation to SCM strategies only.

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REFERENCES Cox, A. (1997) Business Success. Helpston: Earlsgate Press. Lonsdale, C. and Cox, A. (1998) Outsourcing: A Guide to Business Risk Management Tools and Techniques. Helpston: Earlsgate Press. PA Consulting Group (1996) Strategic Sourcing: International Survey. London: PA Group. Porter, M. (1985) Competitive Strategy. New York: Free Press. Rumelt, R. P. (1997) ‘Theory, strategy and entrepreneurship’, in D. Teece (ed.) The Competitive Challenge. New York: Harper & Row. Womack, J. and Jones, D. (1996) Lean Thinking. New York: Simon & Schuster. 3i (1994) Outsourcing. London: 3i.

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1 Supply chain management and ‘best practice’ sourcing

■

Introduction

■

The four basic sourcing options

■

Which of the options is ‘best practice’ for the buyer?

8

■

The key enablers of successful SCM implementation

9

■

Conclusions

■

References

3 4

12 13

1


INTRODUCTION In recent years there has been considerable debate amongst consultants, practitioners and academics about what constitutes ‘best practice’ for those involved in sourcing. For many this debate has led to the conclusion that supply chain management (SCM) constitutes ‘best practice’ in the search for improved value for money relationships with suppliers. The evidence for this viewpoint is the increasing frequency with which old purchasing, procurement and logistics departments have begun to re-brand themselves as supply chain management functions. We have also witnessed the development of SCM practices in all the major consultancy companies and the creation of dedicated MBA and undergraduate degree programmes, as well as departments of SCM within major American and European Universities. Over recent years we have taken something of a contrary view about the appropriateness of this view of ‘best practice’ (Cox, 1997a, 1997b, 1998; Cox et al., 2000a). Much of our criticism of the SCM bandwagon has in the past been based on deductive reasoning about the logical approaches to sourcing that must be made under different circumstances of power between buyers and suppliers. At the same time we have undertaken research into how power regimes create opportunities, as well as problems, for buyers and suppliers as they seek to implement particular sourcing approaches in changing circumstances of power (Cox et al., 2000b, 2001). Some of this empirical research has been reported already and it demonstrates clearly that there are some circumstances in which buyers can pursue SCM approaches successfully, but also that there are many, many more circumstances when they cannot. Cox et al., 2002 Despite this general conclusion it is clear that SCM practices – when properly conceived and implemented – can provide one of the most powerful mechanisms currently available for buyers to transform the supply offerings they receive from their supply chains. This short volume has, therefore, four major tasks: ■

to help practitioners understand whether or not it is appropriate for them to undertake SCM strategically;

■

to help practitioners to understand if it is possible to undertake SCM strategies operationally within their own organization, and with the suppliers within their external supply chains;

3


■

to help practitioners understand how to implement SCM strategies successfully;

■

to help practitioners understand whether there is any software and Internetbased tool(s) that will facilitate the successful implementation of SCM strategies.

It is important for the reader to understand at the outset, however, that the general argument of this book is that while SCM can be regarded as a ‘best practice’ approach for organizations under some circumstances, it is rarely ‘best practice’ for companies in most or all of their external sourcing circumstances. Given this, the first issue to be addressed is not what is the most effective way to undertake supply chain management, but if it is not always appropriate, what sourcing choices do managers have? The best way to address this issue is by first understanding, logically, the ways in which buyers can work with any supplier and the scope of their activities within a supply chain. By doing this it is possible to define four basic sourcing approaches that are always available for buyers to select from when they seek to manage their supply relationships.

THE FOUR BASIC SOURCING OPTIONS

Ways of working for buyers and suppliers As Figure 1.1 demonstrates, buyers have two basic choices about the ways they can work with suppliers. These are as follows.

Proactive ways of working In this way of working the buyer independently (or jointly with the supplier) designs and specifies in detail the ‘stretch’ improvements in functionality and cost of ownership that the supplier is expected to deliver now and in the future. The buyer will obviously select the most competent suppliers available and undertake robust and rigorous measurement and management of performance against predetermined ‘stretch’ targets. The buyer will also be heavily involved in developing the skills and capabilities of the supplier to deliver the required targets through close and collaborative relationship management.

Reactive ways of working In this way of working the buyer’s role is much more circumscribed since it is normally the supplier who determines what the supply offering to the buyer will be. The buyer is, therefore, rarely directly involved in the design and specification of functionality and costs improvements. Here the buyer normally sources at arm’s

4


length and relationship management is confined to short-term interactions, based on the selection of the most appropriate supply offering and given the available choices provided by currently available suppliers in the market. The buyer does not directly drive innovation in this approach but encourages market contestation so that, over time, competition provides innovation in functionality and cost. Fig. 1.1

The four sourcing options for buyers

Proactive

Supplier development

Supply chain management

Reactive

Supplier selection

Supply chain sourcing

First-tier

Supply chain

Focus of buyer relationship with the supplier

Level of work scope with supplier and supply chain

The scope and level of buyer involvement with supply offerings Figure 1.1 also demonstrates that to achieve improved leverage of supply inputs, buyers also have to make decisions about the scope of their involvement within the supply chain that must be created for the delivery of particular goods and services.

First-tier relationship management In this approach the buyer lacks the internal capabilities and/or external power resources to direct innovation from the extended network of suppliers. The buyer, therefore, can only work with suppliers at the first-tier. The buyer can, of course, choose either short-term arm’s length or longer-term collaborative relationship management styles when sourcing at the first-tier.

Supply chain relationship management In this approach the buyer has both the internal capabilities and the external power resources to drive innovation on its own, or jointly, with the extended network of suppliers within the supply chain (this can be in the total chain or within significant elements of it). Here the buyer works beyond the first-tier

5


supply relationship to improve functionality and/or reduce costs on a continuous basis, normally using long-term collaborative relationships.

The four sourcing options facing the buyer Figure 1.1 further demonstrates that putting these four basic variables together provides the buyer with four basic sourcing options. These are differentiated on the basis of the level of external complexity and internal resource intensity that must be managed by the buyer.

Supplier selection This option is the one most commonly used by buyers in all types of organization. Supplier selection implies that the buyer’s role is confined primarily to reactive sourcing at the first-tier. This means that the buyer normally selects products and /or services from the supply offerings made by suppliers currently operating in the market, with analysis of the power and leverage opportunities between the buyer and supplier confined only to the proximate supplier of the finished product or service being sourced. It is the supplier who designs and specifies requirements, with the buyer’s role confined to market analysis of supplier offerings and, using robust supplier selection procedures, the sourcing of the best value for money supplier(s). This approach also normally requires robust performance measurement in order that the buyer can determine whether the supplier has delivered what was expected. If it has been, then the supplier may expect to receive further orders from the buyer, assuming no other suppliers can offer a better value proposition to the buyer when contracts are reviewed. Of all of the four options available to a buyer, supplier selection makes the least demands on internal resources and requires the least commitment to long-term collaborative external sourcing relationships.

Supply chain sourcing The supply chain sourcing option is similar in many ways to the supplier selection option. The major difference is that, instead of the supplier assessing the suitability of suppliers at the first-tier, the buyer is now involved directly in understanding the structure of the supply chain through which products and services are created. This approach requires, therefore, that buyers develop rigorous and robust source plans in order that the current power structures between buyers and suppliers within the total supply chain can be understood. Once again, however, the buyer’s role is confined to market intelligence (but now within the total supply chain) rather than the detailed design and specification of

6


supply offerings. The buyer’s motive in undertaking source planning is to understand whether there are opportunities for effective leverage within the totality of the supply chain relationships, rather than merely at the first tier. The buyer does not, however, undertake a proactive role with the supplier or supply chain. The buyer in fact simply assesses the scope to use the current leverage that is available if sourcing is undertaken in the supply chain beyond the first-tier. This approach makes more demands on the internal resources of the buying company than supplier selection because it involves the development of competence (and therefore the expending of scarce internal resources) on supply chain not just first-tier information search and analysis. It also involves the development of more supply relationships externally and, therefore, more external performance measurement and relationship management responsibilities.

Supplier development Supplier development refers to a process by which, having undertaken the same initial type of analysis and selection as that outlined under Supplier selection above, the buyer works on a continuous basis with the supplier to transform the current trade-off between product or service functionality and the overall cost of ownership. The key difference with supplier selection is that the buyer is now heavily involved, not only in selection and assessment but also in the fundamental design and specification of the product and service offering that the supplier will provide now and in the future. Clearly, depending on the respective resources and capabilities of the buyer and the supplier, this will either be determined by the buyer or it will have to be a joint effort. It is clear that this approach makes much greater demands on the internal resources, as well as upon the external relationship management skills, of the buyer than the two more reactive options outlined above. In this approach the buyer has to commit considerable internal resources to the design and specification process, as well as to external relationship management. Furthermore, this approach requires that buyers and suppliers must normally develop longer-term relationships. This is because, if both parties have to make dedicated investments in the relationship to make it work, neither side is likely to do this without some longer-term commitment. It is also essential that the power structure is favourable to the buyer since it is unlikely that dominant suppliers will be willing to respond positively to the design and specification requirements of buyers.

Supply chain management The final option available to buyers is the most demanding of both internal resources and external relationship management. The approach is similar in all respects to supplier development except that, having first undertaken source planning, the buyer

7


now assesses the scope to undertake proactive supplier development linking together all the buyers and suppliers in the chain. The aim of this network relationship management is to encourage the players in the chain to dedicate their business strategies to the delivery of improved functionality and lower costs of ownership for the ultimate customers in the chain. It is self-evident that this approach, which incorporates the same selection and performance measurement tools and techniques as outlined under the reactive approaches provided earlier, is the most difficult for buyers to implement. The reason being that two major enablers must be in place before any buying organization can implement this approach. First, the buying company must have the internal capabilities to shape the ‘stretch’ design and specification requirements for the chain as a whole and have the internal resources to embark on the complex and time consuming role of developing all the buyers and suppliers within the chain. Second, there must be a power structure that is conducive to buyer-led supply chain improvement. Obviously, depending on the power relationships within the chain, it may be necessary for the buyer to work jointly with the buyers and suppliers within the chain or, if the buyer has sufficient internal resources and power over the players in the chain (or a substantial proportion of them), it may be possible for the buyer to dictate what they will do.

WHICH OF THESE OPTIONS IS ‘BEST PRACTICE’ FOR THE BUYER? Our research and consulting activities over the last ten years have continually reinforced one conclusion: whatever the hype, most buying organizations do not in practice do very much SCM (Cox et al., 2001; Cox et al. 2002). The reason for this is self-evident. Few buying organizations have either the internal resources or the external power circumstances that are conducive to longterm and continuous collaborative buyer and supplier relationship management. This implies that, whatever proselytizers of SCM argue about it being ‘best practice’, for the bulk of their spend, most practitioners will never be in a position to implement it because the achievable gains are not worth the internal and external efforts required. This is not to deny that SCM is a most effective and appropriate thing to do if the buyer is in circumstances conducive for its implementation. Unfortunately, however, the empirical evidence seems to confirm that most buyers will only ever have the internal resources and external power opportunities to undertake reactive sourcing options. It is imperative, therefore, that managers recognize this fact and that organizations begin to analyze the objective circumstances they are in, so that they can properly

8


understand whether they have proactive and/or reactive sourcing opportunities and which of the four options outlined here is likely to be the most efficacious for improved leverage in the future for any particular category of spend. This is because our work with many companies over the last ten years has indicated clearly that, while SCM may be possible and desirable in some industries – like automotive, food retailing, process construction, personal computer manufacturing, chemical refining and aluminium (to mention just a few) – this does not mean that this approach is the most appropriate for buyers to adopt in all circumstances. Indeed our research has demonstrated quite clearly that not only is it impossible for the majority of organizations to adopt SCM approaches but also, and perhaps more to the point, companies pursuing SCM approaches in their direct, revenuegenerating supply chains often find it impossible to do so in their indirect, non-production areas of spend. In these circumstances even SCM-focused companies are often forced to adopt supplier development, supplier selection and supply chain sourcing options for some of their categories of spend. Key learning point 1.1 ■

‘Best practice’ cannot be about the development of any one particular sourcing approach.

■

Rather ‘best practice’ must be the ability to understand which of the four sourcing options available is the most appropriate in any given circumstance.

THE KEY ENABLERS OF SCM IMPLEMENTATION Our work has led us to conclude, therefore, that there must be circumstances when SCM strategies can work and there must be circumstances when they are unlikely to do so. It is interesting that most SCM strategies seem to operate well in circumstances in which the buyer has high volume and fairly regular and constant demand relative to a supply market in which there are many suppliers, all of whom have similar capabilities, and who are normally highly dependent on the buyer in one form or another. It is worth noting that many of the industries in which SCM strategies have been pioneered – the automotive, the aluminium, the chemical refining, process manufacturing and process construction – have these demand and supply characteristics. But there are also circumstances where SCM strategies based on longer-term collaborative relationship management approaches do not work well.

9


It is interesting that SCM strategies do not appear to work well in circumstances where the buyer has low volume and infrequent or ad hoc demand, and in which there are dominant suppliers who are not dependent on the buyer in any form. It is highly unlikely, therefore, that a buyer (individual or corporate) could currently force Microsoft or Cisco to adopt SCM strategies against their will, or seek to appropriate for themselves most of the increased value from working together. The reason for this is self-evident. From a dominant supplier’s perspective, unless a buyer has sufficient volume relative to its alternative customers and unless that demand is constant, there is no reason why it should work with any particular buyer to create value-adding activities. Furthermore, there is no reason why it should want to share any value created with its customers if it can keep such value for itself. This is just another way of saying that demand and supply variables create a situation of power and leverage between buyers and suppliers at all points in a supply chain – we refer to this as the creation of power regimes within the complex networks of buyer and supplier exchange that exist in any and all supply chains for products and services (Cox et al., 2000b). Unless managers understand the ways in which the power circumstances between buyers and suppliers create opportunities for, and obstacles to, the development of potential SCM strategies, then there is a significant risk that managers will be pursing external sourcing approaches that are impossible to implement. Given this, as Figure 1.2 demonstrates, the ability of managers to undertake SCM strategies will be heavily dependent on the power relationships that exist between buyers and suppliers within the supply chains that must be managed if SCM strategies are to be implemented effectively. In deciding whether it is strategically or operationally possible for buyers to undertake SCM strategies, much of the initial decision will have to be made by understanding where the buyer and supplier sit in The Power Matrix outlined in Figure 1.2. Fig. 1.2

The Power Matrix between buyers and suppliers

High

Buyer dominance

Inter-dependence

Low

Independence

Supplier dominance

Low

High

Relative utility and scarcity of buyer’s resources for supplier

Relative utility and scarcity of supplier’s resources for buyer

Source: Cox, A. et al., Power Regimes, Helpston: Earlsgate Press (2000b) p. 18

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As Figure 1.2 indicates there are four objective power situations that buyers and suppliers can find themselves in: ■

Buyer dominance means that the buyer can control the relationship with the supplier and can fix the price and quality trade-offs in the buyer and supplier relationship.

■

Interdependence means that the buyer and the supplier are both heavily dependent on one another and they must work together and jointly decide on price and quality trade-offs in the relationship.

■

Independence means that neither the buyer nor the supplier have any resources to determine and shape the specific relationship and both receive price and quality on the basis of market competition and contestation.

■

Supplier dominance means that the buyer is in no position at all to shape the relationship with the supplier and must receive quality and price decisions that are dictated by the supplier.

The significance of external power relationships for the effective implementation of SCM strategies is outlined in far more detail in Chapter 3 where the second major operational enabler is also discussed. This enabler is the issue of internal capability. As Figure 1.3 demonstrates, there are always power circumstances at play within organizations, as well as externally with suppliers. Our research has led us to conclude that effective SCM strategies cannot be undertaken unless there is clear support within an organization to make them work. Fig. 1.3

Internal opposition and support for SCM strategies

Understand what SCM is

Enemies

Confirmed allies

Don’t understand what SCM is

Zombies

Potential allies

Don’t want to help SCM implementation

Do want to help SCM implementation

Once again we discuss these issues in more detail in Chapter 3. It is worth stressing, however, that unless there are more confirmed allies and potential allies than enemies and zombies internally within an organization, it is unlikely that such SCM approaches can ever be made to work successfully – however conducive the

11


external power relationships with suppliers. Attention to internal buy-in for SCM strategies by those managing external resources is clearly a critical success factor. Key learning point 1.2 There are two major enablers of successful supply chain management strategies: ■

buy-in from a significant proportion of those within the organization who have the capability to stop effective implementation;

■

conducive external power structures in the supply chains to be managed – normally of extended buyer dominance or interdependence – that allow the buying organization to drive (or significantly shape) quality and price trade-offs.

Both of these enablers must be in place for a successful SCM strategy to be attempted. But even these two factors, while necessary, are not a sufficient cause of success. For ultimate success to be achieved, the buying organization must be able to implement their SCM strategy appropriately given the internal and external power circumstances they face – both pre- and post-contractually.

CONCLUSIONS SCM strategies can be highly successful mechanisms for the leverage of improved value for money from suppliers. But it is also necessary for successful implementation that buying organizations do not fall into serious errors of judgement when they consider which of their resources and capabilities they should manage using longerterm collaborative relationships. This is another way of saying that it will not always be appropriate for buyers to use SCM strategies for all their supply requirements. On many occasions supplier selection, supply chain sourcing and supplier development approaches may be far more appropriate mechanisms by which to leverage value for money than SCM strategies, and for most buyers these three approaches may well be their most frequently used sourcing tools. Having said that, it is also worth stressing again that when SCM strategies can be used they are an extremely powerful mechanism for leveraging improved value for money from suppliers and their supply chains. Nevertheless, even when there is a supportive internal and external environment for the successful implementation of SCM approaches (as described in Chapter 3) sometimes these strategies are not adopted successfully. The major reasons for this are threefold and will be discussed later in some detail.

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First, as indicated in Chapter 2, buying organizations sometimes outsource the wrong skills and capabilities to suppliers and do not understand what are core and non-core competencies. Buying organizations also often misperceive the preand post-contractual power circumstances they are in and, over time, find that they become victims of post-contractual lock-in to suppliers who were once in the buyer dominance or interdependence power situations. As result of poor practice, it is possible for the buying organization to find that during implementation the power situation reverts to supplier dominance. This error of implementation must be guarded against at all costs. Sometimes it is also necessary that, whatever the perceived benefits of SCM approaches, organizations do not outsource their internal competencies at all. Second, buying organizations often fail to understand how to implement their SCM strategies appropriately, because they fail to recognize the differences between the types of products and services that must be managed, as well as the focus of their SCM initiative. In Chapter 4 we outline in detail how SCM strategies must be aligned with the types of products and services (and their underlying demand and supply structures) if SCM approaches are to be implemented effectively. We differentiate primarily between SCM initiatives aimed at cost reduction through process efficiency and those directed at achieving market differentiation through product and service innovation. Third, Chapter 5 outlines some of the major software and Internet-based tools available for those developing SCM strategies. In this discussion we provide managers with a series of templates to enable them to understand whether any of these tools can provide them with significant benefits. At the same time we ask whether any of these tools can create an unacceptable risk of post-contractual lockin that makes effective exit difficult for the buyers or the suppliers in the chain. Having addressed these issues, we hope that practitioners will be in a better position to understand when SCM approaches make sense for them strategically and operationally and, if they do, how they can be implemented successfully.

REFERENCES Cox, A. (1997a) Business Success. Helpston: Earlsgate Press. Cox, A. (1997b) ‘On power, appropriateness and procurement competence’, Supply Management, 2 October, pp. 24–7. Cox, A. (1998) ‘Clarifying complexity’, Supply Management, 29 January, pp. 34–6. Cox, A. et al., (2001) ‘The power perspective in procurement and supply management’, Journal of Supply Chain Management, (37) 2, 4–47.

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Cox, A., Ireland, P., Lonsdale, C., Sanderson, J. and Watson, G. (2002) Supply Chains, Markets and Power: Mapping Buyer and Supplier Power Regimes. London: Routledge. Cox, A., Sanderson, J. and Watson, G. (2000a) ‘Wielding influence’, Supply Management, 6 April, pp. 30–3. Cox, A., Sanderson, J. and Watson, G. (2000b) Power Regimes: Mapping the DNA of Business and Supply Chain Relationships. Helpston: Earlsgate Press.

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3 Is supply chain management feasible operationally?

■

Introduction

■

Internal success factors

40

■

External success factors

51

■

Conclusions

■

References

39

62 63

37

Is supply chain management feasible operationally?

INTRODUCTION The previous chapter developed a framework for identifying when it is strategically and commercially sensible to implement a strategy of SCM. In this chapter we address the question of whether a buying company can operationally implement SCM strategies in any chosen supply chain. The answer to this question is essentially a function of two interrelated success factors. Each of these success factors must be present both within the buying company and within the supply companies in the extended supply chain if SCM strategy is to be effective. There is an internal dimension and an external dimension to the effective operational delivery of an SCM approach. The first success factor is the need to have competent managers, who possess a solid understanding of the technical, operational and commercial tools and techniques of SCM. Beyond this operational understanding, however, competence also requires companies to understand how their particular organizational functions (be it sales and marketing, production or procurement) must operate to support such a strategy. The requirement to have competent managers is equally critical both within the buying company and within the supplier organizations in the extended supply chain that has to be managed. The reason for this is that the deployment of SCM strategies requires co-ordinated managerial effort in a number of interconnected organizations. No single organization can, nor indeed should, try to manage a supply chain on a unilateral basis. This is impractical and would imply a greater degree of direct intervention in the affairs of other companies than is possible without vertical integration. Another important internal factor in SCM initiatives is the willingness of key organizational actors, both within the buying company and in the supply chain, to commit the necessary time and resources. Many companies are so focused upon making SCM work and, therefore, concerned with matters of managerial competence, that they fail to ask a vital prior question: ‘What incentive, if any, do key internal organizational actors have to make the necessary commitment?’ SCM initiatives tend to fail not because there is a lack of managerial understanding or competence but because internal and external actors are not prepared to commit the substantial resources that are needed (Sanderson et al., 2001; Cox et al., 2002). It will be important, therefore, to explore what determines the willingness of internal and external organizational actors to be supportive and to make the necessary investments. The second critical success factor, therefore, is the availability of supportive power structures. It is clear that intra- and inter-organizational power structures are crucial in understanding the incentives of key managers.

39


It follows, therefore, that an understanding of the resources underpinning these structures, and a capacity to manipulate these resources, must lie at the heart of a successful SCM strategy. Key learning point 3.1 There are two basic success factors for successful SCM strategies, both of which must be present in the buying company and in the supply organizations in the extended supply chain to be managed. These are: ■

managerial competence and understanding. This includes an awareness of the operational tools and techniques used in SCM strategies and an understanding of what is required of particular organizational functions to manage demand effectively;

■

an appropriate alignment of intra- and inter-organizational power and incentives. SCM strategies require substantial dedicated investments, both by the buyer and by their suppliers in the extended supply chain. These investments are only likely to be forthcoming if internal and external actors have an incentive to make them. Incentives are a function of power.

INTERNAL SUCCESS FACTORS Managerial competence and understanding in your organization It is clearly important to be aware of the competence of those managers working within the sourcing function, but it is also necessary to be aware of the competence of managers working within other functions that have an impact upon sourcing decisions. Studies of organizational buying demonstrate that the buying decision usually involves a number of actors from several different functions (Webster and Wind, 1972; Sheth, 1973). Each of these actors has a specific role to play within the buying process and each, therefore, influences particular aspects of the relationship between the buyer and its suppliers. Consequently, the likely success of SCM strategies is crucially dependent upon the managerial competence and understanding present within the different functions involved in the sourcing process. These various decision roles and aspects of influence are summarized in Table 3.1.

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Table 3.1

Actors involved in the organizational sourcing process

Role

Influence on buying process

Functional examples

User

Initiates the buying process by recognizing a requirement; often involved in writing the specifications for specialist, technical products or services; may also be involved in supplier development activity

CEO; Strategy; Strategic Business Units; Finance; Marketing; R&D; Engineering; Production and Operations; HR; Legal; Environmental;Shared Services; Facilities and Estates; Logistics etc.

Influencer

Provides information and opinions used for evaluating alternative suppliers/products; reviews specifications

As above

Gatekeeper

Affects the search for information by distributing or screening marketing materials and supplier bids

Normally Procurement, SCM, Logistics; R&D; Engineering; Production and Operations

Approver

Authorizes the proposed expenditure

As above under User (if they are budget holder)

Buyer

Selects and develops suppliers; negotiates, manages and monitors contracts; monitors supplier performance

Normally Engineering; Production and Operations; Logistics; SCM; Procurement

There are normally two broad categories of managerial competence and understanding that are crucial to the success of SCM strategies. The first is operational competence. This is an understanding by managers in the organization of the various tools and techniques that exist to support the implementation of SCM strategies. The most important of these tools and techniques are listed in Table 3.2. While the majority of these tools are likely to be used by the gatekeepers of the sourcing functions, it is still vital for the other functions involved in the sourcing process to be aware of what they can achieve. This is because, as Table 3.1 suggests, functions such as engineering and production and operations can have a direct impact upon the effectiveness with which these tools are implemented. They might do this either by acting directly in the sourcing role or by providing information (such as supplier performance data) that the procurement, logistics or SCM function uses in the development of strategy. The tools and techniques shown in Table 3.2 are discussed in detail in Chapter 4. The remainder of this section is devoted, therefore, to the second main category of internal competence and understanding: demand management competence.

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Table 3.2

Key tools and techniques for SCM

■

Lean Thinking

■

Pareto Curve Approach

■

Agile Thinking

■

Surge and Base Approach

■

Critical Asset Thinking

■

The Supply Chain Response Matrix

■

Seven Principles of Muda

■

The Production Variety Funnel

■

JIT Production and Supply

■

Quality Filter Mapping

■

Big Picture Mapping

■

Demand Amplification Mapping

■

Value Stream Mapping

■

Decision Point Analysis

■

Vendor Managed Inventory

■

Physical Structure Mapping

■

Cycle Time Reduction

■

Supplier Associations and Networks

Demand management competence means that each function involved in the buying process understands the need to configure the organization’s demand in a way that makes it attractive to current and potential suppliers. Demand management is an important competence because the more attractive the buyer is perceived to be by its suppliers, the more willing those suppliers will be to invest in SCM initiatives. The willingness of suppliers to make the necessary investments is a function of their incentives to do so, and those incentives are in turn a function of the power structures that exist between the buyer and each of its suppliers. One key power resource is the attractiveness of the buyer’s expenditure for particular suppliers. In short, the more attractive or important the buyer is as a customer, the more likely a supplier is to co-operate with their SCM initiatives. Presented in Figure 3.1 is a simple Customer Portfolio Framework that can be used to assess how attractive the buyer’s business is to each of its suppliers. As Figure 3.1 shows there are two main factors to consider when analyzing the relative attractiveness of the buyer’s business to a supplier. The first is the ease with which a supplier can service the buyer’s requirements and, by extension, how costly it is for that supplier to work them. The key costs incurred by suppliers in servicing their customers’ requirements fall into two main categories: ■

Transaction costs. These are the costs incurred by a supplier in drawing up, managing and monitoring its contract with the customer, in particular the costs of invoicing and ensuring that payment is made. The fewer invoices that a supplier is required to send out and the more prompt are a customer’s payments, the lower these transaction costs will be.

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■

Production costs. These are the costs incurred by a supplier in the production of goods or services to meet the buyer’s requirements. The less standardized/the more bespoke or unique are the buyer’s requirements, the higher these costs are likely to be because the product or production process will have to be redesigned. Equally, if the buyer requires a supplier to produce a product or service at short notice, these costs are likely to rise because the supplier will be forced to make unplanned demands on its own production processes and to acquire material inputs from its suppliers without a significant lead time.

Fig. 3.1

Customer portfolio framework: what type of customer is the buyer?

Ease of servicing buyer’s business

High

Development customer (win more business)

Key customer (aim to please)

Low

Nuisance customer (ignore)

Leverage customer (take advantage)

Low

High

Value of buyer’s business to supplier

Clearly, all else being equal, a supplier is likely to prefer a customer that is relatively easy and therefore inexpensive to service, because its profit margin is likely to be more substantial. It is possible that customers that are difficult/expensive to service will see any additional costs being passed on in the price that they pay. Market competition dictates, however, that this is not always possible. The second main factor is the value of your business to the supplier. The issue of value can be understood in a number of ways: ■

the size of buyer expenditure with the supplier relative to their overall turnover;

■

the regularity and predictability of buyer expenditure;

■

the prestige/marketing value of the supplier’s association with the buyer;

■

the supplier’s association with the buyer leads to product innovations that they can sell to other customers, or process innovations that reduce their costs/improve their profitability.

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Putting these two factors together (ease of servicing and value of business) creates four basic types of customer as shown in Figure 3.1. As the figure suggests, the most attractive, or key customer, is one which is relatively easy to service and whose business is highly valuable to the supplier. This type of customer is likely have substantial power or influence over its supplier. Consequently, a key customer should expect its supplier to be willing to invest and participate in SCM initiatives. At the other end of the spectrum of attractiveness lies the nuisance customer. This is a customer whose demands make it difficult/costly to service and whose business is not particularly valuable to the supplier. Consequently, a nuisance customer is unlikely to receive support from its supplier for costly SCM initiatives. The remaining two types of customer, the development customer and the leverage customer are in intermediate positions. It seems likely, however, that a development customer would receive greater support from its supplier for SCM initiatives given the supplier’s desire to increase the volume and regularity of business that it receives from such a customer. A supplier servicing a leverage customer will not have to pursue such initiatives, but it may if it feels there is some benefit for itself from going along with the customer’s wishes. Exercise 3.1 Locating suppliers in the customer matrix It is clearly vital, therefore, to understand how suppliers view the buyer before embarking upon SCM initiatives. The matrix shown in Figure 3.1 allows a buyer to locate each of its suppliers by asking two key questions: 1 How easy is it for the supplier to service the buyer’s business? 2 How valuable is the buyer’s business for the supplier? It is also vital to understand that it is the configuration and management of the buyer’s internal demand that will dictate the type of customer that suppliers perceive the buyer to be. There are five main potential problems to be considered when thinking about the way in which the buyer manages the demand for everything that it buys from external third parties. These are shown below in Table 3.3 with a brief explanation of the impact they might have on the buyer’s attractiveness as a customer. As can be seen from Table 3.3, each of the five demand management problems can have a serious negative impact on the buyer’s attractiveness as a customer and, by extension, the willingness of suppliers to support SCM initiatives. The key question that arises, therefore, is ‘what are the primary causes of these problems, and what, if anything, can you do about them?’ At least some of these

44


problems will have purely technical or operational causes, such as a lack of comprehensive and compatible information technology, or the demand for rigorous safety standards from the buyer’s own customers. It is less often understood, however, that a good many of these demand management problems arise as a result of the political struggles that go on between different functions within an organization. Table 3.3

Potential demand management problems

Demand management problem

Impact on customer attractiveness

Over-specification

Makes the buyer’s requirements more difficult/costly to service, which may impact on the supplier’s profitability (nuisance or leverage customer)

Unplanned changes in specification

May require the supplier to make costly lastminute alterations to the product/production process (nuisance or leverage customer)

Poor demand information

Makes it difficult for the supplier to pre-plan its production activities and may require the supplier to pay a premium for its supply inputs (nuisance or leverage customer)

Fragmentation of expenditure

Each separate transaction undertaken with a supplier will be of limited value, and multiple interactions will increase transaction costs (nuisance customer)

Maverick buying

Diminishes the volume/value of business awarded to approved suppliers (nuisance or development customer)

Intra-organizational power and incentives This section explores the idea that organizations are a political battleground. This is because individual functions within an organization have a tendency to pursue their own interests and objectives and to interpret the overall goals of the organization in light of those interests and objectives. It is the pursuit of these individual agendas by different functions that often causes the demand management problems discussed above. One of the key internal challenges facing anyone in trying to implement SCM initiatives is to persuade those functions causing these problems that they should change their behaviour and support the initiative.

45


Two important questions arise as a result of this line of argument: ■

What creates the ability to persuade other organizational functions to change their demand management behaviour in support of SCM initiatives?

■

What is the attitude of other organizational functions to SCM initiatives? Have they been co-operative historically or unco-operative?

The ability to persuade other functions to support SCM initiatives, or any other sourcing initiative for that matter, is largely determined by the power of one function relative to that of other functions. With this in mind a simple predictive model of intra-organizational power is provided based on three factors in the sourcing process: ■

the ability of different functions to cope with uncertainty in the sourcing process;

■

the centrality of different functions to the process;

■

the substitutability of different functions in the process.

This simplified ‘strategic contingencies’ model (Hickson et al., 1971; Pettigrew, 1973; Pfeffer and Salancik, 1974) explains which functions are most powerful in the sourcing process and which are less influential in decision-making. By combining this information with that on their attitude to cross-functional initiatives, it is possible to categorize each function and decide whether the internal balance of power is conducive to SCM initiatives. In short, it is possible to assess whether there are too many ‘enemies’ or whether there are sufficient ‘allies’.

Uncertainty Uncertainty means that decisions are taken about suppliers and their products and services where there is limited information about future outcomes. In other words, supply alternatives and their possible outcomes in terms of value for money can often be highly unpredictable. This problem of supply uncertainty is particularly acute in the outsourcing of complex IT services (Lonsdale and Cox, 1998; Audit Commission, 2001). There is evidence that there are significant cost overruns and operational delays associated with buying such services. Moreover, these problems can often become much more than an irritation for the buying organization, because information processing is now fundamental to so many activities. Uncertainty might contribute to such difficulties in one of two main ways. ■

The buying organization might suffer from needs uncertainty. This means that the buyer is unable to provide the supplier with a full and detailed statement of requirements, because it is uncertain as to how its needs might change over the life of the contract. Consequently, even if the supplier acts in good faith, it

46


might still be forced to charge more or to fall behind in delivery of the customer’s requirements, because these requirements change in radical and unforeseen ways. ■

The buying organization might also suffer from means uncertainty. This implies that the buyer has a fairly clear understanding of its needs, but that it is uncertain as to the means by which those needs might best be fulfilled. In this case, there is a very real danger that the supplier might act opportunistically and fulfill the buyer’s needs in ways that allow it to earn more money than is strictly necessary.

It is clear that these different types of uncertainty can have an enormous impact upon the value for money that buyers are able to achieve. Consequently, those functions within a buying organization that are best equipped to help the organization cope with or manage such uncertainty will have a critical power resource in the sourcing process. Coping with uncertainty in the sourcing process could mean: ■

Prevention. A function could prevent needs uncertainty by providing expert advice that enables the organization to plan its requirements over an extended period;

■

Information. A function could provide technical/operational information on alternative methods of fulfilling a requirement to help the buying organization overcome means uncertainty;

■

Absorption. A function could react to supplier opportunism by helping to develop and implement an exit strategy.

Centrality Centrality refers to the importance and closeness of a particular function to the sourcing process. There are two key variables that can affect the centrality of a function to any sourcing decisions. The first variable is the extent to which a particular function performs activities in the sourcing process that impact directly upon the sourcing activities or decisions of other functions. For example, in many manufacturing organizations it could be said that the production and R&D departments enjoy a high degree of centrality in the sourcing process, because they are key players in recognizing and defining the organization’s need and in drawing up the original specification. These decisions are fundamental in driving the activities of all other actors involved in sourcing. In contrast, we might argue that the sales and marketing function has a high degree of centrality in the sourcing process of a service sector organization,

47


because it defines the market offering and thereby determines the organization’s input requirements. Finally, it might be argued that in all types of organizations the finance function enjoys a high degree of centrality by virtue of its capacity to veto or approve major items of expenditure. The second variable that determines a function’s centrality to the sourcing process is the extent to which the function performs activities that are deemed essential to the successful completion of the process. In other words, if an organization were unable to buy any products or services without an input from a particular function, then that function would be deemed to possess a high degree of centrality. Conversely, a function would have a lower degree of centrality if it only had an involvement with the buying of certain categories of goods or services, or if it was only active when certain types of buying decisions were being taken (i.e. buying a new item from a new supplier). This is an important point, because it emphasizes that the centrality of a particular function to the sourcing process is likely to be variable and context specific. Indeed, on many occasions the procurement function itself might have no involvement in the buying process. For example, it is not unusual for an organization’s procurement department to have no involvement in capital expenditure, with these items being handled instead by Business Units or production functions.

Substitutability Substitutability is the third factor that determines the power of a particular function in the sourcing process. This refers to the ease with which the activities performed by that function can be performed equally well by other actors, either inside or outside the organization. If a function has no substitute in the process because it is a repository of tacit and therefore non-transferable skills and understanding, it has a critical power resource. For example, certain engineers in the oil industry gain a power resource from the fact that they are part of a select band that understand the way in which the drilling equipment interacts with different geological environments. As a consequence of this knowledge these engineers are non-substitutable actors when an oil company’s requirements for equipment and maintenance services are being specified. Conversely, if one or more other actors, either internal or external, can perform a function’s activities equally well, then its power resources in this dimension are limited. This issue of substitutability has become particularly topical in recent years with the increased use of outsourcing. The outsourcing trend has inevitably caused those functions faced by the threat of transfer to a third party to argue that they are non-substitutable, because they understand the historical legacy and idiosyncrasies of the organization.

48


On occasion such arguments win out, but more often the pressure for headcount reduction and cost efficiencies takes precedence. It might be argued therefore that non-substitutability has been significantly eroded as a basis of internal power by the increased willingness of organizations to shift their external boundaries. Key learning point 3.2 An understanding of the relative power of different functions in the sourcing process can be acquired by considering three factors: ■

the ability of different functions to cope with uncertainty in the process;

■

the centrality of different functions to the process;

■

the substitutability of different functions in the process.

A highly powerful function, therefore, will be characterized by a significant ability to cope with uncertainty, a high degree of centrality in the sourcing process, and by non-substitutability. Conversely, a function that is relatively lacking in power will display an opposite set of characteristics. Table 3.4 presents in summary form the relationship between different combinations of these variables and the commensurate degree of intra-organizational power. This table can be used as a quick checklist to rate the relative power of different functions within any organization. Table 3.4

Rating the power of the different functions involved in the sourcing process

Coping with uncertainty

Centrality

Substitutes

Power rating

Good

High

None

Very High

Good

High

Many

High

Good

Low

None

High

Poor

High

None

High

Good

Low

Many

Medium

Poor

High

Many

Medium

Poor

Low

None

Medium

Poor

Low

Many

Low

The power of different functions within the sourcing process is a necessary but not sufficient factor in any decision as to whether the internal environment of a company is conducive to SCM initiatives. The insights that are gleaned from the above analysis

49


must also now be combined with information on the historical attitude of different functions in an organization to sourcing initiatives. It is necessary to ascertain whether a particular function has tended to be co-operative in the past or whether they have had a tendency to act as a brake on new SCM initiatives. The reason for doing this, as can be seen in Figure 3.2, is to create a categorization that differentiates between a powerful and co-operative function and one which has power but is unco-operative. Figure 3.2 also brings back into the picture the managerial competence issues discussed earlier. We argued that each of the functions involved in the sourcing process must have two different competencies if SCM initiatives are to be successful. These are an operational understanding of the tools and techniques used in SCM initiatives and an understanding of how internal demand should be configured to make the organization attractive to its suppliers.

Categorizing functions The basic categorization shown in Figure 3.2 divides functions into those with a high level of competence and those with a low level of competence. The former are those functions with a solid grasp of both the operational and the demand management requirements of SCM. The latter are those functions that have neither of these competencies or where they are significantly under-developed. Fig. 3.2

Knowing your enemies and your friends

Attitude of function to procurement initiatives Co-operative

Unco-operative

Power of function in procurement process Low–medium

High–v. high

Low–medium

High–v. high

High

Ally

Key ally

Enemy

Key enemy

Low

Potential ally

Potential key ally

Irritant

Loose cannon

Competence of function

The primary managerial benefit of categorizing the functions in an organization as shown in Figure 3.2 is that it enables managers to decide what kind of strategies

50


they need to follow to build a coalition of support for SCM initiatives. This point is illustrated in the following exercise. Exercise 3.2 Linking management styles to SCM initiatives Use the above matrix to categorize the various functions involved in sourcing in the organization and then answer the following questions: ■

What type of managerial style should be adopted with each function based on its position in the matrix – conciliatory, confrontational, mentoring, avoidance?

■

How might each type of function fit into a strategy to build support for SCM initiatives?

EXTERNAL SUCCESS FACTORS The success of SCM initiatives has both an internal and an external dimension. The remainder of the chapter discusses the key external factors that must be present if SCM is to be successfully implemented. These key external factors are an exact mirror image of those discussed about the internal context: a high level of managerial competence and understanding in the organizations in the supply chains to be managed; and, an appropriate alignment of inter-organizational power and incentives. We can summarize these two factors by asking whether the organizations in the supply chain that you want to manage are both competent and congruent (Cox, 1999). We turn first to the issue of competence.

Managerial competence and understanding in supply chain organizations When managers ask questions about the competence of their suppliers, they are usually interested in whether they can deliver effectively on specified quality, cost and delivery (QCD) requirements. Indeed, it is these three factors, in combination with the financial stability of a supplier, that form the basis of the vast majority of supplier assessment and selection procedures. This definition of supplier competence is, however, far too narrow if the aim is to select suppliers to be part of SCM initiatives. To achieve proper alignment with suppliers in SCM initiatives it is necessary to consider whether a supplier is also competent in the two spheres that we discussed earlier in the internal context.

51


Do suppliers have an operational understanding of the tools and techniques that underpin SCM, and do they understand how to manage their demand effectively so that their own suppliers view them as attractive customers? In short the buyer should be interested in whether a supplier is competent not only to meet QCD requirements but also to improve upon them through the deployment of SCM tools and techniques and the effective alignment of its own internal demand. The exercise below provides a simple checklist that can be used to assess the competence of suppliers on these two important measures. To be truly competent a supplier must demonstrate a robust understanding of both the operational and the demand management requirements of SCM. Exercise 3.3 Are suppliers competent for SCM? Name of supply chain organization Operational competence How much knowledge/experience does the supplier have of the following SCM tools and techniques?

Demand management competence To what extent does the supplier exhibit the following demand management problems?

Tools Substantial Limited None Problems Over specification Lean thinking Unplanned changes Agile thinking in specification Critical asset thinking Seven principles of Poor demand Muda information JIT Big picture mapping Process activity mapping

Substantial Limited

None

Fragmentation of expenditure Maverick buying Other (specify)

Value stream mapping Vendor managed inventory Cycle time reduction Supplier association and networks Pareto Curve approach Surge and Base approach Supply chain response matrix The production variety funnel Quality filter mapping Demand amplification mapping Decision point analysis Physical structure mapping

Clearly, the checklist shown in Exercise 3.3 provides only a fairly basic insight into the competence of the organizations in the supply chain that has to be managed.

52


That said, this analysis should enable managers to take a view on whether a particular supply chain organization already understands what is required and how to do SCM, or whether it needs to be educated. Moreover, if a supplier is deemed not to be competent, a judgement must also be made about whether it can be persuaded to commit the time and resources needed to bring its competence up to the required level. This issue is important because it is illogical and impractical to suggest that a supplier could ever be forced to develop its competence. A supply chain organization must be willing to learn what is necessary to participate in any SCM initiative. This question of persuading other actors to support the initiatives of the buyer requires a consideration of power and incentives. This requires consideration of the inter-organizational power circumstances in which a supplier might be expected either to improve its competence or, if already competent, to use what it knows in support of a buyer’s SCM initiative. Equally, those power circumstances in which a supplier is unlikely to be willing either to improve or to deploy its SCM competence must be considered.

Inter-organizational power and incentives When selecting suppliers to be part of SCM initiatives it is not enough to think solely about their competence. It is also necessary to understand whether a particular supply chain organization has an incentive to make the substantial investments that are needed to be part of such an initiative. These investments are of two basic types. ■

The first type of investment relates to developing and improving the required operational and demand management competencies. The focus here is primarily on management education to promote knowledge and understanding of SCM tools and techniques and the commercial implications of poor buying behaviour.

■

The second type of investment relates to the organizational change process that might be necessary to make SCM initiatives effective. For example, a supply chain organization might be required to redesign its internal production process, alter its capacity planning/allocation, introduce a new management information (ERP) system, or reorganize its in-bound and out-bound logistics to create a synergy with any SCM initiative. All these organizational innovations will carry a substantial cost in terms of managerial and financial resources.

The key question is, therefore, under what inter-organizational power circumstances would a supply chain organization be willing to make such substantial up-front investments? Before this question can be answered the range of power circumstances that might exist between a buyer and any supplier must be identified. These issues were

53


discussed in Chapter 1 but, as Figure 3.3 shows, the four basic buyer–supplier power circumstances have key attributes for buyers and suppliers. This model provides a simple checklist of criteria that you can use to assess your power relative to particular suppliers (Cox et al., 2000; Cox et al., 2001). The same criteria can also be used to assess the relative power positions of buying and selling organizations further upstream in the supply chain that the buyer is seeking to manage.

The attributes of buyer and supplier power

Fig. 3.3

Buyer dominance (>) ■ ■ ■

High

■ ■ ■ ■ ■ ■

Attributes of buyer power relative to supplier

Few buyers/many suppliers Buyer has high % share of total market for supplier Supplier is highly dependent on buyer for revenue with few alternatives Supplier’s switching costs are high Buyer’s switching costs are low Buyer’s account is attractive to supplier Supplier’s offering is a standardized commodity Buyer’s search costs are low Supplier has no information asymmetry advantages over buyer

■ ■ ■ ■ ■ ■ ■ ■ ■

Few buyers/few suppliers Buyer has relatively high % share of total market for supplier Supplier is highly dependent on buyer for revenue with few alternatives Supplier’s switching costs are high Buyer’s switching costs are high Buyer’s account is attractive to supplier Supplier’s offering is relatively unique Buyer’s search costs are relatively high Supplier has moderate information asymmetry advantages over buyer

Independence (0) ■ ■ ■ ■

Low

Interdependence (=)

■ ■ ■ ■ ■

Supplier dominance (), implies that a buyer has little or no dependence on a particular supplier, whilst suppliers are highly dependent upon the buyer’s business;

■

supplier dominance, represented by a less than symbol (

Scenario 1:

Buyer dominant power regime

A

A

Supplier dominant power regime

A

C

B

D 0

C

D
D

A=B A

C

Supply Chain Management: A Guide To Best Practice (Management Briefings Executive Series)

Supply Chain Project Management

Supply Chain Logistics Management