By Hans Dau - December 25, 2020
Early in the COVID crisis, companies just froze up and lean supply chains' risks were dramatically exposed. Price became almost meaningless in the face of severe shortages of key inputs. Aggressive, often private equity-owned companies squeezed suppliers for flat discounts and extended payment terms. As the economy bounced back, these short-term measures backfired as the supply chains were as vulnerable and undiversified as before, but with broken or strained supplier relationships.
Smart companies should use this crisis as an opportunity not to indiscriminately squeeze incumbent suppliers, but rather to strategically re-source core supply chains for both better long-term pricing and more diversity and robustness. 2021 is the time to do this. Suppliers are highly motivated and seek long-term partnerships in the context of generally weak demand.
A proper strategic sourcing approach is grounded in microeconomic principles and designed to reduce costs for both parties in the long term. Here are the key steps:
Envision target supply chain: A desired end state vision is a useful planning device, but companies should remain flexible and include suppliers they may not have used in the past and consider them for development. It's important not to restrict the solution before all the facts and data have been gathered and terms have been fully negotiated. Restricting the degree of freedom by presupposing an answer and having a specific end state in mind this early in the game, can be very costly and highly counterproductive.
Raise the stakes for suppliers: In most circumstances, neither purchase-by-purchase bidding nor single sourcing are appropriate strategies. Raising the stakes simply means making it more painful to lose the business and more attractive to win it. It forces suppliers and buyers to think hard about how to work together and puts the best minds and most senior decision-makers on both sides in charge. This can be accomplished by aggregating volumes over time, consolidating suppliers, and ensuring that all purchased items are explicitly priced.
Design the correct pricing model: The method of pricing is the most powerful lever in strategic sourcing. The way one asks for a price determines how suppliers respond, how much of the spend is covered, what we learn about the supplier economics, it enables long-term relationships, most importantly, aligns incentives to reduce cost and innovate long-term pricing contracts. Unlike cost-plus approaches, pricing models are industry-based, competitive, centered around buyers' requirements.