(How to use your customers’ strategic sourcing framework to find your sweet spots.)
We recently completed an adjacent-market strategy project for an automotive supplier looking to diversify beyond the cyclical and price-sensitive auto OEMS into adjacent markets with similar technology needs. For them, like many of us, the phrase “strategic sourcing” conjured up images of scowling purchasing managers at their automotive customers devising ever more diabolic approaches to drive down their prices.
At first glance, other markets seemed more attractive – while they were somewhat lower volume than automotive, they did not have the reputation of cutthroat automotive purchasing departments and might make it easier for our client to get a good return on their application engineering investment. Our job was to help them figure out where to focus, separating the ‘grass is greener’ bias from the reality of how these adjacent market customers make buying decisions.
It is generally true that purchasing managers focus on driving down prices – they don’t design the part or determine the number of pieces, so getting the best price is how they add value. However, even companies with the worst reputations for aggressive price negotiation, have adopted some form of strategic sourcing framework. They have acknowledged that just driving down cost per part is not enough if you don’t have access to the supplier’s best technology, or worse drive the supplier out of business (again, see: automotive).
As a result, most companies work with established frameworks for categorizing purchases and developing appropriate sourcing strategies for different categories that explicitly acknowledge the value a supplier can bring beyond simply lowering price. Better understanding how your customers apply these strategic sourcing frameworks can help inform suppliers as to how to best target and approach markets, segment them and develop specific value propositions to bring to customers.
How does strategic sourcing approach the supply market?
One well established framework for strategic sourcing is referred to as Kraljic’s matrix (1). The matrix characterizes purchase categories based on two dimensions: business importance and market risk / complexity. Business importance refers to the category’s influence on profitability but is often simply gauged based on the proportion of cost represented. Supply Risk/Complexity refers to the ability to secure supply at competitive costs; this is typically driven by the degree of competition, pace of technology evolution, complexity of logistics, and so on.
The following table, adapted from Kraljic’s article, summarizes the framework.
As a business, you’ll end up with spend in all four quadrants. You’ll also do everything possible to drive suppliers to the lower left or at least convince them that that is where they are in an effort to get better prices. But the reality is that you will still end up with suppliers in all four quadrants.
How can we turn strategic sourcing around and apply it to suppliers?
As a supplier, with each market or market segment that you approach, you will end up in different quadrants from the customers’ perspective. For your business, the priority markets will be those for which you are positioned to the right side and preferably lower right (everything else equal) of the matrix. You may not be able to ignore the markets/segments on the left if that is where the volume is (again, see: automotive), but if that is all you do, you are defining competition as a race to commoditization.
So from a strategic growth perspective, your energy should be focused on the evolving features and capabilities that will help drive you to, or better yet, grow your business on the righthand side of the matrix.
The first step in applying this framework as a supplier is to understand where purchasing teams in each market (and eventually each market segment) see your business in the matrix.
To gauge importance to the customers’ business (the vertical axis), a great starting point can be your price as a proportion of the customer’s cost. There is a bit of judgment in gauging this, but if you are getting the attention of customer category managers on a regular basis vs working through buyers, you’re of higher importance.
To gauge Supply Risk / Complexity for the customer (the horizontal axis), a simple proxy is assessing how many supply options a customer could secure in relatively short order. If there are multiple options, you’re on the left side; if there are few, you’re on the right side. Beyond that first pass, you will also want to consider specific differentiation of your own offering: intellectual property or process know-how, product and service differentiation, level of knowledge of and integration with customer’s process, etc.
What are the implications on strategy and execution for suppliers?
Strategy starts with an understanding of where you are in the matrix with existing customers, but that is just the baseline. Your goal should be to focus on products/services that create differential value and can (even temporarily) move you to the more attractive righthand side.
When evaluating new business opportunities (organic), the key is to assess where your offering would land in the matrix above for the the new markets (and segments) being considered. To properly gauge the horizontal axis, you will need to understand what problems we solve for the customer, what value we add vs the next best alternative and whether there are few or many alternatives that can solve the same problem. Building this understanding before entering a market, either organically or through acquisition, will help you avoid the trap of starting with a ‘me-too’ offering that only accelerates commoditization.
How did this apply to our automotive supplier client?
Our automotive client recognized that despite the reputation of automotive customers, much of their automotive business was towards the upper right-hand corner of Kraljic’s matrix. However, to ensure the ongoing profitability of their existing automotive business, they were in a constant battle to innovate and maintain their position on the right-hand side of the matrix.
When applying this thinking to new business opportunities, the client was able to better recognize that in several vertical markets the major customer had deep engineering expertise, and so potential customers would quickly take the integration of our client’s offering in-house and so shift our client to a more commodity-like purchase to the left of Kradjic’s matrix. On the other hand, in several other vertical markets where the clients’ offering was of similar business importance the potential customers didn’t have the scale to vertically integrate; here the client was a strong candidate for a strategic partner.
Despite a better understanding of Kradjic’s matrix our client still thinks of “strategic sourcing” as scowling purchasing managers devising diabolical schemes to drive down prices and ruin their profitability. However, with this more informed perspective, the client was better able focus on the best target markets and segments where players were facing specific technical challenges and needed to rely on supply partnerships. The analysis provided additional insights that guided specific focus within each segment on the aspects of the client’s offering that were “strategic” or “leverage” opportunities in those markets / segments.
Turning the sourcing strategy around allows you to think like your customers. It can provide a critical perspective on how and where you can best add value, informing how to best target and approach markets, segments and individual organizations for selling. This is useful in guiding strategy and execution in both your home markets and when considering adjacent markets.