Podcast: How strategic sourcing became the golden goose

Strategic sourcing, including early supplier involvement and outsourcing, provides significant competitive advantage to companies and represents a fundamental change in the way firms drive the bottom line. Thomas Choi, professor of supply chain management at the W. P. Carey School of Business, looks back 20 years to explain how the relatively mechanical procurement function evolved into supply chain management, a sophisticated approach to managing cost, increasing quality and driving profitability.

Strategic sourcing, including early supplier involvement and outsourcing, provides significant competitive advantage to companies and represents a fundamental change in the way firms drive the bottom line. Thomas Choi, professor of supply chain management at the W. P. Carey School of Business, looks back 20 years to explain how the relatively mechanical procurement function evolved into supply chain management, a sophisticated approach to managing cost, increasing quality and driving profitability.

Transcript:

Knowledge: Many managers wonder why supply management is so important. Supply management at its core is simply buying goods and services from suppliers. Buying is buying, and it should entail a simple set of mechanical steps such as looking at the potential supplier list, issuing requests for quotations, getting the quotes and finding the lowest cost supplier. So, why has supply management become such a big deal?

How has it emerged as a strategic priority in many leading companies such as Honda, IBM and Motorola? Here to answer that question is Thomas Choi professor of the supply chain management at the W. P. Carey School of Business. What is some of the historical perspective you can give us on the prominence of strategic supply management?

Thomas Choi: Well, the field of supply management has come a long way. During the days when large corporations were really large, with their vertical integrated organizational structure, supply management entailed primarily buying activities that required strict adherence to mechanical procedures. The buyer would take orders from the operations or the engineering department and then follow the well delineated guidelines for buying goods or services. This sort of buying required basic skills and did certainly not require a professional degree.

However, things began to change in the early 1990s, about 17 or so years ago. Fields of buying or procurement underwent immense transformation, from being reactive and mechanical to being proactive and strategic. And, in fact, in the last 10 years or so, the landscape of supply networks changed to the point where many suppliers are now considered as long-term partners rather than short-term easily expendable and replaceable sources of goods and services.

They have also come to take up a large portion of what determines the buying company's competitive success. So, consequently, the old days procurement was viewed as, how should I put it, a job where all it had was a mid-level management as the title line. However, in recent years we've seen companies adopt the title called Chief Procurement Officer or CPO and many of these CPO's hold a Vice President level title.

For instance, the Head of Supply Management of Honda of America carries the title of Senior Executive VP. Further, in the old days, the CEO's and presidents of large corporations moved up through the ranks of accounting or engineering, perhaps. However in recent years, we've seen upper management coming out of the ranks procurement or supply management. For instance, the former President of Chrysler, moved up through the ranks of procurement. So, buying has become strategic sourcing and in that sense procurement has become supply management.

Knowledge: So, what were some of the initial motivations for companies to turn to outsourcing?

Choi: We, also, to answer that question we kind of have to go back and think about what happened during the early 80s, 90s and subsequently in 2000s. During the early 1980s, you may recall, some of us at least may recall, the world coming to well, quality contents, through the success of largely Japanese companies.

And many companies around the world, all came to realize the importance of supply of quality; subsequently many companies came up with supply quality programs and supply certification programs, such as Forbes Q1 or General Motors Spear one status. We even saw the emergence of international certification agencies such as ISO. Now, after the quality movement came the race to bring the goods and services to market fast.

It's around the late 1980s and early 1990s, in other words, time to market then appeared as the next competitive advantage over quality during that time. You know, we heard about the legendary stories of how Lexus and Acura first emerged in the market, challenging the luxury brands of Mercedes, BMW and Cadillac and how they found a foothold in that fiercely competitive market niche, by introducing their products by two or three years less time.

Subsequently, managers came to know that the new product development strategies such as concurrent engineering, simultaneous engineering and platform engineering, where in many different functions come together and engage in new product development activities in parallel rather than tossing the designs over the walls that surround the different functions within a company such as design, manufacturing and procurement.

We also saw, consequently, the importance of involving suppliers in this process, known as early supply involvement, and other supply involvement programs such as Value Engineering and Value Analysis. Knowledge: What did they eventually discover about this?

Choi: They eventually discovered this, you know the companies learned that, while they are competing on time to market, you know, basically, advantage, they gain a lot of advantage, by relying on their suppliers and that will help them compete on time to market. Now, let me clarify, they discovered that it was much more expedient and faster to turn to the supply market than to try to coordinate internal operations.

As reliance on suppliers increased the requisite side of the companies became reduced. Furthermore, as the level of outsourcing increased companies also at the same time reduced the rationalized their supply base. In other words, level of supply reliance increased while the overall number of suppliers became reduced. Consequently, each supplier remaining generally received a higher volume of work.

At least, in the automotive industry in the late 80s and early 90s, some part suppliers were told by their major buying companies such as Ford to merge and expand their capacity and capabilities. This effort gave birth to many new large integrated first tier suppliers, such as Tower Automotive. Many parts suppliers that did not become part of a top tier supplier then became second or third tier suppliers. This sort of tiering dynamic, in fact, in my opinion, contributed to the popularization of the term, Supply Chain Management.

So, top managers came to realize two things, and then this is the punch line, first; outsourcing permits them to operate with less assets, which increases their return on investments. In fact, Motorola, refers to this approach, operating in an "asset light" environment. Two, top managers discovered that dollar saved on the incoming side, incoming parts and services generally impacted the bottom line a lot more significantly than a dollar increase on the sale side.

In fact, the percentage of outsourcing increased with respect to overall costs of good sold, this impact of a dollar saved on the bottom line increased all the more. Therefore, by the time the 2000s rolled around, many top managers treated supply management as somewhat of a "golden goose" wherein higher outsourcing led to less overall asset and also lead to more opportunity to increase profit margin by reducing supply costs.

Knowledge: So, looking into your crystal ball, what do you see as the future of outsourcing?

Choi: I believe that outsourcing will continue to increase, and at the same time, it will become more sophisticated. In other words, in the past, because American corporations were not familiar to this thing called strategic sourcing, many companies took a very simplistic approach, meaning that they just focused on cost, right? So, I think in future, companies will not only focus on cost, but they'd also realize the important association, between having a good buyer-supplier relations, and in fact its impact on eventual cost savings.

So, eventually, I think strategic sourcing will continue to be discovered by the managers as a mantra in a sense for the benefits I alluded to a few minutes ago. And I believe that it will help them continue to build close relationships with their suppliers, maintain competitive advantage and offer them more efficient processes and capabilities.