June 20, 2011
by Shawn Casemore
PURCHASINGB2B MAGAZINE: MAY 2011
This article is a preview of Shawn Casemore’s presentation at the PMAC conference. “Creating competition in sole-source scenarios” focuses on sourcing methods to increase cost savings in technical and perceived sole-source scenarios. See it June 10 at 11:55am.
Sole-source decisions are effective and welcome when approached strategically. But when the decision is made outside the guides of procurement, the results can increase the cost and risk.
There are predominantly two types of sole-source relationships. The first includes those instances where a sole source is entered into strategically, to reduce cost and leverage spending over fewer suppliers.
The second type of relationship is less desirable, and often entered into outside of the influence of procurement. This kind of agreement often comes from the perception of non-existent competition, supplier proprietary rights to design or manufacturing, or a customized, highly technical version of an existing product or material.
To determine if a sole-source relationship is beneficial to your sourcing decision, there are five main questions for which you should have a positive response:
1. Is there a good relationship between the procurement department and the supplier?
2. Does the supplier invest time collaborating and communicating with procurement, or are they working directly with other departments?
3. Is the supplier willing to discuss or negotiate cost savings opportunities? If so, are they able to provide more hard cost savings versus soft costs?
4. Is the supplier willing to negotiate sole-source purchases, or do they stand firm on their original quote?
5. Does the supplier allow procurement to complete the necessary due diligence for each contract, or does the supplier create undue pressure to drive orders through the organization, minimizing time available to discuss and negotiate?
When strategically entered, sole-source relationships can provide many advantages over typical competitive sourcing, including:
Increased financial leverage. Through increased spending with a sole vendor, an organization can gain leverage to pursue additional services or products at a reduced cost. The more you buy, the lower the price.
Improved supplier relations. Managing a reduced vendor base gives more time for managing fewer relationships. Additional time can be invested building supplier relations, managing suppliers to performance metrics, and participating in joint strategy sessions to discuss customer challenges and seek new opportunities to build market share.
Confidence in Quality. Strategically building a sole-source relationship can provide opportunities to increase quality and service levels. This is why you will find fast food restaurants maintaining long-term relationships with suppliers of key ingredients, or automotive manufacturers maintaining a sole source for drive-train components for several years. Fewer sources of supply allow for better control of quality, and in turn more confidence in the quality of the final product.
Entering sole-source relationships out of perceived necessity, or as the result of decisions made outside of a strategic framework, can lead to several disadvantages, including:
Price creep. Sole sourcing activities reduce the pricing pressures inherent in a competitive marketplace. Lack of competition will lead, either initially or over time, to increased prices.
Organizational saturation. Most sole-source relationships—whether entered by choice or not—have a product, service or material that requires significant interaction with the customer. This often means frequent site visits, offline discussions with engineering, operations, or production. Relationships are built through this interaction, increasing the perceived reliance on the supplier, allowing for more sourcing opportunities within the organization that may not have been available had this relationship existed. This saturation allows suppliers the opportunity to increase business volume and blanket much of the new business as a perceived sole-source requirement, even though this may not be the case.
Dependency. Once a supplier has penetrated the organization, if they’re adept at building relationships and searching for opportunities, they can grow quickly. They will create opportunities to increase business and, in some instances, find and exploit organizational weaknesses. Once this has occurred, it can be almost impossible to exterminate the supplier from the organization.
Techniques to reduce risk
By using the following techniques, organizations can reduce the risk and cost from entering a sole-source relationship.
Implement a “cost plus” model. Work with the supplier to develop a collaborative approach to billing. Through implementation of a cost and profit pricing model, supplier costs become known, as do profit margins. With this information we can assist the supplier with controlling costs while ensuring profit margins are reasonable.
Develop intimate knowledge of the supplier’s supply chain. As the saying goes, with knowledge comes power. By understanding the entire supply chain and becoming aware of supplier manufacturing processes, information can be gathered that may help in developing new sources of supply in the future. At the very least, a thorough understanding of supplier costs can be developed that may present opportunities to challenge supplier costs.
Investigate unbundling opportunities. Understanding processes and sub-supplier inputs can provide opportunities to unbundle services and cost structures. Unlike buying a meal deal at a fast food restaurant, in a sole-source relationship these bundled costs often lead to higher prices than might otherwise be available. Having a thorough understanding of the suppliers and processes within the value chain will shed light on cost structures, providing insights into areas for potential unbundling of products to reduce pricing structures.
To remove the dependency on a sole source relationship and identify new sourcing strategies, pursue the following strategies:
Investigate reverse engineering opportunities. Reverse engineering is a viable alternative for those materials and products that are not proprietary. If the end product is known, the materials and processes to create the end product can be developed. The only difference is the make and model.
Capitalize on relations with existing suppliers. I’m constantly surprised by the capability and willingness of existing suppliers I had never considered. Existing suppliers offer a solid relationship and commitment that may be unmatched by new, unproven sources. Through continuous discussions of potential business opportunities with existing suppliers, opportunities may arise that benefit both organizations.
Think globally. As globalization continues, the days of sole sourcing due to proprietary or custom designs are dwindling. From garments to commercial goods, new sources of supply are popping up daily. Locating new sources can be as easy as Internet searches, networking at industry functions or talking to existing suppliers.
A sole source relationship does not have to be a dependency, but can be a strategic advantage to meet the needs of niche markets. Whether initiated strategically, or inherited tactically, opportunities exist to build partnerships to reduce cost and mitigate risk. b2b
Shawn Casemore, who has nearly two decades experience in supply chain management leadership roles, operates the consulting firm Casemore and Co. Reach him at firstname.lastname@example.org or (519) 470-7697.