Systems, Modules or Components? New Light on Purchasing
Capturing the full potential from suppliers has always been a challenge. To pull it off, successful companies have devised ways to effectively integrate the right suppliers into their business processes. In so doing, they have created powerful supplier relationships that simultaneously encourage cooperation and competition.
The results of these best-practice relationships are demonstrable. In our most recent case work, we have found opportunities to reduce total cost by 15 to 30 percent by creating more effective supplier relationships. We have also found that these best-practice savings can be sustained. But how are such relationships achieved?
A previous article based on our case research -- "Balanced Purchasing," in Issue 2 of Strategy & Business -- argued that achieving the balance between cooperation and competition requires a new set of purchasing skills throughout the organization. This article, the second in a series based on our case research and practice findings, describes one of those key skills. This one, which plays out on the strategic level, is the ability to define clearly what we have termed a supplier's "scope boundaries."
A Simple Example
To maximize the performance of suppliers, a company must disaggregate the end product into sets of components and/or functional groupings. These sets can be produced by various suppliers. Optimally defining the lines of supply resulting from the disaggregation allows the company to examine and organize its suppliers in ways that create the most value. We call these lines "scope boundaries." The scope can be narrow or broad -- and can focus on value creation through product innovation or through closer integration in the manufacturing and delivery process.
Scope boundaries affect the amount and type of value creation available to the company and the supplier. Exhibit I provides a simple example of the way this works by demonstrating the possible evolution of a supplier of bolts.
Source: Booz-Allen & Hamilton
In a traditional arm's-length relationship, a supplier has a very narrow scope. In this example, the bolt supplier does not understand the customer's needs beyond the design specifications, known as a make-to-print arrangement. Accordingly, the only opportunity for the supplier to create value is to reduce its internal manufacturing cost. As a result, opportunities are lost for suppliers and customers to cooperate in product innovation and in creating a tighter integration of processes to deliver products faster or at lower costs to consumers. Fortunately, our research indicates, few companies are content to keep their key suppliers in arm's-length relationships.
With longer-term supplier relationships, new methods of value creation can be opened up. For example, the supplier may integrate its processes with those of the customer as in just-in-time delivery and integrated quality assurance arrangements. Through these joint efforts, new cost reduction opportunities can be exploited in the shared value chain -- not just in the supplier's portion of it. Additionally, if there were a closer relationship, the bolt supplier could begin to challenge the specifications: "Why this tolerance? Why should the bolt be plated?" These questions, which ultimately lead to joint designs, are a vital initial step aimed at increasing the level of value creation.
Over time, the relationship with the supplier might produce a broader scope. For example, the supplier might be asked to evolve beyond bolts to cover a wide range of "fasteners" (such as Velcro or plastic clips), which have the same basic functionality. With this broader scope, the supplier can propose alternative product-technology choices that best meet the customer's application without the risk of losing the customer's business. In this broad relationship, the supplier is no longer motivated to suggest that a bolt is always the right solution. Value creation comes from providing innovative solutions to problems based upon a deep understanding of customer needs.
Alternatively, the supplier may be asked to take on a subassembly project. In this case, the supplier can create value by making trade-offs between the different components in the subassembly operation. Often, the supplier can save money by delivering larger modules to the customer, which minimizes inventory and handling costs. However, we have observed that this route can be difficult, because it puts more focus on the supplier's manufacturing capability than on innovation and customer understanding.
Both broad paths -- the fastener-solutions provider path, which focuses on the greatest opportunity for product innovation, and the major-subassembly producer path, which focuses on delivery stream integration -- are logical options for the supplier-customer relationship. However, each will tap a different set of opportunities and requires a different set of capabilities of the supplier. The challenge is to select the option that provides the greater opportunity for value creation.
Complicated Set of Trade-Offs
When it comes to finding the optimal solution to the supplier-customer relationship, we have observed that few companies systematically define the trade-offs that are essential to the process. Although the bolt supplier example makes the issue look fairly straightforward, reality is quite different and often more complicated.
In our work with dozens of clients, and in our survey of the literature, we have observed three major pitfalls in defining optimal scope boundaries:
1) Using historical boundary definitions, rather than rethinking new boundaries that can create more value.
2) Defining broader responsibilities, but continuing to manage the supplier at a narrower level.
3) Developing overlapping boundaries among suppliers, or between the company and the suppliers, that generate sub-optimal trade-offs.
At worst, the first pitfall avoids change -- at best, it allows change simply to happen without it being actively managed.
The second pitfall is common for companies that are trying to make the philosophic shift to broader boundaries. Unfortunately, the transition is difficult because it requires relinquishing traditional responsibilities to suppliers.
The third pitfall is far more subtle and is only just beginning to surface at leading companies. These companies have broadened the suppliers' scope boundaries but now see conflicts and overlaps and are finding that defining the optimal boundaries is an increasingly complex task. As the bolt example illustrates, even for a simple product, there are a wide variety of options.
Exhibit II captures the findings from some recent field work. The quotations show why moving from historical boundaries is so difficult: There is no consensus about where or how to move the boundaries. Even within the organization of one original equipment manufacturer, we found major disagreements about what to do.EXHIBIT II: CONFLICTING VOICES AT THE O.E.M.
In the second pitfall, companies define broader scope boundaries, but continue to manage the suppliers as component sources. Exhibit III illustrates a common symptom: continuing to control the second-tier sources while encouraging a first-tier source to step up to a broader role.EXHIBIT III: MANAGING SUPPLIERS NARROWLY
Although the vehicle manufacturer in the exhibit has re-thought boundaries and positioned a select set of suppliers as first-tier "brake system integrators," it still requires these suppliers to source from a complex set of pre-selected component suppliers. To truly capture the value of a system integrator, key decisions and trade-offs -- like second-tier source selection -- should be left to the first-tier supplier.
Finally, even when companies get over the inertia of tradition, they find that new scope boundaries can create a complicated series of overlaps between their own operations and those of suppliers, as well as between suppliers themselves.
Again, using an automotive industry example, vehicle manufacturers have been broadening the scope boundaries of major suppliers. Consider the case of A.O. Smith, which was traditionally a "metal bender," providing a variety of components stamped or forged from steel. Now the company provides entire rear-axle assemblies to vehicle manufacturers, complete with brakes, steering knuckles and major suspension subassemblies. This broader boundary has far more components and provides many opportunities for A.O. Smith to create value.
However, this bigger mandate could interfere with value-creation opportunities from other suppliers -- such as a brake system supplier that can integrate the functions of the foundation brakes with the actuation hardware and the increasing electronic content of anti-lock brakes.
As Exhibit IV illustrates, a brakes system supplier can create significant value by designing the system as an integrated whole. As this example shows, a major challenge is choosing between boundaries defined by "functional system specifications," like brakes, and those defined by "physical boundaries," which describe modules delivered to the customer as a single subassembly, like the rear axle.EXHIBIT IV: CHOOSING CORRECT BOUNDARIES
Both options provide broader boundaries for suppliers, opening up more opportunities for value creation. However, the overlap between these boundaries creates confusion, and often "systems" and "modules" choices are mutually exclusive.
Conclusion: How to Move Forward
To avoid these pitfalls and move toward optimizing a company's extended enterprise of suppliers, our research suggests following a structured five-step methodology.
This robust, iterative process starts with:
1) The economic decision as to how to create the most value.
2) From there it defines supplier capability requirements.
3) It also identifies the appropriate suppliers that can manage the given scope.
4) To deliver the results, the methodology deals with the specific tactical decisions about how to structure the best working relationship with the suppliers.
5) To insure continued and sustained results, it provides a performance-monitoring system to drive improvement. (See Exhibit V.)EXHIBIT V: FIVE STEPS TO SUCCESS
The methodology also has many feedback loops that force a revisiting of the scope boundaries question, based upon the current supply capabilities and strategic imperatives. A paper entitled "Suppliers in the Innovation Stream" (to be published later this year as a Booz-Allen & Hamilton Viewpoint) describes the methodology in more detail.
Scope boundary definition is complex, because of the difficulty in quantifying value creation and in managing trade-offs. Furthermore, the "optimal" boundaries are constantly shifting, as new functionality is added to the end product and new technologies provide innovative solutions.
Nonetheless, understanding and optimizing the boundaries are critical first steps in capturing the full potential of the extended enterprise of suppliers.
Reprint No. 96302
Timothy M. Laseter, email@example.com
Tim Laseter is a vice president with Booz Allen Hamilton in McLean, Va. He has 14 years of experience building organizational capabilities in sourcing, supply chain management, and e-business strategy in a variety of industries.
C.V. Ramachandran, firstname.lastname@example.org
C.V. Ramachandran is vice president in the operations practice at Booz-Allen & Hamilton and leads the firm's thinking on the impact of electronic commerce on buyer-supplier relationships.
Keith H. Voigt,
Keith H. Voigt is a senior associate in Booz-Allen's operations management group and has recently transferred from Cleveland to Lima, Peru. Mr. Voigt supports the firm's innovation and strategic sourcing teams. He holds an undergraduate degree in electrical engineering, summa cum laude, from Michigan State University; a certificate in nuclear engineering from the U.S. Navy Nuclear Power School, and an M.B.A. with distinction from the University of Michigan.