Introduction

The supply chain management area and procurement role within it have become more and more
critical. Companies depended on the number of resources and the capabilities they had. During the
20th century, they competed with each other based on the resources they used to have with them.
To reduce cost and improve efficiency, the companies adopted Vertical Integration. Vertical
Integration is a strategy used by the firms wherein a firm acquires the business operations within
the same production vertical unit. Today, companies are gaining an advantage by outsourcing the
business. Outsourcing is defined as obtaining a business function by subcontracting it to an outside
supplier. Suppliers are making better investments as they can pool demands across various
customers. The organizations can save both on cost and time of switching out the internal assets
of an organization.
Organisations started moving away from vertical integration and shifted their focus towards
building the core competencies. Core competencies is the balanced combination of various
resources and skills that creates a point of differentiation for an organisation from others in the
marketplace. The shift from vertical integration towards core competencies was a move taken to
improve the strategic positioning and the company’s performance due to the high competition and
pressure created from the high cost.
In earlier days, sourcing used to be a matter of finding providers who can offer low cost. Sourcing,
also known as procurement, is defined as location and selection of business and individuals on the
basis of defined criteria. Sourcing has become a strategic function and is responsible for an
organisation’s value chain (flow of activities carried and analysed, which helps in bringing a
product in the marketplace) determination. It also helps in keeping a flow of activities involved in
delivering an excellent good or service to the market. It ensures a supply of products to the
customers and providing services like maintenance, support and after-sales services.
Strategic Sourcing Decisions
Strategic sourcing is not only focused on cost savings but also focuses on making the company
realise its long term goals. It has become an essential part of strategic management. Strategic
sourcing decisions helps a company determine where to procure the products and services that are
needed. The decisions made by an organisation has to be aligned with the business and operation
strategy of an organisation. Operations strategy is a plan that identifies the allocation of resources
to support both the infrastructure and production of a company. The business strategy drives the
operation strategy of an organisation and is responsible for maximising the production
effectiveness and support various elements by minimising the costs. Business strategy is a set of
competitive actions, moves taken by a company. It focuses upon attracting the customers for its
business, competing successfully in the market with its competitors and achieving the goals of an
organisation. It defines the steps that need to be taken to carry out the business and reach its desired
result. The main focus of an operational strategy is to optimise the functional aspects of sourcing
arrangements. On the other hand, business strategies focus on identifying the threats of the
environment around, the opportunities created and optimising the relationship of an organisation
with the stakeholders involved in the business. It is not always necessary that the sourcing
approach, which has an alignment with the operations strategy, will always align with the business
strategy also.
There are two decisions involved when one needs to determine from where to procure the products
and services. The first decision is to decide whether procurement should be done within the
organisation or outside the organisation, i.e. from an external supplier. This is also known as make
or buy decision wherein a manager has to decide about the time investment should be done on
building the resources and capabilities of an organisation. The second decision taken focuses upon
the procurement source, i.e. where to procure from, and it considers the geographical location of
goods supply. Hence, where - to - obtain decision presents specific opportunities and
vulnerabilities of the value chain and how- to - procure decision ensures opportunities realisation
and management of those vulnerabilities.
One of the critical attributes of a sourcing decision is the product structure. Modularity is the
degree to which a product/ process is divided into different subsystems with its well-defined
boundaries. In case of a modular product, it is easy to source standardised components or
subsystems from competing suppliers. Modularisation is driven by the need to manage complexity.
It is done by empowering specialists team to work on subsystems independently (both in terms of
design and production). The process of modularisation creates an opportunity to design products
which use standard components and can perform delayed differentiation. One of the critical
attributes of a product is tradability. A good is called as tradable when it is sold in a location
different from its place of production. Level of tradability is determined by the transport cost
relative to the total value of a good. Tradability of a component or good offers an advantage to the
organisations to choose suppliers who are dispersed geographically. Tradable sector size has
increased due to the use of technology, which has increased the speed and lowered the cost of
transportation of both physical goods and information.
The supply landscape offers choices wherein it helps an organisation to decide from where they
will source the goods and components they require. The decisions made are governed by various
factors like the physical footprint of an organisation, financial implications, industry’s nature of
supply base. One of the crucial managerial decisions is about size and scale. It is essential to decide
how much capacity should be maintained internally and how much should be used from the
sourcing partners. This is dependent on the fact of how much a company can capture or leverage
the efficiencies of scale. Another major factor which affects the sourcing decision is the location
and arbitrage. Arbitrage is defined as the practice of taking advantage of price differences that
exist between two or more markets.
Sourcing decisions help in reconfiguring the value chain of a system. It either helps in the creation
or destruction of value through its impact on various factors such as the visibility of supply chain,
quality of product and its cost. Configuration of value chain helps in exposure determination to
different issues like security and brand risk, customer goodwill erosion and disruption of business
and supply chain. It is an integral part of strategic sourcing to anticipate the risk of a business
disruption. Business disruptions include interruption of supply, the occurrence of natural disasters,
changes in the costs of producing a good.
For classifying components in a good, a framework was given by Peter Kraljic which advises
managers to examine the complexities of a supply market and purchased item importance. This
framework helps managers in minimising the vulnerability of supply while making the most of
potential buying power. According to Kraljic, sourcing strategy of an organisation depends on two
factors: risk of supply and impact of the component on business and profitability. Supply risk is
determined outside the firm and considers the strategic importance of parts purchased in terms of
value added by the product line, raw material percentage in terms of costs. By the second factor,
the nature of dependency on the supplier is determined. According to Kraljic, four sourcing
strategies have been proposed based on components impact on profitability and risk of supply in a
two - by - two matrix. This categorizes and perceives the difference in power and dependence
between the suppliers and buyers. Purchasing strategies for each quadrant would be developed in
the matrix: partnership formation for critical/ strategic products, supply for bottleneck products,
power exploitation for leverage products and efficient processing for non-critical products. In the
Kraljic analysis, purchased item importance is examined, which results in a simplistic perception
of category value. A manager perceives the category value as a positive way of saying that the
performance of procurement is measured by cost savings and not as value for money from the
supply. And this is important from the strategic viewpoint of a company. Hence, sourcing decisions
are made based on tactical management focused on cost savings rather than value-driven
management concentrate on value.