We continue our series of the top procurement myths here on Chief Procurement Officer. Make sure to check back as we tackle the remaining dozen myths.
13. The Kraljic Model Should Be Used to Define, Manage Spend Categories
One of the fundamental concepts in sourcing and category management is segmenting your spending into logical groups of similar items/services from similar suppliers and tailoring your processes that manage them. This is not a new idea. Peter Kraljic’s seminal 1983 paper titled “Purchasing Must Become Supply Management” helped build the foundation of the modern procurement organization by stating that strategic procurement organizations should segment their supply base based on the importance of their spend and buyer/supplier market dynamics such as those established by Michael Porter (and his 5 Forces framework) in order to formulate effective sourcing strategies. Kraljic’s paper introduced this famous 2x2 supplier segmentation matrix of spend category importance of the spend category vs. its supply market “complexity” – and the resultant quadrants of leverage, strategic, bottleneck and non-critical.
More than 30 years later, the world has become much more complicated, but also has much more sophisticated techniques and tools. On the demand side over the supply chain, massively sophisticated customer-facing analytics working on “big data” allow firms to micro-segment their demand and customer bases based on hundreds of variables to gain a competitive advantage by personalizing product offerings and serving them up in real time – and making sure the supply chain can support this omni-channel model to the consumer. Yet, when you look at how well companies can perform that same approach to the supply side, the majority of procurement organizations are still stuck in the most rudimentary of segmentation models. However, this is starting to change in many ways. Just consider these segmentations and the questions that you might ask yourself about tailoring your supply management processes based on them (hint: the answer to all of them is “yes”):
- Supplier performance: Should you manage your suppliers differently based on how well they are performing? What should you do when the trend on certain performance categories (i.e., quality, delivery, responsiveness, etc.) starts to change?
- Supplier risk:should you segment your risk identification and mitigation activities based on spend category, too? Should you “right-size” how you monitor the various risk types against performance data and external market intelligence data? Many companies have morphed their “complexity” metric from the X-axis of the Kraljic 2x2 to represent supply risk and to improve how they monitor and manage the “causal factors” that impact supplier quality, delivery, flexibility, viability, etc.
- Suppliers' segmentation of YOU: While the good balance of trade and dependency ratio analysis is standard fare for any good sourcing process, do you think that your attractiveness as a customer (which includes a “customer of choice” measurement that you might seek from your suppliers with a “reverse scorecard” process) is also important in terms of how you engage suppliers?
- Regulations (and related internal compliance processes) in force: Since different suppliers not only present different risks to you, but are alsosubject to highly varying compliance regimes based on industry, geography, etc., do you feel that you should only be executing the truly important compliance activities so that you’re not “checking the boxes” on compliance while ignoring truly critical risks? Wouldn’t you like to kick off supplier management processes that ask for only the key information needed that ties back to true customer/regulatory requirements? For large customers who place unique compliance requirements upon you, do you think it would be strategically differentiating to show them how you customize your supplier management requirements specifically to their specific needs?
- Type of sourcing work: Should you segment even just your sourcing activities based on the nature of demand? For direct spend, the answer would seem to be an obvious yes, but how about for indirect? For example, how do you deal with large dollar non-recurring sourcing activities that seem to drop from the sky (e.g., you acquire a new company or decide to pursue a new CapEx project)? And how about your lower dollar “tail-spend” activities? Should you tailor your sourcing processes and resources (e.g., consideration of using third parties) to these varying types of sourcing projects? Couldn’t you, in fact, view tail spend sourcing projects as a mega spend category in its own right regardless of the nature of items and services themselves?
- Types of demand (even for the same item): we started this whole line of questioning with the notion of “omni channel” customer management. So, how do you support that? For example, if you are a luxury retailer that has the same packaging used for general consumption in the stores – as well as used in the bill of material for a direct-to-consumer order – can you manage that? How about if you bring vendor managed inventory and complex fulfillment into the equation? Segmentation of your physical supply and related aspects (e.g., demand volume/variability by channel) definitely must also be considered in spend categorization.
You get the idea. If you are going to mass customize your procurement processes based on the highly multi-variant nature of the spend categories (i.e., not just 2 variables), you need to evolve your segmentation techniques and then have good processes and technology that can manage this more dynamic and granularly segmented spend that drives targeted activities (beyond sourcing) to extract more value from supply. It's not easy, but you need to master it if you are going to master complexity rather than buckle under it.