Keelvar Blog

Choosing the Best Sourcing Strategy

January 12, 2015

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Choosing the Best Sourcing Strategy

Sourcing strategy planning has received little attention for technology providers. It is assumed that RFX rules and eAuction designs are chosen outside of the tool in some undefined process and this can be where the first mistakes are made leading to a competition failure. But there is light at the end of this tunnel. The concept of market design has received increased attention in recent years, primarily due to Alvin Roth winning a Nobel prize in Economics in 2012 for research in this area. Since then it’s application is beginning to appear in a raft of different contexts.

Sourcing Strategy is Market Design

Sourcing strategy is Market Design because it concerns how bidders should communicate and how your interact. If this design is effective you increase the odds of securing the best outcome; be that promoting innovation, or capturing price information in a way that discovers efficiencies. The outcomes of procurement events are significantly impacted by decisions made at the sourcing strategy stage. Effective market design at this point is the foundation upon which any successful procurement event is built. These design decisions include; what auction format you chose to use, whether you allow lotting and whether you look to elicit more expressive bid information from suppliers e.g. whether they are permitted to offer conditional discounts i.e. discounts based on certain criteria such as winning a number of lots etc

Logistics Example:

Many companies procuring freight transport services (be it air, ocean or over-the-road) at scale aggregate their demand to capitalise on economies of scale. The common failing, however, is that the sourcing strategy creates 2-4 Lots that bundle many lanes that each have unique origin destination pairs. This is a classic mistake because it is the carriers and third party logistics companies who know how best to bundle the lanes.

As a result the supplier base tends to narrow as only the very largest hauliers can bid on the business and the unintended consequences can be significant. If the purchaser is then content to contract with a small number of providers, given that they do not want to ‘manage additional suppliers’ the consequences of this reasoning can be significant. The inherent problems with the above approach is that the procurer has essentially created an oligopoly in which each provider has a suboptimal allocation of lanes with no back-haul opportunities.  The providers may also have excess market power which will typically lead to market abuse over time.

Alternatively, in this example, those procuring could move away from aggregation by region and break demand down into routes (or trucking lanes in this logistics example) encouraging suppliers to bundle and package routes as they see fit. This encourages them to look at backhaul opportunities (whereby an empty truck returning to base picks up supplies en route). Given the Department of Transport in the UK indicates that an astonishing 25% of road transport operations make the return journey empty, the opportunities to operate more efficiently are significant. Of course this more granular approach also means that small regional operators may be able to offer exceptionally competitive rates within their local area. Participants are then encouraged to offer discounts based on winning packages that match their requirements (perhaps contiguous routes that start at their base and return to it by the end of the day).

Technology to Support Smarter Sourcing Strategies

As can be seen from the above example, the best sourcing strategy was in fact a simpler approach in which the bidders were permitted to express their optimal bundles with conditional discounting to express economies of scale. The purchaser can then focus their sourcing strategy on key objectives such as

  • the range of supplier numbers,
  • anti-mononpoly constraints,
  • switching costs and other award criteria.

Having an evaluation engine frees up the sourcing team to be more strategic and not be bogged down in spreadsheet calculations that inevitably bind the purchasing organization to suboptimal strategies. The net effect of these changes in disaggregating demand and encouraging conditional discounts, can be significant savings and a much stronger and more competitive supplier base. The beauty of applications like Keelvar’s solution is that it offers users (particularly in the private sector) more control, so they could include additional constraints such as ‘I want at least 3 suppliers’ or ‘I do not want any one supplier to manage more than 40% of my business etc’ and have one-click evaluation.

Summary

In summary, the old Henry Ford adage that ‘if you always do what you’ve always done, you’ll always get what you’ve always got’ holds true. However, If you are looking for a different outcome from your procurement exercise, you need to assess what can be done differently to ensure better results while remaining compliant. Where market design and sourcing optimization was once the exclusive preserve of the largest of enterprises, it is now available to the wider procurement community via Keelvar. And what is most appealing is that the easy to use interface means the time savings for those procuring via Keelvar are also considerable.