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Factoring uncertainties into supplier strategy decisions builds agile procurement into the whole supplier life cycle. Procurement leaders of the future will measure uncertainty through quantitative analyses, modeling scenarios to take key uncertainties, such as supplier bankruptcy or material scarcity, into account. They will then define strategies and design a supplier portfolio based on expected values (prices and costs) rather than those defined in contracts. They will always have alternative solutions ready to be activated for critical suppliers and parts. They will consider the overall, global supplier footprint, and they will evaluate and compare all possible supply solutions: make versus buy, backward integration versus direct sourcing options, and single versus multiple sourcing.
Li & Fung is an example of a company that factors uncertainty into its supplier strategy. As the largest outsourcing agent in the apparel industry, having $10 billion in revenues and 12,000 suppliers in more than 20 countries, it was particularly vulnerable to volatility. It now has the ability to instantly switch to alternative suppliers and countries to minimize exposure to currency risk, quota and tariff risks, raw-material price risks, and other, political risks.
As another example, a global tire manufacturer reduced costs by 7 percent through global dynamic sourcing of polybutadiene rubber. The company made arbitrage gains by switching sourcing regions when appropriate. This was enabled by building up suppliers in all regions and by contracting in a way that allows the manufacturer to switch between them.
To secure its supply of lanthanum, a rare earth element, Toyota has become the first and only car company to invest in a rare-earth mine. First discovered in 1893, lanthanum is more abundant than silver or lead and is the second most abundant rare earth element. Because there weren't significant uses for it, though, lanthanum mostly went into stockpile, waiting for the day when it could be sold off for higher prices. That day has come. Today, every Toyota Prius hybrid car carries about 10 pounds of lanthanum as the metal in its 'nickel-metal hydride' battery. These batteries pack more power into a smaller space - they're about twice as efficient as the standard lead-acid car battery. Lanthanum's general abundance aside, there is not enough of it available on the supply market today to meet demand for this breakthrough technology, which is also used in other hybrid cars and small mopeds in China.
Helix, a maker of high-performance vacuum pumps, illustrates the flexible supplier approach with its "demand flow technology," an operational strategy version of lean that enables it to segment manufacturing processes into short, easily-taught subprocesses. In the event of a disruption in a Helix plant, these subprocesses can be quickly taught to suppliers so that they can make the company's products. This requires Helix to analyze the capacity and capabilities of its suppliers, and to enter into flexible volume contracts with them. More than 3,200 companies use Helix's demand flow technology, including GE and Boeing.
Developing suppliers and their ecosystems
Building agile suppliers and investing in their ecosystems will have a lasting impact on supply stability and quality. Future leaders will include risk preparedness as a key dimension in the criteria for supplier selection. They will correspondingly support suppliers with agility best practices and collaboratively develop an integrated approach to risk management by sharing know-how, investing in training suppliers, holding joint workshops, and defining shared risk-management standards.
To sustain an agile network, they will adopt a more structured, standardized approach to selecting and approving new suppliers in markets experiencing temporary volatility. They will also invest directly in the development of the supplier ecosystem by cooperating with local authorities, investing in stabilization and development funds, and lobbying.
Diageo, Ikea, and Nestle are companies that develop agile suppliers.
Diageo invests in farmer development in Kenya, providing technical training to more than 10,000 farmers to ensure quality. Supply security goes hand in hand with lower COGS, because it decreases the need to import more expensive barley and enables reduced shipping costs. This allows Diageo to ensure supply as well as to hedge prices and mitigate risk. Similar programs have already been implemented in Nigeria, Ghana, Sierra Leone, and Cameroon.
Ikea is fully financing training small-hold cotton farmers in India and Pakistan. The training for better cotton cultivation is conducted by WWF and supervised by Ikea employees. The effort has involved more than 18,000 farmers, who can produce a cumulative capacity of 150,000 metric tons. Farmers save 4 to 7 percent of their input costs. Use of water has been reduced by 50 percent, pesticides by more than 50 percent, and chemical fertilizers by more than 35 percent.
Nestle tackles volatility and ensures the quality of milk by establishing long-term relationships with thousands of Chinese suppliers. The company buys fresh milk from some 25,000 Chinese dairy farmers and provides the group with an overall income of approximately CHF 500,000 per day. Nestle has also undertaken several initiatives to establish deeper relationships with farmers. It helps to arrange affordable bank loans for farmers so that they can expand their capacity, and it has helped to find local suppliers for essential equipment.
Meet the authors
* Peter Spiller is a principal in McKinsey's Frankfurt office and leader of the firm's EMEA purchasing and supply management practice. He serves clients in automotive, telecommunications, and high-tech sectors on operations transformations and strategy. His specialises in transformation design and advanced procurement analytics
* Nicolas Reinecke is a tenured expert principal in McKinsey's Hamburg office. He is part of the EMEA operations leadership team. His areas of expertise are large scale tranformations, capability building and advanced negotiations. He is also an adjunct professor at The Wharton School
* Drew Ungerman is a director at McKinsey's Dallas office and leads the firm's Americas purchasing and supply management practice. He advises clients across the healthcare value chain on strategy and operations. His area of expertise includes large scale transformations, strategic supply chains and healthcare strategy and operations
* Henrique Teixeira is a principal in McKinsey's Sao Paulo office. He is the leader of the firm's Latin America purchasing and supply management practice and sourcing centre. He has served clients mainly in automotive, basic materials, consumer goods and telecommunications industries, focusing mainly on large purchasing transformation programmes.
PROCUREMENT 20/20: SUPPLY ENTREPRENEURSHIP IN A CHANGING WORLD
AUTHORS: Peter Spiller, Nicolas Reinecke, Drew Ungerman, Henrique Teixeira
PUBLISHER: McKinsey & Company
This article was originally published in Procurement 20/20: Supply Entrepreneurship in a Changing World. Copyright (c) 2013 McKinsey & Company. All rights reserved. Reprinted by permission
