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Strategic Sourcing in the Time of Deep Discounting

Although the 2016 holiday season turned out to be a bit better than anticipated, many retailers paid a price for attracting all of those customers. The US Census Bureau reported a holiday adjusted retail sales increase of 3.5% year-over-year in 2016. Unfortunately, the sales increase came at the cost of deflated margins from a flurry of year-end sales and promotions. Most retailers matched their deep discounts from 2015, while some others, like Walmart, seem to be increasing discount percentages over 2015.1 But which retailers can successfully launch promotional activities—and inventory management—to drive top line sales without compromising margin dollars?

Analysts watching these scenarios unfold are focusing on pricing, promotions, and inventory management—and they are right to do so. These have long been the key benchmarks of a successful retailer. However, forward-thinking retailers are increasingly adding a new arrow to their quiver to drive and protect margin dollars: next-generation strategic sourcing.

In our experience, many retailers today believe that as long as an organization hits a target cost, then sourcing has met its objectives. This is not ideal. Given the current economic environment of commodity pricing and excess capacity, retailers have the opportunity to vastly improve cost of goods sold (COGS) and margin, if they take a comprehensive strategic sourcing approach.

So what do we mean by strategic sourcing?

“John: Gentlemen, gentlemen. First, we must plan our strategy.

Cubby: Uh, what’s strategy?

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John: A plan of attack.” – Peter Pan

Strategic sourcing often means something different to different people since its complex on multiple facets. But when we talk about strategic sourcing we mean a combined approach covering:

  • Raw materials, currency, manufacturing capacity, and supplier landscape research
  • “Should-cost” exercises for individual products to estimate savings opportunities
  • Market-price discovery through a bidding process
  • Category management to balance national brand and private label in the assortment
  • Supplier portfolio optimization and final business allocation to maximize returns while minimizing transition and other operational risks
  • Continued management to ensure product quality and supplier service

Ideally, this approach links to specific corporate margin improvement initiatives and is executed on a well-defined timeline. Based on projects we have done with multiple clients, the authors believe that it can yield 5% or more cost decreases for national brand products, and 10% or more for private label. In the following case study, we discuss how one retailer launched a multi-year project to look at all of their COGS with the goal to fully optimize the portfolio over two to three years. This retailer aimed to transform its organization to sustain the momentum and emerge with a vastly improved margin from a strategic sourcing initiative.

Case Study: How one retailer did it

The challenge:

We worked with a large retailer that recently converted their longstanding, merchant-influenced sourcing organization to sourcing-led and merchant-partnered teams. This new structure empowered individuals with strong sourcing backgrounds to deploy strategic sourcing levers, lead negotiations, and drive meaningful savings for the broader organization. Along with merchandising, the finance team supported the initiative via a database of all supplier funds, which helped determine all cost structures and provide visibility to true product pricing. Alongside these organizational changes, the company also implemented a new set of sourcing best practices and placed all product categories that would normally be considered “off limits” into the process.

The new sourcing organization challenged incumbent suppliers in several ways. It brought in new suppliers, conducted market price testing through request for proposals and reverse auctions, engaged in direct negotiations with suppliers with full disclosure of gap to market prices, completed thorough product quality tests before final business allocation, and rationalized its vendor portfolio to reduce the number of suppliers by 10-15%. Incumbents also had the opportunity to compete in broader set of categories. Many incumbents not only managed to retain existing business, but also “win” new business by providing more competitive value across multiple categories.

In tandem with the sourcing initiative, the company modified their agent partnerships and reduced their dependence on agents, providing additional cost savings to the supply chain.

The outcome:

The company was able to lower COGS by more than 15% in just 15 months. They will most likely continue to see benefits to their bottom line for the next several years as they move toward more transparent relationships and fact-based negotiations with their suppliers.

If it is so easy, why isn’t everyone doing it?

“Nobody goes there anymore. It’s too crowded.” – attributed to Yogi Berra

So why is strategic sourcing not part of every retailer’s core operating procedures? We believe that there are some universal challenges to transforming sourcing, regardless of a retailer’s product mix:

  1. Inefficient organization design, with merchants often left in sole charge of sourcing
  2. Lack of dedicated and skilled sourcing specialists with authority to engage suppliers
  3. Lack of strategic sourcing process, tools and roadmap linked to margin improvement goals
  4. Lack of clarity and transparency in cost sheets that prevents meaningful comparisons
  5. Ad hoc private label development plan
  6. Strong incumbent bias stemming from a general belief that suppliers hold more leverage and can hurt the retailer if business is taken out to bid

Utilizing a strategic sourcing process should be, in our opinion, a requirement for all retailers in today’s low inflation and high competition market. However, these processes sometimes create strongly negative feelings within retail organizations. This can be especially true among the merchant team members, who are often worried about loss of control as well as cheapening the product offering. Sometimes the negative feelings stem from poor prior experiences with low-cost suppliers. Sometimes it is just a perception, often instilled by incumbent suppliers through subtle fear mongering, that lower prices necessarily mean lower product quality and service.

Stay tuned for part 2 in this series where we will delve deeper into each of these elements crucial to implementing a sustainable strategic sourcing process.

John Bonno, Murali Gokki, and Apratim Sarkar are managing directors at AlixPartners, a business management consultancy, specializing in turnarounds.