Looking toward Strategic Sourcing to Alleviate the Ravages of the Recession

Few industries know better the pain of a lack of consumer confidence like retail. Even with statistics telling us the recovery is under way, retailers are cautious, and they should be. In addition to circling the wagons, however, there is an opportunity here to redesign the retail sourcing strategy, according to Alan Pincus and Kristie Tippner of Kurt Salmon Associates. Not only will this help the industry survive, but it will give retailers a solid plan for growth after the recession is truly over.

Alan Pincus and Kristie Tippner -- Supply Chain Management Review, 11/19/2009

With the release of recent economic data, one thing is certain: When it comes to real economic recovery, no one can state with confidence whether business has bottomed out or when consumer confidence will return. Few other industries have been pummeled harder than retail and, as a result, retailers are faced with trying to stimulate business in uncertain times. Among U.S. retailers, September 2009 same-store sales climbed 0.6 percent, according to an index of 30 retailers compiled by Thomson Reuters,¹ the first year-over-year rise in sales in 13 months. This, coming on the heels of ten consecutive negative sales growth months, should be interpreted as good news, but retailers remain extremely cautious as we head into the fourth quarter and the holiday season. With uncertainty still found in sales and the overall economy, retailers must continue to aggressively reduce costs to meet profitability expectations.

With cost structure adding up to as much as 80 percent of net sales, retailers must aggressively scrutinize every dollar spent and look internally to strategic sourcing to aid in identifying and realizing cost savings. The entire spend base must be considered, from dollars that are directly related to final merchandise to dollars associated with non-product spend areas (e.g., real estate, fixtures, professional services, marketing and advertising). With costs directly related to final merchandise making up the vast majority of retailers' costs (being as high as 60-70 percent of sales), strengthening sourcing capabilities has been a common response by retailers-resulting in significant costs being removed from merchandise. With vendors struggling to survive and feeling the pinch of declining volumes and canceled orders, there are still opportunities for additional savings and improvements for both retailers and vendors. By collaborating with key vendors and taking a strong business position, retailers will realize additional savings and improvements previously difficult to achieve. There is also an opportunity for retailers to realize significant cost savings without impacting the customer experience or product offering, especially if the same cost-saving rigor is applied to the spend not directly attributed to final merchandise.

Kurt Salmon Associates estimates that retailers can realize between 2-4 percent reduction in COGS through an aggressive strategic sourcing program that includes negotiating more favorable agreements and improving collaboration with vendors. Benefits can be higher depending on the retailer's sourcing capabilities and willingness to pursue product and vendor-related savings. However, pursuing sourcing opportunities across the entire spectrum of spend requires a broad set of capabilities, flexible processes and renewed negotiations with vendors.

Sourcing Opportunities across the Entire Spend Base

As retailers pursue a comprehensive strategic sourcing program to address the entire spend base, there are unique market, vendor and product considerations that must be taken into account when addressing a specific spend area-as demonstrated in Exhibit 1. Sourcing opportunities in the spend areas directly related to final merchandise come largely from optimizing the sourcing operating model while ensuring effective collaboration between the retailer and its vendors. Retailers must actively manage the total cost of sourcing products by working effectively with their vendors, which requires information sharing earlier in the supply chain and more efficient execution of seasonal calendars while pursuing longer-term commitments with their vendors. Retailers must take a hard look at their sourcing model, for example, whether to source using internal resources or via agents. Once the appropriate model is determined, retailers must look at their product requirements, by category or brand, and pursue aggressive sourcing opportunities across each tier of their vendor base. This may mean reevaluating the relationship with each vendor, providing volume commitments to those strategic vendors or aggressively negotiating all financial terms above and beyond product cost. These improvements will result in a more stable business relationship and allow the vendors to plan their processes and capacity more effectively, which will free up savings for both retailers and vendors.

Specific to non-product spend areas, sourcing opportunities for retailers are found primarily by aggressively negotiating more favorable terms across company-wide spend, challenging selection of products and product specifications that drive costs while selecting vendors who can meet product and service expectations across multiple brands and businesses. Examples of retailers pursuing cost savings include Sears, Macy's, J.C. Penney, Saks, Nordstrom, Neiman Marcus and Target, cutting a collective $668 million in selling, general and administrative expenses in the first quarter, and pushing their SG&A expense down 6.3 percent from a year earlier.²

 

 

 

 

Roadmap for Pursuing Strategy Sourcing Opportunities

To reap the benefits of a strategic sourcing program, retailers need a detailed roadmap specifying cost-reduction targets and prioritized activities required to realize the identified cost reductions. "There are significant savings opportunities for retailers to benefit from as a result of a well-thought-out roadmap combined with effective and efficient execution," says Anthony Romano, executive vice president of Global Sourcing and Business Transformation at Charming Shoppes, Inc. "As General George S. Patton Jr. once said, ‘A good solution applied with vigor now is better than a perfect solution applied ten minutes later.'" The major components of a strategic sourcing roadmap will often include the following (Exhibit 2):

• Sourcing Strategy-identifying and prioritizing supply and demand improvement opportunities by area of spend
• Sourcing Operating Model-process and organization required to support the overall sourcing strategy, goals and objectives
• Vendor Management-approach and process required to manage vendors to ensure that product is provided at the right total cost with minimized risk
• Cost Management-knowledge of product/service total cost and applying the understanding of cost drivers in vendor negotiations
• Sourcing Technology-tools required to enable the sourcing organization to realize cost-savings goals

Retailers should build a sourcing roadmap that prioritizes efforts on issues with the largest return on investment while addressing the most critical issues first. For example, if a retailer has not attacked non-product spend areas in recent years, focus should be placed on establishing the appropriate sourcing strategy for this key area. More specifically, focusing on spend analysis and diagnostics as well as contracts and administration improvement will provide a quick understanding of what is being spent, by whom and with which vendors. This focus will also provide opportunities to negotiate more favorable pricing, optimize the vendor base and determine what product specifications can be simplified to reap additional savings.

 

 

 

 

Tackling Spend Related to Final Merchandise

The current economic landscape is forcing retailers to challenge established processes and relationships with current vendors in spend areas directly related to final merchandise. A key component within a sourcing roadmap addressing product-related spend is determining whether to keep sourcing activities in-house or to utilize sourcing agents (Exhibit 3).

Determining the appropriate business model strategy aligned with sourcing goals and objectives has significant organization and resource implications:

• Resource Requirements-domestic and overseas resources needed to manage sourcing activities with vendors or agents to facilitate development and product movement throughout the supply chain
• Resource Capabilities-appropriate country and vendor knowledge to collaborate effectively with vendors and agents without sacrificing quality and cycle time
• Performance Management-metrics that monitor and report vendor and agent performance on delivery, cost, quality, cycle time and collaboration

 

 

 

 

Whatever the operating model, it must improve the way a retailer collaborates with vendors and yield benefits to both sides. Vendors involved with a retailer's planning and development can better plan for their own materials and production capacity to enhance efficiency. This enables a retailer to make product decisions closer to consumer purchasing decisions, resulting in more effective product assortments and reduced store inventories. "Pressure on revenue and top-line contraction have caused an intense focus on managing our costs," says Anthony Romano. "In order to provide products to our customers that have the quality appropriate for the brand while being rewarded at retail, we must work with our vendors to be as cost competitive as possible. Collaboration with our vendors is critical to achieving these goals and objectives-partnering with them to understand our product requirements, offering alternatives without sacrificing quality or consumer expectations, will go a long way in being cost competitive and maintaining healthy margins."

A key part of a successful strategic sourcing program is the identification and management of vendor risk. "The recession affected all aspects of the supply chain worldwide with closures of suppliers numbering in the thousands. Panjiva, an internet-based tracker for shipping data, said that, during the period July-October 2008, there was a 72 percent drop in the number of active apparel suppliers worldwide, thanks in large part to the huge decrease in volume shipped to the US."³ Retailers must become much more proactive in identifying vendors whose financial or operational risks could disrupt supply. Doing so requires a formal vendor performance evaluation process using specific metrics that monitor both short-term and long-term expectations.

Where risks are high or performance fails to meet expectations, retailers should work with vendors to improve processes, or start building relationships with alternative sources of supply; however, building relationships with new vendors takes time before trust is established between both parties.

Getting Aggressive with Non-Product Spend

With non-product spend contributing as high as 20-30 percent of a retailer's cost base, a well defined strategic sourcing program to aggressively pursue savings opportunities in this area can realize tens of millions in savings. Saks is a case in point. "From travel to supplies to benefits to marketing to information technology, we're leaving no stone unturned," said Stephen I. Sadove, chairman and chief executive officer of Saks, which reduced first-quarter expenses by $44 million, more than it planned to cut for the whole year.⁴

With marketing and advertising spend by retailers exceeding $17 billion in 2008,⁵ it is easy to see the importance of a comprehensive strategic sourcing program to identify and realize savings opportunities. The initial focus for the sourcing roadmap addressing marketing and advertising is determining the appropriate strategy to most effectively collaborate with marketing and advertising (Exhibit 4). Given that collaboration between marketing (the part of the organization that establishes and controls the marketing budget) and sourcing (the part of the organization that negotiates with vendors to expand the marketing budget) may be inconsistent, the initial sourcing strategy must put marketing at ease that sourcing will not seek to reduce budgets while pursuing cost savings. Instead, the goal is to work with current vendors to expand ROI on marketing spend, thereby strengthening relationships both internally and externally while increasing value.

 

 

 

 

Similar to other non-product spend areas, marketing spend tends to be fragmented across different brands; therefore, it is critical to document and analyze company-wide marketing spend to best understand the current vendor base, detailed costs and the buying behaviors unique to each brand. Before pursuing opportunities to improve marketing spend, significant time must be spent by sourcing to understand the marketing function and build the trust of marketing. Only after spend and product demand are thoroughly analyzed and a collaborative relationship is built between sourcing and marketing can significant improvements via strategic sourcing be aggressively pursued.

Keeping the Post-Recession Focus on Cost Reduction

As a retailer's sales begin to improve with the waning recession, the tendency is to fall back on old sourcing habits. Sourcing, operations and finance senior executives must take the initiative to make sure this trap is avoided. By putting into place a well-defined strategic sourcing program addressing the entire spend base, retailers will redefine relationships with vendors and revise internal processes and behaviors to ensure cost reduction remains top of mind for years to come. Even with the improvements and savings achieved to date, there are significant savings yet to be realized by both retailers and vendors.

 

Alan S. Pincus is a senior Supply Chain and Operations professional within Kurt Salmon Associates' Product Development and Sourcing Practice, and has almost 20 years of experience helping Consumer Products companies address their most significant Product Development and Sourcing issues.

 

Kristie Tippner is a Supply Chain Management professional with over 10 years industry and consulting experience in the Product Development and Sourcing areas. At Kurt Salmon Associates, Kristie's work has focused on consumer product categories in product development and sourcing.