It is no coincidence that transformation of procurement from tactical processor of POs into corporate strategic powerhouse can trace its roots to about the same time the Harvard Business Review first published Michael E. Porter’s seminal
How Competitive Forces Shape Strategy in 1979.
As HBR observed when introducing an updated version of Porter’s work in 2008, the original paper “started a revolution in the strategy field.” Emphasizing such concepts as neutralizing supplier power, supply-side economies of scale, reducing switching costs, obtaining preferential access to best suppliers, standardizing parts and so forth, Porter helped to unleash a strategic reinvention of procurement. Many of today’s best procurement practices can be recognized easily in the pages of Porter’s work. But procurement leaders have continued to innovate their strategic roles, expanding the function’s reach to influence both supply and demand sides of corporate competitive market positioning.
In revisiting Porter’s work today, we hope to inspire a new generation of procurement professionals at all levels to explore how his thinking remains relevant today and can be incorporated into such strategic activities as:
Analyzing supply markets.
Spotting, driving and exploiting supplier innovation.
Improving supplier performance.
Collaborating with suppliers to change or manipulate industry competitive structures in mutually beneficial ways.
BARGAINING POWER OF BUYERS AND SUPPLIERS
The nexus of contemporary strategic sourcing and procurement derives from two of Porter’s Five Forces: decreasing supplier and increasing customer market power. In addition to classic power-shifting strategies, procurement organizations have added:
Increasing supplier-switching costs (e.g., encouraging suppliers to co-locate, assume greater inventory risks, invest in proprietary equipment).
Unbundling and ‘commoditization’ of goods and services.
Pushing suppliers for greater cost transparency; introducing transparency to opaque markets.
Standardizing to reduce switching costs.
Segmenting suppliers for different types of treatment.
Alleviating costs and complexities of bidding more suppliers competitively and across larger geographic scopes.
To continue innovating procurement’s corporate role and influencing competiveness in positive ways, a new breed of procurement leaders must assume that suppliers will always seek ways of regaining market power they have ceded. Porter cites, for example, the strategy in which component manufacturers market directly to end consumers with a goal of creating strong end-market preferences for their parts. The Intel Inside campaign, first launched in 1991, is a brilliant example. PC manufacturers gaining from Intel’s marketing strategy were those obtaining most favorable terms, greatest dedicated production capacity, fastest deliveries and so forth from the chipmaker at the time that the campaign was active.
Market analyses are another area where procurement leaders can apply Porter’s Five Forces. For example:
How rigorously are we applying the framework in assessing suppliers’ competitive structures?
Are we defining our supply markets correctly for present and future?
Can we use the Five Forces to positively exploit our supply industries?
Deepening procurement’s insights may prove invaluable in deciphering and predicting suppliers’ go-to-market strategies, evaluating suppliers’ bids and shaping strategies for awarding business among groups and across regions.
THREAT OF NEW ENTRANTS
“When the threat of entry is high, incumbents must hold down their prices or boost investment to deter new competitors,” Porter writes. The simple takeaway for procurement is to cut costs as means for keeping end-market prices low. The savings can be reinvested into R&D as another way to keep out market entrants.
But procurement leaders are expanding their thinking here as well. Porter emphasizes, for example, demand-side benefits of scale. “Buyers may value being in a “network” with a large number of fellow customers.” A good example is the Apple iPhone, where users share special abilities to message one another, trade files and use social-sharing applications not available to other smartphones.
Through creative uses of eRFx, supplier information and onboarding processes, procurement is uniquely positioned to gain deep insights into what suppliers worldwide (even those in unfamiliar markets) may be developing for years into the future. Procurement teams most capable of discovering and capturing supplier innovations will be best positioned to generate consumer network and other demand-side effects that may prove to be important differentiators.
Barriers to entry work against procurement when they limit competition in supply markets. While Porter cites high capital requirements as one barrier to entry, savvy procurement teams are moving increasingly into supply-chain financing and investment as means for tearing down such barriers. Procurement can, likewise, offer easier ways for new suppliers to introduce themselves and showcase innovations that might prove to be ‘the next big things’ for engendering customer brand loyalty.
THREAT OF SUBSTITUTE PRODUCTS
Procurement is also uniquely positioned to discover and exploit substitution opportunities. Classically, procurement seeks substitutes to reduce supplier power, but it can also spot potential substitution threats to a company’s own product lines. What may be needed are better ways of documenting and reporting such intelligence as it is captured.
Combining and using procurement’s internal and external business intelligence to understand and predict cost structures, profit margins, supply risks and other trends substitute markets is another untapped area where procurement is positioned to exert real competitive influence on the demand side.
Are sellers of substitute products well placed to endure?
What risks lurk in their supply chains?
What are future expectations for their costs, profitability and other success factors?
Such intelligence from procurement can inform and direct a company’s strategies for pursuing leaner inventories, better manufacturing processes and so much more.
RIVALRY AMONG COMPETITORS
While promoting rivalry among suppliers can diminish their market power, there are also ways that procurement can help to minimize negative influences of rivalry — especially price wars — in a company’s own end markets. “Competition on dimensions other than price — on product features, support services, delivery time or brand image, for instance — is less likely to erode profitability because it improves customer value and can support higher prices. Also, rivalry focused on such dimensions can improve value relative to substitutes or raise the barriers facing new entrants,” Porter observes.
Again, strategic contributions from procurement come from:
Communicating with suppliers and coordinating innovation roadmaps.
Co-developing with suppliers (which require underpinnings of trust built via consistent and strong performance).
Collaborating to drive substantial improvements in supplier performance
- for example, massive leadtime or fixed-cost reductions throughout multiple supply-chain.
FACTORS NOT FORCES
To deploy the Five Forces framework, Porter emphasizes the importance of defining industries correctly (recognizing the full scope of potential competition) and of distinguishing between competitive forces – which determine an industry’s long-run profit potential and how value gets divided — and nonstructural factors. Examples of nonstructural factors include industry growth rates, government and complementary products and services.
The most successful companies, Porter suggests, will find ways to manipulate or change industry forces and structure in their favor. While procurement clearly can play a huge role, it cannot operate in a vacuum. A company’s overriding competitive strategy must clearly articulate how it will attempt to exploit or change industry structure altogether. The strategy, in turn, needs to be quite clear in articulating how procurement is expected to behave both strategically and tactically.
This article only scratches the surface of possibilities for procurement-led business performance improvement captured in Porter’s Five Competitive Forces. We encourage all to read Zycus’ whitepaper on the same topic for some deep thinking about where procurement will go next with strategic process innovation. The whitepaper can be downloaded