The unparalleled pace of globalization presents opportunities as well as challenges for industrial product companies. Customers are shifting their supply base and, with competitive pressures intensifying, it is only a matter of time before you do the same.

by Paul Loftus

Leading organizations on the path to high performance are accelerating their global sourcing strategies, driving more aggressive cost reductions, and looking to contract manufacturing to leverage and expand the value of their brand. Most significantly, these organizations plan to double spend on low-cost-country sourcing during the next three years.

Accenture research also reveals that high-performance businesses in your industry are masters of five procurement-related capabilities. Their practices include:

• Source more direct materials globally and in low-cost countries to improve gross margins;

• Combine low-cost contract manufacturing and “buy-brand-sell” strategies to cut costs on low-margin products and fuel new growth by extending into complementary product lines;

• Elevate procurement to a strategic function to increase overall supply-chain reliability and minimize total landed costs;

• Integrate purchasing earlier in the product-development process to take maximum cost out of product design; and

• Deploy consistent processes and tools across business units and operating companies to aggregate and standardize spend data and improve compliance.

THE ADVANTAGE OF SIZE
Many companies do not yet view procurement as a strategic function and source of value. The typical smaller and medium-sized company lags far behind the largest industrial products and automotive companies in its use of global and low-cost-country sourcing. Most take a fragmented approach to procurement, which leaves individual operating companies to pursue autonomous procurement policies and procedures with largely domestic suppliers.

These companies take a traditional view of procurement as an order-taking activity. Many remain reluctant to risk new and untested global suppliers for direct material components.

Many more believe that they lack the scale and skill set to undertake a global sourcing program. And because they fail to appreciate the full potential of a strategic, global approach, sourcing savings remain unrealized.

Yet we know from experience that you do not have to be huge to have a successful global sourcing program and improve business performance as a result.

Consider the case of American Standard, a $10 billion global manufacturer of plumbing fixtures, heating and air conditioning equipment, and vehicle control systems. American Standard realized more than $300 million in savings in the first five years of a global materials management program that leveraged the company’s collective buying power on a global basis and moved both production and sourcing to low-cost regions.

For a typical industrial products company, the impact of global sourcing on profitability can be substantial: $100 millon to $200 million in annual savings (for a $5 billion company spending 50 cents out of every sales dollar on direct materials).

The time is right for companies to take a closer look at expanding their global sourcing efforts. Here’s why.

Global sourcing of direct materials is no longer an option. It’s a competitive necessity, thanks to the rapid rise of low-cost, emerging nations as both sources and consumers of direct materials. Newly industrializing countries are now the world’s biggest manufacturers and consumers of steel.

And China is an infrastructure giant in terms of both supply and demand. China’s current five-year plan calls for the construction of an additional 6,000 kilometers of rail track, 200,000 kilometers of roads, 141 deepwater ports, and 57 airports. Its projected energy requirements will necessitate an additional 500 gigawatts of capacity—80 percent of Great Britain’s total capacity—every year for the next 10 to 15 years.

Growth at this speed and on this scale spells enormous opportunities for global industrial products manufacturers, as well as for potential domestic suppliers and competitors.

Leading industrial products companies of all shapes and sizes are beginning to source more direct materials, including critical components, from low-cost regions. Witness the recent decision by Valeo, a leading French automotive equipment supplier, to source a whopping 70 percent of its procurement expenditures in low-cost countries by 2010.

Or that of Cooper Industries, a $5 billion manufacturer of electrical products, tools, and hardware for industrial applications. In 2004, it opted to source some 35 percent of direct material spend with low-cost countries—more than $350 million in China alone.

For many, the decision to “go global” has two strategic goals: to take advantage of low-cost production opportunities as well as to boost revenues from developing markets. General Motors (GM) recently broke ground for a green-field assembly plant in St. Petersburg to capitalize on the rapidly expanding Russian market for automobiles. By boosting domestic Russian assembly capacity, the new Chevrolet facility will lower not only GM’s cost to serve but also its supply in a market where the carmaker has enjoyed record sales during the past year.

Danaher Corporation, meanwhile, plans to eventually have 40 percent of its procurement volume and the same proportion of its manufacturing located in low-cost regions.

And by sourcing steel and iron castings, forgings, and non-metallic components from China, another global construction equipment manufacturer has cut 30 percent from its total landed cost.

The following chart (Fig. 1) illustrates actual landed cost savings on representative direct material categories across a range of Accenture industrial products and automotive global sourcing projects. Across all categories, clients can expect net direct material cost savings from 10 percent to 20 percent, with an average net savings of about 15 percent.

Moreover, because high-performance businesses clearly understand their total landed cost, they are much more likely to realize their target margins and experience less margin leakage throughout the supply chain.

LEVERAGING GLOBAL SOURCING
To help protect and extend the power of their brand, leading companies are starting to rely on global sourcing, too. Many companies struggle with low-margin products—whether to kill the product and yield share to competitors or continue to earn sub-standard returns on a portfolio laggard. Global sourcing, however, may offer a compelling alternative.

By using low-cost contract manufacturing, you can change the underlying economics of low-margin products. If it is no longer cost-effective to manufacture your own products, consider outsourcing these products to a contract manufacturer in a low-cost region, then brand them as your own, and sell them to customers through your current distribution channels rather than exiting the products completely. This strategy helps you protect current revenue while improving margins as well as prevent competitors from stealing market share and gaining a foothold with your established customers.

“Buy-brand-sell” strategies can also help you tap into the power of your brand to fuel growth by adding complementary products to your portfolio without incurring the usual product design and development costs that result in time-to-market delays.

By elevating procurement to a strategic function, high-performance businesses can flex their global-sourcing muscle in support of top-level business strategies.

When procurement ceases to be just an order-taking activity and becomes part of a cross-functional team, on par with engineering and product development, supply chain, and logistics, true category expertise in direct materials can be developed and leveraged. Procurement’s prominence becomes more pronounced as global sourcing capability strengthens.

Consider, for example, procurement’s role in the management of critical strategic commodities. Leading companies dedicate a small but highly skilled team of managers— for example, people who really know all about both the manufacture and uses of steel—to take responsibility for the commodity. These managers lead efforts to standardize the grades and codes of steel used in their products to concentrate their steel buy and gain greater leverage with steel suppliers. They extend the benefits of their steel purchasing power to their suppliers and contract manufacturers to lower the cost of their finished components as well. And by revisiting their contracts to sell scrap, they ensure that the scrap price per ton rises in line with their steel raw material price increases.

A local procurement presence in key emerging markets targeted for sales growth can also be important, and not just because it helps to diversify suppliers and thus mitigate volatility. Local knowledge can stay abreast of developing market conditions and help prevent the loss of market share to cheaper local producers. Some companies that recognize the importance of local procurement presence but cannot afford the time to establish local operations are actually outsourcing this function, letting others act as their international procurement office in China, for example.

A STRATEGIC FUNCTION
When procurement is a strategic function, it can drive component and module standardization. High-performance businesses maximize their use of standard components, as well as strategic partners and suppliers—a critically important capability in an industry where so many direct material purchases support new products, platforms, or projects that require custom engineering.

One global truck manufacturer, for example, realized total savings of €45 million and a 36 percent reduction in its supplier base as a result of standardization initiatives in which procurement worked side by side with engineering to reduce the number of component variations across multiple platforms.

Indeed, because it shares equal status with product development, the procurement function in a high-performance business can play a pivotal role in decisions about how products should be designed. By driving more extensive supplier involvement in your design process, for instance, suppliers get a better understanding of the customer problems you are trying to solve, while they bring a fresh set of design ideas and access to their latest technologies. The upshot: your product is easier to manufacture, assemble, deploy, and service in the field.

As key technical services such as design and engineering—the “crown jewels” of many industrial products companies—become candidates for outsourcing, procurement’s function becomes more strategic still. The Boeing Company, for example, contracted out the technical design and engineering work on its new 787 Dreamliner to 1,600 Russian engineers, a clear recognition of that country’s unparalleled expertise in titanium technologies.

The aircraft manufacturer also is a striking example of how integrating purchasing early in the product development process can optimize global sourcing opportunities.

Some industrial products companies are actually outsourcing the management of all indirect materials to fully dedicate purchasing resources to more strategic, direct-material-oriented programs. Along with building deeper, direct-material expertise, this shift typically yields its own value proposition as companies gain access to greater economies of scale and purchasing power on indirect and maintenance, repair, and operating (MRO) items through their outsourcing provider.

One of Europe’s leading construction services companies, for example, lacked category expertise in indirect materials, had a relatively fragmented supply base, and was experiencing low compliance. By outsourcing its category management, strategic sourcing, and process support for indirect materials (including the helpdesk), the company is implementing robust, consistent processes across multiple spend categories—processes that are saving 6 to 12 percent while freeing up internal resources to focus on direct materials.

ALL ABOUT THE DATA
Deploying consistent processes and tools across business units and operating companies lays the foundation for aggregating spend data. Together with streamlining the requisition and approval process, common processes and tools can build the fact base to instantly understand what you are spending on major categories, as well as just how fragmented or concentrated your supply base actually is.

Capturing accurate spend information is critical to understanding a company’s exposure to one supplier. Aggregated data supports fact-based negotiation and helps reduce your strategic supplier base (and associated costs). Once your strategic supply base has been consolidated, consistent processes and tools can help ensure that you buy the right product from the right supplier at the right time, driving those responsible for requisitioning toward standard items from approved or preferred suppliers.

Standardized reporting of performance metrics provides a consistent view for the company’s executives on supplier performance. It also establishes expectations for suppliers during the sourcing processes. Suppliers get a chance to provide feedback on the company—for example, information that can help reduce the cost of doing business.

Capabilities across the board are enhanced because consistent tools and processes boost efficiency and reduce risk. Procurement professionals are free to focus on high-value activities such as supplier performance management. And these professionals’ performance is likely to improve as well, thanks to greater job satisfaction.

Deploying tools such as eRFP (electronic request for proposal) and online marketplaces can also reduce the sourcing process time. A few years ago, for example, Boeing reduced its procurement cycle time from weeks to days by utilizing online tools for sourcing natural gas.

The use of consistent, front-end processes for requisitions, approval, purchase orders, and change orders help ease back-end processes as well. Standardized processes involving the approval of requisitions, rather than invoices, limit the leakage of purchases to non-approved suppliers or for non-standard items.

They reduce the cost of managing the number of items as well. And by easing access to contract terms, they help ensure compliance.

THE PAYOFF
High performance businesses in your industry are already boosting gross margins by sourcing more direct materials globally and in low-cost countries. Combining low-cost contract manufacturing with buy-brand-sell strategies has not only helped them tackle the problem of low-margin products, it has actually boosted growth by enabling profitable expansion into complementary product lines.

Because they have made procurement a strategic function, equal in stature to engineering, product development, logistics, and supply chain, these high performers are minimizing total landed costs and increasing the overall reliability of their supply chains.

By integrating purchasing earlier in the product development process they also have slashed the cost of product design. And compliance, too, has significantly improved, thanks to the deployment of consistent processes and tools right across the business.

The opportunities for substantial savings in terms of both margin improvement and revenues from these capabilities are real. Isn’t it time you joined the industry leaders on the path to high performance?

Paul Loftus is a managing partner with Accenture and currently leads the industrial equipment practice within North America. In this capacity, he has responsibility for the industrial equipment clients that Accenture serves in this region.