Revisit Porter’s Five Forces to Unleash Procurement Innovation
Revisit Porter’s Five Forces to Unleash Procurement Innovation Introduction 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 (HBR) 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 raw-materials sources, standardizing parts and so forth, Porter helped to unleash a strategic reinvention of procurement. The transformation was led by some of the world’s most disciplined and innovative companies — GE, IBM, Intel, Motorola, Honda, to name just a few — and propagated worldwide by some of the biggest players in management consulting.
With technology developers stepping in just a few years later to automate tedious, complex and expensive procurement processes and to solve large business-intelligence problems for procurement and supply management, strategic elevation of the function has continued to grow and proliferate worldwide. It has spread from developed into emerging economies, and from very large, multinational corporations to mid- and smaller-sized companies and also to institutions of government, education and healthcare.
Revisit Porter’s Five Forces to Unleash Procurement Innovation
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Many of today’s best procurement and supply-chain management practices can be recognized easily in the pages of Porter’s original work. But procurement leaders have also continued to innovate their strategic roles, expanding the function’s reach to influence both the supply and demand sides of a company’s strategic and competitive positioning.
In this whitepaper, we revisit Porter’s original work with the intent of inspiring procurement executives and professionals at all levels to explore how Porter’s Five Forces can and should be considered as they undertake such strategic procurement activities as:
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Analyzing supply markets. Spotting, driving, evaluating and exploiting supplier innovation. Discovering and developing new suppliers. Improving supplier performance. Negotiating and writing creative contracts. Collaborating with suppliers to change or manipulate industry competitive structures in mutually beneficial ways.
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And so many other opportunities to influence global business competitiveness from within the procurement and supply management functions.
Revisit Porter’s Five Forces to Unleash Procurement Innovation
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How Procurement Can Counter Porter’s Five Forces
Threat of New Entrants
Bargaining Power of Buyers
• Keeping end-market prices low by maintaining competitive cost
• Unique product design through supplier involvement right from the engineering phases
• Reinvesting cost savings into R&D
• Discovering unique service partnership opportunities in the supply base to enhance overall package
• Moving increasingly into supply-chain financing and investing as a means for tearing down supply-side barriers to entry
Rivalry Among Competitors
• Driving customer loyalty by employing strong governance and ongoing performance management over strategic non-product factors like after-sales support, return goods policies, or grievances redressal
• Communicating with suppliers and coordinating on innovation roadmaps • Co-developing with critical suppliers
Threat of Substitute Products
• Collaborating to drive substantial improvements in supplier performance
• Spotting potential substitution threats to a company’s own product lines • Understanding the historic trends, volatility patterns and future expectations for costs, profit and other success factors of substitute markets • Analyzing the risks in supply chain of competitors selling substitute products
Revisit Porter’s Five Forces to Unleash Procurement Innovation
Bargaining Power of Suppliers • Increasing the percent of suppliers’ business dependency on your company • Unbundling and commoditizing of complex goods and services • Pushing suppliers for greater cost-to-price transparency
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Countering Bargaining Power of Suppliers
The nexus of contemporary strategic sourcing and procurement derives from just one of Porter’s Five Forces: neutralizing supplier power. In addition to classic power-shifting strategies such as demand aggregation to gain leverage vis-à-vis suppliers, procurement organizations have added:
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Increasing dependency (percent of suppliers’ business deriving from customers). Increasing supplier-switching costs (for example, encouraging suppliers to co-locate, assume greater inventory risks and/or invest in proprietary equipment).
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Unbundling and ‘commoditization’ of complex goods and services. Pushing suppliers for greater cost-to-price transparency. Introducing price transparency into formerly opaque markets. Standardizing parts to reduce switching costs and eliminate other barriers to entry in supplier-side market.
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Segmenting suppliers to isolate high-, medium and low-leverage suppliers for different types of treatment.
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Increasing market competition by alleviating costs and complexities of bidding more suppliers competitively and across larger geographic scopes.
Revisit Porter’s Five Forces to Unleash Procurement Innovation
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Impacts of procurement technology tools such as Spend Analysis and eSourcing/eAuction have been strongly felt in enabling procurement to evolve and refine these aforementioned strategies. But, while they have been quite successful at neutralizing and reducing supplier power over the past several decades, procurement teams must assume suppliers will continue to seek their own innovative ways of regaining the market power they have ceded.
Porter cites, for example, a 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 the most from Intel’s marketing strategy would have been the ones obtaining most favorable terms, greatest dedicated production capacity, fastest deliveries and so forth from the chipmaker at the time that the massive campaign was active.
Market scans and analyses are another area where procurement leaders can bring Porter’s Five Forces to bear. For example, procurement pros should be asking:
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How rigorously are we applying the Five Forces framework in assessing the competitive structures of our critical supply industries?
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Have we considered how the Five Forces might be exploited or manipulated in our supply industries? Or how they are likely to change on their own in the future?
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Are we defining supply markets correctly (neither too narrowly, nor too broadly) for both present and future?
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And how might the results of our analyses change when market scope is shifted in various directions?
Deepening procurement’s insights along these lines could prove invaluable in deciphering and predicting suppliers’ go-to-market strategies, evaluating suppliers’ bids, conducting various ‘what-if’ analyses and shaping strategies for awarding business among arrays of suppliers and across global regions in order to consistently maximize buying power.
Revisit Porter’s Five Forces to Unleash Procurement Innovation
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2 Countering Bargaining Power of Customers
To continue innovating procurement’s corporate role and influencing competiveness in positive ways, a new breed of procurement leaders and practitioners must also be exploring how they might address another of Porter’s Five Forces – countering customer power. “Buyers are powerful if they have negotiating leverage relative to industry participants, especially if they are price sensitive, using their clout primarily to pressure price reductions.”
Industries that fall frequently into price wars – cable television, mobile telecom and airlines – all suffer to varying degrees from excessive customer power. One response, according to Porter, is to expand services and find new ways of increasing customerswitching costs. The airline, for example, might serve better food, offer more choices for in-flight entertainment or superior experiences related to baggage handling and so forth. Procurement’s role, in this sense, is to discover unique service partnership opportunities in the supply base, negotiate profitable deals and to employ strong governance and ongoing performance management over strategic service-provider relationships.
Revisit Porter’s Five Forces to Unleash Procurement Innovation
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3 Countering 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 here for procurement is to focus on cutting costs as a means for keeping end-market prices low. Procurement erects barriers to entry by developing supply-side economies of scale: buying in higher volumes, commanding lower prices and better terms from suppliers. Resulting cost savings can then be reinvested into R&D as yet another means for keeping out new market entrants.
But procurement leaders are expanding their thinking in this area 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,” he writes. A good example is the Apple iPhone, where users share special abilities to message one another, trade documents and use social-sharing applications that are not available to other smartphone operating systems.
Revisit Porter’s Five Forces to Unleash Procurement Innovation
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Through creative uses of eRFx, supplier information management and onboarding processes, procurement is uniquely positioned to uncover not only existing supplier capabilities but to gain deep insights into what suppliers worldwide (even those in unfamiliar markets and economies) may be developing for several years out into the future. Procurement teams most capable of discovering and capturing supplier innovations may be able to generate consumer network and other demand-side effects that prove to be important competitive differentiators going forward in time.
Barriers to market entry work against procurement when they limit supply-market competition and engender greater supplier power. While Porter cites high capital requirements as one barrier to entry, savvy procurement organizations are also moving increasingly into supply-chain financing and investment as means for tearing down supply-side barriers to entry in certain cases. Other ways procurement can remove barriers to entry in supply markets is to create easy ways for new suppliers to introduce themselves and showcase products and innovations that can engender demand-side economies of scale, brand currency and long-term customer loyalty.
Revisit Porter’s Five Forces to Unleash Procurement Innovation
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4 Countering Threat of Substitute Products “A substitute performs the same or a similar function as an industry’s product by a different means,” Porter writes. “Strategists should be particularly alert to changes in other industries that may make them attractive substitutes when they were not before. Improvements in plastic materials, for example, allowed them to substitute for steel in many automobile components.”
Strategic enterprise procurement, with its horizontal perspective spanning the many verticals in which most large companies operate, is also uniquely positioned to discover and exploit substitution opportunities. Classically, procurement seeks substitutes to reduce supplier power, but it can also focus on spotting potential substitution threats to a company’s own product lines. What may be needed in procurement are better ways of documenting, structuring, evaluating, reporting and otherwise sharing this type of market intelligence as it is captured through supplier due diligence, eRFx, onboarding and other processes.
Combining and using procurement’s internal and external business intelligence to understand and predict cost structures, profit margins, supply risks and other trends in competing (substitute) markets is another untapped area where procurement is positioned to exert real competitive influence on the demand side of things.
• Are your company’s competitors (those selling substitute products) well placed to endure for many years in the marketplace? • What risks lurk in their supply chains? • And what are the historic trends, volatility patterns and future expectations for costs, profitability and other success factors?
Such intelligence coming from procurement can help to inform and direct a company’s strategies for pursuing leaner inventories, better manufacturing processes and so much more.
Revisit Porter’s Five Forces to Unleash Procurement Innovation
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5 Countering Rivalry Among Competitors “The degree to which rivalry drives down an industry’s profit potential depends, first, on the intensity with which companies compete and, second, on the basis on which they compete,” Porter writes.
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.
Once again, the strategic contribution from procurement comes from:
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Communicating with suppliers and coordinating innovation roadmaps. Co-developing with critical suppliers (which requires underpinnings of trust often built via consistent and strong supplier performance).
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Collaborating to drive substantial improvements in supplier performance — for example, massive lead-time or fixed-cost reductions throughout multiple supply-chain tiers — which can enable all operating in the industry to avoid indulging in price wars.
Revisit Porter’s Five Forces to Unleash Procurement Innovation
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Conclusion - Factors Not Forces In deploying the Five Competitive Forces framework, Porter emphasizes both the importance of defining industries correctly (recognizing the full scope of potential competition) and also of distinguishing between competitive forces – which determine an industry’s long-run profit potential and how the value gets divided among players — and nonstructural factors. “It is especially important to avoid the common pitfall of mistaking certain visible attributes of an industry for its underlying structure.” Examples of such factors would include industry growth rates, technology and innovation, government and complementary products and services.
The most successful companies, Porter suggests, will find ways to successfully 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 industry structure in its favor in order to reap a larger share of available profits or to change industry structure altogether (perhaps increasing the size of the total pie). The strategy, in turn, needs to be quite clear in articulating the various ways in which procurement is expected to behave and that needs to trickle down into all the daily activities of procurement practitioners.
Procurement technology tools, which by now have evolved to a highly advanced stage, can help to make that trickle down happen. For example, by controlling the way in which a company:
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Configures and weights its systems for measuring supplier and procurement performance. Filters and mines Big Data for opportunity discovery. Captures and structures market intelligence via RFx, contracting, supplier onboarding and supplier information management processes.
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And builds standard and innovative terms and conditions into contracts.
This whitepaper only scratches the surface of possibilities for procurement-led business performance improvement captured in Porter’s Five Competitive Forces. We encourage procurement leaders and professionals to revisit the original works (1979 and 2008) and also our series of related blog posts as a point of departure for some deep thinking about where procurement can go next in terms of strategic process innovation over the coming five to ten years.
Revisit Porter’s Five Forces to Unleash Procurement Innovation
www.zycus.com
About Zycus RCE-TO-PAY SOL UTIO S SOU U C NS ZY Financial Savings Management Invoice Management
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Zycus is committed to positioning procurement at the heart of business performance. With our spirit of innovation and a passion to help procurement create even greater business impact, we have evolved our portfolio to a complete Source-to-Pay suite of procurement performance solutions - Spend Analysis, eSourcing, Contract Management, Supplier Management, eProcurement, eInvoicing and Financial Savings Management. We are proud to have more than 200 solution deployments among Global 1000 clients across verticals like Manufacturing, Automotives, Banking and Finance, Oil and Gas, Food Processing, Electronics, Telecommunications, Chemicals, Health and Pharma, Education and more. To learn more about the Zycus, address e-mail to information@zycus.com or visit http://www.zycus.com
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