June 2007 | Commentary | Viewpoint

Sourcing in a Seller's Market

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Rising commodity prices, growing global consumer demand, and increased political instability have put an end to the buyer's market in procurement. Today, buyers are just as likely to be "fired" by their suppliers as they are to experience supply chain shortages or out-of-stock notices.

So what is this new "seller's market" like? And is the sourcing professional really captive to it?

A seller's market exists when demand for a certain product is strong and prices remain relatively high. Several other factors—capacity constraints, unexpected supply disruptions, proprietary components or materials—can lead to the perfect storm that creates a seller's market.

Beating the Odds

Despite these factors, sourcing professionals with the right strategy can overcome the odds that are stacked against them. The trick is to anticipate the forces that create a seller's market and organize supply chains in advance to ensure minimum disruption.

Applying information from key market indicators can help sourcing professionals do just that. Sources to consider include Producer's Price Index, capacity utilization, and inventory levels.

Like all sourcing strategies, smart sourcing in a seller's market requires analysis of not only the supply market, but also specific factors related to the products or goods being sourced.

A supply market characterized by little competition, full production capacity, specialized products, long lead times, and/or difficult or localized fulfillment issues requires a well-thought-out, proactive, flexible sourcing strategy that takes into account a variety of factors, including:

  • Supplier competition.
  • Production capacity and/or supply chain issues.
  • Specialization.
  • Pace of industry change.
  • Geographic impact.

For certain products or goods, understanding the buyer's specific, internal organizational factors may be critical to deciding which suppliers to work with and which sourcing methods to choose.

Among the factors influencing buyers' sourcing strategies are:

  • Strategic importance.
  • Influence of incumbent suppliers.
  • Subject matter.
  • Buying power.
  • Stakeholder impact.

The more important a product is to a company, the more important it is to develop a flexible, robust sourcing strategy that balances supply market competition with supply market risks. Companies should consider the following when analyzing products:

  • Size of current spend and future spend forecast.
  • Product complexity.
  • Switching costs.
  • Total cost of ownership.
  • Product's impact on the current supply chain.

Next step, Execute

Typically, the most productive sourcing strategy for improving negotiating leverage in a seller's market is to expand the traditional supply base. Common methods for developing alternate supply sources include direct investment in or acquisition of suppliers, developing low-cost country supply sources, or insourcing products.

These strategies, however, are also among the most difficult to deploy, and require significant investment.

If up-front investment is not an option, buyers should implement a sourcing strategy well before supplier negotiations begin.

Developing strong relationships with the supply base will help buyers negotiate advantageous pricing. Although pricing may increase over time due to constrained supply market conditions, suppliers in deep relationships have incentive to ensure that their valued customers remain strong and viable. They may even be willing to sacrifice short-term margin.

In some cases, buyers face a seller's market without the benefit of available investment capital or solid working relationships with suppliers. Companies in this position can use several tactics to strengthen their negotiating position with suppliers:

  • Link purchase of one product to another.
  • Enact long-term contracts with forecasts.
  • Reduce payment terms.
  • Leverage supply continuity.
  • Make credible threats.

New Tools for Buying

Recently, buyers have also begun to incorporate online tools into their sourcing strategies. The traditional Request for Proposal delivered online can certainly help buyers gather supplier qualifications and start prices for negotiations, but doesn't offer much incremental benefit or power to drive negotiating leverage in a tough supply market.

If it is apparent that competition will be limited, buyers should consider sacrificing the liquidity derived through an online market or auction for a more traditional, offline negotiating strategy.

Traditional negotiations protect the buyer's position by ensuring that the number of bidders and interest in the business remain confidential.

If several suppliers compete in the same market, however, buyers should consider the potential impact and value of an auction. Where multiple suppliers exist, an auction can drive results, even in a constrained supply market.

Auctions including two suppliers typically yield 9 percent average savings, while those with three or more suppliers increase savings to more than 13 percent on average.

The trick to running an auction in a seller's market is to generate competition. The specific set-up of an online auction event can dramatically influence the perception of competition among suppliers.

Example set-up strategies include:

  • Provide suppliers with visibility into rank position only.
  • Low bid wins all.
  • Creative lotting.

Another auction format gaining acceptance with buyers in a seller's market is a Dutch Auction, which lets the buyer set the initial price and price increments, while suppliers bid on the quantity of product they will provide at each given price.

This format encourages seller participation by focusing on volume versus price. It also allows multiple sellers to compete for business, increasing surety of supply.

Finally, when buyers are considering more than just price, an optimization strategy may enable them to sort through and compare competing seller offers. This technique is effective when buyers want to parse an award among various sellers—it allows buyers to test multiple award scenarios to optimize their best interests.

In addition, optimization gives sellers flexibility to craft a proposal that best meets their sales objectives, thereby providing more incentive to compete for the buyer's business.

Play to Win

Strategies such as these, however, don't easily come together. To win in a seller's market, sourcing professionals must keep current on all factors that affect their strategic supply markets.

They must also anticipate changes. Then, when a seller's market does occur, they can quickly execute innovative strategies that allow them to level the playing field and make sure they receive the most competitive pricing possible, given the circumstances.

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