The chief function of your business is to make profit. This is largely affected by the inputs (direct and indirect materials) that your business requires which means that your purchasing portfolio has to be on point, less the results be reflected in your income statement.
The questions that procurement managers need to concern themselves with given the importance of purchasing to the company’s bottom line include:
- How can a company guard itself against supply interruptions?
- What about economic changes resulting from ever changing technologies?
In 1983 peter kraljic, through his post in Harvard business review, presented a model that aimed at making the purchasing function of an organization to be strategic and get answers to the above questions.
The way the kraljic model works can be seen through four steps
- Purchasing classification
- Market analysis
- Strategic positioning
- Action planning
STEP ONE: CLASSIFYING YOUR PURCHASES
As the procurement specialist the first thing you need to do, assuming you already know your business need is to analyze your purchases using two criteria:
- Their profit
Fuel will have a high profit impact to a logistic company or even raw fruits to a person selling juice. Profit impact is high when the item adds significant value to the organization’s output
- Their supply risk
Supply risk will depend on whether or not the items you intend to procure are readily available in the market.
Assessing your potential purchases using these criteria will give you the following purchasing matrix which is a defining matrix in Kraljic model:
The important thing to understand here is that each of the items in their respective quadrant will require distinctive approach to procure.
Non-critical items
These have a low impact to your profits and their supply risk is equally low. An example in this category could be regular office supplies like pens.
The purchasing approach here will be having standardized products and optimizing inventory levels since you don’t want to have a lot of these items just laying around for no reason.
Leverage items
These types of items have high profitability impact and low supply risk factor. This gives the buyer an edge for greater returns.
The purchasing approach to consider here will be substitute products or alternative suppliers and placing high-volume orders
Bottleneck items
This category is the opposite of leverage items, that is, high supply risk with low profitability impact. The suppliers are strong in the case of items to be found here. The main problem with items in this category is that while they may not greatly affect your profits you end up spending a lot of time dealing with the few available suppliers. A common solution here would be over ordering when the item is available.
Strategic items
These are items of high profitability impact and high supply risk. Given the critical nature of these items they deserve the most attention from the purchasing department. In this category you have few suppliers and therefore you have to develop long-term supply relationships, analyzing and managing risks regularly and also considering making the item in-house if possible rather than buying.
STEP TWO: CONDUCTING MARKET ANALYSIS
Having classified what you want to buy and seeing where they fit in the kraljic model matrix, the next step is to analyze your companies bargaining position. A good tool that you can use here would be the Michael porter’s five forces analysis which you can see here.
STEP THREE: DETERMINING YOUR STRATEGIC POSITION
Once you have classified your products and identified your bargain position, it’s time to come up with the purchasing portfolio matrix. The purchasing portfolio helps you to compare your company’s strength against the supplier’s strengths
STEP FOUR: DECIDE ON YOU ACTION PLAN
You action plan in relation to the items you are to buy will come down to 3 strategies:
- Exploit – use your power to secure good prices and long-term contract from a number of suppliers who will fall in this category, that way you reduce supply risks. You have to be careful not to push your suppliers to their limit
- Balance- Take a middle approach between the exploration and diversification
- Diversifying- this means reducing risks by seeking alternative suppliers, for instance, you could in case of inbound logistics under you primary business activities, use a mixture of both road and train to get the goods if logistics is the issue.