Retailers Look to Strategic Sourcing for Sustainable Savings

Uncertainty still overshadows the economy's early signs of recovery, and retailers are responding accordingly, slashing costs to meet profitability expectations. The reasons are obvious: Total costs can add up to as much as 80 percent of net sales for some retailers. As such, industry leaders are scrutinizing every dollar spent and looking internally to systematically create a much smaller overall cost structure.

Most retailers have significant savings opportunities in trimming product - and non-product - sourcing spend. While product sourcing costs can be as high as 60 percent to 70 percent of sales, non-product sourcing costs (e.g., real estate, fixtures, professional services, marketing and advertising) can represent a significant source of savings as well. When it comes to aggressive cost cutting, follow the lead of Stephen Sadove, chairman and CEO of Saks: From travel to supplies to benefits to marketing to information technology, leave no stone unturned.

Kurt Salmon Associates (KSA) estimates that most retailers can realize between a 2 percent and 4 percent reduction in costs of goods sold (COGS) through an aggressive strategic sourcing program centered on negotiating more favorable agreements and improving collaboration with vendors. Benefits can be higher depending on the retailer's sourcing capabilities and willingness to pursue product- and vendor-related savings. But ultimately, for all retailers, minimizing costs across the entire sourcing spend spectrum requires a broad set of capabilities, flexible processes and renewed negotiations with vendors.

Strategic sourcing opportunities
The most successful retailers systematically analyze their entire spectrum of spend and then develop a comprehensive strategic sourcing program accordingly. Such a program addresses the cost drivers unique to a particular spend area and also takes into consideration specific market, vendor and product needs so as to not jeopardize product quality or customer experience.

For spend areas directly related to final merchandise, savings come largely from optimizing the sourcing operating model. Accordingly, a key decision is how to source each product type, i.e., whether to use internal resources or agents. With this foundation in place, retailers can evaluate product requirements, by category or brand, and unearth savings opportunities across each tier of their vendor base. This may mean reevaluating relationships with each vendor, providing volume commitments to those strategic vendors or aggressively negotiating all financial terms above and beyond product costs. These improvements will result in a more stable business relationship and allow vendors to plan their processes and capacity more effectively, freeing up savings for both retailers and vendors.

In non-product spend areas, the focus is twofold. Externally, retailers can aggressively negotiate more favorable terms across companywide spend. Internally, they can reevaluate the selection of the products and product specifications driving overall costs, as well as the selection of vendors meeting those product and service requirements across multiple brands and businesses.

Strategic sourcing roadmap
A fundamental tool to help retailers realize potential sourcing savings is a detailed roadmap specifying cost reduction targets and prioritized activities.

"There are significant savings opportunities for retailers to benefit from as a result of a well-thought-out roadmap combined with effective and efficient execution," says Anthony Romano, executive vice president of global sourcing and business transformation at Charming Shoppes Inc. "As

General George S. Patton Jr. once said, "A good solution applied with vigor now is better than a perfect solution applied 10 minutes later."

The major components of a strategic sourcing roadmap often include:

*Sourcing Strategy - identifying and prioritizing supply and demand improvement opportunities by area of spend
*Sourcing Operating Model - process and organization required to support the overall sourcing strategy, goals and objectives
*Vendor Management - approach and process required to manage vendors to ensure that product is provided at the right total cost with minimized risk
*Cost Management - knowledge of product/service total cost and applying the understanding of cost drivers in vendor negotiations
*Sourcing Technology - tools required to enable the sourcing organization to realize cost-savings goals

Logically, activities with the largest return on investment are the highest priority. However, sourcing leaders will balance this with activities that also address any critical issues. For example, if a retailer has not attacked non-product spend areas in recent years, efforts might first center on establishing the appropriate sourcing strategy for this key area. More specifically, initial activities might include a spend analysis, as well as an evaluation of current contracts and administration requirements. The expectation is that this initial effort will provide a quick understanding of what is being spent, by whom and with which vendors. This focus also will provide opportunities to negotiate more favorable pricing, optimize the vendor base and determine what product specifications can be simplified to reap additional savings.

Final merchandise spend
The current economic landscape is forcing retailers to challenge established processes and relationships with current vendors in spend areas directly related to final merchandise. A key component within a sourcing roadmap addressing product-related spend is determining whether to keep sourcing activities in-house or to use sourcing agents.

Determining the appropriate business model strategy aligned with sourcing goals and objectives has significant organization and resource implications:

*Resource Requirements - domestic and overseas resources needed to manage sourcing activities with vendors or agents to facilitate development and product movement throughout the supply chain
*Resource Capabilities - appropriate country and vendor knowledge to collaborate effectively with vendors and agents without sacrificing quality and cycle time
*Performance Management - metrics that monitor and report vendor and agent performance on delivery, cost, quality, cycle time and collaboration

Whatever the operating model, it must improve the way a retailer collaborates with vendors and yield benefits to both organizations. Vendors involved with a retailer's planning and development can better plan for their own materials and production capacity to enhance efficiency. This enables a retailer to make product decisions closer to consumer purchasing decisions, resulting in more-effective product assortments and reduced store inventories.

"Pressures on revenue and top-line contraction have created an intense focus on managing our costs," says Romano. "In order to provide products to our customers that have the quality appropriate for the brand while being rewarded at retail, we must work with our vendors to be as cost competitive as possible. Collaboration with our vendors is critical to achieving these goals and objectives - partnering with them to understand our product requirements, and offering alternatives without sacrificing quality or consumer expectations, will go a long way in being cost competitive and maintaining healthy margins."

A key part of a successful strategic sourcing program is the identification and management of vendor risk. The recession affected all aspects of the supply chain worldwide with closures of suppliers numbering in the thousands. For example, Panjiva, an Internet-based tracker for shipping data, noted a 72 percent drop in the number of active apparel suppliers worldwide during a four-month period last year.

In turn, risk-wary retailers are proactively identifying vendors whose financial or operational risks could disrupt supply. Doing so requires a formal vendor performance evaluation process using key metrics to monitor both short-term and long-term expectations. Where risks are high or performance fails to meet expectations, retailers can work with vendors to improve performance or start building relationships with alternative sources of supply. Of course, building new vendor relationships takes time, effort and resources, all of which are in short supply for many retailers during lean times.

Non-product spend
With non-product spend contributing as much as 20 percent to 30 percent to a retailer's cost base, a well-defined strategic sourcing program to aggressively pursue savings opportunities in this area can net tens of millions of dollars in savings. Case in point: marketing and advertising, which is a large part of non-product spend for most retailers.

In identifying opportunities in this area, a key first step is to create a culture of effective collaboration between marketing, the part of the organization that establishes and controls the marketing budget, and sourcing, the part of the organization that negotiates with vendors to expand the marketing budget. Many retailers are unable to fully realize significant savings because of misaligned goals and priorities between the two functions.

The most successful sourcing functions focus on working with current vendors to expand the return on investment for marketing spend, as opposed to a myopic focus on slashing budgets, which provides only a temporary fix at best. By comparison, the former approach strengthens relationships both internally and externally while simultaneously increasing value.

Similar to other non-product spend areas, marketing costs tend to be fragmented across different brands; therefore, it is critical to document and analyze companywide marketing spend to best understand the current vendor base, detailed costs and the buying behaviors unique to each brand.

Cost-reduction focus
Lean times create leaner competitors. While less disciplined sourcing organizations might tend to return to old habits once sales start to rebound, stronger sourcing groups will continue to drive toward a lower cost structure they can sustain for the long term. Accordingly, industry leaders will continue to invest in strategic sourcing programs that address their entire spend spectrum, redefining vendor relationships and revising internal processes and behaviors to ensure a "leaner retailing" mindset for years to come.
Alan Pincus is a senior manager at Kurt Salmon Associates, a global management consulting firm specializing in the retail and consumer sectors. For more information, email [email protected] or visit
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