Very few companies operate today without external support from third parties. Whether they are providing services, such as catering or cleaning, or specific parts necessary to manufacture products, most companies rely on outside suppliers in some capacity. For years, many organizations treated suppliers like nameless, paper-based transactions, designed to get the best price and little else. Over the past decade or more, much research has been done that supports a fundamentally different approach, one that embraces the idea that more can be gained from suppliers if the agreements are collaborative and based on output or outcomes – if they are seen as “relationships” and not “transactions.”
This article outlines seven sourcing business models that organizations should consider to improve their sourcing effectiveness and get the best results from supplier relationships.
Key Concepts to Improve Sourcing Effectiveness
Nobel prize winner Dr. Oliver Williamson laid some of the groundwork for the business models with 10 key lessons that contribute to more effective sourcing agreements.
1. Look at sourcing as a continuum, not a final destination
2. Develop contracts that create mutual advantage
3. Identify all costs, including transaction costs and their impact on risk and price
4. Understand that the greater the bilateral dependencies, the greater the need for preserving continuity
5. Use a contract as a flexible framework, not a legal weapon
6. Develop safeguards to prevent defection
7. Minimize transaction costs with shared visions and predicted alignments
8. Be credible – your contracting “style” matters (read: don’t strong arm your suppliers)
9. Build trust – leaving money on the table will come back to you in spades
10. Keep it simple
Now, if you keep those 10 key concepts in mind, it’s easy to see how your relationship with suppliers will improve, isn’t it? The theory of sourcing business models draws upon Williamson’s concepts above and shows seven different approaches that you can use to harness the power of your suppliers and create long-term success.
>>SIG MEMBERS: For more clarity on how sourcing business models can help you improve your sourcing effectiveness, check out the Unpacking Sourcing Business Models whitepaper from the SIG Resource Center<<
So what is it? A sourcing business model is a combination of a company’s relationship model, which defines how you will formally control your supply source, and economic model, which determines how you will manage the economics of the relationship. The correct business model for you may be different for every supplier relationship and depends largely on the purpose of that agreement.
Let’s take a look at each sourcing business model.
Basic Provider Model
This model is used when your primary purpose is to acquire goods or services at the lowest possible cost. A Basic Provider Model is transaction-based and grounded in the assumption that you are looking for something that will be priced per unit, per activity or per hour. This is a simple buy-sell relationship that uses standard or generic information for broad supply options.
Approved Provider Model
When you want to leverage volume discounts with proven suppliers, this is an appropriate model to consider. An approved provider generally signs a master agreement and is selected because they have either proven performance previously or they meet pre-defined quality standards and/or qualification characteristics. You could have many approved providers.
Preferred Provider Model
A Preferred Provider Model generally involves a longer contract because it offers value-added capabilities or volume discounts with specific, often exclusive providers. This type of relationship, which is based on value vs. price, streamlines the buying process and makes repeat business easy.
In this type of model, you are tapping into provider expertise to drive efficiency and ensure predefined service levels. The risk is shifted to the supplier, who is being “paid for performance” (also known as “pain share/gain share”). This output-based model offers performance incentives, generally in a longer contract, as the supplier is making more of an investment.
Vested Business Model
A Vested Business Model is highly collaborative and requires a “what’s in it for we” (WIIFWE) mindset, in which both sides of the agreement are equally committed to the success of the other. These relationships tend to be longer term (five to 15 years) and drive innovation, better manage risk and, as they are co-developed and co-managed, achieve better business outcomes.
Shared Services Model
This is an investment-based model for companies that seek to create its own internal supplier. In this model, the organization essentially creates a stand-alone unit that provides services to the broader organization and then charges the various business units for those services that they use. In this situation, processes are typically centralized and are “priced” to be competitive with external solutions.
An equity partnership is legally binding through formal structures which can take many different forms, e.g., acquisitions, joint ventures, subsidiaries or even purchasing cooperatives. In this situation, companies are making a direct investment to build capabilities in partnership with another company. This is typically asset-based and involves a comprehensive governance framework. This type of relationship can be costly and complicated and as such, is high-stakes, highly collaborative and requires a strong WIIFWE approach.
The seven sourcing business models are often viewed along a continuum. As the goods and services become more strategic, companies tend to shift along to the continuum to those that are more sophisticated.
The fact is that no one sourcing business model is appropriate for every situation or category, but determining which one is right for you at any given time can be easily done by understanding your business requirements, determining the relational model best suited to your specific needs and defining the economic model that makes the most sense.
Want to know what business model is best for your supplier relationship? The SIG Resource Center has a toolkit that can help you determine just that!
Mary Zampino is the Vice President of Content, Research and Analytics at SIG, with over 20 years of experience in information technology and over 15 years of experience in sourcing. Prior to joining SIG, Mary worked at Enporion, where she was responsible for the analysis, configuration, execution and award evaluation for over one thousand sourcing events, across a diverse range of direct and indirect categories. Mary is committed to customer service and considers information sharing and usability the top priorities for any project or organization. Mary holds a Bachelor's Degree in Information Science from the Florida State University and has completed certifications in Health Information Technology and Requirements Gathering.