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Anewkindofprofessionalpurchaserbentongettingrock-bottomcoststhreatenssuppliersofbasicmaterials.Butthesecompaniescansavethemselvesbytakingupthepurchasers?weaponsThereisakillerontheloosenearthestartofthevaluechain.Suppliersofbasicmaterials1haveseentoughtimesastheirownsuppliersconsolidatedandcustomerssqueezedtheirmargins.Nowsomeofthosecustomersareusingakindofsophisticatedprofessionalpurchaser,knownasa"sourcer,"whothreatenstoruboutthemeagermarginsthatremain.Armedwithadetailedknowledgeofthesuppliers?economics,thesourcerspurnsthetraditionalapproachofbuildingcloserelationshipsinfavorofextractingthemostvalueatthelowestpossiblecost.Somesuppliersmaynotsurvivetheassault.1/23Indeed,thismismatchcandestroyvaluequickly.Oneglobalproducerofspecialtylubricantsrecentlyacquiredseveralservicebusinessesinanefforttodistinguishitselffromcompetitors.Theinitialstrategywassound.Butthensourcersdemandedthatthesupplierbundleitsnewserviceswiththelubricantsatnoextracharge.Topreservesalesvolumes,thesupplieracquiesced.Intheend,whathadstartedasasensibleefforttocombineachemicalbusinessthathada5percentreturnonsaleswithservicebusinessesthathada15percentROSgavethecompanyanoverallROSoflessthan5percent.Somesuppliershavesufferedsomuchfromthesourcers?attacksthatcounteringthem,ratherthanpassivelywatchingmarginserodefurther,mustnowbeastrategicpriority.Afirststepisforsupplierstounderstandhowsourcershaveshiftedtheoddsagainstthem.Thesecondistousethatunderstandingbyfightingbackthroughinternalimprovementsandbytaking2/23advantageofthementalityofthesourcerstocreatevaluefor boththemandthesuppliers. Andsuppliers musttakeamuchtoughernegotiatingstand 梚fnecessary,reducingtheirservicestocustomersorevenabandoningcustomers,howeverlong-standing,thathavebecometooexpensivetoserve.SMARTSTUFFProfessionalsourcersfirstappearedabouttenyearsago.Initially,theytargetedretailersanddistributors;latertheymovedupthevaluechaintoincludesuppliersofbasicmaterials.Insteadoflookingforsuppliersthatofferthelowestunitpriceforproducts,sourcersconcentrateonreducingtheircompanies?totalcostofowningtheproductsinquestion.Thetotalcostofownership(TCO)includesallexpensesincurredingetting andusingproducts 梟otonlyinvoice prices, butalsocostssuchasdelivery,storage,andthedisposalofpackagingmaterialsandby-products.3/23Sourcersstartbyusingtheirvolumetosqueezeasmuchvalueoutofasupplieraspossible.Thisapproachisn抰new,buttheywinadditionalvaluebyshiftingcostsandriskstosuppliers.Sourcersdon 抰careabouttheeffectthislineofattackmighthaveonrelationships:thegoalistograbvalue.Knowledgeisthesecondimportant weaponofthesourcers,whounderstand their owneconomicsandthetotal costofusingproductsorservicesand,nolessimportant,theeconomicsandofferingsoftheirkeysuppliers梠ftenbetterthanthesuppliersdo.Why?Becausesourcerssystematicallyaggregatealloftheavailableinformationfromtheirownorganizations,othersuppliers,trademagazines,othercustomers(legally,throughconsortiums),industryexperts,andthelike.Meanwhile,theinformationthatsuppliershaveaboutthemselvesliesinvariousfunctionsandITsystemsandusually hasn抰beenpulled together. Sourcersthereforehaveintimateknowledgeoftheeconomicimpactoftheir4/23options(forexample,thecostofswitchingsuppliers),sotheycangenerally decideontheir sourcing strategiesandpinpoint acceptable trade-offs before they evenstartdiscussionswithsuppliers.Sourcers,forexample,typicallyshiftcostssuchasfreight,storage,andfinancingtosellersbyhavingsales contracts specify delivered rather thanplant-departureprices,therebyexcludingthecostandriskofgettinggoodsfromthesupplier 抯totheuser抯plant.Anothertacticistoshiftrisktothesupplierbyusingfixed-pricecontracts,2whichforceittoabsorbunexpectedpricehikesforrawmaterials.Sincethemid-1990s,pulpandpapermanufacturers,forexample,havedemandedfixedpricesforhydrogenperoxideoncontractswithtermsofuptoayear.Becauseofthispricecap,manyhydrogenperoxidemakerspostedreturnswellbelowtheircostofcapitalin2001,whenasharpriseinnatural-gaspricespusheduptheircosts.Intheory,suppliersbenefitfromfixed-pricecontractsif5/23raw-materialspricesfall.Inreality,whenthathappens,suppliersbentonpreservingrelationshipswiththeircustomersoftenletsourcers,whowatchupstreampricescarefullyforsuchopportunities,cutpricesbyrenegotiatingcontractsprematurely.Costsinmostbasic-materialsindustriesarerisingbecauseconsolidationamongtheirownsuppliershaspushedupthepriceofrawmaterialsandbecauseadriveforhigh-tech,efficientproductionhasforcedthemtomakelargecapitalinvestments.Meanwhile,strongcompetitionandthecommoditizationofformerlydifferentiatedproductsareholdingdownthepriceofthebasicmaterialsthesecompaniessell.Thesupplier抯salesforceisaneasytargetforprofessionalsourcers,sinceinbasic-materialsindustriesmostincentiveplansforsalesrepsarebasedonvolume,whichpredisposesthemtoacceptthesourcers?demands.Whenmarginsarethin,salesrepsoftentrytobuildsalesvolumesbyofferingbuyersthelowestlistpriceandevengiving6/23awayservices,particularlytolargecustomers.Managersencouragethisvolumementalitybypressingforgreatermarketshareatalmostanycost.Andtheseindustriesasawholeemphasizetheimportanceofretainingcustomers,therebypromptingsalesrepstoavoidmeasuresthatcouldjeopardizerelationshipswiththem.THESOURCERS?APPRENTICEMostcompaniesinbasic-materialsindustriesalreadyfeelpressurefromsourcers.Manysuchcompanieshavesofarfollowedastrategyof"stealth"defense;thatis,theyhopetostayoffthesourcers?radarscreensbykeepingalowprofile.Butsourcersaresystematicallymovingupthevaluechainandwilleventuallyconfrontalmostallcompanies.Whenthathappens,suppliersmustbeabletoavoidsurrenderingvalueonanytermsthesourcerschoose.Thekeytosuccessistounderstandthesourcers?approach,whichfocusesontotalvalueratherthanlowestprice,andtopreparetheorganizationforanewkindofselling.7/23Inthis way,asupplier canrestore thebalance ofpowerwithitsbuyersandgivethemgreatervaluewhilenotthreateningitsownviability.Formostbasic-materials suppliers, twomeasuresshouldgoalongwaytowardrebalancingthescales:counteringthe knowledge of the sourcers by understanding theeconomicsofthecompaniestheyworkforandretrainingthesupplier 抯entireorganizationtosellnotjustvolumebutalsomorevalue(Exhibit1).Theamountofemphasisasupplierplacesoneachoptionshoulddependlargelyonhowactivesourcersareinitsindustry.Acompanythathasalreadybeencriticallyweakenedbytheirpowerprobablyalsoneedstoreevaluateitscorebusiness梩hatis, thewayit makes(asopposedtosells)itsproducts.8/23WISEUPSincesourcerscometothenegotiatingtablearmedwithadetailedunderstandingoftheirownandthesupplier抯economics, thesupplier mustdothesame.Thatis,

itmustunderstandhowitmakes(andloses)moneyfromitscurrentcustomers,thekeyfactorsthatmakethembuy,anditscompetitors?blindspots.Aswehaveseen, thesales repsandeventhemanagers

ofasupplieroftenonlyvaguelyunderstanditseconomics,becausetherelevantinformationisdispersedacrossfunctionsandITsystems.Thus,forexample,salesreps9/23whomustfactor thecostoffreight into aninvoice pricewhentheirowncompanypaysforshippingmayhaveonlyaroughideaofwhattherealcostmightbe.Adetailedanalysis of individual transactions at oneEuropeanchemicalcompanyshowedthat,forsomeclients,freightexpensesbornebythesupplieractuallyexceededtheinvoicepricewhenexpeditedarrangementswerefactoredin.Warehousingtoo,thoughnotalwaysitemizedoninvoices,cansharplyreduceacustomer抯valuetoasupplier.Indeed,suppliersrarelycalculatethepocketprice3foreachorderorcustomer.Butthepocketpriceisvitalformakingakeystrategicdecision:whetherthesuppliershouldwalkawayfromanycustomer 抯business.Ataminimum, information about acustomer 抯 historicalpriceresolve

performanceshouldduringnegotiations

strengthen theby showing

supplier抯wherelossesusuallyoccur.Ifacompany 抯customerbaseisveryfragmentedandscrutinizingindividualaccountsisn10/23

抰practical,analysisofgroupsbasedonconsiderationssuchaspurchasingpatterns,keybuyingfactors,orsizecouldinformthesedecisions.Toraisepricesorcutservicelevelsforanunderperformingcustomertothepointwhereitmightdefect,asupplier抯salesforcemustembraceaprofoundculturalchangeanddeveloptheabilitytoassessrisk.Thepayoffisabetternegotiatingstanceandthusimprovedmargins.Droppingacustomeralwaysposesdangers,buttheycanbemitigatedbyathoroughknowledgeofthebusinessatrisk.WhenonelargeNorthAmericanpetrochemicalsupplier,forexample,sawitsmarketthreatenedbyanAsiancompetitorofferinglowerprices,thesupplier,inacarefullycalculatedmove,letgothreeofitslargestbutmostunprofitablecustomers(whosesourcerstriedtoforceittoofferfullservicefreeofcharge).TheNorthAmericansupplierunderstoodwhatwasfundamentallyimportanttoitscustomersaswellastheweaknessesofitsnewcompetitor.Twoofthethree11/23defecting customerscamebacktothesupplier after justtwomonthsofcopingwiththecompetitor抯poorlogisticsandevenpoorerproductquality.Indeed,theyacceptedhighernetpricesandlonger,guaranteed-volumedeals.Asuppliercanfindoutitscustomers?keybuyingfactorsanditscompetitors?blindspots,initiallybyquestioningitssalesandmarketingemployeesandthenbyholdingthoroughdiscussionswithitscurrentandprospectivecustomers.Theinsightsitgainswillhelpthesalesforceandmanagersweighpotentialtrade-offsinnegotiationswithparticularbuyers.Saythatoneofthemthreatenstoswitchsupplierstogetalowerprice.Ifthesalesforceknowsfromthecustomeranalysisthatanotherbuyingfactor 梖orexample,thelevel ofservice梒oncernsthiscustomerlessthanprice,thesuppliercanoffer tocutbothits prices andits service levels,thuskeepingthecustomeranditspreviousmargin.Suchtrade-offsmustofcoursebemanagedtoassurethatthe12/23companybalancesabilitytocontrol

thefixed

riskcosts

oflosingvolumeacrosstheentire

andthecustomerportfolio.Anaccurateknowledgeofcustomersalsogivesasalesforcethepowertodenyhistoricdiscounts,rebates,orotherservicesthathaveceasedtomakebusinesssense.Suchinformation, for example,inspired alarge Europeanaluminum processor to stop playing lifeguard for adisloyalclientele.Someofthiscompany抯largestcustomershadbeguntosourceupto20percentoftheirbusinessfromnewEastEuropeanproducers.Whenthenewsuppliersmissedadeliverydate,theoldoneoftenrescuedthesecustomersbyexpeditingtheiremergencyorders,buttheincumbenteventuallydecidedtoletthemfeelthefullpainoftheshifttolower-qualitysuppliers.Asaresult,90percentofthecustomersstoppedusingthemandaskedtheincumbentforguaranteed-supplyagreementsathigherprices.SELLVALUE13/23Aknowledgeofcustomersincludesanunderstandingoftheirrequirementsaswellastheireconomics.Bylookingataproductorservicefromtheviewpointofthecustomerandunderstandingitstotalcostofownershipandthewayitcreatesvalue,asuppliercandeterminehowexistingornewofferingscouldhelpthecustomeraddstillgreatervalue(Exhibit2).Such"valueselling"differsfromthecommoncosts-plusapproach,whichbasespricesonthesumofcostcomponents;itisinsteadbasedoncreating,emphasizing,andcapturingmoreoftheeconomicvaluefromaproductorserviceforalldownstreamplayers.Asupplierthattakesthisapproachgoesbeyonditscurrentcatalogbyinventingcombinationsofproductsandservicesandbysuggestingoutsourcing opportunitiesthatmeet eachcustomer 抯long-termneedsbetterthanitscompetitorscould.14/23Sellingvalueisdifferentfromthetraditionaljobofsellingbasicmaterials.Tomakethetransitionandmastertheartofvalueselling,acompanymustoftenchangetheskillsandeventhepersonnelofitssalesforce,whichwillhavetoundertakeadditionalknowledge-buildingactivitiessuchasconductinginterviewswithcustomers,endusers,andindustryexperts;visitingcustomers?sites;andevenplacingorderswithcompetitorstoexperiencetheirserviceandprocessesdirectly.15/23Suppliersthatidentify combinationsofproducts andservicescapableofreducingacustomer抯totalcostofownershipcanbringastrongpackagetothenegotiatingtable.Typically,costsrelatedtoacquisition,operations,andsafetyandassurancecanbecut.Oneglobalpackagingsupplier,forinstance,sawthatitcouldreducetheoperatingcostsofitscustomersintheconsumerelectronicsindustrybydesigningamoredurableboxthatwouldreducetheirlossesfrombrokentelevisions.Byquantifyingthetotalvalueofthatcostreduction,thesupplierjustifiedincorporatingsomeoftheadditionalvalueintothepriceofthebetterboxes.Althoughtheythenhadhigherpricesandmargins,thecustomers?totalcostofownershipfellbecausefewerbreakagesoccurred.Thevaluemayseemobvious,yetthesalespitchcouldn抰bemadeuntilthesupplierestimatedthecostofthebrokentelevisionsets,offeredguaranteestoitscustomers,andhelpedthemtotracktheimpact.Incertaininstances,thistypeofbundlingcould16/23evenserveasthefoundationfornewbusinessunitsofferingbroad-basedsolutions(forexample,consultingservicesforpackaging).4Consideranotherexampleofthewaysupplierscanbenefitfromreducingtheircustomers?overallexpenses.Aglobalpaintmanufacturerrecognizedthatlaboraccountedfortwo-thirdsofthecostsofitsprofessionalcustomers.Acquiringpaintwasparticularlylabor-intensivebecausepainterslefttheirworksitestopurchasesuppliesasneeded.Bydeliveringpaintdirectlytoworksitesandchangingitsformulationtoprovideforone-coatapplication,thesuppliermadeorderseasiertofulfillandloweredthesecustomers?overallcosts.Althoughthepriceofthepaintdidn抰riseimmediately,theimprovementsshifteddiscussionswithcustomersawayfrompriceandtowardthevalueofferedbythesupplierandseemedlikelytoyieldamarginimprovementovertime.17/23Sellingvalueinthiswayanswersthesourcers?mainconcerns.Itproclaimsthatthesupplierhastheinterestsofitscustomersinmindandthatbothpartieshaveacommonunderstandingofwhatisonthetable.Andsuchacompellingvaluepropositionalsomakesalternativesupplierslessattractivetocustomers.Riskisanothercommonproblemthatsupplierscanassumeforsourcersifthepriceisright.Tostart,asuppliermustunderstandthehistoricandpotentialrisksinquestion 梥uchasvolatileraw-materialspricesorashortage of supply 梐 nd the waythey affect thecustomers?product costs. Then the supplier mustunderstandwhoisabsorbingtheserisksnowandatwhatexpense.Withthisknowledgeinhand,thesuppliercanset a range of prices it will charge for acceptingdifferentlevelsofrisk.Aboveall,itshouldmakeitsminimum(or walk-away) prices clear toits salesrepssothattheydon 抰createnewoptionsonthespotduringnegotiations.18/23Onemetalcompanythatsuppliestheaerospaceandautomotiveindustries,forexample,developedadeepunderstandingofthecostsandrisksofitscustomers?supplychains,fromrawmaterialstoinventorycontrol.Italsocalculateditsowncostsinthesameareas.Afteranalyzingthetwopositions,itproposedtosomecustomersthatitassume,forareasonableprice,therisksinherentintheentiresupplychain.Thesemovesactuallythinnedthesupplier 抯marginsatfirstbutalsolockedincustomersforthedurationoftheirproductprograms梪ptoadecadeinaerospace梐ndallowedthesuppliertoeventuallyincreaseitsmarginsbyimprovingperformanceallalongthevaluechain.Tomeetthesourcershead-on,suppliersmustbewillingtomakethesetoughdecisions.Thetricktogettingthisapproachtopayoffisknowinghowmuchflexibilityyouhaveinsteadofmakinguninformedtrade-offs,underduress,thatarealmostguaranteedtobedisadvantageous.19/23ACOURSEOFACTIONManycompanieswillfindthatdefiningthelevelofthreatposedbysourcersisthestartingpointfordecidingonacourseofactionanditstempo.Intheworstcase,thesourcers?tacticswillaffectmostofacompany抯business,andexecutivesmaywellfeelthatthewholeenterpriseisunderattack.Inthisevent,thesuppliershouldimmediatelymovetobuildaknowledgebasethatwillallowittogohead-to-headwithsourcersassoonaspossible.Thereafter,itwillknowenoughtodropcustomersthataskfortoomuchandtotakeafirmerstandinnegotiations.Shiftingtovaluesellingwillbeasecondarypriority.Inthehardestcases,wherethemarginsofthecorebusinesshavebeencuttounsustainablelevels,5managementmayhavetoconsidermorefundamentalchanges,suchasformingjointventures渨ithservicecompanies,buyingdis