Sourcing has won a reputation over the past decade as a powerful tool for improving profitability. It is easy to see why. In a survey of electronics companies,1 we identified a 19 percentage point gap in profitability between the most and least successful companies, a full 13 percentage points of which was accounted for by the lower cost of goods sold (COGS) (Exhibit 1). A closer look at the structure of COGS showed that 40 to 70 percent was accounted for by the cost of purchased goods and services (Exhibit 2).
Most companies have tried in recent decades to reduce the cost of purchases by distinguishing between strategically vital goods and those that are in ample supply or easy to substitute, and between critical and non-critical suppliers. In the case of essential goods that might hitherto have come from a single supplier, buyers cultivated a second source in order to introduce a degree of price competition. In the case of less essential goods, companies played suppliers off against each other.
Much of the (single-digit) cost-reduction potential in this method seems to have been realized. But that does not mean purchasing costs cannot be cut further. The world’s more...