In September 1983, an article entitled “Purchasing must become supply management” appeared in Harvard Business Review (HBR). Here’s how it started: “The stable way of business life many corporate purchasing departments enjoy has been increasingly imperilled. Threats of resource depletion and raw materials scarcity, political turbulence and government intervention in supply markets, intensified competition, and accelerating technological change have ended the days of no surprises. As dozens of companies have already learned, supply and demand patterns can be upset virtually overnight.”
Re-reading these words, they seem almost perfectly written for the conditions we face today: depletion, scarcity, turbulence, intervention, competition and change. All are no surprises in modern supply chains enduring a shifting world order. Prescience notwithstanding, this is how the business world was introduced to author Peter Kraljic’s four-box “portfolio analysis” model. It is the basis on which many purchasing board presentations, organisational designs and careers have been built ever since. Indeed, it probably represents the touchstone of contemporary strategic purchasing.
A quarter of a century on, we caught up with Kraljic (pronounced “Kra-litch”) to explore what lay behind his seminal thinking and the origins of the article (see the print edition of CPO Agenda or buy a PDF). We found him relaxing in his native Slovenia, but as energetic and insightful as ever on supply management’s role in business.
Risk exposure
During the 1970s, Kraljic, who trained as a metallurgist, was working with McKinsey & Company for a major German-based chemical firm. As a vertically integrated organisation, with operations from base oil or gas feedstocks supplying through complex operations to end-consumer products, the company was highly exposed to supply management risks emanating from the disruptions mentioned in his opening paragraph.
“Purchasing was seen as a second-class function, a service, and certainly not strategic,” says Kraljic. In common with many companies then and now, purchasing activity was transactional and was not addressing strategic risks, nor was it exploiting the opportunities that longer-term supply management thinking would offer.
Recognising the company’s reliance on supply markets with 60-70 per cent of revenues being spent with third-party suppliers, Kraljic identified the 70-80 major categories of spend (the “portfolio”) that required individually defined approaches. There were no hiding places, as goods, materials, services, outsourced activities and even capital expenditure came under the spotlight. “The company was spending 5-7 per cent of sales revenue on capital items,” he recalls, “and it was necessary to optimise the dreams of engineering with the reality of production and purchasing.”
Segmenting the dimensions “importance of purchasing” and “complexity of supply market” into the four categories of strategic, bottleneck, leverage and non-critical provided just the lens he needed to focus senior management on the case for change.
The next steps were to build individual plans for each category, mimicking the model used in the other great outward-facing business activity of marketing, and to develop a purchasing organisation capable of sustaining the strategic long-term thinking and behaviours required. Kraljic regards these steps, aimed at providing durable change and improvement, as being as important as the initial segmentation stage.
Portfolio power
The consequences for his client were huge. Questions arose ranging from how to deal with suppliers in a longer-term, relationship-based manner through to the cash management of the business resulting from the supply market risks and opportunities identified. Unexpected proof of the power of portfolio analysis was that Kraljic was required to keep the model confidential, as his client saw it as a source of competitive advantage. (How many modern-day consultant models could make the same claim?) The surprise is that the idea behind the article was developed and used nearly 10 years before it was published. The response from the readership of HBR, however, was not surprising. Helping the business community to re-position purchasing from being an operational activity to encouraging organisations to think through their supply chains encouraged many new clients to reach out for help.
Kraljic defines purchasing as a “multi-faceted strategic planning and decision-making process” and it seems that he was surprised both at the breadth this process spanned and the fact that the benefits appeared in unexpected places such as managing cash flow. If the main impact of the idea was to uplift senior management’s thinking about supply markets, it almost seems secondary that its main object was to focus on the risks and opportunities presented by the supply market.
Kraljic presented his thinking to a purchasing conference in Stockholm shortly after publishing in HBR. Although generally well received, his ideas did meet resistance. “The article and the conference created a lot of attention, but also brought criticism from old-school thinkers who didn’t understand the need for purchasing to be seen as a strategic activity,” he recalls.
Ironically, it was the German members of his audience who felt that the new label “supply management” was unnecessary. “They already had three different terms for purchasing and felt that a fourth would only confuse matters.” Indeed, they even challenged his notion of the “supply chain”, arguing that his approach might end up leading people to count waste management as a valid consideration in purchasing circles. Imagine such radicalism back in the dark 1970s industrial landscape!
Paradoxically, the sceptics were probably more in tune with Kraljic’s thinking than they believed, as he encouraged them to think through the supply chain and later developed models such as lifetime costing and acquisition costs. Others needed no such persuading. Encouraged by his simple 2x2 model, easily memorised and eminently presentable to senior management, Kraljic’s approach catalysed a huge industry of segmentation tools, category management processes and transformational consulting firms.
“Within McKinsey, it spearheaded our purchasing development and operations practice,” he says. “My colleagues developed it further and experimented with a nine-box version that allowed more flexibility. But always it must be adapted to the characteristics of the company where it is being used.” When it came to public consumption, the simplicity of the 2x2 original won the day.
Conversation with Kraljic is both enlightening and refreshingly different. He talks with real passion about purchasing improvement ideas that are still too rarely practised in 2008. Where many purchasing discussions predictably mention cost savings in their first sentence, we were 35 minutes into our three-way conversation before the topic arose.
Instead of the usual purchasing buzzwords of spend, cost or savings, the word “risk” features prominently in Kraljic’s vocabulary. “The 1970s oil price surge shocked companies and caused them to ask how to manage supply risk. Cost savings may be the final result, but the primary aim is long-term supply security. You have to be particularly alert when things go smoothly,” he advises. “This is your opportunity to negotiate with suppliers to establish the trust-based relationships you need to see you through the tough times.”
Building equity while the sun shines so you can trade with it on a rainy day is a principle we could all learn from as we segue from an era of plentiful growth to one of constrained austerity.
“During boom times, supply is not an issue and companies underestimate the importance of the supply side,” says Kraljic. As an example, he points to changes in the markets for iron ore and coke. “Steel companies sold iron ore quarries and focused on mergers and acquisitions in their own sector. Similar concentration in the iron ore and coke supply markets led to bottlenecks where alarmingly few global companies controlled the supply markets. The few backward-integrated companies are in a significantly stronger competitive position. Never mind a tripling of the iron ore price, simple availability could become a more realistic challenge.”
He continues: “If purchasing is not done in a strategic way then you may not just miss an opportunity, you may incur a serious threat. How sure are most of us in how our essential supply markets are structured?”
Questioning wisdom
Kraljic consistently reiterates his challenge to conventional wisdom with this question: “What is our total value chain and what is my risk position? Then think differently about the input side. Purchasing is the operational part of it and supply management is the strategic part. Taken together it is a multi-stage strategic process and it is necessary to think through how it interacts with other functions.”
What about the many derivations, permutations and complications that his heuristically simple, but deeply effective, model has been subjected to? When asked about this, Kraljic professed surprise, just as he did when we suggested that it had also been catalytic in the creation of many contemporary category management processes. Although he acknowledges that his article “did spark interest, had positive responses and had uplifted the thinking of purchasing people and senior people”, he seems unaware of just how great his impact has been. “I’m sorry I didn’t patent it!” he says of his model when we point this out, adding modestly: “But I am pleased that the idea is being spread around.”
At the same time, Kraljic argues powerfully for simplicity. “The original idea is like a Romanesque church,” he says. “It has clear structure and focus. But if you develop it too much it becomes Rococo and because of all the additional features you don’t see the church any more.”
Considering the attention span of the typical CEO, the simpler the model the better, in our view. It’s a similar story when it comes to effectiveness. The power of Kraljic’s portfolio analysis model lies in its ability to provide a way of thinking, relevant to almost everything an enterprise buys or needs. Think value, think risk, ask “so what?”
Kraljic returns repeatedly to the theme of risk and opportunity. “My question to CEOs is ‘Are they aware of opportunities and risks in their supply chains and how do they deal with them?’” And the main opportunities? “New sources in emerging countries, backward integration possibilities, and innovation. Innovation is a particularly sensitive one,” he argues, “as it needs to be trust based so that both supplier and customer can gain. But all of
these opportunities are only worthwhile if they deliver sustainable improvement.”
So what is the essence of the Kraljic message?
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Encourage CEOs to look at total spend, including direct costs, indirect costs, capital expenditure and outsourced activities.
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Integrate the needs of the many departments involved.
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Look at risks in a focused manner, concentrating on the long term as much as the short term.
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Think through the supply chain from end to end, building relationships with suppliers over everything else to access the quality of materials, services and supply.
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Ensure long-term supply security and optimise lifetime cost.
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Build the right organisation internally and staff it with people who can sustain the work to make the improvement durable.
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Use the human resources function as a means to manage a talent supply chain to support this work.
Kraljic adds: “Don’t keep it bottled, but spread it around and do things to make it last. You have to combine the new way of thinking with organisational measures such as putting a CPO at board level. Also, put high-flyers into the CPO position for 2-3 years as part of their career development en route to the top leadership position in the company. When they move on, they will spread the gospel around.”
Sadly, the importance of organisational measures seems lost on many companies as they focus on structural change to achieve short-term cost savings. “I recently addressed a conference in which 50 global companies participated,” says Kraljic. “Only 15 per cent had a CPO at board level.”
Our final question was an obvious one: If you had the chance to rewrite the article in 2008 with the benefit of 25 years’ hindsight, would there be anything to add?
“Yes,” he replies, “but the first thing is that I would not address it to the purchasing community, but to the CEO. CEOs know what it takes, they can appoint the right people, and then they can uplift and anchor supply management so that is clearly visible. As regards the basic message of identifying critical items and building management talent, no, I would not change it other than to add trust into the equation – the importance of trust in long-term relationships with suppliers. You need to create win-win.”
ANALYSIS 1:
ACADEMICS, CONSULTANTS AND PRACTITIONERS: A CHALLENGE
I spent nearly 10 years working in purchasing before I was introduced to Peter Kraljic’s portfolio analysis model, although at the time I didn’t know that it was either his or one model. Instead, I encountered a sequence of derivations – and, occasionally, strangulations of it – so numerous that I assumed it was available in kit form to suit the day of the week.
A casual moment surfing for “portfolio analysis” exposed its origins in Harvard Business Review, and downloading Kraljic’s article gave me much greater insight into his thinking than the thinly disguised versions peddled so widely.
It also raised three quite demanding questions: first, why no one had introduced this thinking to me at the outset of my career; second, why the consultants sent to “help” us missed the clarity of Kraljic’s thinking and insisted on presenting their own versions that did not credit the author; and third, why academia has yet to develop a more fundamental principle on which to base purchasing strategies, organisations and activities.
So, on the 25th anniversary of Kraljic’s HBR article, it seems reasonable to throw down a challenge to academics, consultants and purchasing practitioners everywhere. Here goes:
To those in academia who have the luxury of spending more time thinking than doing: Dispense with your models of buyer power, supplier power, numbers of buyers, numbers of suppliers, those with awkwardly labelled axes, from six to nine to as many as 16 boxes, those requiring colour solely for explanation, and those that simply don’t work. Instead, construct a way of thinking for purchasing that delivers so much value from so few inputs and that is capable of outlasting Kraljic’s.
To those in purchasing consultancy: Until the academics have done their job, please give Kraljic his due credit. It’s not just “portfolio analysis”, it’s not “supply segmentation”, it’s certainly not “sourcing objectives” (huh?) – it’s “Kraljic’s portfolio analysis”. Would you ever call Boston Consulting Group’s matrix simply “the matrix” and expect people to recognise it?
To those in purchasing practice: Read, or re-read, Kraljic’s article (see the print edition of CPO Agenda or buy a PDF) and then make sure two other people get to see it. The first is your CEO, the second is the next person you hire into your team.
Philip Usherwood
ANALYSIS 2:
‘AN OASIS OF COOL THINKING IN AN INTELLECTUAL DESERT’
“In a landscape bereft of any useful techniques that might dispel the idea that purchasing requires anything more than the back of an envelope to work on, Kraljic’s portfolio analysis has to be welcomed as a step in the right direction.”
I have certainly misquoted these reluctant sentiments, and I have no idea who penned them, but the essence is as their author intended. They appeared shortly after Peter Kraljic’s idea came into view as an oasis of cool thinking in purchasing’s intellectual desert. Its genius was that it held up a simple mirror to real life and revealed what was there – and what had to be done – in stark focus. Despite much subsequent tinkering by others, including me, the labels Kraljic gave to the four boxes of his matrix – strategic, bottleneck, leverage and non-critical – have stayed the course.
Testimony that Kraljic’s portfolio analysis was received as manna from heaven is that it featured prominently, and early on, in the many presentations I have seen made by CPO-hopefuls to their company boards. Typically, it opened people’s eyes to the magnitude of supply-side expenditure and the fact that supply markets must be treated in different ways. The result was to give new prominence to purchasing’s contribution to the firm – exactly as Kraljic intended.
What he would not have liked was that “making cost savings” was embraced as the main driver of change. Sadly, this is still cited by too many as the main task of purchasing. In our discussion with Kraljic, he acknowledged that cost savings would be one result of carrying out purchasing properly but argued that its greater purpose was to evaluate supply risk and then develop supply strategies to manage it.
Although Kraljic’s Harvard Business Review article provided the key that opened closed doors, it also described the strategic purchasing world that lay beyond. If you stop reading one-third of the way through, where the four-box matrix model appears, then you miss the good stuff in the rest of the piece.
“Just doing” portfolio analysis is like laying out the pieces on the chess board. What really matters is how one party judges the other’s strength, and consequently how best to optimise one’s position. Kraljic therefore advocates deep market analysis and gives eminently practical advice on how to do it – “the end product being a set of systematically documented strategies for critical purchasing materials that specify the timing of, and criteria for, future action”.
How many of these exist in a typical company? My impression is that for every 100 critical items purchased there might be 10 long-term agreements, and for every 10 agreements, only one strategy.
Kraljic’s article also addresses the organisational and policy issues to be considered by a company that is serious about sustaining its new purchasing impact. It is a feast of common sense that is still uncommon in practice.
Enjoy reading it in its entirety and, despite his modesty, celebrate the fact that Kraljic – along with other pioneers such as David Farmer – got us thinking about what we were doing when spending someone else’s money. The abiding challenge is to advocate that we have to do more than simply save it.
Dick Russill
Philip Usherwood (philip.usherwood@uk.bp.com) is head of purchasing and supply chain management, IT and property for BP’s North Sea operations, based in Aberdeen, Scotland.
Dick Russill (richardrussill@aol.com) is an independent coach, consultant and author, based in Pembrokeshire, Wales
