More CPOs should be leading contract manufacturing operations. But to do so they need to refine their strategic sourcing approach
Ask most teenagers to explain the nuances of their athletic shoes and they will be able to summarise succinctly the many differences. Yet, in reality, the leading products of Nike, Reebok and Adidas have a critical similarity: in most cases, Asian contract manufacturers produce these products. Maintaining independence, the buyers of these outsourcing services do not retain technical or legal ownership of the manufacturing facility. Furthermore, in many cases the same complex is simultaneously producing products for multiple brand leaders. To the brand's loyal consumers these products look and feel unique - and that's the ultimate goal.
"Contract operations", whether for packaged food, toiletries or consumer electronics, abound, but are perhaps the most underanalysed area of outsourcing. Despite their rise in popularity, often CPOs are not leading strategy development or execution. As a result, buyers of these services are typically not generating the same returns that they enjoy in other purchasing disciplines.
What are contract operations?
Contract operations typically comprise:
Manufacturing - conversion of raw materials to finished goods.
Co-packing - combining multiple finished goods into "kits" for a consumer promotion or to increase consumer value.
Re-packing - creating retail displays or modules to increase attractiveness.
In some cases, suppliers have vertically integrated to provide these and other value added services to customers. Co-packing and re-packing have emerged predominantly within consumer products based on retailers increasing demands. In all cases, the motivation seems clear. Buyers want to increase return on capital investment, speed to market and flexibility while leveraging the expertise of a third party that views the operation as a "core competency". But is there more to the growth than a better focus on core competencies?
A study last year by AMR Research, Contract Manufacturing at a Crossroads: Brand Owner Need for Visibility, highlighted the growing divide between buyer and seller in contract operations. Buyers generally focus on costs - primarily labour. Sellers view the marketplace differently, citing higher quality above cost benefits (see chart, below). While the growth is likely being driven by a combination of many factors, understanding the different views of buyers and sellers is important.
A new strategic sourcing playbook
Most large procurement organisations are adept at managing a structured strategic sourcing process to identify and partner with the most appropriate suppliers. Such a process is valuable in contract operations, but a number of modifications are necessary for greater success.
As with other supply markets, it's important to understand the dynamics of the industry - supplier/buyer power, consolidation/fragmentation, typical pricing mechanisms and service levels, and so on. The sourcing process should be as broad and all-encompassing as the process for the most complex direct or indirect category. A structured negotiation approach can prove effective and, if executed well, can shorten the cycle time to contract execution. None of this is unique to contract operations; it just needs to be done well.
Fundamentally, the stakes are higher in this form of strategic sourcing. Contract operations are placing your name on the product and in many cases shipping it directly to your customers. If ever there was a time to get business partners engaged, this is it.
In consumer electronics, large multinationals have emerged, such as Flextronics, Solectron and Jabil. But in many other product categories, the providers are more regional, or local, and smaller. Given these dynamics, popular advanced sourcing tools such as e-auctions often don't have the same applicability to the strategic sourcing process. Successful buyers rely on more relationship-building approaches such as supplier conferences and round-robin negotiations.
In the end, developing strategic sourcing expertise in this field is proving challenging. Top practitioners are able to lead an internal operation from a technical standpoint, yet also have the procurement skills of a seasoned buyer. Functions that do it well can be an excellent source of talent for the entire company.
Lessons from the front lines
Johnson & Johnson Consumer & Personal Care Group (JJCPG), like all of our competitors, must leverage contract operations for top and bottom-line growth. Our approach in doing so has evolved over time and our model is now grounded on fundamental supplier relationship management principles. The strategy begins with the identification of a select group of partners chosen based on their volume, breadth of capabilities, responsiveness and commitment. With these partners, we have developed a common set of robust tools and processes to better integrate them with JJCPG. Examples include:
A customised strategy process where joint supply chain objectives are documented with each partner and then used to guide decision-making through the year.
Quarterly on-site "top-to-top" reviews with cross-functional leaders (purchasing, operations, finance, R&D, quality, marketing, etc) spending 1-2 days reviewing business results and forward-planning through a mix of group and/or breakout sessions.
"Two-way" operational dashboard (see Metrics, below). Most buyers focus primarily or solely on performance elements they care about with little regard for the supplier's needs. In reality, even the most traditional buyer metrics have complimentary metrics of great interest to the supplier.
"Parametric" pricing models wholly based on the supplier's cost structure. This tool allows us to accurately estimate a cost range for new products in minutes, and as such streamlines the product launch process.
An "externship" programme where JJCPG provides a junior person to the supplier for an extended period of time to develop skills and execute projects that are mutually beneficial to cost, quality and/or service.
Supply chain visibility is another critical success factor. In most of our contract operations we have implemented a "directed pure-buy" model. This allows the supplier to provide a "turnkey" service where it can manage raw material ordering and receipt while JJCPG pays one price for the finished product. However, we direct it to use only our approved suppliers.
Additionally, we negotiate key terms of trade with the raw material suppliers so that JJCPG is able to leverage its scale. To support the model,we have developed a number of important and proprietary electronic tools to manage the flow of information across our extended supply chain. With this approach, inventory levels are appropriately managed and all parties recognise liability for the flow of materials and goods.
CPOs - get in the game
It's hard to imagine a product-based company that won't seriously consider contract operations in the near term. The same needs that brought the CPO to the boardroom will be required to ensure success in executing a contract operations model.
In some organisations the CPO may feel that since this function does not report through purchasing, it's not their business. Nothing could be further from the truth. CPOs are experts in supplier selection, negotiation and supplier development. Objectivity is critical for important "make-or-buy" analyses, while developing strategic partnerships is our core competency. Providing leadership in these areas stretches and tests CPOs.
Experiences in contract operations were critical building blocks in my career. Not all of these were successful - I've faced service outages, cost overruns and product quality issues. Fortunately, lessons were learnt and there have been more productive relationships than dysfunctional ones.
Recently, I moved on to a leadership position on the largest acquisition in our company's history. Making this deal work requires many of the same principles as contract operations. While these may be the CPO's most difficult challenge, they could also prove to be their greatest growth opportunity.
Brian Slobodow (bslobod@cpcus.jnj.com) is vice-president, global supply chain, at Johnson & Johnson Consumer Products in Skillman, New Jersey
