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AbstractIndustrial Marketing Management 32 (2003) 365 374Strategic cost management across boundaries of firmsAnna Dubois*Department of Industrial Marketing, Chalmers University of Technology, Gothenburg S-412 96, SwedenIn recent years, increasing attention has been placed on how purchasing strategies may contribute to the efficiency of firms. In this paper, acase study illustrates how one firm implemented a supplier base reduction to enable a high involvement strategy in relation to appointed keysuppliers. The effects of this change in purchasing strategy were extensive cost rationalisations. The main change in this process was aredefinition of the unit of analysis from individual transactions to buyer supplier relationships. However, the costs in the relationship aredriven not only by internal factors on the two sides of the relationship but also by how the focal relationship relates to other relationships.Therefore, the ways in which the costs are affected by other parties, such as the suppliers supplier, the suppliers other customers, thecustomers other suppliers, and the customers customers, need to be included in the analysis.D 2003 Elsevier Science Inc. All rights reserved.Keywords: Purchasing; MRO; Total cost1. IntroductionThe supply side of companies has become increasinglyimportant over the last few decades. One reason is that thecosts of purchased goods and services represent the majorityof total costs for most companies. This high share isattributable to the ambition of companies to concentratemore of their efforts on a limited part of the total activitystructure of the business networks in which they areinvolved. By outsourcing activities to suppliers, firms areable to specialise their own operations.It is not only the increasing financial impact that makesthe supply side significant. Another more important reason isthe changing nature of the content of buyer supplierexchange. Over time, outsourcing of manufacturing activ-ities has been followed by outsourcing of design anddevelopment work. To an increasing extent, suppliers arecontributing to the technical development of a company.This change has been accentuated because of increases in thenumber of different technologies a company now needs inorder to be able to operate and because of the higher cost ofdeveloping each subsequent generation of technology. Com-panies today are dependent on knowledge developed andsupplied by other firms.* Tel.: +46-31-772-1196; fax: +46-31-772-3783.E-mail address: anndubmot.chalmers.se (A. Dubois).A third reason for which the supply side has come moreinto focus is the enhanced significance of interfaces withother firms(Araujo, Dubois, & Gadde, 1999). Interfaceswith suppliers are crucial not only when it comes to technicaldevelopment, but management concepts and techniques suchas just-in-time (JIT), total quality management (TQM), andzero-defect principle also have substantial impacts on theway firms operate. Applying these techniques requires theactive involvement of suppliers and affects the costs andbenefits of both buyer and supplier.The enhanced significance of the supply side has madepurchasing a strategic function. The contributions frompurchasing to the strategic development of a company maybe summarised in two strategic roles: rationalisation anddevelopment(Axelsson & Hakansson, 1984). The devel-opment role concerns the purchasing functions contributionto the technical development of the firm through organisingand managing relationships with suppliers. As regards therationalisation role,Gadde and Hakansson (2001)distin-guish three main types of roles. The first is related todiscovering what needs to be purchased. The second isrelated to rationalisation of logistics activities and the thirdto rationalisation of administrative routines.To enable the purchasing function to contribute to theseroles, purchasing strategies are needed. According to Gaddeand Hakansson (2001), three strategic issues need to beconsidered: (1) make or buy decisions, (2) supply basestructure, and (3) nature of customer supplier relationships.0019-8501/03/$ see front matter D 2003 Elsevier Science Inc. All rights reserved.doi:10.1016/S0019-8501(03)00010-5366A. Dubois / Industrial Marketing Management 32 (2003) 365374In this paper, we concentrate on the rationalisation role andhow it affects and is affected by the supply base structure andthe nature of buyer supplier relationships.The aim of the paper is thus to discuss how the purchasingstrategy may contribute to the rationalisation role of pur-chasing. In particular, it focuses on how changes towardshigher levels of involvement in buyer supplier relation-ships, in parallel to efforts to reduce the number of suppliers,may impact on the suppliers ability to contribute to costrationalisations.The first part of the paper focuses on purchasing strategiesand how they are assumed to contribute to the efficiency ofthe firm. Thereafter, cost rationalisation through supplierrelationships is discussed and Maintenance Repair andOperations (MRO) supplies are introduced as a particularlycomplicated purchasing area where there are typically largerationalisation potentials. A case dealing with MRO pur-chasing is presented in Section 3 and analysed in Section 4.Thereafter, the concluding discussion focuses on how andwhy strategies focused on high involvement with fewsuppliers can and should be successfully pursued. Finally,some managerial implications are addressed focusing on thetotal cost concept and the problems and potentials of itsapplication.2. Purchasing strategiesThere are different dimensions in which purchasingstrategies are described. There are also different suggestionsas when to apply different strategies, i.e., how to distinguishamong situations where they can contribute to the efficiencyof the firm. We focus on two such dimensions: the degree ofinvolvement in individual supplier relationships and thenumber of suppliers(Gadde & Hakansson, 2001; Gadde& Snehota, 2000). Gadde and Snehota propose involvementas a concept to describe the extent of integration in relation-ships. As such, it is useful to distinguish three dimensions ofinvolvement that affect outcomes in supplier relationships:coordination of activities, adaptations of resources, andinteraction among individuals.Recommendations for applying a strategy based on lowinvolvement with suppliers are based on the assumption thatinternal or indirect purchasing costs can be kept low whenthere are limited coordination, adaptation, and interactionwith individual suppliers. Furthermore, the price, or thedirect purchasing cost, is assumed to be low when severalsuppliers are played off against one another(Gadde &Hakansson, 2001).Strategies based on high involvement, on the other hand,are assumed to result in cost benefits in terms of reducedcosts in production processes and material flows as well asimproved service levels and flexibility. Furthermore, it ispossible for the customer to take advantage of supplier skillsand capabilities to improve the quality of its own productsand services, which, in turn, has revenue benefits (Gadde &Hakansson, 2001, p. 139). These gains, however, cannot beattained without substantial coordination, adaptation, and in-teraction, entailing costs. Hence, purchasing strategies basedon low and high involvement, respectively, are assumed tocontribute in different ways to the efficiency of the buyingfirm.Most current purchasing management literature suggests amixture of low and high involvement strategies in relation tosuppliers. Various purchasing portfolio models (e.g., Ben-saou, 1999; Kraljic, 1983; Olsen & Ellram, 1997) suggestdifferentiated purchasing behaviour for different categoriesof products and purchasing situations. Low involvement, orarms-length relationships, is suggested when the firmspower or bargaining position permits them to use a pricepressure strategy, while high involvement, and thus somesort of partnership, is suggested when interdependence onindividual suppliers cannot be avoided (Dubois & Pedersen,2002). There are typically two dimensions that determine thechoice of strategy for each product or purchasing situation:(1) the importance of purchasing and (2) the complexityof the supply market (Kraljic, 1983).If the buyer cannot avoid dependence on a particularsupplier, the portfolio models typically advise partnership,where the buyer and supplier become mutually dependent.Hence, high involvement relationships or partnershipswith suppliers are suggested as means of dealing with acomplex purchasing situation. However, as it entails recip-rocal dependence between the buyer and the supplier,partnerships are mainly seen as problematic and thussituations that should be avoided if possible.The number of suppliers is of importance in bothpurchasing strategies but for different reasons and in differ-ent ways. High involvement is commonly associated with asingle sourcing policy and low involvement with dual ormultiple sourcing (Gadde & Snehota, 2000). When pursuinga strategy based on low involvement, a number of compet-ing suppliers is necessary in order to achieve the lowestpossible price for each purchase. However, since there arecosts associated with playing the market (Hahn, Kim, &Kim, 1986), the number of suppliers used, or tendersrequired, has to be balanced against the potential gains inobtaining a low price.When a high involvement strategy is pursued, the numberof suppliers is of importance simply because it is not possiblefor a firm to cooperate closely with too many suppliers.Therefore, single sourcing is often suggested as a means ofreducing the supplier base and thereby of enabling closercooperation with the remaining suppliers (Gadde & Hakans-son, 2001). However, for most manufacturing firms, thevariety in their purchasing needs implies that the totalnumber of suppliers would remain large even if they con-centrated on one supplier per product. In this respect, it is notalways obvious exactlywhatis to be purchased. This isparticularly problematic because most existing models ofpurchasing are based on specified purchasing needs, whichare thus considered to be givens.A. Dubois / Industrial Marketing Management 32 (2003) 3653743673. Cost rationalisation through supplier relationshipsFor most companies, the costs of purchased goods andservices have come to account for the majority of total costs.The primary driving force of this development is the increas-ing reliance on outsourcing, making efficient purchasingactivities crucial to the financial performance of companies.Therefore,Monczka and Morgan (2000)argue that theremust be an absolute linkage of sourcing, purchasing, and thesupply chainto the financial plan and thus to the financialoutcome of the operations of the firm. The authors concludethat increasing attention to cost management is the mostimportant factor for the future of purchasing and supplymanagement. They also refer to numerous examples wherecompanies have been able to reduce purchasing costs. In mostcases, these efforts have concerned direct purchasing costs,such as price, transportation costs, etc. However, sometimes,the indirect costs associated with purchasing (e.g., costs ofwarehousing, administration of paper work, and supplierhandling costs) represent greater potential for rationalisation.The problem is that these costs are more difficult to affectbecause most of them can be tackled only through jointefforts with suppliers. Consequently, these costs are oftenneglected, and Monczka and Morgan (2000, p. 55) conclude:And regardless of all talk about strategic cost manage-ment, most companies are only at the tip of the iceberg interms of actual practicesin terms of looking at wherecosts reside, looking at cost drivers, building cross-enterprise strategies and share the results. All of thesepractices are going to need to be refined. Cross-enterprisecost is, and will increasingly be, critical to a firms success.It has been argued that purchasing of MRO items is one ofthe areas where actions to reduce costs across firm bound-aries are most evident (see, for example,Avery, 1997;Bechtel & Patterson, 1997; Le Sueur & Dale, 1998). Anumber of companies report considerable activities in mak-ing their MRO purchases more efficient (see, for example,Purchasing, 2001a,b,c and d). One example of what seem tobe a common tendency is MRO purchasing at Boeing, whereit is moving from a nonstrategic, ad hoc, decentralisedpurchasing activity to a more strategic and virtually central-ised purchasing practice (Purchasing, 2001d).According to Bechtel and Patterson (1997), purchases ofMRO items were previously based strictly on obtaining thebest price. Hence, buying firms tried to lower purchasingcosts by focusing on direct costs for individual transactions.When it became clear that substantial indirect costs accom-pany this purchasing orientation, firms began to makeinternal rationalisations of these purchases. In particular,the huge amount of paperwork generated appears to havebeen considered a problem. By introducing blanket ordersand system contracting the paper flow could be reducedconsiderably. In this way, the buying firms made it possibleto reduce the time spent on these purchases(Bechtel &Patterson, 1997). A further improvement of internal pur-chasing routines was made when purchasing cards wereintroduced. Using these cards meant significant administrat-ive processing savings, since purchasing requisitions andpurchase orders could be eliminated.However, internal efforts to reduce cost while maintaininga large number of suppliers can only take the firm to a certainpoint after which there are no additional cost rationalisationsto be obtained in-house. Therefore, companies seem to beabandoning this philosophy, favouring consolidation tofewer suppliers(Gadde & Hakansson, 2001). There areseveral examples reported where supplier base reductionsand centralisation of the purchasing function have gone handin hand. For example, before 1997, each of Whirlpoolsmanufacturing divisions purchased the MRO items theyused. While there was commonality both among itemspurchased by different divisions and the suppliers they wereusing, there was no central function to leverage buying. In1997, Whirlpool created a centralised purchasing organisa-tion for MRO and other indirect materials. Following thisreorganisation, Whirlpool has consolidated its spending withnational and regional suppliers. The new purchasing organ-isation has proven to be able to put good effective agree-ments in place with suppliers. According to the purchasingdirector, relationships with the right suppliers can helpWhirlpool minimise its risk, be competitive, and set newexpectations for performance(Purchasing, 2002b). SonyElectronics in Pittsburgh also reports savings from MROpurchasing rationalisation programs. The main activities inthe Sony program concern centralisation and consolidationto fewer suppliers. The benefits of the program are concernedwith leveraging of buying as well as with developingcommon standards and service requirements(Purchasing,2002a). Furthermore, John Deere now applies a formalisedstrategic sourcing process to its MRO purchasing (Purchas-ing, 2001a). The first step in this process was to select asupplier for each commodity group. These suppliers werechosen on the basis of their ability to provide all of the Deereplants in North America with full services. To be able toattain significant improvements in service and technicalsupport to the plants, Deere realised they had to reduce thesupplier base. Furthermore, it was necessary to assure thedifferent business units served that the suppliers selectedwould be delivering the equivalent, if not better, service thanprevious suppliers had been providing. These examplesillustrate how MRO purchasing has been improved byreducing the number of suppliers and by developing highinvolvement relationships with selected suppliers.In summary, the review of MRO purchasing practiceshows that reduction of the supplier base is a commoningredient in efforts to reduce costs, since the number ofsuppliers is considered a cost driver. Reducing the supplierbase is thus a potential tool for improving performance. Thecase presented in the next section illustrates how, by analys-ing its purchasing costs, one firm implemented a supplierbase reduction to enable a high involvement strategy inrelation to appointed key suppliers.3684. The case studyA. Dubois / Industrial Marketing Management 32 (2003) 365374revealed the following primary cost drivers: First, thenumber of firms in the companys supplier ledger wasThe case study was conducted in cooperation with asubsidiary of a large multinational company and specificallyinvolved a local service unit (LSU). The LSU provides fivebusiness units (BU) located at the same plant with variousservices (see Fig. 1). The LSU is responsible for MRO pur-chasing for the business units. It also buys MRO items forfour workshops (WS), carrying out technical service activ-ities within the LSU. The purchasing team consists of aboutseven buyers, but other employees are also involved in pur-