To make the best possible profit, you need to maximize your revenues and minimize your costs. There are plenty of tools that can help you think about increasing revenues. But what about reducing costs? In particular, how can you reduce the cost of the resources that you're purchasing, without exposing yourself to an unacceptable level of risk? This is where a tool like the Kraljic Portfolio Purchasing Model can be particularly useful.

Classify your purchases. ©iStockphoto/Maxian

1. Purchase classification.
2. Market analysis.
3. Strategic positioning.
4. Action planning.

• Supply risk is high when the item is a scarce raw material, when its availability could be affected by government instability or natural disasters, when delivery logistics are difficult and could easily be disrupted, or when there are few suppliers.
  
  
• Profit impact is high when the item adds significant value to the organization's output. This could be because it makes up a high proportion of its output (for example, raw fruit for a fruit juice maker) or because it has a high impact on quality (for example, the cloth used by a high-end clothing manufacturer).

• Non-critical items (low profit impact, low supply risk)
  
  Purchasing approaches for these items include using standardized products, monitoring and adjusting order volume, and optimizing inventory levels.
  
  
• Bottleneck items (low profit impact, high supply risk)
  
  Useful approaches here include over-ordering when the item is available (lack of dependable availability is one of the most common reasons that supply is unreliable), and looking for ways to control vendors.
  
  
• Leverage items (high profit impact, low supply risk)
  
  Purchasing approaches to consider here include using your full purchasing power, substituting products or suppliers, and placing high-volume orders.
  
  
• Strategic items (high profit impact, high supply risk)
  
  These items deserve the most attention from purchasing managers. Approaches include developing long-term supply relationships, analyzing and managing risks regularly, planning for contingencies, and considering making the item in-house rather than buying it, if appropriate.
  
  Note that step 3, below, provides detailed options for the best purchasing approach for these items, after considering other factors.

• Exploit: Make the most of your high buying power to secure good prices and long-term contracts from a number of suppliers, so that you can reduce the supply risk involved in these important items. You may also be able to make "spot purchases" of individual batches of the item, if a particular supplier offers you a good deal.
  The only real caution is not to take any aggressive approach too far, just in case circumstances change.
  
  
• Balance: Take a middle path between the exploitation approach and the diversification approach described below.
  
  
• Diversify: Reduce supply risks by seeking alternative suppliers or alternative products. For example, in our logistics example, could you use the railroad to ship some of your overland freight instead of relying solely on trucking companies?

A Final Note from James

When you're making decisions, it's all too easy to overlook key factors or allow opinion to cloud your judgment. That's why tools like Kraljic's Portfolio Purchasing Model are invaluable, as are the many other decision making and strategy tools (member only) at Mind Tools. Whether you're in purchasing or in any other business function, I urge you to try out these tools out for yourself to sharpen up your own decision making.

Look out for the next newsletter from Mind Tools in two weeks time, when we'll be looking at the challenges of doing more than one job, and asking you "How Good Are Your Project Management Skills?"

Until then, have an excellent two weeks!

James Manktelow email us Mind Tools Essential Skills for an Excellent Career!