Supply base rationalization: How to create a manageable supply base for supplier optimization
A supply base tends to grow large over the years especially in companies with multiple locations. At the same time, effective management of supplier base requires substantial resources proportional to the size of supply base. Most procurement professionals agree that every interaction with suppliers has a cost associated with it. Activities such as visits to supplier sites, processing RFQs, POs, invoices or tracking their quality & delivery performance all translate into resource and transaction costs. Naturally, larger the supply base, more difficult and expensive it is to maintain it. That’s where “supply base rationalization” comes in. The goal of this process is to determine the right number of suppliers with right capabilities to meet the company’s requirements for goods & services. This process is also the crucial first step towards supplier development and supplier optimization.
It is, therefore, imperative to bring the supplier base to a manageable level in order for procurement organization to do an effective job of managing supplier performance. Furthermore, a poorly managed supply base presents many supply line risks. Suppliers who have marginal performance, limited plant capacity or inadequate financial capability all present ongoing risks to a company’s supply chain and as such systematic elimination or replacement of these suppliers is warranted. For these reasons, a procurement organization has vested interest in taking necessary steps to ensure the supplier base is not only comprised of highly capable suppliers but also remains consistently at manageable levels. Companies have used some or all of the following approaches to rationalize their supply bases:
Some companies would arbitrarily slash the number of suppliers to half in size or even a lower number as mandated by the senior management. They often have poorly defined supplier reduction criteria and perform this task in a haphazard manner much like a shot gun approach to the problem. As a result, they end up eliminating good with the bad to the detriment of the company’s supply chain. While this might be the quickest way to achieve supplier optimization, this is a flawed strategy nonetheless that should be avoided altogether or executed with pragmatism.
Top spend approach
Typically, 20 percent of suppliers factor for 80 percent of company spending. A history of dependability goes a long way. Some companies use this factor as a criterion to reduce the supplier base by eliminating lower tier of those 80% suppliers who receive smaller share of the business. One obvious disadvantage of this approach is that some really competent suppliers get eliminated merely because they were getting a smaller share of the business dollars. On the other hand, suppliers getting bigger share of the business may not necessarily be the best performers in one or more categories. As such, this approach requires care and due diligence to avoid getting blind-sided.
Best in the category
Many suppliers have expertise in one or more categories or groups of purchased items like machined parts, sheet metal parts, cables & harnesses, electronic components and or PCBs to name a few. They are leaders in those categories and as such logical choice for keeping them in the supply base. However, sometimes a supplier would be doing business across two or more categories while they are best only in one category. Accordingly, they can be retained as prime source in one category and back up source in the other categories.
Sole source suppliers
Some suppliers have unique capabilities to manufacture highly critical products that others cannot produce. These suppliers are essential to business success and as such must remain in the supply base. That being said, never rely on a sole vendor for your procurement. Instead, have backup sources and eliminate the risk of monopolized vendors in your system. Ultimately, a sole vendor brings risks including price escalation and supply line disruption. If they take damage to their single location, it’s game over for you.
Quality and delivery threshold
This is a simple and straightforward yet very effective approach. Establish specific thresholds for acceptable quality level and on-time delivery and communicate to suppliers. If they don’t need the criteria you’re after, drop them from the supplier base. Supplier who commit to continuous improvement will stand the test of time. Others will drop off. Whatever, the case, don’t compromise on quality.
Dormant and inactive suppliers
Interestingly, some suppliers do not receive a single purchase order for months or years, yet they continue to remain on the vendor base. Generally, this happens when a purchasing organization doesn’t have enough time or resources to efficiently manage the vendor database. It is imperative to identify and delete such suppliers from the database or replace them with good reliable suppliers. You need to check vendor data regularly to weed out dormant and duplicate suppliers. This helps you maintain the integrity of supplier base.
After eliminating ineffective and marginal suppliers, the next logical step is to add new competent suppliers through a selection process. Supplier rationalization requires ongoing maintenance of the supply base. It’s all about replacing good suppliers with better or the best ones. The ultimate goal is to create a manageable, risk-free, and optimized supply base and cultivate lasting business relationships with suppliers.
We want to hear about your approach to supplier optimization and how it is working for your company. Comment in the thread below!
This is a guest post by Omar Khan, a career procurement professional with more than 30 years of experience. If you’re interested in sharing your knowledge with Spend Culture readers please contact us.