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:
- Arbitrary Reduction.
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 the objective of supply base reduction, this is a flawed strategy nonetheless that should be avoided altogether or executed with pragmatism.
- Top Spend Approach.
Typically 20% of the suppliers’ factor for 80% of the company spends dollars because they have a history of dependability or buyers are used to doing business with them. 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, procurement organizations should always try to develop one or more back up sources in efforts to limit or eliminate reliance on the sole or single sources. Additionally, a sole source is often associated with inherent risks of price escalation and supply line disruption if their single location plant is damaged due to a catastrophic event.
- Quality & Delivery Threshold.
This is a simple and straightforward yet very effective approach. Specific thresholds for acceptable quality level and on time delivery are established and communicated to the suppliers. Suppliers that fail to meet these criteria during the pre-defined time period are then dropped from the supplier base. Only those suppliers that are fully committed to continuous improvement usually succeed in staying on while marginal performers get eliminated.
- Dormant / 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. Vendor data base should be checked regularly to weed out dormant and duplicate suppliers in order to maintain the integrity of supplier base.
Once the ineffective and marginal suppliers are identified and eliminated, the next logical step is to add new and more competent suppliers through robust supplier selection process. Supplier rationalization is a continuous process that requires ongoing maintenance of the supply base by 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. Now that you know how other companies are managing this process, tell us about your approach to supply base rationalization and how it is working for your company.
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 Procurement Sense readers please contact us.