As businesses grow and scale, oftentimes, so does their supply base and the number of suppliers they work with. As you grow, you want to optimize your supply base. According to Industry Star, most businesses spend 80 percent of their cost of goods sold (COGS) with just 20 percent of their suppliers.
Supply base optimization ensures that you are focusing on working with suppliers that are the most productive and beneficial to your business.
Here’s everything you need to know.
First thing’s first: what is supply base optimization?
Supply base optimization is a strategy used to reduce the number of suppliers you work with, especially those who are inactive or limited-use suppliers. This way, organizations can spend more time with fewer suppliers.
Effective supply base optimization can help reduce costs, improve supply chain efficiency, better supplier performance and collaboration, and increased revenue.
6 steps for successful supply base optimization
Now that you know what supply base optimization is, how do you actually go about doing that? Supply base optimization requires a strategic plan so you can reduce the number of suppliers you currently have, and spend more time with the ones who are adding value to your organization.
Here’s how you can get started:
1. Analyze your current suppliers
The first thing you want to do is analyze your current supplier spend, business capabilities, and performance. Take a look at the past three or four quarters and consider factors such as:
- Last PO issue date
- Monthly or quarterly usage
- Current inventory
- Lead time
- Payment terms
- Supply performance ratings
One way to assess your current supplier outlook is to conduct an onsite or offsite supplier audit. When you conduct an audit, focus on things like each supplier’s performance data, product and process management, how the company operates, the structure of their quality management system (QMS), and personal interactions with other staff.
Once you’ve completed an objective analysis, group your suppliers into:
- A: High-performing suppliers
- B: Low-performing suppliers that have missed performance goals
- C: Suppliers who can’t meet current or future performance goals.
2. Determine your selection criteria
Once you’ve analyzed your current suppliers, determine which suppliers you’d like to continue working with.
This is a crucial step and should be a top priority. Selection criteria could include quality of the product, processes, meeting business objectives, operational policies, and certifications. Ideally, you want your suppliers to deliver high quality products and services within the required timeframe at a reasonable price.
3. Track supplier performance
Over a period of time, track your suppliers’ performance against set KPIs. Keep this data handy and track things like whether the order is correct, delivery times, response times, and quotes.
4. Rationalize your supply base
When you rationalize your supply base, you reduce the number of active suppliers. Take a look at your suppliers’ current spend, capabilities, and overall activity and performance.
From here, determine who are the most valuable suppliers. Rationalizing your supply base will help streamline your organization’s spend. We’ll take a look at how to rationalize your supply base in the next section.
5. Create a transition plan
Once you’ve rationalized your supply base, you’ll likely need the leadership team to sign off on it. Create a thorough transition plan including timelines, budget, and cross-functional coordination.
You’ll also want to secure written agreements from any new vendors or understand if any contracts have changed with current vendors. Make sure to clearly communicate this plan to the leadership team and the rest of the company so that everyone is on the same page throughout the transition period.
6. Ongoing supplier management
Now, supplier management should be easier and more efficient. You may be able to get some suppliers to review their internal processes or re-sign their contract. Getting to know your suppliers allows you to improve transparency, negotiate deals, build trust, and optimize your supply base all at the same time.
Creating a manageable supply base with supply base rationalization
As organizations grow, supply bases also tend to grow. This is especially true in companies with multiple locations. Effective supplier base management 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 and delivery performance all translate into resource and transaction costs. Naturally, the larger the supply base, the 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 the right capabilities to meet the company’s requirements for goods and services. This process is also the crucial first step towards supplier development and supplier optimization.
It is imperative to bring the supplier base to a manageable level in order for procurement organizations to do an effective job of managing supplier performance. What’s more, 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. 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 not only comprises highly capable suppliers, but also remains consistently at manageable levels.
Here are some ways you can use supply base rationalization strategies to create a more manageable supply base:
Some companies arbitrarily slash the number of suppliers to half, or even a lower number, as mandated by the senior management. These companies often have poorly-defined supplier reduction criteria and perform this task in a haphazard manner much like a shotgun approach to the problem.
Yes, the goal of supply base optimization is to reduce the number of suppliers. But with arbitrary reduction, companies 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 that should be avoided altogether or executed with pragmatism.
Top spend approach
Typically, 20 percent of suppliers account 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 the lower tier of those 80 percent of suppliers who receive a 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 a 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. For example, in manufacturing, individual suppliers may specialize in producing items such as machine parts, sheet metal parts, cables and harnesses, electronic components and/or PCBs to name a few.
They are leaders in those categories and as such a logical choice for keeping them in the supply base. However, sometimes a supplier may 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, you should 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 also brings a number of risks including price escalation and supply line disruption. For example, if they take damage to their single location or product and you don’t have a backup supplier, 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. Suppliers who commit to continuous improvement will stand the test of time, while 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 the 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.
Benefits of supply base optimization
1. Cost reduction
When you reduce the number of suppliers you work with and synchronize your supply chain systems, you’ll also reduce your costs. You’ll save money in warehousing, transportation, logistics, and inventory management.
2. Improved supply chain visibility and access to information
Supply base optimization will also visibility into the overall supply chain. With fewer suppliers, everyone has easy access to the project and progress.
A lean supply chain also allows you to make strategic business decisions based on real-time information. You can see which suppliers are performing well and which ones aren’t. It’s also easier to identify where bottlenecks are occurring in your supply chain.
3. More effective supply chain collaboration
Supply base optimization allows for more collaboration with your suppliers and other partners. Using supply chain technology such as automation and analytics will also help organizations work with their partners and provide visibility into all supply chain operations. This will help reduce inventory, improve fulfillment times, and increase profitability.
4. Increased sense of control
Optimizing your supply base increases everyone’s control. Vendors have more direct access to the organization they are working with, senior leaders have more control and insight into sales forecasting, cash flow, and other KPIs, and it’s easier to ensure that everyone is following the proper rules, policies, and procedures.
Although supply chains are constantly changing, one thing that isn’t changing is that consumers want high-quality products delivered in a reasonable amount of time for a reasonable price.
As organizations grow and scale, so does the supply base. It’s important to keep an eye on how many suppliers you are currently using. There’s no magic number of suppliers that you should be using; you should do what works best for your business. When you’re optimizing your supply base here are some things to consider:
- Are there redundancies in your supply base?
- Do you have underperforming suppliers?
- Are their gaps in your supply base (ie. not enough suppliers)?
- Do you have too many suppliers?
At the end of the day, you need to find the right balance. You want to make the most of your resources to have a cost-effective, efficient supply chain that can deliver high quality products and services to your customers and having good relationships with your suppliers can help make that happen.
Editor's note Original publish date: 8 Oct 2014 Original author: Omar Khan We've since updated and republished this blog post with new content.