Supplier Segmentation for Efficient Purchasing

In an environment characterized by scarce resources, increased competition, higher customer expectations and faster rate of change, organizations are finding it increasingly difficult to compete effectively, generating suitable profits at the same time providing quality products within cost limits to the consumer. The enhanced level of competition has constrained the suppliers ability to increase prices, while at the same time increasing input costs have eroded profits. Faced with these problems corporations today are exploring different means of cost reduction. This has brought into focus an important but seldom celebrated function, i.e., Procurement, as an effective means to reduce costs while at the same time maintaining quality. Though procurement generally accounts for nearly 60% of the total spend of an organization, it is only in recent times that it has come to be seen as more of a control tool rather than just a support function As organizations move towards making their procurement processes more efficient and more in line with their strategic plans, attention has also shifted towards one of the most crucial aspects in supply chain management, i.e., Supplier Relationship Management. Wikipedia describes SRM as SRM is a discipline of working collaboratively with those suppliers that are vital to the success of your organization to maximize the potential value of those relationships. The basic motive of SRM is to develop a two mutually beneficial relationship between an organization and its strategic supply partners. Organizations, across different industries, typically use a number of suppliers for raw materials and for intermediate goods. In such an arrangement, how well a company does, the quality of its products and its ability to deliver products on time to the consumers is dependent on the suppliers and thus it is necessary to have some sort of synergy between an organization and its suppliers so as to ensure proper return for both the stakeholders in the relationship. As the production levels increase, companies will have to outsource more parts of their work to different suppliers in order to meet demand and to reduce costs, making it more important for organizations to better manage their suppliers and thus risks and vulnerabilities in their supply chains. So the question is how will supplier segmentation help companies better manage their suppliers? Organizations these days generally employ a number of suppliers, and it is a known fact that there is a different approach for different types of suppliers. An excellent process for one relationship may be completely wrong for another. Companies that try to use the One size fits all approach soon discover that this can be a source of significant problems. The kind of relationship fostered with supplier of a customized critical component differs a lot from that with a supplier of standard equipment, and using the same tools in both situations results in a misalignment of strategic goals and wastage of corporate resources. Breaking suppliers into different groups in terms of what were looking for from them and taking the supplier-relationship management to the next level, which is to segment based on what the suppliers can do versus our objectives, and then being

willing to invest in those suppliers to be able to drive value is the major goal of segmentation. In a highly competitive market situation and rising commodity costs, there is a trend towards reducing the number of suppliers an organization uses. This helps companies in consolidating their purchases and negotiating better prices. There is however only a limited amount of benefit to be derived from the above strategy and organizations have started searching for newer areas of cost reduction. In this regard Supplier Segmentation has emerged as a highly effective means to further reduce costs and at the same time establish relationships that move beyond the transactional level. You cant have deep, collaborative relationships with all your suppliers, and you need to really identify which ones are the players Supplier segmentation helps organizations to align allocation of limited resources with their strategic goals. It helps in clarifying roles, responsibilities, actions and expectations of both the parties at every point of contact. It helps in building preferential relationship with different suppliers and thus better allocation and utilization of limited management time resources. A large number of suppliers usually lead to little time spent per supplier and thus it becomes difficult for organizations to analyze the supply base as well as prevent maverick suppliers from being added and thus segmentation acts as a critical tool to maintain the quality of their supply base. The obvious question now is on what criterion do we segment the suppliers? A number of factors need to be considered before an organization decides to segment its suppliers. The most obvious factors for differentiation would be the level of spend by amount, the volume of procurement, the strategic importance of the supplier, the number of units of the company being served by a particular supplier and the type and number of products or services a supplier provides. Others factors to be considered include the degree of interdependence between the supplier and client, the complexity and frequency of changes in supplier requirements, the cost and difficulty associated in switching suppliers, the criticality of the service level needed , the suppliers anticipated quality level and the suppliers technological capability and compatibility with the organizations processes. Depending upon the criterion specified above the suppliers can in general be classified into four different categories. These are defined below: 1) Bottleneck Supplier: Only a few suppliers are usually present in this category. Bottleneck products are those that can be acquired from only one supplier and their delivery is otherwise unreliable and these items have a low impact on the financial results. However the unavailability of these items may lead to production stoppage. The buyer-supplier relationship in case of these suppliers is usually supplier dominated with a moderate level of interdependence. Organizations should direct medium to low resources towards such suppliers. 2) Routine Supplier: Suppliers in this category usually provide products of standard specifications for which a number of suppliers are usually available in the market. As a result it is easy to switch suppliers. The relationship is on the whole evenly balanced. 3) Collaborative Suppliers: These constitute a high percentage of the organizations total spend. Generally several come in this category and thus a number of alternatives are available for the buyer. The products supplied by these suppliers are somewhat differential in specification.

4) Strategic Suppliers: These are the most important type of suppliers as they usually are critical for an organizations competitive advantage and for ensuring profitable growth and as such the highest amount of the companys resources should be directed towards these suppliers. An organization typically has a small number of such suppliers and thus these are difficult to replace. They supply non standard products with unique specifications. Such relationships are usually focused on development and driving performance to the next level. Effective supplier segmentation yields many benefits both within the procurement department and across the various business units involved. It provides organizations the opportunity to not only negotiate the best prices for the product or service being sourced, but also the ability to negotiate contracts of appropriate duration and with the appropriate level of oversight. Supplier segmentation is a multi-dimensional and dynamic process, and for it to be effective it is crucial to consider the different stakeholders involved. The same supplier may have different strategic value to different business units within the same company and thus it is necessary for organizations to constantly review whether their strategic objectives are still in alignment with their segmentation strategies.