Spend Matters welcomes a guest post from Joshua Nelson, Director in the Strategy and Operations Practice at the Hackett Group.
During the past two decades, companies have adopted strategies to rationalize and consolidate their supplier base. In many cases, the supplier rationalization programs have created a single sourcing strategy for many commodities. This strategy has enabled companies to build stronger and more collaborative relationships that deliver a range of benefits, including:
- Improved bargaining power to reduce costs
- Decreased effort to track supplier performance and manage relationships
- Improved innovation and design collaboration
- Improved plan synchronization and information exchange
- Improved supplier responsiveness
The strategy has been well proven and many companies have been able to gain a competitive advantage by enhancing the capabilities of their supply chain. The realization of cost savings has been further enhanced by another mega-trend in supply chain management - the globalization of the supply chain and the use of low-cost country sourcing.
Though globalization has contributed significantly to cost reduction objectives, it has extended the length of the supply chain and has made companies more susceptible to supply chain risks. A summary of supply chain risks that companies must now manage is presented in Figure 1 below.
When evaluating the use of global sourcing and single vendor sourcing, many procurement managers have become very concerned about their risk exposure and are seeking options to mitigate risk. According to The Hackett Group's Key Issues Study conducted in 2012, mitigating supply chain risk has been identified by 77% of supply chain executives as a key issue that must be managed (see Figure 2).
The emergence of supply chain risk mitigation as a key issue has caused many procurement managers to reassess their reliance on single sourcing strategies. Before embarking on a change in sourcing strategy, it is important to evaluate the supplier relationships for each category of good and assess supply chain risk holistically, across all risk categories. For example, while multiple vendor sourcing may reduce dependency on a single vendor and reduce capacity risks, it may increase other supply chain risks, such as quality, contractual, or management risks. An objective evaluation will assess total risk and guide procurement managers to the appropriate sourcing decisions.
Evaluating Supply Chain Risk Associated with Single vs. Multiple Vendor Sourcing
To begin the evaluation it is important for the buying manager to assess the significance of the business (category and overall relationship) to both the supplier and the buying company. The analysis will reveal mutual vs. lopsided dependencies on both sides, as Figure 3 demonstrates.
Supply chain risks are higher in a lopsided dependency scenario as the relationship between the two trading partners is asymmetrical. In this scenario, both sides will not consistently respond to issues with mutually beneficial behavior. For example, in the event that the buying company is more dependent than the supplier, the buying company will count on reliable, defect free supply of goods. If an issue arises and/or the supplying company becomes capacity constrained the likelihood that the supplier responds to other customers first is very high. In this scenario, a transition to a multiple supplier strategy would help mitigate supply risks and reduce the buying company’s reliance on one supplier.
The other lopsided dependency occurs when a supplier is highly dependent on a relationship that the buying company holds with low importance. In this scenario, if a supplier is highly reliant on sales of a category of low importance to the buying company it may not have the resources or flexibility to adjust to changes in demand and/or lead time. If demand increases, the supplier may not have the capacity to respond quickly enough, resulting in a capacity risk. If demand drops significantly, the supplier may have difficulty remaining financially viable. To manage these risks, a multiple sourcing strategy would be beneficial to the buying company, as demand would be spread across a number of suppliers that, collectively, would have more capacity and be more responsive to the buying company.
In the case of high mutual dependency, both sides will regard the relationship with high importance. In the event of demand shifts, the supplier will be more responsive and more flexible to meet the needs of the buying company. Further, both sides will have more motivation to reduce costs, improve designs, and deliver higher quality. For a relationship with mutually high dependence maintaining a single sourcing strategy is advantageous. Splitting demands would only make the supplier less responsive and would make it more difficult for them to dedicate resources to resolving quality and/or capacity issues.
In summary, the decision to use a single vs. multiple vendor sourcing strategy will vary depending on the category and relative importance of the relationship between trading partners. Procurement managers should assess the supplier relationship dependencies and evaluate scenarios by measuring the probability and severity of risk. The scenarios can be compared using a single vs. multiple vendor sourcing strategy. The results of the analysis will vary by company and category but will follow the major themes below:
- If both sides are mutually dependent on each other, a single sourcing strategy can have many risk reducing effects on the supply chain. Companies should continue to enhance supplier relationship management programs with these suppliers.
- Lopsided trading partner relationships will present the greatest opportunity to reduce risk by using multiple vendor sourcing strategies. These strategies will decrease the severity of a problem as buying companies can quickly initiate alternate supply plans with other suppliers.
Joshua has over 16 years of experience managing and leading supply chain, operations improvement, and product development teams to deliver solutions to strategic problems.