5 Reasons Supply Base Rationalization Can Be the Enemy of Effective Procurement Spend Management

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Traditionally, procurement organizations have been advised to consolidate their supplier base (with the handful of suppliers with the greatest percentage of purchases), negotiate strong contractual discounts and encourage their employees to purchase from these preferred vendors at the prenegotiated pricing.

On the surface, rationalizing an organization’s supply base can seem like an effective way to improve procurement performance. By rationalizing the number of suppliers that enterprises work with, procurement leaders can reduce costs, improve quality and save the time of procurement teams who are too often lost in the arduous process of managing indirect tail spend. However, due to the rise of more advanced B2B e-commerce platforms and highly volatile pricing fluctuations for products, the supplier consolidation strategy is quickly becoming outdated.

In reality, supply base rationalization results in many inefficiencies. In fact, such an approach can be the enemy of effective indirect spend management. To understand why and select the appropriate strategy for your organization, here are five reasons supplier rationalization may lead to missed savings, weaker supplier relationships and more.

1. Ignores the Positive Savings from Price Dispersion 

Although procurement professionals may not use the term in their daily lives, price dispersion is a key purchasing concept that is ignored in traditional supply base rationalization. Price dispersion is an economic scenario in which various sellers offer different prices for the same product in a specific market. It arises from a lack of price transparency across all sellers at any given point in time.

Research indicates that harnessing the power of price dispersion can be very effective for securing savings. Simply put, due to continual price fluctuations, even with the strongest negotiated contract pricing, no one supplier will provide the lowest-priced products all the time.

According to a 2006 research report from Ed Hopkins Economics1, economists who study price dispersion have found differences between the lowest and highest prices offered from various suppliers for the same products can average around 9%. However, with modern e-commerce systems and advanced pricing software, these price fluctuations can be even greater.

In a recent white paper published by Aquiire2 that analyzed samples of past purchases of large enterprises, their data analysts found that organizations can save more than 19% on their indirect spend by adding more suppliers into their private e-procurement marketplaces and selecting the lowest-priced products at the time of purchase via real-time comparison shopping. The research compared pricing in a competitive e-commerce environment and included approved (pre-negotiated) suppliers, contracted group purchasing organizations (GPOs) and select B2B e-commerce marketplaces.

The practice of rationalizing a supply base and asking employees to purchase from a limited number of approved suppliers prevents procurement organizations from realizing these savings benefits. And since no single supplier has the lowest cost on a specific product at every given moment in time, locking a few partners into a prenegotiated, catalog-based pricing for internal purchases prevents e-procurement users from accessing the benefits of price dispersion—except when they go rogue and purchase outside of the procurement platform.

2. Leads to Increased Maverick Spend

When organizations push too hard to consolidate suppliers, they inevitably reduce the number of catalog items available to users. This in turn pushes users out of the system, leading to increased maverick spend.

A UPS Study3 shows that the Millennial generation will have the most impact on the future of B2B buying,  and will dramatically reshape purchasing policies as they advance their careers in procurement. The study reveals a significant loss in direct distributor sales among Millennial buyers due to their strong preference for competitive purchasing from e-marketplaces. The report reveals that if this generation is restricted in their purchasing choices, they will go rogue and seek out buying options outside of the procurement process.

The consequences of such behaviors are troubling. In additional research compiled by Aquiire4, up to 20% of expected savings is lost on products purchased outside of the prenegotiated supplier contracts, and about 33% of total products purchased by enterprise employees were outside of procurement.

The risk of increased maverick spend is in many ways tied to the end user’s expectation of a consumerized experience when using e-procurement software, which when left unmet, ultimately leads to purchases from third-party sites like Staples, Amazon or local stores. And for enterprises with hundreds of millions of indirect purchases each year, the losses really add up.

According to a study5 Spend Matters conducted on tail spend management, corporate e-procurement tools don’t currently fare well against the top 10 consumerized capabilities that were considered most valuable from a survey of procurement professionals. The top three included complete self-service shopping, breadth of supply selection and the ability to flexibly search and find what they need. Only 16% of study respondents were “net promoters” of their e-procurement technology providers (i.e., many would not strongly recommend their current technology providers to their peers).

All three of the above capabilities are areas harmed by supply-base consolidation. By reducing supply selection and boxing users into a smaller number of choices without a competitive shopping environment, procurement organizations risk driving users away from their e-procurement systems and into the Wild West of off-contract internet shopping. This not only leads to lost savings and a lack of spend visibility, it also reduces compliant spend and revenues for your strategic suppliers.

3. Weakens Procurement’s Negotiating Position

In addition to issues with poor internal user adoption and lost savings opportunities, supply base rationalization can also backfire with suppliers themselves by reducing a business’ negotiating leverage. Organizations are becoming aware that they must fully integrate and collaborate with suppliers to remain competitive and achieve procurement excellence.

The consolidation approach may work for direct spend, which is managed expressly by procurement and can benefit from an optimized approach to supply chain management. But extending the concept to indirect spend without fully understanding the differences between the two spend types can lead to unintended consequences.

Progressive indirect purchasing organizations are beginning to change their procurement strategies to bring more suppliers in comparison/compliant shopping environments. When organizations have a larger mix of suppliers, they encourage a natural competitive dynamic in the supply base. Suppliers who show deficient performance (i.e. lackluster quality scores, poor on-time delivery, and higher costs) are automatically “optimized” through negative supplier/product user reviews and lower-placed search ranking results within the competitive marketplace.

When suppliers recognize that their products are not the only purchase options for a specific category of spend, they will instinctively strive to be more responsive, flexible and provide the best pricing to win business—leading to self-service collaborations and improved services. Selecting only one or two large suppliers to service a specific category of spend eliminates this leverage, exposing procurement to unexpected prices increases and a less cooperative supplier relationship.

Ultimately, consolidation can be a useful tactic to secure indirect savings, but the consolidation should be at the point of purchase within the internal marketplace, not with the supply base. Additionally, by maintaining and measuring historical pricing data in categories of spend, procurement will have the actionable information they need to not only show their suppliers the categories where their pricing is higher than their competitors, but also missed sales opportunities resulting from their employees selecting lower-priced alternatives.

When an e-procurement system provides real-time search capabilities and pricing integration, it makes an organization a more attractive sales channel for suppliers. As user adoption and purchasing increases through the e-procurement marketplace, supplier sales will also increase (even in a competitive shopping environment), leading to better contract negotiations that benefit both procurement and suppliers, increasing the value of the relationship and driving additional cost savings.

4. Increased Risk of Price and Product Creep 

Containing costs and preventing unnecessary purchases are top challenges for any CPO. But a well-negotiated contract means nothing if the discounted prices are not reflected at the time of purchase.

As a contract matures, unchecked pricing commonly “creeps” up far beyond the agreed amount in many categories. This is because most procurement organizations lack the analytical tools to continuously compare contract pricing with actual purchases, and without proper compliance controls or rules-based workflows, e-procurement users will unknowingly walk into an uncompetitive pricing scenario.

Some increases occur for valid reasons, but that’s not always the case. Some companies use price creep as a deliberate business strategy to secure more profits. They offer a product at a low price at contract negotiation, set up a private e-commerce (punchout) website with specific pricing, then once customers start buying it, slowly start hiking the pricing.

Additionally, due to advanced technologies, pricing fluctuations have become much more volatile as a growing number of retailers and suppliers are using software that automatically change online prices based on factors including demand, competition, inventory and even the temperature and time of day! This “price optimization” is a method applied via their software that automates the ideal price for a product to a potential buyer in various channels. This, of course, is used to maximize revenues for the supplier.

Consolidation of suppliers into a non-competitive environment only adds to the possibility of price and product creep. Often, lengthy audit processes are needed to uncover these issues, resulting in lost time and few guarantees to recapture lost savings. Maintaining a competitive supply base, complemented by real-time audit checks will reduce these risks and protect against lost savings before the price discrepancy takes place—not months after.

5. Reduced Supplier Diversity, Flexibility and Innovation 

As leading procurement organizations understand, internal B2B purchasing entails far more than lower pricing and the availability of stock. Ultimately, the suppliers that procurement chooses to collaborate with can also provide access to innovative new solutions.

The U.S. Census Bureau estimates that racial and ethnic minority groups will compose a majority of the U.S. population by 2042. Yet while minority-owned firms have historically accounted for 51% of all companies in the U.S., these businesses only realized 10.9% of overall revenue, according to a 2012 Pew Research study.

However, according to The Minority Business Development Agency, minority-owned firms outpaced the growth of non-minority firms in gross receipts (55%), employment (27%) and number of firms (46%). These statistics indicate smaller diversity suppliers are starting to dramatically impact the supply chain and provide outstanding opportunities to contribute directly to a competitive purchasing environment as their B2B e-commerce capabilities continue to improve.

A study6 by the Hackett Group showed the greater financial benefits of securing business relationships with diverse suppliers. Based on a study of 50 companies from both the service and manufacturing sectors, the research demonstrated that companies with a strong diversity focus generated an average of 133% greater procurement ROI than the average comparable business and drove an additional average of $3.6 million to a company’s bottom line.

As businesses and customers become more diverse, it makes sense that so too should an organization’s supply base. But this is not just about creating good PR or achieving internal diversity goals. Research shows that diverse suppliers tend to be smaller businesses that offer greater flexibility, better hands-on support, lower cost structures, more creative resources and patents on new, innovative problem-solving products.

A heavily optimized supply base will restrict businesses access to a wide variety of MBE, women-owned, environmentally-friendly and local suppliers. If the ultimate goal is to drive more value to your organization and stakeholders, then building a diverse, competitive supply base, facilitated by easier self-service supplier onboarding and management features, should be a top priority for procurement.

Changing Perspectives 

Labeling supplier rationalization as an ineffective approach to spend management may seem counter intuitive. Certainly, there are several strong reasons why this strategy became a traditional approach. From the time savings of negotiating with numerous suppliers to the trend toward outsourcing indirect spend to third parties (e.g., group purchasing organizations), procurement organizations struggled to prove the ROI of maintaining a more complex and dynamic supply base.

But technology has changed the equation for determining the ideal supplier count. New e-procurement solutions are emerging that can connect businesses and their partners in real time, facilitate quick and easy supplier management, and provide real-time competitive purchasing dynamics that lead to improved user adoption, lower costs, compliant shopping and easier (and more valuable) supplier collaborations.

Consequently, supplier rationalization is quickly becoming a strategy of the previous decade. Just as procurement organizations expect to begin employing cloud-based software that utilizes artificial intelligence, machine learning and real-time data to transform their indirect e-procurement strategies, they’ll also begin to take a fresh look at how they can deliver more value and savings for their organizations by welcoming more suppliers into their base—not less—and organizing them in new ways only possible with modern technologies. 

References 

  1. Ed Hopkins. "Price Dispersion." The New Palgrave Dictionary of Economics. Second Edition. Eds. Steven N. Durlauf and Lawrence E. Blume. Palgrave Macmillan, 2008. The New Palgrave Dictionary of Economics Online. Palgrave Macmillan. 06 April 2017. Retrieved from
    http://www.dictionaryofeconomics.com/article?id=pde2008_P000368
  2. “Reshaping Traditional eProcurement to Achieve Extraordinary Savings on Indirect Spend.” Retrieved from https://www.aquiire.com/2017/08/22/white-paper-reshaping-traditional-eprocurement-achieve-extraordinary-savings-indirect-spend
  3. “UPS Industrial Buying Dynamics Study: Buyers Raise the Bar for Suppliers.” Retrieved from: http://www.sipotra.it/wp-content/uploads/2017/06/UPS-Industrial-Buying-Dynamics-Study-Buyers-Raise-the-Bar-for-Suppliers.pdf
  4. “Evolving Indirect Purchasing: Traditional vs. Real-Time eProcurement in the ‘Now Economy.’” Retrieved from: https://www.aquiire.com/2017/12/05/evolving-indirect-purchasing-traditional-vs-real-time-eprocurement
  5. Spend Matters. “Fix the Tail to Propel Procurement: Attacking the Tail Spend Problem in B2B.” Retrieved from: http://spendmatters.com/research/fix-tail-propel-procurement-attacking-tail-spend-problem-b2b/
  6. The Hackett Group. “Top Supplier Diversity Programs Broaden Value Proposition to Drive Increased Market Share, Other Revenue Opportunities.” Retrieved from: https://www.thehackettgroup.com/news/top-supplier-diversity-programs-broaden-value-proposition

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Voices (5)

  1. Karri Suosara:

    Hello Nick,

    Very interesting short study. Thank you. May i quote you and this article when discussing the subject in business world?

    BR, Karri

    1. Nick Heinzmann:

      Hi Karri,

      Glad you liked it! Please feel free to quote us and point to where you read the article as needed.

      Thanks,
      Nick

  2. Sue Hope:

    Excellent article which shows the depth of the problem and how much thought and analysis should go into making decisions to result in an optimal supply base. The analysis is not difficult as such but it is time consuming and requires considerable detailed focus. I would suggest it will be well worth the investment.

  3. Peter Sammons:

    Useful and thought provoking article. Thank you.

  4. Peter Smith:

    Nick, this is excellent. I’ve written about this issue many times over the years but this is as insightful and wide-ranging a review as anything I haveever seen on the topic. As I said here, http://spendmatters.com/uk/finding-new-suppliers-right-sizing-supply-base-sensible-procurement-objectives/, the objective for procurement should always be to get the RIGHT number of suppliers for each product / category we buy. That number might be one, it might be 1001. I accept many firms have more suppliers than the optimum, but unthinking goals to “reduce supplier numbers by 50%” are almost always useless and self-defeating.

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