Concentrating and Consolidating Spend – Be Aware of the Risks

This is the latest in a monthly series of articles addressing supply chain risk issues, in conjunction with our sponsors riskmethods, who provide technology that helps firms monitor risk, minimise the impact and proactively take action to mitigate risk.

One of the major corporate procurement trends in recent years has been to consolidate spend. Almost every “procurement transformation programme” or conference speech from a new Procurement Director or CPO will talk about reducing supplier numbers, aggregating and leveraging spend.

So a spend category that had tens, hundreds or even thousands of different suppliers will be analysed, data collected, and then procurement will go out to the market with a view to dramatically reducing the number of suppliers. That might be through genuine aggregation of similar spend, or it could be based on the hope that certain suppliers will be able to meet a range of requirements themselves; or it may look to use a “prime contractor” type approach.

A typical example of that could be in the facilities management spend area, where we have seen the growth of the TFM (total facilities management) concept. A single supplier will provide a whole range of services such as repairs and maintenance, catering, cleaning, and security. Usually, the firm will carry out some of these activities themselves, but some other firms will carry out certain elements of the work as part of the overall supply chain. However, it will all be managed (and invoiced) through the TFM provider acting as the “prime”.

In other cases, the consolidation may simply mean that whereas previously the organisation had 20 suppliers of cardboard boxes, a particular car component or skimmed milk power, the spend is now aggregated so there are only two or three.

Now clearly there are some significant potential advantages in this approach. It may be more convenient to have fewer suppliers, and the transactional and contract management costs should be lower. Taking a “prime” type approach can help to make it obvious which supplier is responsible – for both good or poor performance. Standardisation can be driven more easily with fewer suppliers, which in itself can generate more efficiency benefits. And of course, most obviously, we hope to capture and gain economies of scale and more market power by concentrating our spend with fewer suppliers.

However, there are some real negatives with this sort of approach, and these are not always considered as thoroughly as the positives. Many of the negatives are connected with risk in some way, starting with the loss of resilience that can come when fewer suppliers are available for a particular item.

If one or two suppliers have a problem, and we have ten more on hand, then the organisation will probably be fine. But if we have concentrated spend on just one or two, and there is an earthquake affecting the supplier’s factory or a labour dispute, or a takeover of a supplier by one of our own competitors, then suddenly the supply situation can look very precarious. Consider the problems Volkswagen had last year during a commercial dispute with a supplier, without an alternative source for the item supplied, the entire VW Golf factory was shut down.

Concentrating supply, particularly if some sort of “prime” approach is being followed, can also lead to the buyer losing visibility of the entire supply chain. Apart from the prime, which other firms are making an essential contribution to the overall supply situation? If the buyer loses sight of this and does not understand the bigger picture, there are obvious risks, both if risk events affect those other organisations or indeed simply through the prime holding too much power over the buyer.

There are also risks that innovation through the supply chain will not be passed on to the ultimate buyer, but retained by the prime – or indeed offered by the innovator to other end-customers with whom they do hold a direct relationship.

So concentrating spend, while often a sensible strategy, needs to be done in a considered and thoughtful manner. For instance, if there are only two or three suppliers for a critical item, the buyer should understand the risks that apply in some detail. Are all those suppliers manufacturing in the same part of the world, or are they all dependent themselves on the same second tier supplier?

Some of these issues are discussed in our recent paper, titled Supply Chain Risk – Getting To Grips With n-Tier Visibility which you can get here, free on registration. Of course, this is not just a risk issue; the commercial questions around economies of scale, manageability and standardisation also need to be considered, and it is undoubtedly true that many firms have more suppliers than they really optimally need in certain spend areas. But reducing supplier numbers blindly, without thinking through all the issues, is not the right approach for any sensible procurement professional.

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