Best Practices in Supplier Rationalization

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By: Ipsita Suman -- Lead Analyst, Procurement and Finance Business Services

15 September, 2017

Best Practices in Supplier Rationalization
WHITEPAPER

Abstract

1    Introduction

Supplier Rationalization is one of the most strategic  yet enduring activity in a procurement organization. Most of the organizations are at a stage where they have very little visibility into their supplier base.

2    Main

Supplier rationalization can be broken up into a four stage activity - Preparatory Phase, Framework Development Phase, Supplier product and Data Analyzing Phase, and Implementation and Evaluation Phase. Each stage has challenges which can be dealt with proper reasoning and collaboration with business users. Key challenges include:

  • Competitiveness of suppliers (Indirects category) which can be addressed by looking into other aspects of supplier performance apart from quality such as certifications and financial performance
  • Issue with price volatility (Directs category) because of the possible downward market fluctuations. This can be addressed by focusing on the key differentiating point for each category/ sub-category

3    Recommendation

The four step approach to Supplier Rationalization would give organizations a clear guide to implement and maintain the rationalization process in-house. It is also important to sign long term contracts or undertake collaboration exercises with selected suppliers to achieve full potential of the suppliers.

Introduction

Supplier rationalization, also known as supply base reduction [SBR] is the process of shrinking the supply base by reducing the number of active suppliers. The primary agenda of supplier rationalization is to streamline the organization’s spend to fewer suppliers and driver better value from those relationships.

Supplier base reduction may not be a new purchasing concept, but it is an enduring, challenging, and strategic one. The benefits of Supplier Rationalization are immense.

Having fewer suppliers simplifies process automation which in turn reducing P2P costs. However, procurement team faces a constant challenge when it comes to reduction in the number of suppliers.

Proposed Solutions

Below is the Best-in-Class Supplier Rationalization process identified in the industry.

Source - Metropolia

Stage 1- Preparatory Phase 

Establishing a Cross-functional team

  • The primary aim of the cross functional team is to obtain inputs and collaboration from the relevant stakeholders
  • The cross- functional team involves specialists from technical, sourcing, purchasing and supplier relationship management teams as they are directly connected to suppliers

Conducting Spend Analysis

  • Best-in-class companies develop a commodity sourcing strategy based on spend analysis
  • This step involves a detailed analysis of data related to past purchase, material and suppliers which could be extracted from the ERP or SRM tool.
  • An in-depth analysis of the data is conducted to remove duplicate suppliers. Suppliers contributing to tail end spend are also identified

Defining Supplier Base Reduction approach

  • To determine which supplier base reduction approach is more appropriate to the scenario
  • Supplier elimination - The number of suppliers are reduced based on a clearly defined set of criteria pertaining to supplier performance and capabilities
  • Product Standardization - An approach to replace several products by a single product having similar functionalities

Key challenges faced - Procurement can face issues from the business users as many times they feel that reducing the number of suppliers reduces the competition among a company’s suppliers rather than enhancing it.

Solution – Focus on Rationalization approach if any of the criteria holds good

  • Suppliers whose quality/performance levels are trending down
  • Suppliers whose prices are trending up
  • Suppliers whose financial performance is trending down
  • Number of innovation ideas generated by suppliers is low
  • Suppliers do not meet regulatory parameters such as certifications

Stage 2 - Framework Development Phase

Identifying supplier elimination criteria

  • Some of the key criteria considered for eliminating suppliers are as follows:
  • Amount of past purchases from a supplier
  • Number of products assigned to a supplier
  • One time suppliers

Identifying supplier selection criteria

Some of the key criteria considered for selecting suppliers are as follows:

  • Supplier quality records
  • Supplier performance
  • Price
  • Financial stability
  • Production facilities and capacity
  • On time delivery
  • Compliance to environmental regulations and policies
  • Labor relations record
  • Geographical location

Targeting suppliers for elimination

The elimination criteria are applied to the supplier database. The outcome of this step are as follows:

  • A preliminary list of targeted suppliers for elimination
  • A preliminary list of targeted suppliers that require further detailed product and service analysis

Source – Metropolia, Accenture

Key problem faced – In Directs category, stakeholders do not want to enter into long-term contracts with suppliers on commodities because of the possible downward market fluctuations

Solution – Procurement can focus on the key differentiating point for each category/ sub-category. The must have characteristics can be analysed and evaluated.

 Stage 3 - Supplier Product and Data Analyzing Phase

Identifying common suppliers across business units

The list of suppliers that pass through the initial selection criteria along with targeted suppliers that require further detailed product and service analysis are considered for analysis in this step.

Analyzing the products

  • A detailed supply risk assessment on supplier’s products is conducted to arrive at a final list of suppliers to be eliminated
  • These suppliers are analyzed to identify their ability to create value for the company
  • The list of non-critical suppliers are eliminated

Identifying and comparing contracts of key suppliers

The contracts of key suppliers falling in the Core and Leverage quadrant are compared to identify suppliers of core and leverage products.

Some of the main points considered while comparing the contracts of key suppliers are:

  • Intellectual property and confidentiality
  • Long-term contract duration
  • Product Endorsement
  • Sustainability

Key challenge faced – Procurement might face challenges in terms of gathering inputs from business users while analysing the suppliers.

Solution – Holding periodic meetings and involving business users while determining key suppliers is crucial. There are times when suppliers have to be evaluated subjectively rather than objectively. Procurement should be open for such situations.

Stage 4 - Implementation and Evaluation Phase

Targeting suppliers for consolidation across categories and service areas

Suppliers for specific categories are consolidated as follows:

  • Strategic suppliers in high value and critical categories such as R&D, CAPEX, and major raw materials.
  • Collaborated suppliers in key categories such as Packaging, Marketing, and Logistics
  • Standard Suppliers in standard categories such as MRO, HR, Finance, Legal, and Fleet
  • Conditional suppliers in transactional categories such as Office Supplies and  Facilities Management

Evaluating the results of Supplier Base reduction process

The aim of this step is:

  • To evaluate the impact of the Supplier Base Reduction process on the performance of the final list of selected suppliers across categories
  • To assess the effectiveness of the rationalized supplier base

Conducting evaluation exercise on a continuous basis

The Supplier Rationalization Process is executed each year to classify key suppliers for specific categories such as Strategic, Collaborated, Standard and Conditional.

Key challenge faced – There might be instances where the selected supplier might not fare well in the future. There might be issues with selected suppliers and business users for challenge other than quality.

Solution – Procurement can re-evaluate and bring the parameters which created issue in the next iteration of the exercise. Procurement must be open to conducting this exercise on a continuous basis with business users’ support.

 Timeframe of Implementation

Supplier Rationalization is an on-going process. However, the first phase of implementation takes around 22 - 24 weeks. The timeframe by sub-process is given below.

Source - Beroe Analysis

Do’s and Do not’s in implementing Supplier Rationalization Process

yes Best practice is to have a well-defined supplier evaluation system to reward selected suppliers with long-term contract

yes Receiving inputs and ensuring the participation of other departments is critically important for the implementation phase of the supplier rationalization program

yes When moving from larger volumes of suppliers to fewer suppliers, companies need to ensure that the selected suppliers have the capacity and capability to support larger volumes and meet the requirements in terms of quality and lead-time which are the most important criteria

yesThe changes that result from the supplier rationalization program such as new suppliers list needs to be communicated to internal users directly or indirectly affected by the program

no Reducing the supplier base without establishing contractual relationships with suppliers could disrupt the supply of products

noCompanies should not give high priority to price criterion in the initial phase of supplier elimination

Case Study- SMRT Corporation’s in-house approach to reduce supplier base

Source: SMRT

Case Study- A freight transportation company’s combined approach to reduce maverick spending and reduce supplier base 

Source: Prokarma

Conclusion

  • Unless a company has a well-defined supplier evaluation system and displays readiness to reward a selected supplier with a long-term contract, the supply base reduction (SBR) benefits are difficult to achieve
  • Companies that utilize an in-house approach continuously monitor supplier performance and conduct reviews that comprehensively measure subjective performance indicators which are not captured through formalized metrics
  • By conducting this process in-house, companies with high procurement maturity can rationalize their supplier base by 5-10 percent in key categories
  • By conducting this process in-house, companies with low procurement maturity can rationalize their supplier base by 60-70 percent in key categories.



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