…and how to capitalize on them

A couple weeks back I wrote about increasing gross margins through negotiating better programs with your existing suppliers. Central to the discussion was understanding how your suppliers view your organization, knowing with great confidence how you fit into THEIR strategy. That’s a critical step, and one that is often overlooked. But it’s only half of the equation. The other half is defining the role that the supplier plays in YOUR organization, and it usually falls into one of four classifications that – once clarified – will help you develop not only your immediate sourcing actions but also your most effective approach to ongoing supplier management. The four classifications were derived from a model created by Dr. Peter Kraljic way back in the early 1980’s[1] but it remains highly relevant today for distributors and manufacturers. I can say for certain that if I paid more attention to this in my own career – especially in my early years – there would have been a lot fewer bumps and bruises, and better results achieved along the way. 

The four supplier classifications are made with “profit impact” and “supply chain risk” as the key considerations.

Classification 1: Strategic – High Profit impact, High Supply Chain Risk
Opportunity – Profitable Growth
In your portfolio there will undoubtedly be suppliers that have significant profit impact on your organization usually because of high sales volume at good margins. Additionally – and for any number of reasons – these suppliers are tied inextricably to your business. This may be due to significant brand equity the supplier has built, patented technologies or other elements that have embedded this supplier into your business, limiting your ability to consider alternative sources. If your organization has similar importance to the supplier, the goal for this relationship should be finding ways to collaborate effectively to identify, create, and capitalize on opportunities and synergies. These can come in the form of discovering white space/incremental volume at the expense of competitors, process improvements that create opportunity for increased profits for both organizations, etc. Win-wins are the suggested path here rather than heavy handed one-sided approaches which are likely to fall short in these situations.

Classification 2: Leverage – High Profit impact, Low Supply Chain Risk
Opportunity – Cost Savings
These are suppliers that have a significant impact on your organization’s profit usually because of high volume at good margins. However, in contrast to your strategic suppliers, this classification is characterized by the existence of multiple alternative sources for the product or service in question. This creates a highly desirable negotiating position for your organization who can use considerable leverage to drive costs further down. If you are looking for improved margins by reducing cost, this is usually the place to find it. It stands to reason that the bigger portion that this classification represents of your supplier portfolio the more control you have over your own profitability. It’s important to note that the importance of collaborative partnerships still exists here as well, but the leverage leans heavily toward the buying organization.

Classification 3: Non-Critical – Low Profit Impact, Low Supply Chain Risk
Opportunity – Time Savings
You don’t buy and sell much from non-critical suppliers and as a result the impact they have on your profit is minimal. Additionally, there are many different choices for suppliers in this classification so if one supplier doesn’t work out for some reason there are plenty of others from which to choose. Since there’s not much here to impact margin it’s not a particularly useful spend of time attempting to negotiate lower costs, but that’s not to say there isn’t opportunity here. In this case the opportunity is to free up time for your team by finding ways to minimize the time spent on such suppliers. This can be accomplished by automating orders, developing more consistent order patterns, among other things. The point is to spend as little time as possible here to focus more time where it’s truly needed. You might be surprised to learn how much of your (or your team’s) time is spent on suppliers that fall in this bucket and there’s big opportunity costs in doing so.

Classification: Bottleneck – Low Profit Impact, High Supply Chain Risk
Opportunity – Supply Chain Risk Mitigation
These are tough ones. You don’t make much profit from these suppliers but they play an important role in your business and have a unique element to them that limits your sourcing options. You might have a handful of large customers who require their specific products which are sold in high volume but at low margins. Conversely, you might have many different customers that use small volumes at similarly low margins and with no alternatives. From a profitability standpoint it would seem feasible to simply walk away from the business but the negative impact on your customers would be real and significant. Given that these suppliers have an important role to play with limited alternatives available, the key here is to ensure your relationship is on solid footing so that you have a reliable supply chain, with focus on mutual optimization wherever that’s possible. If you think it’s possible to develop alternative sources to drive lower costs, you can certainly take steps to do that, but make sure that it’s not at the expense of your existing relationship until your new program is truly ready for prime time.

Wrap-up
To say that suppliers play a critical role in the business of manufacturing and distributing is a massive understatement. As such, our supply base represents many different types and forms of opportunities. Capitalizing effectively on those opportunities comes down to knowing which opportunities to pursue under a given set of specific circumstances. By taking the time to classify your suppliers into the four buckets described here you will do much to help define your engagement strategy and ensure your objectives are the appropriate ones.

To learn more about supplier classification and the resulting actions don’t hesitate to reach out to Steve. You can book time with him here.


[1] Purchasing Must Become Supplly Management – Krajlic, HBR Sept. 1983

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