A Case For Supplier Segmentation

Posted in Operations & IT Articles, Total Reads: 4037 , Published on 29 December 2011
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In the last few decades efficient supply chain management has emerged as a critical component of shareholder and customer value creation. Effective SCs are increasingly buyer driven; starting with understanding the buyer’s needs and subsequently working backwards through the supply chain. The implications are now visible with Supply chain management even being called ‘demand chain management’. But excessive focus on satisfying the customer by offering multitude of variants can increase the supply chain costs exponentially, especially when the organization tries to achieve responsiveness simultaneously.

Supplier Segmentation

To meet this dual challenge of responsiveness vs. variety many techniques have evolved over the years such as

  1. Postponement strategy ( perfected by Dell)
  2. Cross Docking (by many leading retailers)
  3. Drop shipping (practiced by Amazon)

All the above mentioned are means to achieve ‘mass-customization’ i.e offering customization to end-consumers at about the same cost as mass-production. The driving factor behind this kind of offering is the segmentation of customers into clusters also known as market-segmentation.

Market segmentation is critical for mass customization because the products are competitively positioned to meet specific demands. (a commonly cited example is the dell website given below)

Dell supplier segmentation

(The categories are further divided as we go down the hierarchy).

But increasing cost pressures are now forcing companies to look beyond customer segmentation to exploit the similarities in suppliers. Customer demands are increasingly complex; but B2B market demands predictability, speed and reliable delivery. Organizations are now starting to realize the enormous competitive advantages that can be garnered from the supply side of the value chain.

In effect the heterogeneity which was exploited on the demand side can be replicated on the supply side too. The product and customer segments can be defined internally based on the resources consumed in the supply chain instead of the other way round.

Implications of this kind of segmentation can be as follows-

  • Product segmentation based on common cost drivers and resource consumption
  • Varying segmentation depending on the product’s stage in its lifecycle
  • Channel segmentation based on unique demands of supply chain
  • Regulatory requirements which lead to unique flows through the supply chain

This can lead to categorizations based upon logistically distinct consumers/products.

The growing number of suppliers in spite of the pruning of the supplier base and the increasing tiers of suppliers has made the maintenance of supplier relationships tough to manage. The table given below demonstrates the extreme complexity companies have to deal with day in and day out.

Company

Approximate number of suppliers

General Electric

30,000

Boeing

20,000

Hitachi

13,000

General Motors

30,000

A systematic and scientific understanding of supply side heterogeneties can simplify the process of supplier appraisal and bring order to the chaos which can prevail due to conflicts in supply chain. Hence alignment among supplier groups (raw material providers, intermediaries, manufacturers and buyers) for exchange purposes can be beneficial for long-term relationships.

Many firms have already recognized the advantages of clustering suppliers (refer to table below)

Company

Clustering factor(s)

Motorola

Output capacity

Ford

Geographical to reduce inventory costs/delivery time

Honda

Cost, Quality, Delivery

Target

Openness in sharing data

Dell

Product demand variability

But researches claim that the level of supply segmentation is still primitive and has the potential to yield enormous benefits. This can be explained using a simple example (in the next page) - The distinctive features of the suppliers can be assumed to be akin to consumer characteristics in market segmentation. More elaborate characteristics based on product and intricate relationship features can be used for segmentation in real-world.

A purchasing manager for automotive components has three alternatives

Choice

Distinctive feature

Opt for suppliers who are reasonably priced and are extremely reliable

Speed

Or for Suppliers who offer the best quality components (might be for a premium model)

Personalization

Or for Suppliers who offer the lowest price possible but are shaky on delivery dates (low end model)

Cost

A step-by-step approach which can be used for supply-side segmentation can be as follows

Once the options are enumerated, the most viable ones can be zeroed upon based on the supplier compatibilities and costs to the entire value chain. Then the SKU variants to be offered can be decided upon by consulting the retailers. Various KPIs can be selected and used for vendor evaluation and selection to complement the system.

Can this make purchasing efficient?

The firm being the focal point in the supply chain from its own perspective can influence the value chain. By supply side segmentation described in the previous section, firms can make more efficient and quicker decisions to offer better customization to consumers. The unique characteristics of suppliers to satisfy distinct demands can be harnessed to gain economies of scope in purchasing. This would reduce wasteful inventory in the supply chain and make a substantial impact on the bottom-line of the organization. Since segmentation would reduce the differences in channel benefits offered to similar partners, it also would reduce the subsequent conflicts. This reduction in disparities would make the suppliers conscious of the fact that they have been chosen due to specific characteristic they possess. This can increase compliance with company’s policies and can be major motivator to reduce transaction costs which plague the purchasing department. The assurance provided to the supplier and the mutual trust resulting from it can reduce the quality costs and can be win-win situation for both.

This article has been authored by Rohit D from IIM Lucknow


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