Optimize Resources and Achieve Better Results With an Effective Supplier Segmentation Strategy

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Caroline Washington
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1 Optimize Resources and Achieve Better Results With an Effective Supplier Segmentation Strategy Published: 27 June 2018 ID: G Analyst(s): Miguel Cossio Supplier segmentation is a foundational aspect of strategic supplier management. This research helps supply chain leaders in sourcing and procurement learn how to effectively manage a complex supply base while leveraging its full potential. Key Challenges Companies typically have more suppliers than they can efficiently manage. Limited time and resources make it harder for leaders in sourcing and procurement to focus on the right priorities. Prioritizing suppliers based on spend or performance alone will likely result in neglecting other suppliers that could have a greater impact on your overall business strategy. Supplier segmentation is not a "set it and forget it" type of initiative, but rather a strategydefining one that must become relevant to the organization and evolve as business needs change. Recommendations To improve sourcing and supplier management operations and performance: Identify and prioritize your most valuable suppliers by segmenting them using criteria that goes beyond just spend, but is instead focused on supporting current and future business strategic goals. Fifty percent of companies with leading SRM programs use a structured approach. 1 Use the output of your supplier segmentation to tailor sourcing strategies, build deeper relationships and monitor supplier performance. Seventy-nine percent of companies keep their segmentation strategy relevant by refreshing it every one to one and a half years. 2 Table of Contents

2 Introduction... 2 Analysis...4 Segment Your Supplier Base Using a Business-Oriented Criteria That Goes Beyond Spend...4 Vertical Axis... 4 Horizontal Axis...5 Use Supplier Segmentation to Tailor Sourcing Strategies, Develop Strategic Partnerships and Monitor Performance...6 Tailored Sourcing Strategies...6 Develop Strategic Partnerships...7 Supplier Performance Management...9 Gartner Recommended Reading List of Figures Figure 1. Supplier Segmentation Overview...3 Figure 2. Sourcing Strategies per Supplier Segment... 7 Figure 3. From Segmentation to SRM...8 Figure 4. From Core Segmentation to Supplier Performance Management Figure 5. Correlation Between Supplier Segmentation, Relationship Management and Performance Introduction Large companies typically have thousands, if not tens of thousands, of suppliers, and the investment of time, effort and management resources required means that only a fraction of those relationships can be or need to be managed more intensively. Supplier segmentation is much more than spend analysis. And it is not about procurement leaders prioritizing suppliers that can deliver the greatest savings. Supplier segmentation is used by leading organizations to deploy targeted sourcing strategies, build deeper relationships with their most valuable suppliers and track performance of the most relevant suppliers to the business. While the majority of organizations use spend as one the most relevant factors, leading organizations consider other critical aspects such as revenue at risk, complexity to replace and potential value for identifying their most critical suppliers (see Figure 1). Page 2 of 14 Gartner, Inc. G

3 Figure 1. Supplier Segmentation Overview Source: Gartner (June 2018) Organizations often report problems with supplier relationship management (SRM) programs, where common issues such as lack of support from internal stakeholders or unrealized benefits from supplier partnerships have a root cause in a poor approach to supplier segmentation. Unfortunately, while 50% of companies with leading SRM programs report having a structured approach to supplier segmentation, only 10% of them do it in conjunction with their internal stakeholders. 1 It is critical that the segmentation strategy includes input from key stakeholder groups so that its output and the resulting actions meet the needs of the overall organization's business goals, not just procurement's. A well-developed and executed supplier segmentation process will provide direction and alignment between internal stakeholders and the needs for the supplier base that will ensure that procurement leaders are focusing on the right priorities. Gartner, Inc. G Page 3 of 14

4 Analysis Segment Your Supplier Base Using a Business-Oriented Criteria That Goes Beyond Spend Supplier segmentation is a resource allocation step and is designed to quickly identify the level of resources needed to manage different types of suppliers based on their importance to the buying organization. The following are the key benefits of using supplier segmentation: Deploy tailored sourcing strategies based on the suppliers' relevance and supply alternatives. Develop strategic partnerships to fully leverage the potential of the most valuable suppliers. Actively manage performance of suppliers with the highest risk exposure. Supplier spend and complexity to replace are among the most common aspects used by procurement leaders when looking to identify critical suppliers. While both spend and complexity are important factors to consider, they do not take into consideration important aspects such as the suppliers' impact on revenue streams and their overall value in terms of capabilities to support the business strategy. Using a 2x2 matrix, as previously shown on Figure 1, use the following criteria to segment your supplier base. Vertical Axis Level of spend Supplier spend provides a good indicator to the overall size of the relationship between buyers and suppliers, and is part of the criteria used by nearly all companies with leading SRM programs. 1 While spend is important, especially for identifying cost-savings opportunities, it does not provide enough insight to help determine the level of resources needed to obtain additional value from these suppliers. For example, manufacturers in the automotive industry may have significant spend with suppliers of pneumatic tires used in their cars and SUVs. While tires are important, they can be considered a commoditized product that does not provide a top market differentiator and where multiple supply options exist. Revenue at risk This represents the exposure that buying organizations have with their suppliers from a revenue perspective, and is also used by the majority of companies with leading SRM programs. 1 While spend may be relatively small, components or services from these suppliers may be used across a wide range of products. Therefore, they represent a large impact to the buyers' revenue streams. For example, specialty fasteners used by manufacturers in the aerospace industry must comply with strict quality specifications in order to operate under the most severe conditions. While these fasteners may be relatively inexpensive components, they are used across the majority of the final products built by these manufacturers, placing a significant portion of the buyer's revenue at risk. Page 4 of 14 Gartner, Inc. G

5 Horizontal Axis Complexity to replace Represents the complexity level of replacing selected suppliers. This includes suppliers who are single sources, sole sources or other suppliers where resources needed to switch could be considered prohibitive. For example, changing a supplier of a key ingredient in the pharmaceutical industry could require an extensive qualification process to confirm performance is identical. In addition, a lengthy registration process with national health authorities may be required. What would seem like a simple supplier change could result in an expensive and time-consuming ordeal that could take several months or even years to complete, making this a complex move for the buying organization. Supplier value Represents the supplier capabilities that are most valued by buying organizations and that are critical to their current, and future, business strategy. The definition of supplier value must reflect the priorities of internal stakeholders and will vary significantly across different organizations. The inclusion of a supplier's potential value as a criteria used in supplier segmentation has grown over the years as procurement organizations evolve and realize the critical role that suppliers play in their ability to win in the market. Data from 2013 shows only 5% of organizations using supplier value when segmenting their supplier base, 2 while more recent data shows value potential and innovation capabilities now being used by over 80% of organizations with leading SRM programs. 1 For example, an industrial manufacturer focused on providing customers with highly customized and niche products may value suppliers that can grant exclusive access to the latest technologies even if at a premium price. In contrast, another manufacturer in the same industry might place greater value in a supplier's ability to quickly ramp up mass production of products at a global scale at the lowest possible cost. Why is performance not a part of the segmentation criteria? The main purpose of segmenting the supplier base is to increase supplier collaboration and allocate resources based on their relevance to the buying organization. Therefore, it is important to highlight how supplier performance should not be considered as part of the segmentation criteria. While good supplier performance is indeed important, and it will play a critical role in future business opportunities, it doesn't necessarily reflect the relevance or additional value that they can provide to the buying organization. For example, building a strong relationship with involvement from senior leadership teams with a top-performing supplier of commoditized, low-value components will not provide additional value to the buying organization. In contrast, building a stronger relationship and allocating resources to develop a low-performing supplier with unique capabilities will yield significantly better results. Gartner, Inc. G Page 5 of 14

6 Use Supplier Segmentation to Tailor Sourcing Strategies, Develop Strategic Partnerships and Monitor Performance Supplier segmentation is more than simply labeling suppliers. It must become the backbone of how buying organizations approach their supplier base. Rather than trying to set a set of guidelines around how to interact with each supplier segment, mature organizations commonly use supplier segmentation to support the following processes. Tailored Sourcing Strategies One of the most common uses of supplier segmentation is helping procurement leaders define their sourcing strategy and the different approach to each supplier based on its segment (see Figure 2). Strategies for suppliers with low complexity and/or low-value capabilities should be focused on cost optimization by either consolidating transactional suppliers or introducing new supply options to leverage commodity-type suppliers. In contrast, strategies for suppliers that are highly complex to replace or those that possess critical capabilities will instead focus on managing risk with bottleneck suppliers or increasing collaboration with strategic ones. Page 6 of 14 Gartner, Inc. G

7 Figure 2. Sourcing Strategies per Supplier Segment Source: Gartner (June 2018) Develop Strategic Partnerships Supplier segmentation is also used to identify the select group of suppliers that are best suited to participate in a formal SRM program (see "Follow Gartner's 4-Step Framework to Implement an Effective Supplier Relationship Management Program"). However, when segmentation models are used for other aspects beyond category strategy definition, they are often simplified (see Figure 3). Rather than trying to set rules of engagement with four different supplier segments, procurement and its internal stakeholders classify their suppliers as strategic partners vs. the rest of the supplier base (transactional). Note that in some cases, there may be suppliers that had originally been classified as commodity or bottleneck that end up selected as strategic partners to participate in an SRM program. Gartner, Inc. G Page 7 of 14

8 Figure 3. From Segmentation to SRM Source: Gartner (June 2018) Page 8 of 14 Gartner, Inc. G

9 This redefined categorization of the supplier base takes the foundational segmentation model and simplifies it to facilitate how deeper relationships with strategic suppliers are develop jointly between procurement and its internal stakeholders in order to create a sustainable competitive advantage. Considering the amount of time and resources needed to truly develop a partnership with these key suppliers, 47% of companies with leading SRM programs end up considering less than 10 suppliers as strategic, and 68% of companies selecting less than 25 suppliers. 1 For example, food and beverage company Mondelez has more than 60,000 suppliers, but only classifies 10 as strategic partners under its STAR program. 3 Similarly, another industrial manufacturer with over 90,000 suppliers has only selected 12 as strategic. Supplier Performance Management In addition to proving useful for tailoring sourcing strategies and selecting strategic partners, supplier segmentation also helps identify the group of buyers whose performance needs to be actively monitored to control their risk exposure with suppliers. Using the core segmentation model as a starting point, a new supplier class emerges often referred to as "critical" (see Figure 4). Gartner, Inc. G Page 9 of 14

10 Figure 4. From Core Segmentation to Supplier Performance Management Source: Gartner (June 2018) Page 10 of 14 Gartner, Inc. G

11 This group of suppliers often includes large spend suppliers, sole sources and single sources where developing alternatives is simply not feasible. Performance of these suppliers must be actively managed given their criticality to the business. These are suppliers that might have otherwise been considered strategic, but, given the lack of resources or even misaligned business strategies, might prevent building deeper relationships. For example, a manufacturer in the life science industry had a segmentation strategy in place where over 80 suppliers were considered strategic. This large number prevented it from building deeper relationships and no value was created through its SRM program. Looking to improve its segmentation strategy, it focused on narrowing its definition of strategic suppliers. It reduced it to 10 suppliers with whom it started doing strategic quarterly reviews. The rest of the suppliers formerly called strategic were rebranded as "core" and became the group of suppliers where scorecards were deployed. Rather than trying to build deeper relationships with too many suppliers to no avail, it focused on those suppliers with the highest value potential and then actively managed the performance of the rest of its most important suppliers. What role does supplier performance play in the segmentation process? Supplier performance scores provide useful input to sourcing strategies pursued with each individual supplier such as maintain, grow or exit. However, it does not help identify which suppliers should the buying organization partner with by building deeper relationships. Scorecards for these groups of suppliers often include short-term metrics such as quality and delivery, as well as other critical aspects such as payment terms, risk management, technology roadmap alignment and others. While scorecards are often deployed with both strategic and critical suppliers, the approach that buying organizations take differs in the following way: Strategic suppliers Given that the focus with these suppliers is to create joint value, performance management is often approached in a collaborative manner. This means that both parties work to identify the root cause for poor performance and collaborate to improve it. Continuous poor performance from a strategic supplier could severely impact the relationship. However, short-term measures such as moving away business or restricting suppliers from future projects are only taken after other improvement actions are exhausted. Critical suppliers Performance of this group of suppliers will directly impact their access to growth opportunities with the buying organization. A traditional classification of preferred/ approved/restricted is often used, resulting in future business rewards or restrictions based on the supplier's performance. When looking to prioritize new business opportunities and future projects, a common approach is to give preferential access to strategic suppliers, followed by suppliers with top performance and then the rest of the supplier population. A summary of the correlation between supplier segments, relationship engagement types and performance management approach is shown in Figure 5. Gartner, Inc. G Page 11 of 14

12 Figure 5. Correlation Between Supplier Segmentation, Relationship Management and Performance Source: Gartner (June 2018) Page 12 of 14 Gartner, Inc. G

13 Supplier segmentation plays a critical role in procurement's ability to deliver value to the organization by prioritizing those suppliers that are most critical to their business success. For this reason, it must be done in alignment with internal stakeholders and focused on supporting the overall business strategy. In order to keep this important strategy relevant, most organizations refresh their supplier segmentation models every one to one and a half years. 2 Gartner Recommended Reading Some documents may not be available as part of your current Gartner subscription. "Targeted Supply Chain Segmentation Examples by Function" "Supplier Segmentation and Performance Management at AstraZeneca" "Apply a Balanced Supplier Scorecard to Accelerate Supply Chain Excellence" "Follow Gartner's 4-Step Framework to Implement an Effective Supplier Relationship Management Program" Evidence 1 State of Flux. Global SRM Report 2017, n = "Supplier Segmentation Research Study," 2013, n = 37 3 "Supplier Innovation: Collaborating for Competitive Advantage," SCM World Gartner, Inc. G Page 13 of 14

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