Category Segmentation

Posted on October 26, 2012 by Artem Zvyagin

1 In addition to spend data and contracts addressable spend categories should be classified according to strategic importance. This will help us in the future to prioritize strategic sourcing activities based on suppliers/category criticality to the company. The Kraljic Portfolio Model is a commonly used method for this purpose though there are many other models and almost all of them mimic the Kraljic model this or that way. Those other models just change the x and y axis criteria mainly based on the priorities of the categorization exercise. The Kraljic portfolio model helps map out category segmentation in two dimensions: Profit Impact: volume or value purchased, impact on supply chain value -add, business growth potential or dependency Supply Risk/Criticality: product availability, number of suppliers, ease of switching a supplier, availability of substitutes Determine profit impact by answering the questions below: Is the category total value important in the companys total spending? Do the clients end customers perceive that this category adds significant value? Does the category differentiate the end product significantly? Would a category failure affect the clients end customer satisfaction? Determine supply risk by answering the questions below: What is the market internal competition? Can you easily switch to another category? What is your buying power for this category? What is the bargaining power of sellers? Can new entrants be easily found and invited to tender?

In the end category segmentation is all about the approach we will take in supplier relationship management and understanding the type of value category/supplier provides. Hence we can also determine which and how many resources to allocate for supplier segments. After the segmentation is done we have a strategic direction for each category: 1. Leverage products Leverage products allow the company to exploit its full purchasing power through tendering, target pricing and product substitution 2. Strategic products The company should be maintaining good relationships with strategic partners 3. Bottleneck products Bottleneck products should be handled by volume insurance, vendor control, security of inventories and backup plans. 4. Routine products Routine and non-critical products require efficient processing, product standardization, order volume and inventory optimization Another approach to take after the segmentation is complete is to shift categories to neighbour segments. It is called Moving in the Matrix:

- Leverage products -> Strategic products Develop a strategic partnership Exploit buying power - Strategic products -> Leverage products Accept the locked-in partnership Maintain strategic partnership Terminate undesirable partnership, find new supplier - Bottleneck products -> Routine products Reduce dependence and risk, find other solution Accept the dependence, reduce the negative consequences - Routine products -> Leverage products Pooling of requirements Individual ordering, pursue efficient processing

Making Supplier Segmentation a Supply Chain Strategy

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Introduction: In todays world competition, is not among companies it is among supply chains. Companies no longer concentrate their efforts solely on managing their internal activities. In order to deliver value to the end customers, firms need to consider the entire supply chain and look for opportunities of cost reduction and efficiency. Companies often have a range of suppliers who fulfill their needs for different products and services. Since the relative importance and cost of these goods vary, it is essential to build supplier relationships based on the type of products supplied. For example, if a company needs a steady supply of a raw material, it would aim at building a long-term relationship with a reliable supplier. In this case the focus would be on maintaining quality and consistency for an extended period of time. But if the same attention is given to a low value one-time buy component, it would result in wastage of valuable corporate resources. The decision to invest in supplier relationships is a strategic one. The main aim is to align the allocation of the companys resources with its strategic goals. Hence the emphasis should be on those supplier relationships from which the organization expects to generate maximum returns. One way of achieving this is Supplier Segmentation. This method involves segmenting the companys supply base to build a portfolio of supplier relationships with varying characteristics to fulfill its different needs. Supplier Segmentation Strategy: Supplier Segmentation can be defined as a process that involves dividing suppliers into distinct groups with different characteristics, which require different types of inter-firm relationship structures in order to realize value from exchange. Such an approach not only paves the way for better risk management of critical material procurement, but also leads to a more scientific management of supplier relationships. Supplier Segmentation Models, consisting of segmentation bases can be used to divide the heterogeneous supply base of a company into distinct groups. Segmentation bases refer to the parameters based on which supplier interaction can be judged. Given below are some of these criteria: Degree of interdependence between client and supplier Level of spend Strategic importance of the supplier Number of business units within the organization are being served by the supplier Complexity of specifications Frequency of changes or modifications Difficulty and cost incurred to change suppliers Segmentation Models Companies have realized the significance of identifying suppliers based on certain requisite conditions. While for some companies switching suppliers may be the biggest difficulty, for some others the suppliers financial health may be the chief concern. These are the parameters that decide the bases for supplier segmentation across various firms. Following are some supplier segmentation models: 1. Based on Strategic Importance of Supplier and Health of Supplier The matrix given below can be used to segment suppliers on the basis of their: Strategic importance to the company Operational and Financial health

The Health of the Supplier refers not only to financial health, but other operational attributes such as reliability, process excellence and quality also. Critical suppliers who are healthy present an opportunity for continuous improvement, whereas those who are unhealthy are suitable candidates for further investment to improve their position. Non-critical, unhealthy suppliers should ideally be done away with. Strategic Importance of Supplier SUPPLIER INVESTMENT MATRIX Critical Investment Candidate Continuous Improvement Non Critical Contingency Plan / Re-source Continuous Improvement Unhealthy Healthy Supplier Health 2. Based on Purchase Value and Complexity of Alternate Sourcing The purchase value of materials procured from external suppliers is one of the chief factors determining their relative importance. Also, changing suppliers frequently may be difficult for some firms. For example, restaurants conduct quality checks before selecting a supplier of meat. If it has to perform these checks each time that it procures the same material, it would incur extra expenditure. Hence companies often prefer to work with fixed suppliers who are not only reliable, but also understand the exact needs of their customer. Commodities are products that are supplied by many suppliers, have a large dollar value and have ready substitutes. Expendables are routine purchases of low dollar value. These products have substitutes available and are supplied by many suppliers. Key Purchases have low to medium dollar value and are supplied by only a few suppliers. Strategic Components are critical to the core business and have a large dollar value. There are only a few suppliers of these products. Purchase Value SUPPLIER INVESTMENT High Commodities Strategic Low Expendables Key Low Supply Chain Complexity and Difficulty of Alternate Sourcing MATRIX Components Purchases High

Improvement in Purchasing by Supplier Segmentation Supplier Segmentation enables a company to identify and manage suppliers in a structured way. It can be an effective tool to select vendors and to decide whether or not to invest in building a long term relationship with them, depending upon the strategic importance of the product supplied. Vendor segmentation allows companies to setup a structure with the help of which different strategies can be implemented to handle different suppliers appropriately. It is critical for building a framework for Supplier Relationship Management. For example, the purchase of high value, critical medical laboratory equipment, quality and reliability are the most important attributes. A company will choose a reputed supplier who provides high-quality assurance instead of one who offers the lowest price, but mediocre quality. When long term gains are the focus or the item procured is a core item of the business, the cheapest price may not be the best purchase decision. This is particularly applicable in case of expensive items and products that will be used for a long period of time. In this case building a mutually beneficial relationship with suppliers can cut costs. The suppliers are assured of business and are in a position to understand the needs of the customer. The customer on the other hand gains a steady source of material at the correct quality standard and at a low cost. The companys suppliers, thus having a deep alignment with its goals are the Strategic Suppliers.

Contrarily, purchase of low value standard items is not a strategic decision for the company. It can simply go for the supplier offering the lowest price, as the items are standardized. Investing in a long-term relationship with these Tactical Suppliers may be unnecessary. The similar approach can be employed when there are many competing suppliers and switching to a new supplier is easy. In case of vendors who supply in a market where competition is low, the aim of companies should be to become strategically involved with them. These vendors are the Emerging Suppliers. It may so happen that a supplier providing critical services to a company may gradually lose the commitment towards the strategic relationship with the firm. These are Legacy Suppliers. Generally the cost of switching these suppliers is very high. Hence companies must provide them with incentives to continue to work with them. Conclusion On the whole, Supplier Segmentation can provide an effective framework to manage a companys suppliers based on their strategic importance. However it should be mentioned here that the segmentation models discussed above are not exhaustive. A company may segment its supply base depending on the type of product procured. For example, a furniture making company may have different sub-classes of suppliers for its glass requirements. While one vendor may provide the glass used in mirrors, another may supply the glass needed to make table-tops. Further, the segmentation model deemed suitable in one case may be totally inapplicable in another. It is determined by the company policy and by the attributes the company lays stress on. The success of this strategy depends how well a company can align supplier relationships with its long-term objectives. Ahana Chakraborty

Supplier Segmentation for Efficient Purchasing

2:24 PM Sunday December 25, 2011 by: Socrates - Consulting & Strategy Club at IIFT

In an environment characterized by scarce resources, increased competition, higher customer expectations and faster rate of change, organizations are finding it increasingly difficult to compete effectively, generating suitable profits at the same time providing quality products within cost limits to the consumer. The enhan ced level of competition has constrained the suppliers ability to increase prices, while at the same time increasing input costs have eroded profits. Faced with these problems corporations today are exploring different means of cost reduction. This has brought into focus an important but seldom celebrated function, i.e., Procurement, as an effective means to reduce costs while at the same time maintaining quality. Though procurement generally accounts for nearly 60% of the total spend of an organization, it is only in recent times that it has come to be seen as more of a control tool rather than just a support function As organizations move towards making their procurement processes more efficient and more in line with their strategic plans, attention has also shifted towards one of the most crucial aspects in supply chain management, i.e., Supplier Relationship Management. Wikipedia describes SRM as SRM is a discipline of working collaboratively with those suppliers that are vital to the success of your organization to maximize the potential value of those relationships. The basic motive of SRM is to develop a two mutually beneficial relationship between an organization and its strategic supply partners. Organizations, across different industries, typically use a number of suppliers for raw materials and for intermediate goods. In such an arrangement, how well a company does, the quality of its products and its ability to deliver products on time to the consumers is dependent on the suppliers and thus it is necessary to have some sort of synergy between an organization and its suppliers so as to ensure proper return for both the stakeholders in the relationship. As the production levels increase, companies will have to outsource more parts of their work to different suppliers in order to meet demand and to reduce costs, making it more important for organizations to better manage their suppliers and thus risks and vulnerabilities in their supply chains. So the question is how will supplier segmentation help companies better manage their suppliers? Organizations these days generally employ a number of suppliers, and it is a known fact that there is a different approach for different types of suppliers. An excellent process for one relationship may be completely wrong for another. Companies that try to use the One size fits all approach soon discover that this can be a source of significant problems. The kind of relationship fostered with supplier of a customized critical component differs a lot from that with a supplier of standard equipment, and using the same tools in both situations results in a misalignment of strategic goals and wastage of corporate resources. Breaking suppliers into different groups in terms of what were looking for from them and taking the supplier-relationship management to the next level, which is to segment based on what the suppliers can do versus our objectives, and then being willing to invest in those suppliers to be able to drive value is the major goal of segmentation. In a highly competitive market situation and rising commodity costs, there is a trend towards reducing the number of suppliers an organization uses. This helps companies in consolidating their purchases and negotiating better prices. There is however only a limited amount of benefit to be derived from the above strategy and organizations have started searching for newer areas of cost reduction. In this regard Supplier Segmentation has emerged as a highly effective means to further reduce costs and at the same time establish relationships that move beyond the transactional level. You cant have deep, collaborative relationships with all your suppliers, and you need to really identify which ones are the players Supplier segmentation helps organizations to align allocation of limited resources with their strategic goals. It helps in clarifying roles, responsibilities, actions and expectations of both the parties at every point of contact. It helps in building preferential relationship with different suppliers and thus better allocation and utilization of limited management time resources. A large number of suppliers usually lead to little time spent per supplier and thus it becomes difficult for organizations to analyze the supply base as well as prevent maverick suppliers from being added and thus segmentation acts as a critical tool to maintain the quality of their supply base. The obvious question now is on what criterion do we segment the suppliers? A number of factors need to be considered before an organization decides to segment its suppliers. The most obvious factors for differentiation would be the level of spend by

amount, the volume of procurement, the strategic importance of the supplier, the number of units of the company being served by a particular supplier and the type and number of products or services a supplier provides. Others factors to be considered include the degree of interdependence between the supplier and client, the complexity and frequency of changes in supplier requirements, the cost and difficulty associated in switching suppliers, the criticality of the service level needed , the suppliers anticipated quality level and the suppliers technological capability and compatibility with the organizations processes. Depending upon the criterion specified above the suppliers can in general be classified into four different categories. These are defined below: 1) Bottleneck Supplier: Only a few suppliers are usually present in this category. Bottleneck products are those that can be acquired from only one supplier and their delivery is otherwise unreliable and these items have a low impact on the financial results. However the unavailability of these items may lead to production stoppage. The buyer-supplier relationship in case of these suppliers is usually supplier dominated with a moderate level of interdependence. Organizations should direct medium to low resources towards such suppliers. 2) Routine Supplier: Suppliers in this category usually provide products of standard specifications for which a number of suppliers are usually available in the market. As a result it is easy to switch suppliers. The relationship is on the whole evenly balanced. 3) Collaborative Suppliers: These constitute a high percentage of the o rganizations total spend. Generally several come in this category and thus a number of alternatives are available for the buyer. The products supplied by these suppliers are somewhat differential in specification. 4) Strategic Suppliers: These are the most important type of suppliers as they usually are critical for an organizations competitive advantage and for ensuring profitable growth and as such the highest amount of the companys resources should be directed towards these suppliers. An organization typically has a small number of such suppliers and thus these are difficult to replace. They supply non standard products with unique specifications. Such relationships are usually focused on development and driving performance to the next level. Effective supplier segmentation yields many benefits both within the procurement department and across the various business units involved. It provides organizations the opportunity to not only negotiate the best prices for the product or service being sourced, but also the ability to negotiate contracts of appropriate duration and with the appropriate level of oversight. Supplier segmentation is a multi-dimensional and dynamic process, and for it to be effective it is crucial to consider the different stakeholders involved. The same supplier may have different strategic value to different business units within the same company and thus it is necessary for organizations to constantly review whether their strategic objectives are still in alig nment with their segmentation strategies.