Supplier Segmentation, or Supplier Positioning, refers to the process of classifying suppliers in terms of their importance to the organization. It is an integral part of a Supplier Management program that helps define the resources, processes and procedures that are applied to a supplier relationship.
Supplier Segmentation is an approach to evaluate the importance of a supplier to the buying organization. It allows procurement professionals to assess the supply base of the organization and identify the relative importance of suppliers to the business. Suppliers play a major role in business operations; it is important that they are managed in a way that is based on business importance to ensure resources are best focused to realize the best performance of the supply base.
When done correctly, Supply Segmentation provides a consistent measure of supplier importance across supply base and enables procurement professionals to allocate the right resources and processes to those suppliers. With the right attention and processes in place, procurement can drive broader business objectives with the most important suppliers that will have the greatest impact on their organization.
The Supplier Segmentation Pyramid
Businesses often measure a supplier’s importance with the money they spend with them, which is not a clear indicator of whether that supplier is critical for a business or not. The simplest alternative to this is the Supplier Segmentation Pyramid that classifies suppliers based on their criticality. The suppliers at the top of the pyramid are the most valuable to a business, the bottom of the pyramid has suppliers who are least beneficial to the supply chain. The three categories from most to least valuable are Strategic, Important and Transactional.
Strategic Suppliers
These suppliers are the most critical to business operations because they provide high-value and low-volume goods or services. They make up a small percentage of the supply base, and they help the buying organization by investing in innovation and product/service development, making them high-risk and therefore necessary to be monitored closely.
Important Suppliers
These suppliers enable a business to run its day-to-day operations. They are considered essential for the quality, competence and reputation that they provide to the organization. The risk associated with these suppliers is limited to everyday business dealings, so it’s imperative to focus on their performance and foster relationships to ensure that they meet their contractual obligations. Procurement professionals can find alternatives to these suppliers, if required, but replacing them would be burdensome or inconvenient.
Transactional Suppliers
This category constitutes those vendors who provide low-value and high-volume goods or services. There are many alternatives to these suppliers, making them the easiest to replace if their performance or prices become unfavorable. Thus, the risk associated with these suppliers is the lowest out of all three categories.
Important Points on the Supplier Segmentation Pyramid
- Strategic and Important Suppliers together account for 20% of the supply base, but 80% of the overall procurement spend.
- Transactional Suppliers account for 80% of the supply base, and only 20% of the overall procurement spend.
- The pyramid method is usually adopted by small and medium-sized organizations with a lower number of suppliers.
Supplier Segmentation using the Kraljic Matrix
Proposed by Peter Kraljic in 1983, The Kraljic Matrix appeared in a Harvard Business Review article which insisted that suppliers should be plotted on a 2×2 matrix mapped against two dimensions — profit impact and supply risk. Today, the Kraljic Matrix is widely used in organizations for segmentation of their suppliers.
In this method, the first step is to define factors that translate to impact on profit and supply risk for a particular business. These factors look different for every organization, but a few are common across multiple businesses.
Profit Impact
- Whether the supplier helps the business by driving innovation or not
- Whether the supplier offers competitive prices or not
- Whether your spend with the supplier is high or not
- The number of procurement categories that the supplier covers for the buying organization
Supply Risk
- The supplier’s criticality to your business, that is, can the supplier be replaced or not, and the likely extent of disruption in business if the organization loses them
- Whether the supplier is exposed to any financial risks, or if there’s any threat to the good name or reputation of the supplier
- Whether the supplier’s location can lead to delays and disruption, such as political turbulence, proximity to natural disasters, etc. or not
- Whether the supplier has consistently delivered high-quality goods or services on time or not
Once the profit and risk factors are defined, each of them is assigned a weight to derive the correct quadrant for the suppliers. Each of these quadrants in the Kraljic Matrix relates to a specific supplier relationship type and calls for different procurement strategies.
The Quadrants and what they mean for your Supplier Strategy
Non-Critical Items
The non-critical items are low-risk, low-value commodities, like office stationery, that help the staff and employees perform their everyday duties. The suppliers of non-critical items pose negligible risk to the supply chain as there are several ways to procure these items. Consequently, procurement professionals tend to allocate less of their time building relationships with the suppliers from this quadrant.
Bottleneck Items
The suppliers of bottleneck items provide low-value but high-risk goods or services, with many of these suppliers often being single-source. These items are integral to the supply chain, but they do not affect the organization’s profitability by that much. The suppliers in this quadrant can affect the price movements as the business relies on their performance for the time being. Therefore, procurement professionals often have to pay great attention to the suppliers of bottleneck items.
Leverage Items
The leverage items are critical to the business operations, but their suppliers pose little to no risk to the supply chain. There are multiple suppliers of these items, and many of them can provide high-quality articles at competent prices. As a result, buying organizations possess considerable negotiation power, and procurement professionals can drive down the prices of these low-risk items.
Strategic Items
The last quadrant comprises suppliers who provide the most strategic items to the business. These are high-value and high-risk items, and, therefore, procurement professionals spend a significant portion of their time building and maintaining relationships with these suppliers. Suppliers of strategic items require the most careful and intensive Supplier Management.
Conclusion
Supplier Segmentation is a great way to evaluate the level of supplier management activities required for every supplier. An organization should conduct a segmentation activity once every year since many factors can change over time; a supplier’s risk profile may fluctuate, new suppliers may emerge in the market, the items supplied by existing suppliers might become obsolete, etc.
There are several segmentation methods Procurement professionals can use, if they consider both subjective and objective input for their assessment. Lastly, procurement should ensure that the segmentation results are shared with internal users who collaborate with the suppliers to always ensure the correct management of suppliers.
Key Takeaways
- Always assess suppliers based on your organizations perspective
- Re-assess every 12 months to ensure the supply base is segmented correctly as your organization evolves
- Have aligned supplier management strategies and processes to each segment to ensure consistent supplier management across your organization
