The Topic Of Supplier Rationalization Business Essay
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Published: Mon, 5 Dec 2016
This chapter is about the previous research of studies on the topic of supplier rationalization and present the different approaches that how to achieve these goals in procurement sector. Following set of questions is the baseline to search for previous research on this topic. What type of data is available specifically on the supplier’s rationalization in previous studies? What would be the optimum size of the supplier in any organization / Firm? That means what measure would prefer to select and evaluate the suppliers to recommend for doing business with them? Furthermore, what kind of cost savings can be achieved to make such business? What types of risks may include in small size or with few suppliers alliance? And at the end to find out if there is any benefit that goes toward customers by such cost savings?
2.2 Supplier Rationalization:
The word ‘rationalisation’ used by Consins (1999) predominantly aim towards reduction in supply or supplier. However, Dubois (2003) has interpreted the terms cost rationalisation in purchasing to reduce supply cited in Sarkar & Mohapatra (2006). While Choi and Krause (2006) explained the term that reduces the number of suppliers to an organisation, a procedure called supplier rationalisation or supplier optimization or supply base restructuring.
The consensus between articles and research studies (Choi and Hartley, 1996; Narasimhan et al, 2001; Sarkar and Mohapatra, 2006; Kheljani et al., 2009; Ho, et al., 2010; Day, et al., 2009) seems to be significant that is to promote the reduction of suppliers, as many benefits observed. Duffy (2005) research was focused towards the operation of fewer suppliers, but the ideal number of suppliers is not always less. In this review, one of the cornerstone target is the optimum level of suppliers, which is the main focus and thus the perspective of single and multiple suppliers proposal have been given less focus, but this research briefly describe material that is found useful for the two case studies discussed, later in the research.
Normally in procurement business, purchasing is to directly compare prices but in current economic environment proactive competition and to keep sustaining market place review is the path of success. Therefore, procurement is not just purchasing but intelligently buying. Rozemeijer et al. (2003) said that “The level of professionalism is the star of purchasing functions” (Rozemeijer et al., 2003, p.7) cited in (Schiele, 2007). This is the reason that supply-base optimization has become the way to focus in procurement nowadays. The key to generate cost savings is that number of suitable suppliers should continue (Monczka and Trent, 1994). Eventually, eliminate those suppliers that are not capable of achieving world-class performance levels (Schotanus et al., 2010). Therefore, optimization process requires detailed analysis of both supplier capabilities, their performance and how many suppliers required currently and in the future for each purchased product family?
Monczka and Trent (1994) described in their research that the primary goal of optimization is usually a reduction of the overall supply base accompanied by improved cost, quality, and delivery capability of suppliers. The same approach found in the study of Duffy (2005) that increase in costs and control factors significantly influence the circle of supplier rationalisation. Whereas Fig.1 shows his research about supplier rationalisation.
Fig 1: Factors influence the Rationalisation circle
Source of Information: (Duffy, 2005) Self Sketch
However, suppliers rationalisation is not an easy task to do. There are several steps involved to achieve this level. One of the most momentous step, is to classify the suppliers.
2.3 Supplier Classification
There are numerous articles about supplier classification, but most specific one is Kraljic (1983) portfolio. It has been the platform for supplier classification (Caniels and Gelderman, 2005). Kraljic portfolio as shown in Fig.2, was about buyer-supplier division
Fig 2: Classification of supplier-buyer
into four parts i.e. non-critical, leverage, bottleneck and strategic on the bases of profit and risk under low-high parameters (Kraljic, 1983). This was the idea of supplier categorisation and provides the concept for the buyer to choose what kind of relationship they are going to develop with suppliers and what would be the profit, supply risk and bargaining power proportion if they choose the specific quadrant. In this research, the leverage and strategic quadrant would be the critical area of discussion from the buyer prospective and more influential, is any consequence of optimal level where the bargaining power of buyer is quite high. Whereas, this could not be achieved by the reliable method of supplier evaluation and selection.
2.4 Supplier Selection and Evaluation of Performance
The purchasing functions remain one of the most difficult to assess (Easton et al., 2002, p.127). Generally most of the firms evaluate suppliers on some key criteria such as price, quality and delivery (Weber et al., 1991) cited in Sarkar and Mohapatra (2006) but if Firms/organisation would focus the long terms relationships with suppliers then it would be better to choose the benchmarking criteria (Camp, 1989,1995) cited in (Narasimhan et al., 2001) which would strengthen the relationship (Cox, et al., 2003; Tunisini and Bocconcelli, 2009) as well as the quality and innovation (Lamming, 1993) and most valuable aspect is that benefits goes till the end i.e. customers, and it would not be wrong to say that this is the way of success in procurement.
The principal is to choose the criteria for selection and performance for the best fit supplier for the firm / organisation. Usually this criteria depend on firms goal of business i.e. for retail it would be delivery (JIT), for financial sector it would be quality and for Charity organization it would be price of services. The criticality of supplier selection is evident from its impact on firm performance and more specifically on the final product attributes such as cost, design, manufacturability, quality and so forth (Burt, 1984; Burton, 1988) cited in (Narasimham et al., 2001). While Bauker and Khosla (1995) have identified the suppliers evaluation issues as a fundamental decision area in operations management. There are numerous techniques that in use to select the best or most appropriate suppliers (Berger et al., 2004, p.14). While before exploring these techniques it would be better to emphasize the concept towards achieving such approaches. There are three categories, where all approaches base on supplier evaluation.
It is difficult to describe these all three areas in detail but below is a brief review.
2.4.1 Conceptual analysis:
This approach provides theoretical ground for achieving the goals. There is some key research found on conceptual base work of Hahnetal, 1983; Jackson, 1983; Kraljic, 1983; Treleven, 1987; Burton, 1988; Benton and Krajeski, 1990; and Ellram, 1990. All the articles emphasize on the trade-off among supplier performance in cost, quality and delivery attributes. While Narasimhan et al. (2001) provided conceptual approach of supplier selection base on capabilities and performance level as mentioned in Table.1.
Table 1: Supplier Selection by Capabilities and Performance
Quality management practices and systems
Documentation and self-audit
Design and development capabilities
Cost reduction performance
Cost reduction capabilities
Source of information (Narasimhan et al., 2001)
Camp (1989, 1995) presented the idea of benchmarking standards to evaluate the supplier and classified it by ‘inefficient’ and ‘efficient’ under low and high performance criteria. He described in Fig.3 below that benchmarking is the initial step that firms must undertake before being involved in business activity of rationalisation and development strategies towards cost savings cited in (Narasimhan et al., 2001).
Research identified a positive relationship between performance and supplier-evaluation systems (Carr and Pearson, 1999).
Fig 3: On the peak of performance and efficiency
2.4.2 Empirical research:
This approach provides practical ground for achieving the goals. There is some key research data found on empirical base work of Cardozo and Cagley, 1971; Monezka et al., 1981; Moriarity, 1983; Woodside and Vyas, 1987; Chapman and Carter, 1990 and Weber et al., 1991. All of them concluded that quality was the most decisive factor. They all practically evaluated by different methods the quality base supplier line. The key finding of Woodside and Vyas (1987) was that management was usually willing to pay 4% to 6% higher than the lowest acceptable bid for superior product performance.
2.4.3 Modelling research:
This approach provides software base programming to manage day to day activities in highly systematic way. There are numerous articles wrote on this part of research and 47 out of 74 articles mention analytical models for suppliers evaluation such as simple weighted scoring model, mathematical programming approaches and data envelopment analysis (DEA) cited in Weber et al., (1991). However, there are also several other software’s most popular Ariba and SAP programmes as mentioned in Table.2 for more detail. Basically all these models check the best fit suppliers and many other functions providing to reduce the cost and generate more saving and to maximise profit for firms / organisation but now essential to understand that every model would not fit in every business setup for example, Pan (1989) proposes a linear programming model which optimally determine the number of suppliers and his prime objective was to use this template for minimizing the cost per unit as a weighted average of selected supplier’s price. However, the limitations are that several assumptions made in this model do not exist in practical life such as supply is reliable and unlimited. Therefore it is required to choose the appropriate method according to firm’s objectives to optimize the number of suppliers.
However, the most recent work of Ho, et al., (2010) described different multi-criteria decision making approaches of selecting the right supplier. Some methods / approaches are mentioned in Table.2.
Table 2: Supplier Evaluation and Selection methods
Multiple sources of information as mention in the reference column
Table 2(Continued): Supplier Evaluation and Selection methods
Multiple sources of information as mention in the reference column
Table.2 mention, some types of methods, which highly depend on the data, usability, skills of the workforce and implementation would be the fundamental points.
It would be better to describe some examples of selections and evaluation of suppliers in firms / organisation practically in use.
â€¢ Sun Microsystems:
Ranks it suppliers with a ‘Scorecard’ based on quality, delivery, technology and supplier support (Holloway et al., 1996) cited in (Burke et al., 2007, p.96).
â€¢ Motorola’s Mobiles:
Company select and choose a supplier on the bases of order quantity achievement capabilities and periodically check supplier performance and to keep in a group of specialized or generalized strategic sourcing (Metty et al., 2005).
â€¢ GM motors:
GM motors uses e-procurement tools for purchasing by web-based system that easily trace out efficient suppliers and significantly reduce the overall cost such as price of materials, administrative costs, inventory costs and purchase fulfilment cycles (Veverka, 2001) cited in (Burke et al., 2007).
After the above selection and evaluation methods process history the principal objective of this research is that what would be the size of supplier? The next part of research is about this key issue.
2.5 Suppliers Single (Sole sourcing) and Multiple (Dual sourcing) or Optimum Size
The choice of how many sources to be used for purchasing is quite difficult because of criticality involved i.e. supplier financial position, location, operation capabilities, labour efficiency, technology, warranties, market goodwill etc (Zenz, 1994). As already mentioned before, some details and points about suppliers size but in this section, the previous research more specifically dig-out especially sole and dual sourcing aspect towards our optimum size achievement because many firms and organisation practicing single and multiple base sourcing purchasing. Parlar and Wang (1993) compare the costs by single versus dual sourcing for a firm. Their approach was minimizing purchasing and inventory related costs by size of supplier. The key suggestion in their research was economic order quantity (EOQ) based on ordering strategy adopted for different levels to reduce the total cost (Burke et al., 2007, p.98). It seems to ignore the supplier capacity factors which would be critical in the situation of high-demand market and such practice may affect relationship between the buyer and supplier. However, it is to be sure that single sources provide significant benefit, one from it, the lower total cost but high level of supply risk (Larson and Kulchisky, 1998) cited in Sarkar and Mohapatra (2006).
Here, an example of sole and dual sourcing suppliers is mentioned. “Nokia Corporation” uses multiple sourcing policy which immediately switches its chips by other source if some mishap occur in one source. On the other hand, “Telefon” and “Ericsson” other mobile-phone companies using a single sourcing policy of microchip supply and they faced significant losses ($400million) in 1997 as their only source had plant fire and they abandon their sales (Berger et al., 2004).
There are several methods for optimal procurement strategy. The research of Agrawal and Nahmias (1997) then the study of Zeng (2001) provides examples of the optimal number of suppliers. They defined to classify the suppliers by their level of performance and used the mathematical nature of methods to generate the best possible list of suppliers for firms and then select the top level in each category as optimal size. The research of Burke et al. (2007) shows the same level of approach to tiers the supplier by their specialty and selects the right size according to the firm requirement. However, Burke and Vakharia (2004) point out that sourcing strategy base on three key decisions (a) To Identify the pool of suppliers;
(b) Then choosing the right set of suppliers
(c) And how much order from the each supplier (Invoice orders). (Costantino & Pellegrino, 2010, p.27).
Notwithstanding of all above the key issue is always cost factors, which decide the implementation of any strategy if it is applicable or not.
2.6 Cost factors:
Global competition has made the issue of cost control ever more vital for the sake of survival and competitiveness (Soroush, 2007). Doing a supply base rationalization is always cost-related. Newman and Krehbiel (2006) described that suppliers are grouped by cost and quality based metrics cited in Newman et al. (2007, p.153). They divided suppliers in different tiers to analyze their cost and quality based metrics performance. Their approach has been shown by self sketch in Fig.4 .However, Fig.4 will be described in detail in the methodology section when two case studies are analysed.
Cost and Quality Metrics of Supplier Performance lever
Fig 4: Relationship by Cost and Quality Metrics Performance
Self Sketch: Source of information (Newman et al., 2007, p.153)
If pursuing supplier reduction without a clear assessment of the costs and benefits that may create a problem in short and long term strategy (Cousins, 1999). Reduction in supplier or minimizing them just for cost saving is not our objective here but to optimize the supplier is the main objective under specifying cost saving which will also be explained by practical case studies analysis in the methodology section.
The sensitivity of the optimal number of suppliers is that different input parameters involved in achieving the magic number. In the study, of Berger et al. (2004) it was found that “when operating costs of multiple suppliers follows a linear function that the sum of a fixed cost and variable cost is the important numbers to access the suppliers. Let’s assume the optimal number of suppliers is relatively flat as a function of increasing loss, but will increase like the loss increases significantly. Whereas, an increase, in the variable operation cost favours a decreased number of suppliers, which confirms that intuition from a cost-effective point of view. Although, the optimal number of suppliers is remarkably robust and very less probability to all suppliers go-down in the high-demand situation” (Berger et al., 2004, p.15).
Cox (1997) expressed that organisation require a sensitive awareness of the benefits of both a competitive and collaborative strategy, if simply concentrating on transaction costs and not by preparing the organisation in terms of skills, competencies and internal measurement systems for a new style of working, these strategies can cost firms significantly more. This is the pinnacle rule available to continuously update the system for sustainable market place so than short bout of recession would not affect the business and reap-out from the souk. However, costs tend to be realised in the medium to long term, after the benefits of short-term leveraging have been realised (Parker and Hartly, 1997, pp.120-125) cited in (Cousins, 1999). It would be better that firms should focus on the total cost when pursuing these long-term strategic approaches and not primarily focus on the short-term transactional savings. If firms focus exclusively on the administrative transaction costs of doing business they may ignore the others, such as managerial and strategic exposure costs (New and Ramsay, 1997, pp.93-102) cited in (Cousins, 1999).
It would be better to explain the above concept by one example after reading the research work of New (1997); Ramsay (1997) and Cousins (1999) that reducing the number of suppliers requires a different management style; usually buyers focus on strategic level but losing their leveraging expertise. Therefore, buyer needs to use cross-functionally, on one side they coordinate with customers and on the other side with suppliers. Whereas this require new skills, competencies and measurement systems that is why the above supplier evaluation methods provide opportunities to the buyers as well to acquire these skills to practicing them regularly. In addition to these considerations, there is strategic exposure about cost implications for medium to long-term risk may be increased. Kakabadse (2000, p.673) described that “whatever the reason for strategic sourcing, a key purpose still remains, reduction of costs”. The same approach found in Munday (1992b); Carr and Ng (1995); Cooper and Slagmulder (1997 & 1999b). It is crucial to tactically reduce the suppliers that can prevent firms being flexible in periods of high demand. e.g Rolls-Royce, in 1997 pruned its supplier base, which accounts for 70% of its engine components from 1200 companies to just 600 since the recession. This reduction forced Rolls-Royce into inflexibility to meet new demand. Because, in the market, there are fewer strategic suppliers that they react in the short-term when demand cranks-up (Consins, 1997). There are many costs related to procurement which can not possibly be covered because of the limitation of research, but it would be better divide the costs in three categories for brief outlook.
â€¢ Strategic Costs
â€¢ Managerial Costs
â€¢ Operational Costs
(Cousins, 1999, p.152)
2.6.1 Strategic Costs:
The costs of exposure of the business to the market place, such as reducing the number of suppliers will increase the level of dependence on fewer and more powerful suppliers. In addition, this method can also restructure in a semi-permanent way the structure of supply with the industrial market place that other costs might raise the price then there is a risk of potential loss of innovation from a variety of supply (Cousins, 1999).
2.6.2 Managerial Costs:
The costs of managing the relationship, such as problem solving, inter-organisation teams, project management etc(Cousins, 1999).
2.6.3 Operational Costs:
The costs of operating the relationships such as invoicing, telephoning, purchase order creation, transportation, inventory management etc. For example, 30 years old article by Ammer (1974) and recently Morgan (2000) and the Jacoby (2005) that there is a leading void on the operational side. Whereas the Cousins (1999) presented the concept in Fig.5
Relationships factor among categories
Fig 5: Cost relationship by factors
which shows the relationships aspect, which provide, what rates and benefits in return for the short-medium and long-term bases. “Organizational buying is dramatically shifting from the transaction oriented to the relational oriented philosophy, and will vary from a buying process to a supplier relationship approach” (Sheth and Sharma, 1997, p.91) to control the cost of purchasing.
Furthermore, the relationship approaches tremendously influential as per cost reduction (Vijver and Vos, 2004). Let’s assume that if firm / organization demanding price decreases from every supplier and not taking a total cost in focus and leaving no incentive for the supplier to reciprocate so this is the true separation point between both relationships that firm do not realize the long-term gains with supplier relationships.
Fig 6: Cost and benefit control by relationship
Fig.6. shows the cost and benefit by relationship approach that there is more benefit in the long term rather than the short term leverage strategy (Cousins, 1999). Now the question is what is the reason we are doing all this process? The answer is to generate more savings. The next part is about saving prospect.
2.7 Generate savings:
This is an essential part of this research that if any savings will be obtain? Then what kind of costs may be reduced i.e. stratgic, managerial or operational under optimum level of suppliers? Eventually it is noteworthy what kind of savings may gain by supplier rationalization. It would be better to classify the savings. Dmytrenko (1997) used term ‘hard savings’ which he refers monetary savings that directly impact the bottom line. While the nature of this saving is quantitative type that tangible information required for it to measurement. Normally cost reduction is measured by comparing the negotiated price that is paid at the end (Monczka et al., 1979) cited in Nollet et al. (2008). Hard savings are of utmost importance in real measuring saving systems (Verma and Pullman, 1998) cited in Nollet et al. (2008, p.127).
Keen (1997) referred ‘soft savings’ that may be converted into monetary savings, while it is also different to measure it because the difficulty of measuring soft savings accuracy is greater than for the hard savings. Soft savings based on qualitative criteria, its impact on the bottom line may be contingent that when benefits act spread across in various departments.
The measurement system of savings had become such a sensitive issue, that numbers of researcher preferred not to do it because statistics closely linked with a profit margin and researcher always found a barrier to access information from firms / organization for true result (Nollet et al., 2008, p.128). Savings can not be sustained for the longer run which usually decreases over the time, despite constant or even increased efforts. ‘In fact at one point, it might be difficult to get a better price, unless buyers feel justified acquiring lower-quality products’ (Dumond, 1991, p.129) or suppliers ensure a loss.
“If price alone would be the yardstick by which to measure purchasing and its suppliers, things would never improve. Sourcing decisions must be predicated on value not price” (Baia, 1989, p.57). If this is not wrong, then savings generated purchasing strategies, for example negotiation, promoting healthy competition, seizing an opportunity to take advantage of market trends, could be considered and it lead to savings measurement systems to strategies corporate decision making (Evans, 2003, p.129). Numerous articles were analysed on this topic and the key finding from most of them considered that it would be pertinent to have a valid performance indicator, therefore, again supplier selection is the crucial criteria for achieving the magic number of optimization in procurement.
The example of Kraft foods UK shows that after recession dozens of manufacturing plants closed to generate savings of over $ 1 billion dollars in 2009, and now company starts supplier rationalization to save $300 million annually by this process (McLevish, 2009). Therefore, the company looked to select those that provide sustained competitive advantage and who can grow with the company. Which shows company strategic approaches towards relationship to generate more savings.
As discussed above in methods section that software – web base procurement so called e-procurement is the most powerful tools in current worldwide market environment to make costs saving and most relevant to access information which normally extremely difficult even between departments of the same company. The next section is e-procurement to find out the previous research facts and evaluation of this area.
IT industry becomes a fundamental part of modern economies (Cooper, 1990; Jorgenson, 2001). Stefan (2008) expressed that business to business (B2B) activities world exceed $ 7 trillion by 2009, and in this transaction 24% are expected to be done electronically (Ronchi et al., 2010, p.131).
E-procurement is the nature of private, web-based procurement markets that automate communications, transactions and collaboration between supply chain partners (Aberdeen group, 2001a, b). It is about enhancing collaboration streamlining processes, controlling processes, controlling costs and enhancing information exchange within and across organization boundaries (Davila et al., 2003). Numerous articles found that e-procurement is inherently Internet supplier management database which allow one window operation to raise the purchasing process without time wasting.
Fig 9: Supplier Management Database (Self sketch)
Source of Information: (Puschmann and Alt, 2005; Angeles, 2007; Batenburg, 2007)
Fig.9 compress the ideas of different writers (Puschmann and Alt, 2005; Angeles, 2007; Batenburg, 2007). The great deal of management time is spent to keep record, negotiation, to do process with large numbers of suppliers which would be easily handled by supplier management database under e-procurement facilities. Significant literature found on this topic, and it is quite difficult to cover them in detail but summarized in Fig.8.
Fig 10: E-procurement benefits
Eventually there would be some potential risks to reduce the size of suppliers. The next part includes the research on this issue.
The risk usually have two broad categories (1) Supply-side risks including business risks, capacity constraints, quality-related risk, production technological changes, product design changes, switching cost risks (Zsidisin et al., 2000) and (2) Catastrophic risks are such risks, which are out of control of procurement e.g. natural hazards, disasters, blizzards, fires, socio-political problems, terroristic attacks etc impact the procurement strategy (Wagner and Bode, 2006) cited in (Costantino & Pellegrino, 2010, p.28). Here, supply-side risk would be our main focus area of consideration because intentionally we are going to rationalised the suppliers. Smeltzer and Siferd (1998) mentioned that whenever a firm/organisation reduces its supplier base and relies on fewer suppliers for their essential purchasing then there is potential high risk to interruption of supply. The risk factor would be practically analysed more in the methodology section.
The literature review section include the previous research work of different writers under our objective area, limitations were identified under critical review to described own thinking about the subject area and some comparison and contrast pointed out among different writers of different approaches to develop the new concept that may help in the case studies of structure and unstructured base firm and organisation in up-coming methodology section. However, literature review part explained in steps which reveal in Fig.11.
Fig 11: Supplier Sourcing Strategy
Self sketch : Source of information (Vahs, 2005 cited in Schiele, 2007, p.278)
Finally, concluding this section by the words of Duffy (2005) which he expressed about the limited number of suppliers that the supply management will obtain lower prices through leveraged volume, standardized services, and lower costs to manage transactions and the supply base it would be easier to monitor supplier performance if only small numbers of the best fit supplier are in the list then there are significant chances to gain even transfer to customers if the relationships can develop, fostering, trustworthy, value added services and innovation, then greater success in the business should be expected.
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