Procurement

Supplier Consolidation, Versus Rationalization, Leads to Stronger Supply Chains

Nov 06, 2014

Credit: manostphoto at FreeDigitalPhotos.net

Credit: manostphoto at FreeDigitalPhotos.net

Recently, Mahindra and Mahindra Ltd., India's largest utility vehicle and tractor maker, announced plans to reduce its supply base by 10 percent a year for the next five years. We see this type of supplier consolidation happening more and more among discrete manufacturers, especially within the automotive industry.

As you peel back the layers on this approach, you will discover that this type of sourcing strategy is far different from a typical supplier rationalization program. The latter tends to focus on quickly driving down the cost of high-volume, non-critical parts and components. Supplier consolidation, on the other hand, focuses more on building the right long-term supplier relationships where target margins are achievable while also balancing quality, risk, access to innovation, and more.

When done right, a good supplier consolidation program will better enable you to create and maintain a high-quality, cost-competitive, and reliable direct materials supply chain. So how does one go about developing an impactful supplier consolidation program? Here are some steps to consider.

1. Inventory and Segment BOM

Begin by creating a consolidated BOM (bill of materials) across every product your company makes. You need people with good data management skills on your team as getting this step right will directly impact the success of the inventory project. Next, build a segmentation scheme to classify each part and component. Beyond commodity classification, segmentation factors should also include level of criticality to the product, attainability, and degree of engineering.

2. Identify Part Standardization Opportunities

With a full accounting of materials used, you now are in position to examine each and every product design and determine if you can achieve parts standardization. Here, it is critical to have the engineering department involved. First, look for the low-hanging fruit -- situations where Part A can be eliminated in favor of Part B. Next, challenge the engineers to consider how products can be redesigned to use a more common set of parts and components.

3. Centralize Purchasing Power

With higher volume needs in hand, it is time to centralize your purchasing power. For many manufacturers, that means funneling all purchasing for one group. But it doesn't have to be that way. Sourcing technology that enables decentralized groups to work together off the same fact base is available. Working collaboratively, even decentralized groups can leverage greater purchasing power and drive out costs.

4. Build a Total Cost Template

Understanding the true total cost associated with a particular supplier is critical to any supplier consolidation program. Your cost template should include component, transit, finance, and compliance costs, as well as costs of poor quality. And don't forget to factor in lead times, minimum order quantities, payment terms, and Incoterms. These factors have a direct impact on the true total cost of a selected supplier.

5. Identify Critical Non-Cost Factors

An effective supplier consolidation program doesn't focus on finding the lowest cost but rather on creating the right fact base to make the best trade-off decisions. Thus, it is imperative that your sourcing templates also capture critical non-cost information about each supplier's offering. What type of material is utilized? How is the material processed? What types of certifications has the supplier achieved? What is the risk level associated with each supplier (see step 6)? How does all of this impact quality and the overall experience of your customers? You must combine this information with cost in order to make fully informed supplier decisions.

6. Conduct Supplier Risk Assessments

A major objective of a supplier consolidation program is to find suppliers for the long term. Given that selected suppliers will now contribute components to more of your products, you have to be very thorough in assessing the risk you will be taking on with each supplier. Risk assessment goes well beyond their financial stability. How clear is their conflict minerals status? What are their capacity levels? Are they located in a region more susceptible to natural disasters? What risks would you associate with their labor force? How reliable is their production equipment? Budget for on-site visits to suppliers; insights become a lot clearer when you see for yourself.

7. Evaluate Each Supplier's Innovation Potential

Finally, a key factor to consider during a supplier consolidation effort is the supplier's ability to deliver innovation. This includes keeping you up to date on new materials and processes, providing insights into customer needs, and suggesting product design changes that could save you money while not impacting quality. Look for suppliers that want to create win-win situations.

Unlike supplier rationalization, which can be accomplished in months, an impactful supplier consolidation program develops and evolves over a much longer period of time. A great deal of data collection and analysis is needed upfront, and a more thorough supplier-vetting process is required. Suppliers should be phased in and out at the proper pace.

It takes time to build a strong, reliable, long-term supply chain, so be sure to set expectations accordingly. When done well, a supplier consolidation program will provide significant benefits and improve shareholder value.

Michael Cross is the senior manager of solutions marketing at Directworks, a leading provider of cloud-based sourcing and supplier management software for manufacturers. With a sole focus on the manufacturing industry, Michael dedicates significant time and energy studying how industry trends, drivers of change, and emerging market conditions impact supply chain, sourcing, and supplier management processes. Michael has generated a variety of articles, white papers, webinars, and blog posts on the topic. Michael holds a PhD from the University of Pittsburgh.