As companies seek to increase the value of their relationship with suppliers, I am often asked the difficult question, “How many suppliers are required?” Here's my number, regardless of the size of your company: you should have no more than 500 to 1,000 suppliers with whom in excess of 90 percent of your annual spend is purchased.
Okay, stop screaming at the computer screen. Let me give you my rationale for that number; realizing that most companies have in excess of 25,000 suppliers, of whom 15,000 are active and 3,000 to 5,000 suppliers account for in excess of 80 to 90 percent of the annual spend. Since it is impossible to get from over 25,000 suppliers to fewer than 1,000 suppliers by reducing the number of suppliers, let me suggest the approach to use.
The process to reduce your suppliers is similar to zero-based budgeting. That is, start with no suppliers, adding only those that are required. It is also based on the segmentation of the supplier base. Many companies segment their supplier base into four categories: strategic, collaborative, commodity, and transactional. The quadrant approach distinguishes the firm's goods and services according to their value and profit potential and the risk they present to the firm. This is a departure from the traditional way of looking only at the highest dollar volume items and often ignoring the rest. Instead, the quadrant approach examines all items for their value and risk, as shown in Figure 1. My colleague, Professor Joe Cavinato, of Thunderbird International School of Management, and I adapted Figure 1 from a chart originally developed by Peter Kraljic, from the article, "Purchasing Must Become Supply Management," from Harvard Business Review (Kraljic 1983).
- Strategic suppliers provide those goods and services that make the firm's saleable output have a competitive advantage in the marketplace. These are both high risk and high value. Without this supplier, your ability to succeed is hampered. Their value is measured in terms of the ultimate customer and whatever is of value to them.
- Collaborative suppliers provide those unique operational items that are often developed cooperatively and exclusively with a key supplier. Specialized tooling, customized software, and manufacturing processes are good examples. These are only available from one or a few suppliers with long lead times or difficult supply in other ways.
- Commodity suppliers provide the basic items that represent high value but low risk to the firm. Basic production components and materials are examples of commodities. These items are also in plentiful supply and often have little uniqueness.
- Transactional suppliers provide the routine items that often do not enter into the final saleable products of the firm. Their value is low and the risk of disruption to the firm due to supply failures is also low. Generally, these are standardized items in plentiful supply from a wide variety of vendors and distributors.
Allow me to add a fifth category of suppliers: emerging suppliers. An emerging supplier often provides a potential breakthrough but is embryonic and needs intense support. There is no immediate need, value, or risk from these suppliers. These suppliers are an investment in the future. An example would be Microsoft in the 60s.
With this as a definition of supplier segmentation, I have more confidence in telling you that the number of suppliers you need is between 500 to 1,000:
- Strategic—fewer than 75 suppliers
- Collaborative—fewer than 75 suppliers
- Commodity—fewer than 250 suppliers
- Transactional—fewer than 100 suppliers
- Emerging—fewer than 15 suppliers
Part of my rationale for that number is the simple fact that you cannot manage or develop a relationship with more than 1,000 suppliers. Any attempt at supplier quality, joint development, and collaborative effort demands a significantly lower number of suppliers than most companies currently have.
What has been your experience in rationalizing (reducing) the supplier base?