Optimal share of supplier turnover.

As a tactical buyer, establishing healthy supplier relationships is a critical aspect of our role. An essential consideration in these relationships is determining the optimal yearly spend with a supplier in relation to the supplier’s yearly turnover. While the rule of thumb suggests that an optimal spend is approximately 20% share of supplier turnover, several factors must be considered to ensure a mutually beneficial partnership.

Content in article…

1. Supplier Dependency

Relying too much on a single customer can be risky for suppliers. If your spend constitutes a large portion of the supplier’s turnover (significantly higher than 20%), the supplier might become overly dependent on your business. This situation can lead to complacency, reduced competitiveness, or even financial instability for the supplier if your business needs change.

2. Bargaining Power and Flexibility

A balanced spend ratio can enhance your bargaining power and flexibility. Being a significant, but not overwhelming, part of the supplier’s business ensures you are an important customer without creating a situation where the supplier’s financial health is solely dependent on you. This balance encourages the supplier to provide competitive pricing, quality service, and innovation while maintaining their operational flexibility.

3. Risk Management

Diversifying your spend across multiple suppliers or ensuring that your contribution to a supplier’s turnover is balanced can mitigate risks. It prevents disruptions in case of supplier issues. A spend ratio that is too high with any single supplier introduces risk, should the supplier face operational, financial, or quality challenges.

4. Supplier Development and Investment

Investing in a supplier’s growth can be mutually beneficial, especially in strategic partnerships. If a supplier shows potential for innovation or exceptional service, a higher spend ratio might be justified. However, this should be approached with careful consideration of the supplier’s capacity to absorb and effectively utilize the increased business without compromising service quality or financial stability.

5. Market Conditions and Supplier Performance

Market conditions, supplier performance, and strategic importance of the goods or services provided should influence the spend ratio. In some cases, it might make sense to exceed the 20% rule for suppliers who offer critical, high-quality, or highly specialized products and services, especially if there are few viable alternatives in the market.

Kraljic’s Matrix, a strategic tool for managing a company’s procurement portfolio, divides goods and services into four quadrants based on two dimensions: the complexity or risk of supply and the importance of purchasing in terms of the impact on financial performance. These quadrants are Leverage, Strategic, Non-critical, and Bottleneck.

Understanding the optimal yearly spend in relation to a supplier’s turnover within the context of Kraljic’s Matrix can indeed highlight scenarios where a share more than 20% is acceptable or problematic. Learn more about Kraljic in the course “Get to know Kraljic and his matrix“. (After completing the course you will have an understanding of who Peter Kraljic is and the history of his Matrix, how to use Kraljic’s Matrix and in which procurement processes you apply Kraljic’s Matrix.)

1. Leverage Items

Leverage items are those with a high financial impact but low supply risk. Given their characteristics, suppliers in this quadrant are often more numerous and competition among them is higher. Therefore, a spend higher than 20% might not pose a significant risk, as alternative suppliers are readily available. In this quadrant, pushing for better prices and terms through increased spend and commitment can be a strategic move and finding the optimal share of supplier turnover is of less importance under the condition that competition (multiple sources) are available.

2. Strategic Items

Strategic items are of high financial impact and high supply risk. These are critical to your company’s success, often with few alternative suppliers. Here, a spend significantly higher than 20% can be both a necessity and a strategic choice, especially if it helps secure supply, foster innovation, and ensure a competitive edge. The key is to manage the relationship and dependencies carefully, ensuring mutual benefit and risk mitigation strategies are in place.

3. Non-critical Items

Non-critical items are of low financial impact and low supply risk. Given their low strategic importance and the abundance of alternative suppliers, a high spend percentage is usually not problematic. However, it might not be beneficial to concentrate too much spend on these items with a single supplier, as it could lead to missed opportunities for cost savings by leveraging competition among suppliers.

4. Bottleneck Items

Bottleneck items have a low financial impact but high supply risk, often due to limited supplier options. In this quadrant, a spend higher than 20% might indicate an over-reliance on a single supplier for items that, while not significantly impacting the budget, pose a risk to the supply chain due to their scarcity or unique nature. It is crucial to diversify suppliers where possible or develop strategic partnerships to mitigate supply risks without creating undue financial dependency on either side.

Expanding on the discussion around Bottleneck items in Kraljic’s Matrix, it’s worth noting that these items, despite their low financial impact, carry a high supply risk due to limited availability, scarcity of suppliers, or complex specifications that make substitution difficult. This unique position makes them critical to manage, as they can become significant vulnerabilities in the supply chain.

Increasing Spend to Transition from Bottleneck to Strategic

The notion of increasing spend on Bottleneck items to make a buyer more important and potentially transition these items into the Strategic quadrant involves a nuanced approach. By increasing investment, the buyer aims to gain more attention and better service from the supplier, potentially securing a more reliable supply and mitigating risk. This strategy could involve:

Investing in Supplier Development: Working closely with the bottleneck supplier to improve their capabilities or efficiency, thereby reducing supply risk and enhancing the strategic importance of the relationship.
Collaboration for Innovation: Engaging in joint development efforts to innovate or find alternative solutions that could ease the bottleneck situation, making the item less of a supply risk.

However, this approach assumes that the supplier is capable of and interested in evolving the relationship in a way that benefits both parties. It requires a commitment not just in terms of spend but also in time and strategic collaboration.

Changing the Situation

Another strategic approach is to actively work on changing the situation to either mitigate the bottleneck or eliminate it altogether. This could involve:

Diversification: Identifying and qualifying alternative suppliers, even if it means investing in their development to meet your needs. This can reduce reliance on a single bottleneck supplier.
Innovation and Substitution: Exploring alternative materials, products, or technologies that could replace the bottleneck items, thereby reducing the supply risk associated with these critical items.
Strategic Stocking: Building strategic stockpiles of bottleneck items can be a short-term solution to mitigate immediate risks while longer-term solutions are developed.

The Goal of Transition

The ultimate goal in managing bottleneck items is to secure the supply chain while minimizing risk. Transitioning an item from the Bottleneck to the Strategic quadrant is an ambitious move that reflects a significant reduction in supply risk through strategic supplier development or innovation. However, if these efforts do not lead to a sustainable improvement in supply risk, the organization might need to consider more drastic measures, including finding new suppliers or innovating away from the need for that specific item altogether.

While the 20% guideline provides a good starting point, the finding the optimal share of supplier turnover requires a nuanced approach. Considerations around dependency, risk, market conditions, and the strategic importance of the supplier’s goods or services must inform the decision. Regular reviews and adjustments to the spend ratio, aligned with strategic objectives and risk management principles, will ensure a healthy, productive supplier relationship conducive to long-term success.

The appropriateness of exceeding the 20% spend threshold in relation to a supplier’s yearly turnover varies across the quadrants of Kraljic’s Matrix. For Leverage and Strategic items, where financial impact and strategic importance are high, a greater spend can be strategically beneficial if managed with careful consideration to risks and dependencies. For Non-critical and Bottleneck items, the focus should be on managing risks and ensuring supply chain resilience, with a cautious approach to spending that avoids unnecessary dependencies. Each quadrant requires a tailored strategy that aligns with the overall procurement and risk management objectives of the organization.

In practice, each situation will require a bespoke strategy, combining risk management, strategic sourcing, and innovation. The complexity of moving an item out of the Bottleneck quadrant underlines the importance of a proactive and strategic approach to procurement, emphasizing the need for strong supplier relationships and continuous improvement in the procurement process.

Learn more about Sourcing in the bundle The sourcing engine room – a modern sourcing process. The Sourcing Engine room is build around three courses presenting the basics of a modern sourcing process. Learn about the key activities when preparing, negotiating and implementing a new improved supply chain and also the considerations to be made when finding the optimal share of supplier turnover..

Note: Illustration to the blogpost “Optimal share of supplier turnover.” is created by Chat-GPT on March 16, 2024.

At Utbildning Inköp you find more information in Swedish about LHTS’ courses

Tags: Advanced level share of supplier turnover