Balance Supplier Risk Versus Reward

7 steps to gaining the greatest total value from your supplier relationships while minimizing risks


In the wake of constant demand and supply market changes driven by recent economic crises, procurement and supply chain professionals are facing higher expectations from management to drive down costs. But a myopic focus on cost savings can have an impact on supply and supplier risk, and can result in the unintended consequence of diluting the total value delivered from that supplier relationship. The key, therefore, is to balance supplier risk with reward to obtain the greatest benefit from suppliers while minimizing risks.

While it can be difficult to find this balance, there are some approaches and tools that leading companies are adopting, which include:

Defining and prioritizing supplier tiers;

Utilizing risk assessment processes for new product/service requests;

Incorporating initial and ongoing supplier due diligence;

Utilizing balanced category scorecards;

Adopting robust supplier performance reporting and issue resolution;

Developing and regularly updating category market research profiles;

Implementing a supplier Six Sigma program.

The following is an in-depth look at these approaches and tools and how they can be effectively applied.

Define and Prioritize Supplier Tiers

Most companies have critical suppliers that have a significant impact on their revenue and profit. However, these suppliers and/or supplier tiers are not always formally defined, nor have tailored programs been developed to address this segment of the supply base. Companies that adopt a “one-size-fits-all” approach to managing suppliers run the risk of conducting less rigorous assessments of the critical suppliers and over-assessments of non-critical suppliers. This can produce a number of “false positives” or “false negatives” that can result in inefficient allocation of scarce procurement resources and that ultimately decrease the value the procurement function delivers to its internal customer. The following is an example of defining and prioritizing supplier tiers:

Tier 1. A significant-spend supplier whose products/service are critical to a company’s revenues and require:

Complex contracts that drive continuous improvement

Proactive supplier relationship management

Detailed monthly supplier performance reporting

Proactive forecasting

Tier 2. A moderately high-spend supplier whose products/service are important to a company’s revenue and require:

Complex contracts

Proactive supplier relationship management

Detailed quarterly supplier performance reporting

Tier 3. A supplier whose products/service are not critical to a company’s revenue but require:

Complex or basic standard contracts

Annual performance reporting

Tier 4. A supplier whose products/service are not critical to a company’s revenue and who:

Falls within a non-procurement-managed category

May utilize standard purchase order terms and conditions

After creating a tiered approach like the example above, companies can then develop targeted and differentiated programs to adequately identify and manage risks based on the category and supplier.

Risk Assessment Processes for New Product and Service Requests

Many companies have some kind of process to identify risks related to new supplier requests, but they may not review the risk for additional products/services from that same supplier at a later point in time. This can lead to a false sense of security, since although the initial assessment of that supplier was positive, it now may not reflect the higher risk of that same supplier due to potentially new and higher-risk products/services being acquired.

Incorporating a risk assessment activity at the beginning of each product/service request for both new and existing suppliers can help companies identify and manage new risks effectively (see Figure 1 on page 7). The trick is to make the risk assessment process simple enough and streamlined enough so that it does not become onerous or non-value-adding. In addition, there should be steps in the process that include some procurement or strategic sourcing subject matter review. This subject matter review helps ensure that the information provided and risks identified make sense. Also, this helps reduce requestors from “gaming” the process in order to get requests through the process as quickly as possible.

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