SUPPLIER SEGMENTATION: A COMPANY CASE - UCHENNA OHAERI
University of Liverpool EBUS 535: Strategic Purchasing ManagementAssignment 200916841MANAGEMENTSCHOOLUNIVERSITY OF LIVERPOOLEBUS 535 – STRATEGIC PURCHASING MANAGEMENTASSIGNMENT
University of Liverpool EBUS 535: Strategic Purchasing ManagementAssignment 2009168411. According to Kraljic (1983), supplier segmentation is a process of measuring spend or profitimpact via volume purchased, percentage of total cost and impact on product quality or businessgrowth by supply risk via availability, number of suppliers, competitive demand, storage risks,make-or-buyand substitution opportunities. Dyer et al. (1998) takes this further and suggests thatbuying companies should adopt a more strategic approach instead of a „„one-size-fits-all‟‟strategy for suppliermanagement.Kraljic (1983) explicitly applied different strategies which are described to handle suppliers,supply itemsand defining an appropriate sourcing category, segmenting the supplier market andinfluencing the power between a company and their key suppliers in each segment as shown infigure 1 below.HighLeverage Items:Exploitation ofpurchasing power.Strategic Item:Diversify, balance orexploit.Noncritical Items:Efficient processing.Bottleneck Items:Volume assurance,search for alternatives.Low HighSupply riskFig1: Categories and strategies, Source: Modification from Kraljic (1983)As suggested by Rezaei and Ortt (2012), supplier segmentation logically takes place aftersupplier selection.Firstly, in using the Kraljic‟s supplier segmentation model to ensure an appropriate purchasingapproach, the Purchasing Manager must categorise all products and services that they buyaccording to the supply risk and potential profit impact, suppliers are then selected from existingand outside groups via a competitive bidding process and then segment them based on theirstrategic importance and role in Alpha Products‟ business. Secondly, the capabilities of eachpotential supplier are assessed and segmented in the four quadrants of the Kraljic‟s matrix toknow which is best fit in supply areas such as engineering and maintenance services.Effective application of Kraljic‟s supplier segmentation model to Alpha Products‟ purchasingstrategy will yield many benefits including cost reduction, health and safety administration,control, accountability and better relationship with suppliersboth within the purchasingdepartment and across the various business units involved. Cusumano and Takeishi (1991)supported this by saying that a competitive advantage could be achieved by companies throughan effective supplier segmentation process management and improving the qualitative andquantitative levels of suppliers.In the case of Alpha Products, the engineering maintenanceservice supplied by the 52 suppliers falls in the strategic item quadrant (high spend, high risk)
University of Liverpool EBUS 535: Strategic Purchasing ManagementAssignment 200916841which is a lot for one category, it is also worthy of note that they are already using some of theKraljic‟s theory as a powerful tool in Ruth‟s conclusions, but does not reflect the complexity ofthe case, it is not to be seen as a solution, but a guide aimed at starting strategic discussions andvisualisation of purchasing strategies among various functional teams in the company andgetting them to ask the right questions, how can we get risks and costs down, How cancommodities and suppliers be moved around the different portfolio segments andwhat should webe doing with our categories of spend, the answer could be to go into a strategic partnership withsuppliers in that strategic category as suggested by Kraljic, but that isnot the only solution.Another approachas proposed by Gelderman and Van Weele (2002) is to adoptsuppliersegmentation and move items from a strategic to a leverage position with lower spend orincreased profitability impact and low supply risk. This, in their opinion can be achieved througha strategy of supplier development and making the engineering maintenance service product lesscomplicatedand new suppliers are developed and thereby making Alpha Products to have a highdegree of control over their supplier, cost reduction, better health and safety administration,accountability and increased relationship with suppliers to curb the „blame game‟ issues amongthem.
University of Liverpool EBUS 535: Strategic Purchasing ManagementAssignment 2009168412. Partnering is defined as “an on-going relationship between two firms that involves acommitment over an extended time period, and a mutual sharing of information and the risksand rewards of the relationship” (Ellram and Hendrick, 1995, p.41).From the table1 below, eleven main generic benefits of partnership sourcing have been ranked inorder, all of which are important, but the top three seems to be the most significant with highstrategic benefits to Alpha Products.Order Strategic Benefits to Alpha Products1 Long term cost reduction.2 Health and safety risk reduction with rewards.3 Operational process efficiency improvementsvia supplier performance measurementsystem and evaluation.4 Closer and longer term commitment to continuous improvement in product and process.5 Improved ethical standards.6 Increased willingness to co-design and participate in new product/service development.7 Strategic advantage resulting from access to supplier‟s technology.8 Honest and frequent communications/openness.9 Increased willingness to invest in specific equipment.10 Increased mutual respect, trust and honesty.11 Development of tacit knowledge of each other‟s company.Table1: Strategic Benefits to Alpha Products by orderLong term cost reduction:Long term cost reduction can be obtained as one of the most important strategic benefits ofpartnerships to Alpha Products, the three major cost components predominantly affected by thepartnership are, direct service costs (price), acquisition costs, and operations/processing costs(Cespedes 1995; Gyrna 1988; Noordewier, et al. 1990).Lower processing or transactional, and human resource costs can be obtained by engaging in somecooperative cost reduction programmes, such as Electronic Data Interchange (EDI) systemsbymoving their purchase orders and invoices from a paper-based to an electronic system with enhancedtransactional efficiency (increased processing speed, reduced multiple invoices and reduced errors).This will reduce their invoices from 4500 to a much lower number in relation to service ordersthereby reducing their transactional costs.This is particularly important because firstly, this is where they are having an impact, however itmight not get them the true financial savings that they need but can be enhanced by leveraging onspend. Secondly, the clerical unit is heavily overstaffed due to the huge number of paper worksand isadding to their cost base, adopting an EDI system will help to reduce the paper works therebyreducing head count. This is beneficial as supported by Lysons and Ferrington (2006);Tang et al.(2001) and Kannan and Tan (2002), stating that Information technology, combined withcommunication networks serving as intermediaries, has great potential in reducing costs for buyersand suppliers.
University of Liverpool EBUS 535: Strategic Purchasing ManagementAssignment 200916841Health and safety risk reduction with rewards:Being an industrial chemical company, Alpha Products is faced with some health and safety issuesinvolving suppliers, going into partnership will be beneficial to the company with better control onenvironmental health and safety management capabilities(Day, 1994).For example, the difficulties in reporting on-site safety incidents and accountability caused by thehigh number of suppliers used for on-site maintenance can be controlled by focusing onbuilding agreat mutual relationship with one strategic supplierand improving their performance in this area,this will invariably curb the issue of each supplier blaming another for on-site safety problems andAlpha Products will have a better management of any occupational health and safety issues that mayarise in the future by putting in place key risk management elements such ashazard identification,consequence analysis, control or treatment response [and reporting management processes] in place(Greenberg and Cramer 1991, pp.1-2).The importance of reducing health and safety risks cannot be overemphasised because bothpartnerswork in a dangerous environment as it has been argued by Arcury et al. (2002),cited inLangkulsen et al. (2011, p. 389),that the effective coordination and management of health and safetyinformation in a chemical company may lead to reduction in occupational health and safety risks.Operational process efficiency improvementsvia supplier performance measurement andevaluation system:Alpha Products will also get benefits from partnership with improvements in operational efficienciesthrough supplier performance evaluation, this is also important because the company needsperformance improvements in their processes in response to the disequilibrium in the industrialchemical industry and control their business activities in an efficient manner.As pointed out by Lord Kelvin that “If you can‟t measure it, you can‟t improve it”,certain importantsupplier performance criteria such as service quality, service delivery lead times, health & safety andcontinuous improvement has to be measured in order to improve on any deviations from standards.For example, they could adopt the “weighted points plan” supplier evaluation system which willconsist of a battery of questions around the key aspects of supplier performances identified, they arerated, weighed, compared to standards for non-conformance and communicated through an e-reportto the supplier in a bid to improving the anomaly.This is relevant because they are challenged with managing the process of reporting some health andsafety incidents and accountability for the on-site engineering services and Ruth Turner, thepurchasing manager has been tasked with improving supplier performance in this area, and this ispositively correlated with benefits such as improved performance tracking and supplier-buyerrelationship. This is evidence as argued by Gunasekaran et al. (2001) that improved efficiency andeffectiveness of a supply chain are the objectives of performance measurement and by Banker andKhosla (1995) that supplier evaluation is the most important area for effective operationsmanagement.
University of Liverpool EBUS 535: Strategic Purchasing ManagementAssignment 2009168413. There are numerouslimitations of general partnership, and out of the long list, a few number hasbeen highlighted. From table 2 below, three potential problems and risks (limitations)ofpartnership which are jointly faced by bothAlpha Products and O‟Connors,have been identifiedand ranked in order of importance.No. Limitations to Alpha Products and O’Connors1 Mutual dependency2 Power imbalance /Shift3 Joint product development and IPRTable 2: Limitations to Alpha Products and O’ConnorsMutual dependency:Dependence is defined as the extent to which there are noequivalent or better alternativesavailable in the market(Emerson, 1962; Heide and John, 1988, cited in Gao, et al. 2005, p.399).Alpha Products and O‟Connors are strategic partners and as pointed out byGelderman andVan Weele (2002), a position in the strategic quardrant means a high mutual dependencebetween both partners involved in the contract.For example, the high mutual dependence between Alpha Products and O‟Connors, which is asingle source arrangement, will literarily place them in a ‟locked-in‟ situation with risks of notbeing able to diversify to other markets during the period of the contract and making it verydifficult to get out of the partnership, especially if the situation is caused by an IntellectualProperty or Patent Rights. The locked-in situation between both companies will also create a lowor no response to increase in the market dynamics for which they operate, market dynamics suchas commodity prices, raw material prices and general market disequilibrium. This will greatlyaffect O‟Connors especially if the contract is a fixed price one by reducing their profit margin.These views are in line with Gelderman and Van Weele (2002) who also suggested that becauseof the oligopolistic market situation which Alpha Products and O‟Connors operates in, thedevelopment of new suppliers would solve this locked-in situation, thereby reducing the level ofdependency by both partners, stating that in the course of time, the single source partnership maybecome unsatisfactory.Power imbalance /Shift:According to Anderson and Weitz (1989) power imbalance is defined as the ability of onepartner to get the other partner to do something they would not normally do. Alpha Products andO‟Connors will experience a degree of power imbalance due to the interdependency that existsbetween both companies. The power of the buyer orseller is positivelycorrelated to theinterdependence of the partners in a relationship (Anderson and Narus 1990, Ganesan 1994).Therfore, the imbalance in power is related to the level ofthe supplier‟s dependence on thebuyer‟s, and vice versa, hence the need for both parties to increase interdependence on the other(Han, et al. 1993).This is evidence because power dominance is being held by O‟Connors, the supplier, based onthe fact that the engineering maintenance services supplied by O‟Connors is critical to AlphaProducts‟ operations and failure to deliver the services can result in delayed production and lostof sales. Thereby placing O‟Connors in the supplier dominance quardrant of the power matrixshown in figure 2 below.
University of Liverpool EBUS 535: Strategic Purchasing ManagementAssignment 200916841Fig2: The Power Matrix – Modified from Cox, A., Sanderson, J., and Watson, G. Power Regimes,2000, P. 18.The supplier, O‟Connors has power dominance over the buyer Alpha Products as contracts arewriten in favour of the supplier, buyer‟s switching costs are high, and supplier‟s switching costsare low (Cox, 2001).He reveals that the power dominace of buyer or supplier can shift throughthe power matrix depending on the power attributes they possess at any given time in the contract,he further argued thata sufficient condition of success is the ability to find ways to move from thecurrent position of power to other more favorable positions in the matrix.Joint product development and IPR:A joint development venture is an “agreement between two companies to commit resources to acommon project with the intent for both parties to benefit from thecreation and production of thenew product or service”(Temponi and Lambert 2001, p. 336).Alpha Products and O‟Connors arein a strategic alliance, with O‟Connors supplying an item which falls in the strategic itemquadrant (high spend, high risk) of the Kraljic‟s portfolio matrix and as agued byGelderman andVan Weele (2002)that successful strategic partnerships are rare,partnerships may becomeunsatisfactory with time or the supplier does not wish to be involved in joint development.Ruth Turner, the purchasing manager, is keen to develop a long-term relationship withO‟Connors and over this long period of time, there is a possibility that the relationship might gointo a relaxed and indolent state, with both parties loosing interests in co-product developmentand holding back on any existing individual intellectual property assets (patent, confidentialbusiness information, trademarksand copyright) and other trade secrets and confidentialinformation.This is evident because, it has been further agued byGelderman and Van Weele (2002) that evenin the case of a strategic partnership,a buyer (Alpha Products) is always trying to restrict thedependence on the supplier involved in order not to make the business relationship indolent andrelaxed, stating that “Strategic partners should be world class suppliers, they are alert and highBUYER DOMINANCE>INTERDEPENDENCE=INDEPENDENCE0SUPPLIERDOMINANCE<
University of Liverpool EBUS 535: Strategic Purchasing ManagementAssignment 200916841performing, not only in a technical but also in an economical sense. This means that strategicpartners should meet external benchmarks with a more than satisfactory performance”.4. Ellram(1991) partnership development model will be used to measure and review Ruth Turner‟sactions in managing the partnership process between Alpha Products and O‟Connors. The five-phase approachis diagrammed in figure3 below.Fig3: Five-Phase Partnership Development Model – Modified from (Ellram, 1991, p.4)Some of the right steps taken by Ruth Turner when measured against the above best practice are asfollows;a. Thorough analysis of the situation and the supply market.b. Determination of a selection criteria.c. Feedback to selected supplier.Thorough analysis of the situation and the supply market:As part of a company‟s strategic planning process, the preliminary phase of the partnership process isto conduct a thorough analysis of the problem at hand in a bid to establish some strategic needs, Ruthperformed this action in order to chart a course to a proper supplier partnership and development andin her conclusion, seven strategic needs were established.This is evidentas supported by the argument that “a systematic review of the supply market,assessing the availability of strategic materials…and the relative strength of existingvendors”(Kraljic, 1983, p.113).Determination of a selection criteria:A proper and best practice approach to supplier selection was adopted by Ruth, suppliers wereselected from existing vendors via a competitive bidding process based on best price and this lead tothe choice of three suppliers with the largest spend with Alpha Products and finally narrowing itdown to one strategic supplier, O‟Connors after some price benchmarking process.This is important at this phase because, “competitive bidding models analyse the sellers‟ biddingstrategies when the situation does not allow for implicit or explicit coordination of bid prices”(Seshadri, 1995, p. 562).
University of Liverpool EBUS 535: Strategic Purchasing ManagementAssignment 200916841Feedback to selected supplier:This phase was well orchestrated by Ruth as she is keen to develop the partnership, so she arranges ameeting with O‟Connors to give a feedback and sell the idea of a partnership to them.This is particularly important because, the goal is to establish a foundation on which to build astrong, ongoing relationship based on mutual trust, sharing and commitment (Ellram 1991). Sheadded that “a partnership will work only if it is beneficial to both parties”.Some of the bad approach Ruth Turner took during the partnership development process whenmatched with Ellram (1991) partnership development model are as follows;a. Cross-functional teams not formed from the outset.b. Selection criteria from 52 suppliers to 1 based on spend.Cross-functional teams not formed from the outset:For and effective supplier partnership selection process, a team formed by representatives fromvarious organisational functional teams must be formed to aid proper decision making, Ruth flawedon this. The on-site managers were only informed of the changes at the end.This is relevant because “a team representing key functional areas of the firm should be formed towork on the development … and to identify issues”(Ellram, 1991, p. 4).Selection criteria from 52 suppliers to 1 based on spend:Ruth‟s approach in selecting a vital few from existing 52 suppliers was not appropriate as this canbring some potential risk of bringing in unqualified and unserious suppliers to the supply chain. Shealso needs to broaden the scope of potential suppliers and make selections from outside suppliers thatare not part of suppliers used.This is also important because, the case of a US electrical casting company cited in (Kraljic, 1991,p.115), they assessed the capabilities and selected from a group of outside suppliers which reducedthe company‟s outlay for casting by 5% to 15% with improvements in its competitive cost position.
University of Liverpool EBUS 535: Strategic Purchasing ManagementAssignment 200916841REFERENCES:1. Anderson, E and Weitz, B. 1989. Determinants of Continuity in Conventional IndustrialChannel Dyads.Journal of Marketing Science8(4), pp. 310-323.2. Anderson, J. C., & Narus, J. A. 1990. A Model of Distributor Firm and Manufacturer FirmWorking Partnerships. Journal of Marketing54, pp. 42–58.3. Arcury, T.A; Quandt, S.A and Rusell, G.B. 2002. Pesticide Safety Among Farm Workers:Perceived Risk and Perceived Control, cited In: Langkulsen, U; Vichit-Vadakan, N andTaptagaporn, S. 2011.Occupational Health and Safety in Petrochemical Industry in Map TaPhut, Thailand.Journal of Occupational Health 53,pp. 384–392.4. Banker, R.D. and Khosla, I.S. 1995. Economics of Operations Management: A ResearchPerspective. Journal of Operations Management 12, pp. 423-425.5. Cespedes, F.V. 1995. Concurrent Marketing: Integrating Product, Sales and Service. Boston:Harvard Business School Press.6. Cox, A. 2001. Understanding Buyer and Supplier Power: A Framework for Procurement andSupply Competence. Journal of Supply Chain Management. 37(2), pp. 8 –15.7. Cusumano, M.A. and Takeishi, A. 1991. Supplier Relations and Management: A Survey ofJapanese, Japanese-Transplant, and U.S. Auto Plants. Strategic Management Journal12(8), pp.563-588.8. Day, G.S. 1994. The Capabilities of Market-Driven Organizations. Journal of Marketing 58 (4),pp. 37–52.9. Dyer, J.H., Cho, D.S., Chu, W. 1998. Strategic Supplier Segmentation: The Next „BestPractice‟ in Supply Chain Management. California Management Review 40 (2), pp. 57–77.10. Ellram, L. 1991. A Managerial Guideline for the Development and Implementation ofPurchasing Partnerships. International Journal of Purchasing and Materials Management27(3),pp. 2-8.11. Ellram, L. and Hendrick, T. 1995. Partnering Characteristics: A Dyadic Perspective, Journal ofBusiness Logistics16(1), pp. 41-64.12. Emerson, R.M. 1962. Power – Dependence Relations. American Sociological Review27(1), pp.31-41.13. Ganesan, S. 1994. Determinant of Long-Term Orientation in Buyer-SellerRelationships.Journal of Marketing58, pp. 1- 19.14. Gao, T.; Sirgy, M.J. and Bird, M.M. 2005. Reducing Buyer Decision-Making Uncertainty inOrganizational Purchasing:Can Supplier Trust, Commitment, and Dependence Help. Journal ofBusiness Research 58(4), pp. 397-405.15. Gelderman, C.J. and van Weele, A.J. 2002. Strategic Direction through Purchasing PortfolioManagement: A Case Study. International Journal of Supply Chain Management 38(2), pp. 30-38.16. Greenberg, H. and Cramer, J. 1991. Risk Assessment and Risk Management for the ChemicalProcess Industry. New York:John Wiley & Sons.17. Gunasekaran, A.; Patel, C. and Tirtiroglu, E. 2001. Performance Measures and Metrics in ASupply Chain Environment. International Journal of Operations and Production Management,21(2), pp. 71-87.18. Gyrna, F.M. 1988. Quality Costs, cited in Juran„s Quality Control Handbook, 4th ed., Juran,J.M and Gyrna, F.M, Eds. New York: McGraw-Hill.19. Han, S.; Wilson, D. T. and Dant, S. 1993. Buyer-Seller Relationships Today.IndustrialMarketing Management22 (4), pp. 331-338.
University of Liverpool EBUS 535: Strategic Purchasing ManagementAssignment 20091684120. Heide, J.B. and John, G. 1988. The Role of Dependence Balancing in SafeguardingTransaction-Specific Assets in Conventional Channels.Journal of Marketing52(1), pp. 20– 35.21. Kannan, V.R., Tan, K.C. 2002. Supplier Selection and Assessment: Their Impact on BusinessPerformance. Journal of Supply Chain Management 38 (4), pp. 11–21.22. Kraljic, P. (1983). Purchasing Must Become Supply Management. Harvard Business Review.pp. 109–117.23. Lysons, K. and Ferrington, B. 2006. Purchasing and Supply Chain Management, 7thEdition,Prentice Hall, Chapter 11, pp.412.24. Noordewier, T.G., George, J. and John, R. N. 1990.Performance Outcomes of PurchasingArrangements in Industrial Buyer-Vendor Relationships. Journal of Marketing54, pp. 80-93.25. Rezaei, J. and Ortt, R. 2012. Multi-criteria Supplier Segmentation using a Fuzzy PreferenceRelation Based AHP. European Journal of Operational Research 225, pp. 75–84.26. Seshadri, S. 1995. Bidding for Contests.Management Science41(4), pp. 561-576.27. Tang, J., Shee, D. and Tang, T. 2001. A Conceptual Model for Interactive Buyer-SupplierRelationship in Electronic Commerce. International Journal of Information Management 21(1),pp. 49–68.28. Temponi, C. and Lambert, T. 2001. Managing outsourcing in a joint development environment:Impact on Innovation and new Product Development process. Change Management and theNew Industrial Revolution, Proceedings of the IEMC Conference, 7-9 October, 2001. New York,pp. 335-340.