As the economy has faltered so has the demand for certain products and services. In response to these conditions, many companies have been forced to lower operating costs, and one of the areas they are evaluating is their supply chain. Companies are reducing inventory and limiting the number of suppliers they do business with so they can consolidate purchases, gain volume discounts and reduce costs.
Meanwhile, suppliers are seeing lower revenues themselves and have had difficulty securing credit to finance their working capital. As a result, the number of supplier bankruptcies continues to rise. For example, about two-thirds of all auto suppliers faced some form of financial distress last year, according to Motor & Equipment Manufacturers Association.
In such an environment, the failure of even a single supplier can cause significant harm to a company’s business operations. As a result, procurement executives, who have historically focused on securing the highest quality products and services at the lowest possible cost for their operations, are also being tasked with evaluating, monitoring and managing the risk from the supply base.
To ensure that they are able to consistently evaluate and manage supplier risk, procurement executives need a very clear picture of what they are spending with each of their suppliers. They need to know what commodities and components they buy from each supplier and which of these components are the most critical. They need to know the operational, financial, legal and geographical risk exposures for each supplier. They even need to know who their suppliers’ suppliers are and how all their various suppliers are linked. One way to answer these questions is through the use of spend analysis.
Spend analysis is the process of determining what is being spent, with whom and for what. Such insight is typically used to identify opportunities for cost reduction such as determining the optimal supply base (otherwise known as “supplier rationalization”), increasing contract compliance and reducing maverick spending.
But spend analysis is also critical in determining the risk to the supply chain from the supply base. It provides critical information to categorize suppliers by spending, commodity, industry and geography, allowing procurement executives to use that information to create a short list of key suppliers and their possible risk exposures that it can then tailor a supply risk management program around.
Data Aggregation Difficulty
One of the obstacles to conducting an effective spend analysis is the difficulty in obtaining the appropriate data. There are many reasons why this data is not readily available.
In some cases, spend data exists within multiple systems and different codes are used to describe the same supplier or commodity across various platforms. For example, HP may be “coded” as HP in one system at one division and as Hewlett-Packard in another. Similarly, the same component may be represented by different item codes in different systems, making it hard to find out how much is spent on that item. Two suppliers may be providing the same product at different prices, but they are likely to be represented by different item codes. If you cannot correlate this information, you cannot identify opportunities to save money by combining spending across commodities, locations, suppliers and programs.
In addition, relationships between suppliers are sometimes not identified within various systems. For instance, a system may not indicate that Lab Safety Supply is a subsidiary of W.W. Grainger. If it did, the company would realize that it is spending a lot more money with W.W. Grainger than it thought and could use that information to gain negotiating leverage.
Other related information such as shipment performance, quality data from the last 12 months or even credit ratings also rarely exists within many systems. Such information is critical to taking advantage of tax breaks, complying with regulators or assessing risk. Without this data, supplier rationalization initiatives can fall short of expectations.
Due to these data accuracy and completeness issues, it is impossible to take an accurate and comprehensive look at spending by simply bringing together data from various systems and performing the analysis. The data has to first be properly prepared to ensure suppliers are represented in an accurate and consistent manner. Only then the analysis can be done on the data to yield an accurate picture of overall spending.
Reducing Supplier Risk
Spend analysis, no matter how critical, is only one of the many steps that an organization must take to manage suppliers. Here are some other ways to reduce supplier risk.
- Build risk assessment into the sourcing process. Seek a weighted balance between cost, risk, flexibility and performance based on the commodity or component type, as well as other suppliers already in your portfolio. This ensures that suppliers that fall outside your risk profile are eliminated during the supplier selection process.
- Develop a close relationship with your suppliers, so you can sense that something is amiss before it is announced. Read between the lines of what they are telling you. This is key to identifying potential issues before they occur.
- Develop an alternative list of suppliers as a contingency, particularly for strategic categories. Continuously evaluate suppliers on this list as if you were initiating a new sourcing relationship and prioritize them. As a result, you always have a “Plan B” when something goes wrong.
- Create a detailed plan for quickly switching to an alternate supplier (either an existing supplier or one from your list above). In addition to a regular changeover plan and ramp-up period, this step ensures that you can successfully switch over to a different supplier in an emergency.
- For commodities and components where supplier risk is high, explore increasing inventory to give you more leeway. Treat the cost of additional inventory as if it was an insurance premium.
- Aggressively monitor the performance of your suppliers by tracking metrics such as quality, on-time delivery and request for early payment. These signals are often leading indicators that a supplier is in trouble.
- Perform on-site supplier visits on short notice. Observe the business and speak with people at various levels, not just your account manager. You can pick up a lot of early-warning signs.
- If you cannot eliminate an at-risk supplier, renegotiate terms with them. Offer faster payments in exchange for better prices or discounts. This will be a win-win for both parties.
- Consider multisourcing for most components and commodities. This not only reduces your risk and gives you more flexibility; it creates a healthy competition for your business, resulting in better quality and service.
As a result, spend analysis is typically a two-phase process: Phase 1, where the data is prepared for spend analysis using specific technologies, and Phase 2, where the spend-ready data is analyzed.
Phase 1: Compiling Spend Data
This phase consists of two technologically and resource-intensive steps:
Step 1: Extracting information from source systems. Spend data often exists as individual transactions in various source databases such as enterprise resource planning (ERP) systems, e-procurement applications, travel and expense reports. This information must be extracted from the various sources and aggregated into a common location such as a separate database.
Step 2: Cleansing, normalization and enrichment. Extracting spend transaction data into a common location is not enough. The data must then be normalized and enriched.
Cleansing removes typos and spelling errors in supplier names and item descriptions. Normalization ensures that similar supplier names are recognized and converted to a common supplier name. Establishing corporate parent/child relationships is another key step to ensure that all subsidiaries of an organization are being viewed holistically.
In addition, each product should be mapped to popular standards-based classification taxonomies such as the United Nations Standard Products and Services Code (UNSPSC), Standard Industrial Classification (SIC) and North American Industry Classification System (NAICS). This allows users to aggregate spending information for the same commodity type such as five motors from two different suppliers that were identified as different item codes in the ERP system.
Finally, enrichment identifies additional supplier-related information such as parent company name, revenues, financial risks, legal risks, operational risks and performance metrics. This type of data enrichment provides additional information needed for risk assessment and for supply-base rationalization.
Phase 2: Spend Analysis and Supplier Risk Identification
Once data has been cleansed, normalized and enriched, it can be analyzed to not only identify opportunities for cost savings (such as supply-base consolidation and addressing sources of price variance or contract noncompliance), but also to identify the more complex risks faced by a company from its supply base and develop an effective plan to manage these risks.
For example, one strategy can be to classify suppliers by categories such as total spending, commodity, industry and geography. The ability to classify suppliers along these dimensions allows a procurement executive to identify sole-source suppliers, large volume suppliers and those suppliers that provide critical components or commodities. Then, they can prioritize their plans accordingly.
The classification also provides immediate visibility into those suppliers that are associated with an industry or a commodity group that is at risk for exposure to quality issues, commodity and labor shortages, price fluctuations, environmental and safety concerns, and supply/demand imbalances. It also quickly clusters suppliers by geographical risks such as political instability, infrastructure difficulties and currency fluctuations.
By analyzing data with these factors in mind, you can determine who needs to be closely monitored and who might need to be replaced by an alternative supplier before a problem actually occurs.
Many procurement organizations end up focusing their attention on the top 20% of suppliers that make up 80% of spending. But, low-spend suppliers can be a source of significant risk as well. A cheap part in an expensive engine can cause the engine to fail. Data theft enabled by poor security practices of a small IT provider can cause irreparable damage to a retailer’s brand and lead to lawsuits. This is the essence of supply chain risk.
But by conducting a spend analysis regularly (every six months), organizations can keep their finger on the pulse of their supply chains and identify all suppliers that pose a risk-no matter what their size. By having accurate and complete information about all of your spending, it reduces the possibility of unwanted surprises and provides your company with the best starting point for a comprehensive supply risk management initiative.