The mission of The Monthly Metric is challenging supply management practitioners to look at and use analytics in a new way. And that sometimes happens by necessity, when the rule of thumb about a measurement doesn’t match reality.
Year 2 of this blog feature begins with an examination of such a metric: suppliers accounting for 80 percent of total spend. The old 80-20 rule — 80 percent of a company’s spend among the top 20 percent of its suppliers — is often considered an ideal starting point. Looking at the actual numbers, however, can catch even veteran supply managers off guard.
A 2014 report by CAPS Research, a Tempe, Arizona-based program jointly sponsored by Arizona State University and Institute for Supply Management® (ISM®), identified benchmarks for suppliers accounting for 80 percent of spend in such industries as aerospace and defense (6.5 percent), chemical manufacturing (7.7), engineering and construction (4.0), financial services (8.5) industrial manufacturing (7.0), petroleum (3.5) and utilities (4.5).
The overall average: 5.8 percent, down from 6.9 percent in 2010. According to research by The Hackett Group, a Miami-based business consultancy, the average company has 3,000 suppliers per US$1 billion in spend, meaning that 80 percent would be devoted to 174 suppliers.
Jim Fleming, CPSM, CPSD, ISM Program Manager, Certification, was a capital-equipment supply chain manager at Intel Corporation from 2007-14. He says that, at first glance, a figure of around 6 percent would be a red flag. However, he adds, for a company so dependent on constantly evolving technology, it was advantageous to rely on a small group of strategic suppliers.
“We needed to use suppliers who were willing to keep up with us and help us design a couple of years ahead,” Fleming says. “Through those strategic partnerships, we got engineers from (supplier) organizations to work with engineers at our organization. So, it was best to have fewer suppliers for the large dollars that came with capital equipment. That was our largest single expenditure.”
Instead of purchasing new technology every other year, Intel and its suppliers developed plans to refurbish existing equipment, Fleming says.
“If I had decided, OK, I’m going to bid this out every two years, and anybody that builds a piece of equipment can come in, that would have created so much risk,” he says. “Given how delicate and sophisticated the technology was, (a new supplier) wouldn’t even be able scratch the surface of what we needed.”
What the Metric Means
The suppliers accounting for 80 percent of total spend metric is designed to measure a procurement team’s purchasing prowess. The percentage indicates how well resources are being leveraged. A high figure suggests a fragmented and less-manageable supply base, while a lower figure indicates more control — but could also mean the procurement team is failing to generate competition.
Fleming says that a lower number could mean that a company lacks an effective supply management organization. For example, the IT, marketing and legal departments are not used to scouting suppliers, so they tend to “stick with what they know” and become comfortable with one or two suppliers. “They’re not really thinking about cost reduction,” Fleming says. “They’re not thinking about risk management or sourcing. Your operations folks are saying this is who I work with … and they go with a select few suppliers.”
When supply management becomes more involved and other departments give up supplier-selection control, competition is more easily generated. That would cause the suppliers accounting for 80 percent of total spend percentage to go up, Fleming says.
“The 80-20 rule is the fallacy we need to get away from,” he says. A realistic percentage, Fleming believes, is 6-10 percent.
Mileage May Vary
Suppliers accounting for 80 percent of total spend is a metric that has its critics, who suggest that it’s not a one-size-fits-all analytic. In such industries as technology, aerospace and defense, and travel and events, a small group of trusted legacy suppliers is ideal — as was the case for Fleming at Intel. For some industries and organizations, however, a low percentage could not only indicate low competition, but increased risk.
Peter Smith, managing director at Spend Matters, a website operated by Azul Partners, Inc., a Chicago-based procurement analysis and research firm, warned in a 2014 article that organizations are becoming dependent on “supplier oligopolies.” Smith wrote, “In any case, the ‘right’ answer here is highly variable by industry and firm within the industry even, but we’d argue that in many cases, (organizations) have too many large suppliers, and in some categories, too few suppliers.”
Fleming says that when department leaders surrender the spending reins to skilled supply managers, more of a company’s spend can move from the “strategic” quadrant of the Kraljic matrix to the “leverage” quadrant — meaning more supplier competition and cost benefits as well as decreased risk.
“Organizations aren’t doing enough,” Fleming says. “They’re spending too much time thinking about needing only a few suppliers, and they’re not thinking about how to bring in competition or bringing in (a supplier) that can help reduce risk. We’re assuming higher risk with fewer suppliers and larger spends. And supply management can come in and (mitigate) that.”
Suppliers accounting for 80 percent of total spend is an analytic that means different things across companies and industries, and requires practitioners to look beyond the common 80-20 criterion. However, it can help determine if a supply management organization is achieving supplier consolidation or competition, as well as its purchasing strength.
For more about supplier consolidation, read “How Many Suppliers Are Too Many?” from the November/December 2017 issue of Inside Supply Management®.