Article

Building a supplier risk management strategy through spend management

Naresh Hingorani, SearchManufacturingERP.com contributor
In the current economic climate, when demand for products and services is falling at an alarming rate, many members of the supply chain are losing money. According to the Motor & Equipment Manufacturers Association, one-third of auto suppliers are in financial distress, and another one-third will be by mid-year.

The business operations of any company can be damaged by the unexpected failure of one supplier. Procurement organizations, which have historically focused on securing the highest quality products and services at the lowest cost, are now being tasked with evaluating, monitoring and managing supplier risk.

To manage supplier risk, procurement executives need clear visibility into their spend with each of their suppliers at many levels:

  • how much they spend with each supplier
  • what commodities/components they buy from which supplier
  • the split of a commodity/component purchase across suppliers
  • what regions each supplier ships from
  • the operational, financial and legal risk metrics for each supplier
  • who their suppliers are
  • how all the suppliers are linked at different tiers
  • which components are critical to their supply chain

Spend analysis gives procurement executives answers to such questions so they can prioritize which suppliers to focus on, as well as identify opportunities for cost reduction such as rationalizing supply base, increasing contract compliance and reducing maverick spending.

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However, spend visibility can also determine supply chain risk. The information it provides can help procurement executives categorize suppliers by spend, commodity, industry and geography, which they can use to create a short list of target suppliers. It allows the procurement organization to enrich the supplier information with data from external sources and internal supplier performance metrics, so that they can perform a risk assessment of that short list. Investment in spend analysis is the starting point to a comprehensive supply risk management initiative.

Obstacles to spend analysis

Spend analysis is not just about running analytics on top of procurement data with your ERP system. There are five obstacles to doing this:

  1. Spend data sits within multiple systems that need to be aggregated in order to get visibility into overall spend.
  2. Different codes are often used to describe the same supplier or commodity across these systems. Aggregated spend information from multiple systems may not be accurate.
  3. Item codes used by systems do not relate an item to an industry standard classification. Consequently, it becomes difficult to aggregate similar and equivalent data and identify opportunities to save money by combining spend across commodities, locations, suppliers and programs.
  4. Systems rarely identify relationships between suppliers. Your system may not tell you that Lab Safety Inc. is a subsidiary of WW Grainger. You may be spending a lot more money with WW Grainger than you thought.
  5. Minority status of suppliers, shipment performance and quality data from last 12 months or even D&B credit rating usually does not exist within these systems. Such information is critical to assessing risk.

Due to these issues, it is impossible to do a comprehensive spend analysis simply by bringing data from all the systems into a spreadsheet or a business intelligence system. The data has to cleansed to remove errors, normalized to ensure that suppliers are represented in a consistent manner, and finally enriched with commodity classification data, subsidiary relationships and supplier performance data. Only then can the data analysis be performed to get a picture of the overall spend. (Note: Bristlecone leverages SAP Spend Performance Management technology for cleansing, normalization, classification and analytics for our clients.)

Identifying and managing supply chain risk

Once data is analyzed, users can identify "low-hanging" opportunities for cost savings (such as supply-base consolidation or identifying sources of price variance or contract non-compliance and addressing them). More importantly, they can also identify supply chain risk and create a plan to manage this risk.

In one scenario, we can classify suppliers by categories such as total spend, commodity, industry and geography. This allows procurement executives to identify large-volume suppliers, sole-source suppliers and suppliers providing critical components.

Such classification also helps procurement executives identify suppliers associated with an industry or a commodity group that increases their exposure due to quality issues; commodity and labor shortages; price fluctuations; environmental and safety issues; and supply/demand imbalances. It also clusters suppliers by geographical risk such as political issues, infrastructure difficulties and currency fluctuations.

Now they can prepare the shortlist of suppliers that need to be evaluated and monitored for risk.

Most procurement executives that do not use spend analysis tools sort their suppliers only by approximate spend with their companies. They focus their attention on the top 20% of suppliers that make up 80% of the spend.

But low-spend suppliers can also be a source of significant risk. A cheap part in an expensive engine can cause the engine to fail. Data theft enabled by the poor security practices of a small IT provider can cause irreparable damage to a retailer's brand, and lead to lawsuits. Using spend analysis, procurement organizations can find the low-spend suppliers than pose risk.

There's no measurable return from a supplier risk management initiative until the risk materializes and you can quantify the avoided loss. Until then, it's only possible to estimate the impact using a metric that takes the probability of the risk and the expected magnitude of the loss. In any event, even the most successful risk management programs cannot eliminate the risk, they can only reduce its impact.

About the author: Naresh Hingorani is the Integrated Sourcing and Procurement Practice Area Leader at Bristlecone, a global supply chain consulting firm.


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