Supplier Segmentation: How to Prioritize SRM Activities
By Hugo Britt | December 8, 2020
Supplier segmentation refers to the process of differentiating the supply base in terms of their impact on your organization and the risks they pose. In doing so, procurement professionals can determine how much engagement different suppliers require, and effectively allocate their limited resources.
Allocating time to relationships
When it comes to managing your personal relationships, it’s likely that you practice segmentation on a daily basis. It’s simply not feasible to invest an equal amount of time in each and every person that crosses your path.
You may have some low-maintenance friends who you only check in with a couple of times a year, while other people in your life require a great deal more focus and attention.
Whether it’s a friend, brother, grandparent, doctor, yoga instructor, taxi driver, or manager, you’re forever weighing how best to divide your time. Who requires your attention the most? Are there some relationships you value more than others? Which of these relationships will continue to function and flourish with minimal intervention?
Supplier segmentation is essentially the same concept.
What is the purpose of supplier segmentation?
The bigger your supply base, the more important it is to identify your critical suppliers. This enables procurement professionals to:
- Identify the most important supplier relationships across all business categories, therefore improving visibility across the supply chain.
- Divide suppliers into different categories based on impact and risk to determine supplier relationship management (SRM) activities. For example, the greater the risk and impact, the more time procurement should spend nurturing relationships with these suppliers.
- Effectively utilize their time by building relationships with suppliers who either pose a greater risk to supply chain operations or offer the highest return on investment.
- Align procurement activity with business objectives. This could include identifying suppliers who can drive continuous improvements and innovation, for instance.
- Encourage suppliers to strive for excellence and deliver better service in order to achieve critical supplier status.
How to segment suppliers using the Kraljic Matrix
In the past, procurement professionals would typically assign a status to their suppliers based exclusively on their level of spend, but the criteria by which organizations measure supplier risk and impact is evolving rapidly.
Today the most common method for supplier segmentation is the Kraljic Matrix, an approach developed by Peter Kraljic in 1983. Procurement professionals can use this 2 x 2 matrix to plot suppliers into one of four quadrants, as shown in the image below.
The first step in the Kraljic segmentation method is to define the factors that comprise risk and impact for your organization. This will vary across organizations and categories but might include the following:
- How much do you spend with the supplier?
- Does the supplier drive innovation for your organization?
- What is the supplier’s internal coverage, meaning how many categories across the business are served by that supplier?
- Does the supplier offer competitive pricing?
- How critical is the supplier to your organization? For example, are they a single-source supplier? How significantly will your business be disrupted should you lose their services?
- What is the supplier’s financial risk?
- What is the supplier’s reputational risk? Are they compliant with regulations, for instance?
- What is the supplier’s potential for disruption? Are they located in a politically turbulent location? Could they be impacted by increased tariffs, shipping delays, or natural disasters?
- Has their performance been consistent? Do they deliver products and services on time and accurately fulfill your orders to a high standard?
Assign a weight for each of these factors before computing scores for your suppliers and plotting them onto one of the four dimensions of the Kraljic matrix.
The strategic items quadrant represents high-risk suppliers that deliver critical products and services for your organization. Without them, your supply chain could face severe disruption, which means they require the most intensive SRM.
Suppliers who fall into this quadrant are equally critical to your organization, but they present a much lower risk. Perhaps the products and services they provide are easily obtainable elsewhere, or the supplier is capable of delivering to a high-standard with or without your input.
Bottleneck items will largely consist of tail-end suppliers. They’re high-risk but deliver little-to-no value for your organization. It might be worthwhile to consolidate this section of your supplier base, rather than investing in more strategic SRM. However, you’ll need to bear in mind that several of these suppliers will be single-source, and for the time being, your organization is reliant on their services.
Some tail-end spend will also be represented in the non-critical items quadrant. These suppliers provide your organization with low-value, low-impact items with negligible risk. Your supply chain won’t be significantly disrupted should you lose these suppliers. Suppliers in this quadrant require the least effort to manage.
Supplier segmentation is a useful stepping stone on procurement’s journey to implementing an effective preferred supplier program with those falling into the top half of the quadrant being those most likely to become a preferred supplier.