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What is supplier segmentation?

Supplier segmentation is the strategic process of categorizing suppliers based on specific criteria. It helps businesses allocate their resources more effectively and manage different types of suppliers with an appropriate level of care, depending on their importance to core operations.

It’s a fundamental part of supplier relationship management (SRM), and can improve overall supply chain management efficiency. With an effective supplier segmentation model, businesses can ensure that their time managing the supply chain focuses on key suppliers who drive the most value.

They can also tailor their approach to supplier management based on the unique attributes of suppliers in each segment. This can result in efficiency gains that spread throughout the business, affecting procurement, inventory management, and supply chain finance strategy.

Why is supplier segmentation important?

No two suppliers are the same. Variations in each supplier’s size, risk profile, and importance to the buyer business’s operations necessitate a tailored approach to managing them.

In other words, the best approach to supplier management varies depending on each supplier’s size, function, and nature. Segmenting them into cohesive groups makes it easier to deploy bespoke management strategies without considering each supplier separately.

Supplier segmentation is so important because of suppliers’ critical role in the overall success of the buyer’s business. For large companies especially, small positive changes in supplier management can result in large efficiency gains that drive more profit.

Segmenting suppliers can bring about a range of benefits, including:

  • Better supplier relationships: Suppliers that play a central role in the supply chain need more attention than smaller, more expendable suppliers. Supplier segmentation simplifies this process, making it clear which supplier relationships should be prioritized.
  • Reduced supplier risk: All suppliers pose risks, but the more critical a supplier is in a supply chain, the more threatening their risks are to your business operations. Segmentation allows for greater visibility over supplier risks, meaning you can manage them more effectively.
  • Greater supply chain efficiency: No one supplier management strategy fits all suppliers perfectly. Segmentation facilitates bespoke supplier management strategies for different groups of suppliers, which means you can tweak your approach for the best results on a case-by-case basis and achieve supply chain efficiency.

Supplier segmentation models

There are countless ways to segment your suppliers, but the following supplier segmentation models are three of the most common.

The Kraljic Matrix

The Kraljic Matrix, also known as the supplier segmentation matrix, plots suppliers on two axes to segment them according to value and spend. Value refers to the importance of the supplier to business operations, while spend measures how much your company buys from the supplier.

The matrix is split into the following four quadrants:

  • Non-critical: Low-value, low-spend suppliers
  • Bottleneck: Low-value, high-spend suppliers
  • Leveraged: High-value, low-spend suppliers
  • Strategic: High-value, high-spend suppliers

Value and spend are arguably the two most relevant metrics to overall supplier importance. Plotting your supplier network on the Krajlic Matrix helps you to define which ones need the most attention.

Total spend

Segmenting suppliers based simply on their total spend is the most rudimentary common method, but it’s still worth considering.

It stands to reason that the more you spend with a supplier, the more important they are to your business. Therefore, segmenting based on this single metric is a quick and easy way to determine where to focus your supplier management efforts.

To make this method more effective, consider factoring in forecasted spend growth. While you may not spend much with newer suppliers, if your spend with them is growing rapidly, they may still be important in the future.

Supplier risk

Supplier risk refers to the internal and external threats that collaborating with each supplier in your network poses. Risks can range from minor (like the potential for late payments) to existential (like imminent bankruptcy).

Segmenting your suppliers based on the gravity of their risk profile can help you to understand how seriously they threaten your company’s operations. It involves first carrying out risk assessments for each supplier and then splitting them into low-risk, medium-risk, and high-risk categories.

You can then deploy different risk management processes for each category to efficiently mitigate overall supply chain risk.

Best practices in supplier segmentation

Getting supplier segmentation right can help you to manage your supplier base more effectively and efficiently. In turn, this can reduce supplier management costs, improve your key supplier relationships, and ensure your supply chain is operating at its best.

Follow these supplier segmentation best practices to get the most out of the process.

Follow the 80/20 rule

Based on the Pareto Principle, the 80/20 rule states that 20% of your suppliers likely account for 80% of the total value in your supply chain. Keeping the 80/20 rule in mind as you begin segmenting can give you a strong foundational understanding of how you should be prioritizing suppliers. Find the 20% and give them your focus.

Use technology along the way

Technology can help make the supplier segmentation process simpler to tackle and improve the outcomes. Supplier management software, in particular, can help you to log and manage all key supplier information, including risk analyses, spend statistics, and dispute rates. This data can prove invaluable as you come to segment your suppliers, providing a single source of truth on supplier information and performance.

Consider qualitative data

While it can be tempting to rely solely on quantitative data, like supplier spend, qualitative data can be instrumental in your segmentation strategy. Risk analyses, judgments on supplier value, and forecasts of how important specific suppliers might become in the future can all significantly impact your segmentation. Make sure to integrate the important qualitative data in your process to get a complete and accurate picture of supplier importance.

Share what you learn

The results of your supplier segmentation process will hold value to various departments across your business, including accounts payable, procurement, and the C-suite. Seek their input during the data-collection stage, and make sure you share the final segmentation strategy when it’s completed. It can then be used to inform new approaches throughout the supply chain management process.

Action the data

Supplier segmentation is a means, not an end. When you’ve developed your segments, you need to ensure you follow up and action the data. You can apply your learnings in various ways, including reviewing contracts with your most risk-on suppliers and prioritizing building certain supplier relationships.

You can also use the data to improve your working capital position by leveraging tools like supply chain finance or dynamic discounting.

For example, after identifying your top suppliers by spend, you could approach them with a new dynamic discounting proposition allowing you to secure discounts on invoices you pay early. Since these relationships represent the bulk of your total spend, these discounts can add up and give you more capital to spend elsewhere.

Regular segmentation reviews

Finally, make sure to regularly review your segmentation strategy and update it to reflect your evolving supplier base and the changing performance of each supplier. Your spending habits, supplier performance, and supplier risk profiles will all change over time, so scheduling segmentation updates is essential to make sure you’re always operating at your most efficient.

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