As companies continue to focus heavily on reducing the spend made by their purchasing and sourcing organizations, the number of suppliers that each company utilizes has come under intense scrutiny. Once driven by lean principles, supplier rationalization often took on a spend management bent, with a company looking to consolidate requests across the organization and ultimately doing business with a select number of suppliers at significantly reduced piece prices. Volume means savings, and savings is what everyone’s management by objectives (MBOs) called for.

Such rationalization proved to be very successful and fueled both interest and acquisition of spend management tools. It also elevated the status of the chief procurement officer, as well as created ill feelings within business lines that felt that they were trading away advantages, benefits, and even important functionality in return for corporate-level profits. And it certainly did wonders to bring down maverick spend, but at what cost (pun intended)?

No one felt the impact of supplier rationalization more than the manufacturing sector. Sourcing the parts and components needed to build products is the lifeblood of product companies. And it isn’t just about procuring those goods at the lowest prices; it’s about creating the right fact base in order to make the best trade-offs between cost, quality, and risk.

Sourcing direct materials certainly seemed like a ripe playground for lean principles and supplier rationalization. Imagine the cost savings that could be generated by consolidating commodity volumes across the entire company. A company could whittle its supply base down to a handful of strategic suppliers. And fewer suppliers would certainly be easier to manage. What could go wrong?

Well, manufacturers have since found out. History has shown that such supplier rationalization programs have introduced significant risks into the supply chains of manufacturing companies. Here are some of the key issues.

Supplier Capacity
This is the biggest risk of all. Whether it was due to naiveté or wishful thinking, many manufacturers simply assumed that their “preferred suppliers” would always be able to keep up with production needs. But even suppliers have their limits, especially since most of them rely on upstream supply chains themselves to support them.

A single, global manufacturer that concentrates all of its business with one supplier may use up all of the supplier’s capacity by itself. And most suppliers don’t have just one OEM customer. Couple this with multiple manufacturers favoring a few select suppliers and risk that they may not be able to meet demand is quickly created. And when that happens, the OEM’s production line stops, business is lost, and profits fade away.

Supplier Stability
Challenging market conditions place heavy pressures on every business. Prices continue to rise, with no one really in position to absorb the increases. Sometimes, a supplier’s business model cannot adapt fast enough and finds itself in financial turmoil. So what if this happens to a preferred supplier? By putting most of its eggs in one basket, a manufacturer will feel the impact of a key supplier going out of business rise substantially. And it’s that company’s bottom line that is going to take a hit.

Upstream Visibility
Long gone are the days where a company is only worried about its direct suppliers. Suppliers also acquire parts, assemblies, raw materials, metals, and minerals from their suppliers. Without true visibility into who these upstream suppliers are, a company lacks the ability to assess risks associated with geographic clustering, capacity, and the failure of an upstream supplier. In addition, there are potential reputational issues that could arise from the practices of upstream suppliers (conflict minerals and unfair labor practices, as two examples). Expected savings from supplier consolidation can quickly melt away as issues arise.

Access to Innovation
The final issue to consider when consolidating business down to a few key suppliers is access to innovation. Suppliers are a tremendous source of information, especially regarding the performance of new materials and newly developed processes that can help protect or enhance the margins of a company’s products.

By eliminating suppliers and thus access to knowledge in lieu of better pricing, a company will surely find itself in need of alternative sources of information, unless a preferred supplier can serve this role, as well. The challenge is, and apologies for the skepticism, but a low-cost supplier isn’t often known for value-added services, innovation, and thought leadership. But if you do find one, hold onto them for as long as you can.

As a result of the amount of risk that has been created by supplier consolidation, many companies are now redefining supplier rationalization as the ideal number of suppliers needed to optimize the supply chain. In our most recent study on trends in sourcing and supplier management, only one-third of the manufacturers surveyed believe they will be reducing the number of suppliers that they use in 2014. Suppliers as being identified who can provide protection if a key supplier goes down.

Dual sourcing is becoming more vogue. Sought out are suppliers that can contribute to innovation and process improvement. They are more valued if they provide visibility into the supply chain, as well as total cost. Supplier segmentations are no longer based on spend but rather strategic value. It’s now about building the right network for the business and not the lowest-cost network.

Here are some subtle indicators that it is time to rethink the number of suppliers you utilize:

1. Supplier capacity has reached 70 percent
2. Number of suppliers that are sole sources of components
3. Number of suppliers not certified as conflict mineral free
4. Suppliers where quality/performance levels are trending down
5. Suppliers whose prices are trending up
6. Suppliers whose financial performance is trending down
7. Number of innovation ideas being generated by suppliers.

In all cases, you need to identify what role these suppliers play in your supply chain. Are they strategic? Do you already have backups in place? Or do they control a lot of the volume or key components that need to be delivered on time. The more risk you see, the more you should consider adding suppliers.

Michael Cross is the senior manager of solutions marketing at Directworks, a leading provider of cloud-based sourcing and supplier management software for manufacturers. With a sole focus on the manufacturing industry, Michael dedicates significant time and energy studying how industry trends, drivers of change, and emerging market conditions impact supply chain, sourcing, and supplier management processes. Michael has generated a variety of articles, white papers, webinars, and blog posts on the topic. Michael holds a PhD from the University of Pittsburgh.