Contribution by Stuart Rosenberg – Senior Manager
Supply chain management fosters strategic alliances along with operational efficiencies to differentiate itself from other companies. Raw material sourcing is one of these opportunities to minimize risks, reduce operating expenses and ensure continued operations in the face of a supply chain disruption. Single suppliers present companies a chance to reduce procurement expenses through material cost reductions and volume discounts. However, procurement with a single provider has attached to it significant risks such as higher costs and lower profits due to supplier disruptions.
To borrow from a 2005 study by Kevin Hendricks entitled ‘The Effect of Supply Chain Disruptions on Long-term Shareholder Value, profitability and Share Price Volatility’, Mr. Hendricks found that after a major supply chain disruption companies a 107 percent drop in operating income, a 7 percent decline in sales and an 11 percent increase in costs. These were the companies that sourced through a sole supplier.
The supply chain and supplier management relationship can make or break a company. There is a long history of companies suffering huge losses, both financially and in customers, for not being proactive in being responsive to supplier needs. Supplier relationship is more than merely a module in a program: it is actions to ensure suppliers are meeting service level agreements. The lightening strike and fire that took place at the Royal Phillips Electronics chip plant in New Mexico provides an earnest lesson on the importance of proactively managing the supplier / customer relationship.
Two distinctly different responses by Phiilip customers earmarked the point of being proactive. When Nokia did not receive a schedule notification form Phillips they verified chip inventory levels at each Nokia facility. Upon learning the Phillips situation was worse than anticipated Nokia seeked to locate and secure other supply lines to prevent their capacity from being threatened.
Ericsson’s spin on the situation was an entirely different story. Ericsson believed that Phillips would be back on line within a week and did not take any alternative action to ensure their capacity. Thus, when Phillip’s production did not resume within the week it was too late for Ericsson. Ericsson was unable to contract other manufacturing capacity and their mobile phone business has yet to recover.
This situation clearly points to the need for single source manufacturers to establish a cooperative and collaborative relationship with multiple suppliers prior to disruptions. Companies that have multiple sources of supply are more likely to recover from a supply disruption than companies with a sole source of supply.
Nokia proved that sustaining a strong supplier management relationship allows for the immediate response to disruptions. Through this relationship Nokia had the knowledge of Phillip’s situation, made the effort to follow up when communications broke down; it was able to move ahead of Ericsson in the mobile phone market.
There are other sole supplier risks including the purchase of a sole supplier by a competitor, disruptions caused by weather, a supplier declaring bankruptcy and a disruption in a suppliers supply chain preventing them from souring materials.
To alleviate these risks and counteract the effects of a supply disruption a firm might carry a larger safety stock. But the carrying cost of the additional inventory must be weighed against the likelihood of such a disruption and the length of time material will be unavailable. It will be difficult to rationalize adding costs for an event that might well not occur. If the disruption does occur the added cost can be shared with the supplier by vendor managed inventory, reduced prices for tired purchases and payment allowances.
Organizations can provide to their sole suppliers order forecasts to support the stability of raw material supply, both short and long term. A supplier will be more likely to support a customer if there is a collaborative relationship. Under these circumstances a supplier will notify or give preferential treatment to a customer by notifying them sooner to a situation than other customers. This collaborative relationship can pay off for the vendor as well – if events slow down the vendor’s production.
Single suppliers can assist companies to achieve large cost savings through the reduction of raw material costs. However, when companies do use a sole supplier, they should develop supply resource management best practices to control their exposure to the suppliers’ operations. Timely communications and collaboration can prevent a major disruption in the supply chain and minimize negative financial effects. Utilizing collaboration and open communications, safety stock inventory and accurate forecasts will allow companies to curtail the risks of supply disruption and loss of shareholder value.