Segmentation Tools

Procurement and Audit notes revision

i. Supply Chain Vulnerability
Supply chains comprise hundreds or possibly thousands of companies, extending over several tiers, presenting numerous risks and unpredictability. Those risks can arise within the supply chain or/and they can be external to it. Thus, supply chain vulnerability can be defined as ‘an exposure to serious disturbance, arising from risks within the supply chain as well as risks external to the supply chain’. There are a number of factors which have increased the level of risk. These include:
• A focus on efficiency rather than effectiveness
• The globalisation of supply chains
• Focussed factories and centralised distribution
• Outsourcing

• Reduction of the supplier base
• Volatility of demand
• Lack of visibility and control procedures
Supply chain managers and risk managers need methods and tools to enable them to quickly understand how unexpected disruptions in the supply chain start and grow and the extent to which they negatively impact on the flow of goods and services. Supply chain managers need visualize a supply chain, map out disruptive events and understand potential weaknesses in the supply chain design; taking into account the structure, connectivity, and dependence within the supply chain.
ii. Supply Chain Risk Management
Jüttner, Peck and Christopher (2003) defined supply chain risks “any risks for the information, material and product flows from original supplier to the delivery of the final product for the end user.” Tummala and Schoenherr (2011) conceptualized supply chain risk as an event that adversely affects supply chain operations and hence its desired performance measures, such as chain-wide service levels and responsiveness, as well as cost.
Supply chain risk management aims to identify the potential sources of risk and implement appropriate actions to avoid or contain supply chain vulnerability. Consequently, it can be defined as: “the identification and management of risks for the supply chain, through a co-ordinated approach amongst supply chain members, to reduce supply chain vulnerability as a whole.”
Supply chain risk management process provides management with useful and strategic information concerning the SC risk profiles associated with a given situation. The SCRMP ensures SC managers adopt strategic thinking and strategic decision making in evaluating options to improve supply chain performance. The analysis can be used not only for evaluating progress but also for selecting alternative courses of action, based on their respective SC risk profiles.
iii) Boston Consulting Group
The BCG matrix was initially developed in the 1970s by the Boston Consulting Group. The matrix has been used extensively as a portfolio management tool in the identification of priorities in an organisation’s product portfolio optimization and effective resource allocation. The matrix uses two dimensions namely market growth and market share as a basis for classifying strategic business units or markets.

BCG considers the degree of market share and market growth and helps identify where best to use resources to maximize profit from a product management perspective. Market share represents the percentage of the total market achieved by an organization and is measured in terms of revenue or unit volume. The Boston Matrix assumes a high market share provides financial benefits, so a higher share of the market means higher cash earnings. Market growth reflects the attractiveness of a market (ICMBA, 2007).

The Boston Matrix describes the impact of market share and market growth on businesses by using four categories: dogs, cash cows, question marks (or problem children) and stars. It is shown diagrammatically in Figure below.

In terms of the organization’s own categorization efforts, this is a way of identifying which of the organization’s own offers should be prioritized over others. These considerations can be tracked back along the supply chain into how the organization categorizes its inputs. In terms of creating sourcing strategies, the Boston matrix offers insights into what suppliers are aiming to achieve with their offers, and thus informs negotiations with them.

Resources are allocated to business units according to where they are situated on the grid as follows:
• Cash Cow – a business unit that has a large market share in a mature, slow growing industry. Cash cows require little investment and generate cash that can be used to invest in other business units.
• Star – a business unit that has a large market share in a fast growing industry. Stars may generate cash, but because the market is growing rapidly they require investment to maintain their lead. If successful, a star will become a cash cow when its industry matures.
• Question Mark (or Problem Child) – a business unit that has a small market share in a high growth market. These business units require resources to grow market share, but whether they will succeed and become stars is unknown.
• Dog – a business unit that has a small market share in a mature industry. A dog may not require substantial cash, but it ties up capital that could better be deployed elsewhere. Unless a dog has some other strategic purpose, it should be liquidated if there is little prospect for it to gain market share.
The BCG matrix provides a framework for allocating resources among different business units and allows one to compare many business units at a glance. However, the approach has received some negative criticism for the following reasons:
• The link between market share and profitability is questionable since increasing market share can be very expensive.
• The approach may overemphasize high growth, since it ignores the potential of declining markets.
• The model considers market growth rate to be a given. In practice the firm may be able to grow the market.
These issues are addressed by the GE / McKinsey Matrix, which considers market growth rate to be only one of many factors that make an industry attractive, and which considers relative market share to be only one of many factors describing the competitive strength of the business unit.
iii. Pareto’s Theory
The Pareto principle (80/20 rule) is a useful technique for identifying the activities that will leverage your time, effort and resources for the biggest benefits. It is a popular way of prioritizing between tasks and areas of focus.
In procurement context, Pareto principle can be interpreted as 80% of spend being directed towards just 20% of suppliers. This elementary form of segmentation can be used to separate the critical few suppliers who supply

important, high value, high usage items, which can only be sourced from a limited supply market from the trivial many who supply routine, low value supplies which can easily be sourced anywhere. Most procurement effort and energy needs to be focused on the critical or category ‘A’ suppliers and the products produced from them.

Category ‘A’ items generally represent approximately 15%-20% of an overall inventory by item, but represent 80% of value of an inventory. Because of the high value, stock must be minimized. Continuity in supply is also important since there is high usage. Procurement techniques such as just in time (JIT) supply will therefore be used to replenish stock only for known requirements, with low buffer stocks. In general, most procurement and managerial control effort will be focused here.
Category ‘B’ items represent 30%-35% of inventory items by item type, and about 15% of the value. These items can generally be managed through regular stock review and replenishment. Ordering should be against demand forecasting based on historical demand and some safety/buffer stock held to maintain continuity of supply. A moderate level of control will be exercised here.
Category ‘C’ items represent 50% of actual items but only 5% of the inventory value. In general, the least procurement and managerial control effort will be focused here: the organization may use low maintenance or automatic replenishment methods, such as two bin system or vendor managed inventory where responsibility for managing stock is delegated to the supplier. Large levels of safety stocks are typically held to minimize transaction costs.
iv. Kraljic’s Procurement Portfolio Matrix
Segmenting the vendor base is an important part of supply chain management. The Kraljic Matrix also known as ‘portfolio analysis’ or a ‘positioning matrix’, developed by Peter Kraljic, is one of the most effective ways of supplier segmentation. Organisations use this tool to determine two dimensions- risk and profitability.
Risk relates to the likelihood for an unexpected event in the supply chains to disrupt operations, difficulty of sourcing the item, the vulnerability of the buyer to supply or supplier failure and the relevant power of buyer and supplier in the market.
Profitability describes the importance of the item being purchased to the organization (related to factors such as the organization annual expenditure on the items and its profit potential thought enabling revenue earning or cost reductions).
The matrix has therefore four quadrants as follows;

• Leverage items are items that are of high importance to the organization meaning that they have high profit impact and on the other hand they have low complexity of supply market since they are of low supply risk. Examples include local produce bought by a major supermarket, common chemicals. Under this category the buyer’s priority will be to use its dominance to secure best prices and terms, on a purely transactional basis. Procurement approaches will be; leverage buyer power may mean multi- sourcing; taking opportunistic advantage of competitive pricing (e.g. through competitive bidding, tenders or e-auctions). Standardizing specifications to make suppliers or contractor switching easier; and consolidating orders or engaging in buying consortia to enhance buyer power (where necessary) and secure economies of scale.
• Strategic items are items that are of high importance to the organization meaning that they are of high profit impact and also they have high complexity of supply market (high supply risk). Examples include key subassemblies bought by a car manufacturer, or processors bought by laptop manufacturers. Under this category of items there is likely to be mutual dependency and investment, and the focus will be on the total cost, security and competitiveness of supply. Procurement approaches will be; develop long – term, mutually beneficial strategic relationships and relationship management disciplines (e.g. cross- functional teams; vendor and account management; executive sponsorship); collaborative planning; data sharing and systems integration; and so on.
• Non-critical or routine items are of low importance to the organization since they have low profit impact and have low complexity of supply. Examples include common stationery supplies, commercial grade industrial fasteners. Under this category the focus will be on low maintenance routines to reduce procurement costs. Procurement approaches for this will include; arm’s length, transactional approaches such as blanket ordering (empowering end users to make call-off orders against negotiated agreement) and e- procurement solutions (e.g. online ordering or the use of purchasing cards) will provide routine efficiency. The main focus of management will be monitoring expenditure against regular reports received from vendors, end- users or e- procurement systems.
• Bottleneck items are those that are of low importance to the organization since they have low profit impact while they are of high complexity supply (high supply risk). Examples include proprietary spare parts or specialized consultancy services, which could cause operational delays if unavailable.

Under this category the buyer’s priority will be ensuring control over the continuity and security of supply. The following will be part of Procurement approaches; security may suggest approaches such as negotiating medium- term or long- term contracts with carefully pre- qualified and selected suppliers; developing alternative or ‘back- up’ sources of supply; including incentives and penalties in contracts; and performance monitoring and expending, to ensure the reliability of delivery.
v. Supply Chain Mapping
A useful tool for risk and vulnerability identification is the mapping of the supply chain or value stream. Research from Cranfield University (Creating Resilient Supply Chains) argues that a systematic approach is needed to identify business, supply and contractual risks arising from failure within the supply chain, at some point in the flow of value towards the customer, or at some ‘linkage’ point in the chain.
Supply chain mapping is a technique that provides a time-based representation of the process involved as goods, materials, information and other value-adding resources move through the supply chain. The map (e.g. a network diagram or flowchart) shows the time taken at the inter-connection (linkage) and movement points within the chain: This enables organisations to determine:
• The inter-connecting ‘pipeline’ of suppliers through which value-adding elements must travel to reach the end-user
• The transport links by which value-adding elements are passed from one ‘node’ to another in the SC
• The amount of work in progress and inventory stockpiled at each stage in the pipeline
• The time it would take to source replenishment from various points in the pipeline in the event of disruption.
The Cranfield researchers argue that the information gained from such an analysis can assist in identifying areas of contractual and supply risk, and planning actions such as the following.
• Consulting and collaborating with supply chain partners to manage areas of identified vulnerability
• Strengthening relationship and contractual protections at vulnerable linkage points or supplier relationships
• Monitoring and managing first tier suppliers’ management of lower tiers of the supply chain, to reduce vulnerabilities at lower tiers.
• Determining alternative sources of supply
• Holding additional buffer or safety stocks (‘just in case’ inventory)

• Formulating contingency plans for alternative transport arrangements in areas vulnerable to disruption.
Review Questions

1. Discuss vulnerability assessment process
2. Discuss five risk assessment tools or techniques that could be used to assess the probability and vulnerabilities or risks of a procurement entity
3. Discuss using risk probability matrix to assess vulnerabilities or risks of a procurement entity
4. Discuss the benefits and disadvantages of qualitative and quantitative risk assessment
5. Discuss how supply chain management analysis can be used to manage supply chain risks
6. Discuss how supply positioning matrix can be used in managing supply chain risks

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