58 Portfolio analysis

Portfolio analysis

Portfolio analysis is a tool to structure and segment the supply base, and is used as a means of classifying suppliers into one of four types. The objective is to categorise every procurement or family of procurements into one of four categories: critical, routine, leverage and bottleneck. By effectively classifying the goods and services being procured into one of these categories, those responsible for proposing strategy are able to comprehend the strategic importance of the item to the business. The results of this analysis can then be compared to the current sourcing strategy for the category group, and tactics and actions defined for moving forward. Refer to Figure 3.4 in WOU MyDigitalLibrary, E-Course Reserve (see the Course Guide Section ‘E-Course Reserve readings’ for more information). It summarises the essential elements of strategy, tactics and actions associated with managing categories that fall into each of the different quadrants in the matrix.

1.  Leverage commodity — preferred supplier

a.  Relatively large share of product price

b.  Small change in price has large impact on profit

c.  Risk small as there are many alternative suppliers and substitution is possible

d.  Buyer-dominated segment

e.  Competitive bidding

f.  Examples: steel plate and sections

 

A leverage commodity also provides the opportunity for savings. These items or services have a high volume of internal consumption, are readily available, are important to the business, and represent a significant portion of expenditure. Preferred suppliers are awarded the business with the understanding that they will be expected to significantly reduce the cost of supplying these items or services over time, in return for a significant volume of business and possible multiyear agreements. A high level of service is also expected, which may include supplier capabilities such as management of on-site inventory, e-procurement capabilities, and ability to quickly respond to customer requirements. In doing so, the supplier will also be expected to maintain a high level of quality and to reduce the total cost to the business of managing this commodity.

2.  Critical commodity — strategic supplier

a.  Together with leverage products can account for 80% or turnover

b.  Small changes in price will have an immediate and significant impact on costs

c.  Risk significant due to high dependence on supplier

d.  Balance of power may differ between buyers and suppliers

e.  Performance-based partnership

f.  Examples: assemblies, gear boxes, engines and optics

Generally speaking, the goals for a critical commodity are to develop a competitive advantage, support and leverage the supplier’s core competencies, develop best-in-class suppliers, support the organisation’s overall strategy and improve value-added services beyond a simple procurement agreement. Since the annual spend on the item is high, it also makes sense for the organisation to establish a strategic preferred supplier. Formally designating a supplier as strategic preferred supplier builds a foundation for achieving higher levels of information sharing and improvement.

3.  Routine commodity

a.  Can require up to 80% of buying activity for 20% of procurement turnover

b.  Low product/high administrative cost

c.  No risk due to many alternative supplies and large product variety

d.  Reduce number of suppliers

e.  Use systems contracting and e-procurement solutions

f.  Examples: standard office supplies, MRO items and consumables

Products and services in this category are readily available and are often low in cost. The goal for the team is to reduce the number of items in this category through substitution, elimination of small-volume spend, rationalisation of the number of units to control costs, and simplification of the procurement process using electronic tools. The buyer should also try to find suppliers that can automate the buying process to the greatest extent possible, e.g., online catalogue. Buyer can also outsource the procurement of all routine items to a single supplier. For example, some multinational companies in Penang outsource the procurement management of routine items to a local trading agent or SME. By doing so, the buyer just need to communicate and manage one supplier instead of many suppliers. This single outsourced supplier supports the buyer by procuring all routine items from the rest of the suppliers. In return, the buyer may or may not have to pay a higher unit price for this service, depending on the purchasing power and negotiation power of both parties.

4.  Bottleneck commodity — transactional supplier

a.  Relatively limited in value but danger of sudden price rises

b.  High risk due to few, if any, alternative suppliers and suppliers may be technology leaders

c.  Supplier-dominated segment

d.  Secure long- and short-term supply

e.  Seek alternative suppliers

f.  Examples: natural flavours and pigments

The final bottleneck commodities have unique requirements or niche suppliers and are significant to the business. This quadrant is the most unattractive quadrant of the model to be in. The risk to the organisation is high, but the buyer is likely to have little ability to influence the supply market since the level of expenditure is small. Such items tend to be expensive, due to the exclusive market position maintained by the supplier. The goal of the buyer is to not run out and to ensure continuity of supply. The main focus for bottleneck items is on minimising the risk to the organisation. Price and cost of acquisition are of secondary importance because it will be generally reasonable to sacrifice cost, e.g., by paying a relatively high price to reduce the risk.

As mentioned above, the organisation’s expenditure, being relatively low, will not be particularly attractive to suppliers. However, suppliers can be interested in a customer for reasons other than the amounts they procure. We will therefore also consider what to do — as part of the strategy — in order to make the organisation’s business more attractive to the suppliers of such items. We shall explore this further in the later section of suppliers’ motivations.

  Activity 3.6
Question to activity 3.6
Suggested answer to activity 3.6

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